Back to GetFilings.com

Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

(Mark One)

For the transition period from                      to                     

Commission file number 0-5449

COMARCO, INC.

(Exact name of registrant as specified in its charter)

2 Cromwell, Irvine, California 92618

(Address of Principal Executive Offices) (Zip Code)

Registrant’s Telephone Number, Including Area Code: (949) 599-7400

Securities registered pursuant to Section 12(b) of the Act: None

Securities registered pursuant to Section 12(g) of the Act:

Common Stock

(Title of Class)

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No ¨

Indicate by a check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ¨

Indicate by a check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act) Yes ¨ No þ

Common Stock outstanding at April 22, 2004 — 7,284,374 shares.

The total number of shares held by non-affiliates on the last business day of the most recently completed second fiscal quarter (July 31, 2003) was 7,002,526. This number was multiplied by $7.93 per share (the closing sale price of the Common Stock on July 31, 2003 in the NASDAQ National Market System, as reported by NASDAQ) to determine the aggregate market value of non-affiliate shares set forth above. (The assumption is made, solely for purposes of the above computation, that all Officers and Directors of registrant are affiliates.)

DOCUMENTS INCORPORATED BY REFERENCE

The Company intends to file with the Securities and Exchange Commission by May 25, 2004 a definitive Proxy Statement (the “2004 Proxy Statement”) relating to its 2004 Annual Meeting of Stockholders, which meeting involves the election of directors. The 2004 Proxy Statement is incorporated by reference in Part III of this Form 10-K and shall be deemed to be a part hereof.

Table of Contents

COMARCO, INC.

FORM 10-K

FOR THE FISCAL YEAR ENDED JANUARY 31, 2004

INDEX

i

Table of Contents

PART I

FORWARD-LOOKING STATEMENTS

All statements included or incorporated by reference in this annual report on Form 10-K (the “report”), other than statements or characterizations of historical fact, are forward-looking statements. Examples of forward-looking statements include, but are not limited to, statements concerning projected revenue, expenses, gross profit, gross margin, and income, manufacturing capacity, our accounting estimates, assumptions and judgments, the market acceptance and performance of our products, the status of evolving technologies and their growth potential, the cost and success of our development projects, the timing of new product introductions, our production capacity, and the need for additional capital. These forward-looking statements are based on our current expectations and estimates, management’s beliefs, and certain assumptions made by us. Forward-looking statements can often be identified by words such as “anticipates,” “expects,” “intends,” “plans,” “predicts,” “believes,” “seeks,” “estimates,” “may,” “will,” “should,” “would,” “could,” “potential,” “continue,” similar expressions, and variations or negatives of these words. In addition, any statements that refer to expectations, projections or other characterizations of future events or circumstances, including any underlying assumptions, are forward-looking statements. These forward-looking statements speak only as of the date of this report and are based upon the information known to us at this time. Such information is subject to change, and we will not necessarily inform you of such changes. These statements are not guarantees of future performance and are subject to risks, uncertainties, and assumptions that are difficult to predict. Therefore, our actual results could differ materially and adversely from those expressed in any forward-looking statements as a result of various factors, some of which are listed under the section entitled “Risk Factors, Uncertainties and Other Factors that May Affect Results of Operations and Financial Condition” in Part I, Item 1 of this report, and other risks identified from time to time in our filings with the Securities and Exchange Commission (“SEC”), press releases, and other communications.

We file annual, quarterly, and current reports, proxy statements, and other information with the SEC. Our SEC filings are available free of charge to the public over the Internet at the SEC’s website at http://www.sec.gov. Our SEC filings are also available on our website at http://www.comarco.com as soon as reasonably practical following the time that they are filed with or furnished to the SEC. Any document we file with the SEC can be read at the SEC’s public reference room in Washington, DC. For further information on the public reference room, call the SEC at (800) SEC-0330.

General

Comarco, Inc., through its subsidiary Comarco Wireless Technologies, Inc. (collectively, “we,” “Comarco,” or the “Company”), is a leading provider of wireless test solutions for the wireless industry. Comarco also designs and manufactures emergency call box systems and mobile power products for notebook computers, cellular telephones, PDAs, and other handheld devices. Our operations consist solely of the operations of Comarco Wireless Technologies, Inc. (“CWT”).

We have two primary businesses: wireless test solutions (“WTS”) and wireless applications. Our wireless test solutions business designs and manufactures hardware and software tools for use by wireless carriers, equipment vendors, and others. Our wireless applications business designs and manufactures emergency call box systems and mobile power products for notebook computers, cellular telephones, PDAs, and other handheld devices.

References to “fiscal” years in this report refer to our fiscal years ended January 31; for example, “fiscal 2004” refers to our fiscal year ended January 31, 2004.

1

Table of Contents

Our Businesses

Wireless Test Solutions

Our WTS business designs and manufactures hardware and software tools used by wireless carriers, equipment vendors, and others. Radio engineers, network improvement professionals and technicians, and others use these test tools to design, deploy, and optimize wireless networks, and to verify the performance and quality of service delivered by the wireless networks once deployed. As wireless carriers continue to deploy 2.5G and 3G technologies across their existing networks, the demand for our WTS products is expected to increase.

Products

WTS’s product offering is based on our Seven.Five product platform. Seven.Five is a hardware and software solution that is flexible, scalable, and modular allowing our customers to work with all 2G, 2.5G, and 3G technologies. Seven.Five can be configured in virtually any combination of test mobiles and multi-band, multi-technology scanning receivers. Test applications include; optimization and benchmarking of wireless networks, in-building or in-vehicle testing, fixed or mobile, voice, data, or video.

Services

We ceased providing engineering services during the second quarter of fiscal 2003. Prior to that, WTS provided engineering services that assisted wireless carriers, equipment vendors, and others deploy, optimize, and evaluate the performance of wireless networks. When engaged, we were able to provide and support skilled radio engineers and technicians and the test tools best suited for the engagement.

We began offering engineering services, which were complementary to our WTS products, to wireless carriers and equipment vendors during the fourth quarter of fiscal 2000. During the subsequent two years, we were awarded several profitable multi-million dollar contracts, as well as numerous smaller engagements. However, wireless carriers dramatically reduced their spending near the end of fiscal 2002 and the competition to provide engineering services became more intense. Reduced contract pricing and fewer opportunities resulted in reduced revenue and profitability for all engineering services providers. Accordingly, during the first half of fiscal 2003, we ceased our efforts to obtain additional service contracts, and completed our remaining contractual obligations, reduced head count, and sold a portion of the assets previously used in providing engineering services.

Wireless Applications

Our wireless applications business designs and manufactures emergency call box systems and mobile power products for notebook computers, cellular telephones, PDAs, and other handheld devices. Our call box products provide emergency communication over existing wireless networks. In addition to the call box products, we provide system installation and long-term maintenance services. Currently, there are approximately 14,000 call boxes that we service and maintain under long-term agreements.

ChargeSource Products

Our wireless applications business also includes the ChargeSource family of mobile power products. Designed with the needs of the traveling professional in mind, our ChargeSource mobile power products provide a high level of functionality and compatibility in an industry-leading compact design. Our current and planned product offering consists of universal AC/DC, AC, and DC power adapters designed for the right mix of power output and functionality for most retail, OEM, and enterprise customers. Our ChargeSource products are also universal allowing those who use rechargeable electronic devices to carry just one power adapter. By simply changing the compact SmartTip connected to the end of the charging cable, our universal power adapters are capable of charging and powering multiple target devices, including most notebook computers, cellular telephones, PDAs, and other handheld devices.

2

Table of Contents

Until recently, most notebook computers required no more than 70 watts of power to operate. However, the personal computer industry is currently transitioning to notebook computers with increasing power requirements. As power requirements increase, so does the size of the original equipment manufacturer (“OEM”) power adapter sold with each notebook computer. To address this industry wide trend, we have developed a family of high-power ChargeSource products that are compatible with most legacy, current, and planned notebook computers. These new ChargeSource products are able to deliver up to 120 watts of power in a very small form factor. We believe our patented electrical designs will continue to be the basis for even higher-power universal power adapters that are expected to meet evolving global standards, including the planned standards of the European Union (“EU”), and the increasing power requirements of the notebook computer OEMs, and allow us to offer customers cutting edge technology without significantly increasing the size or weight of our products. We also expect these higher-power universal power adapters to continue to be significantly smaller and lighter than their OEM counterparts.

The ChargeSource product family consists of the following released (or to be released, as indicated) universal power adapters:

Marketing, Sales, and Distribution

Wireless Test Solutions. We market and sell our WTS products through a direct sales force of technically trained personnel and through independent sales representatives, and affiliated and unaffiliated resellers. Our North American sales are made through our direct sales and marketing organizations located in California. Sales to our customers in Latin and South America are generally made through our office located in Mexico City, assisted by the sales and marketing organizations based in our California office. These offices also coordinate the marketing, sales, and support efforts of a network of representatives and distributors responsible for sales to customers in other geographic regions.

During fiscal 2002, we purchased an equity stake in Switzerland based SwissQual AG (“SwissQual”), a developer of Quality of Service systems and software for measuring, monitoring, and optimizing the quality of mobile, fixed, and IP-based voice and data communications. Under this alliance, SwissQual is responsible for reselling and supporting our co-branded WTS products in Europe, Middle East, and North Africa (“EMEA”).

3

Table of Contents

Wireless Applications. Historically, our ChargeSource mobile power products have been distributed by Targus Group International (“Targus”). During the fourth quarter of fiscal 2004 we terminated our relationship with Targus and entered into a strategic agreement with Belkin Corporation (“Belkin”). Under this agreement, Belkin granted exclusive worldwide distribution rights to distribute ChargeSource products in several strategic end-market categories including electronic retailers, specialty retailers, OEM third-party options, and Fortune 1000 corporate customers. We expect to make our final product sales to Targus, as well as our initial shipments to Belkin during the first half of fiscal 2005. We market and sell our call box systems through a direct sales force located in California.

Competition

Wireless Test Solutions. The market for our hardware and software test tools is highly competitive and is served by numerous providers. Our primary competitors with respect to our WTS products are Agilent Technologies, Ascom, Ericsson, and Andrew Corporation. Many of our competitors are larger and have greater financial resources.

The wireless industry is characterized by rapid technological changes, frequent new product and service introductions, and evolving industry standards. To compete successfully in our market, we believe we must:

Wireless Applications. The market for our emergency call box systems is also served by numerous providers, including Gaitronics, Talk-A-Phone, and other manufactures of wireless and wireline emergency and information telephones. Numerous providers, including Mobility Electronics and Fellowes, as well as the cellular telephone and personal computer OEMs, also serve the market for our ChargeSource mobile power products. Many of our competitors are larger and have greater financial resources. We believe that the patents that cover our wireless applications products provide us with a competitive advantage. However, our ability to compete in these markets depends on our ability to successfully commercialize new technologies in a timely manner, and manufacture and deliver our products in sufficient volumes.

Key Customers

We sell our products to wireless carriers, equipment vendors, and others located throughout the world. In 2004, we derived 84 percent of our revenues from customers located in the United States and 16 percent from customers located in foreign countries. We derive a substantial portion of our revenue from a limited number of customers. In fiscal 2004, 2003, and 2002 Targus, the former distributor of our mobile power products, provided 38 percent, 43 percent, and 22 percent of our revenue, respectively. In fiscal 2002, Nortel Networks provided 12 percent of our revenue under an engineering services contract. The spending patterns of Belkin, our current exclusive distributor, or any of our other key customers can vary significantly during the year. Any elimination or change in the spending patterns of these customers could negatively affect our operating results.

Research and Development

We sell our products in markets that are characterized by rapid technology changes, frequent new product introductions, and evolving technology standards. Accordingly, we devote significant resources to design and develop new and enhanced products that can be manufactured cost effectively and sold at competitive prices. To focus these efforts, we strive to maintain close relationships with our customers and develop products that meet their needs.

As of April 22, 2004, we employed approximately 30 engineers and other technical personnel dedicated to our research and development efforts. Generally, our research and development and other engineering efforts are managed and focused on a product-by-product basis, and can generally be characterized as follows:

4

Table of Contents

If we fail to properly respond to the needs of our customers with the development of new or enhanced products in a timely manner, our portfolio of products is likely to become technologically obsolete over time. We recently developed a new WTS product platform, Seven.Five, in response to the needs of wireless carriers for flexible, scalable, and high-value mobile test tools. For additional information concerning research and development expenditures, see “Research and Development and Software Development Costs” in note 2 of our consolidated financial statements in Part II, Item 8 of this report.

Manufacturing and Suppliers

We maintain one manufacturing facility located in Irvine, California, which is ISO-9001:2000 certified. Our manufacturing process involves the assembly of numerous individual component products by production technicians. The parts and materials used by us consist primarily of printed circuit boards, specialized subassemblies, fabricated housings and chassis, cellular telephones, and small electric circuit components, such as integrated circuits, semiconductors, resistors, and capacitors. Most of our components and sub-assemblies are made by third parties to our specifications and are generally delivered to us for final assembly and testing.

Patents and Intellectual Property

We hold patents that cover key technical aspects of the products in our wireless applications business. However, we generally rely on a combination of trade secrets, copyrights, and contractual rights to protect our intellectual property embodied in the hardware and software products of our WTS business.

Industry Practices Impacting Working Capital

Existing industry practices that affect working capital and operating cash flow include the level of variability of customer orders relative to the volume of production, vendor lead times, materials availability for critical parts, inventory levels held to achieve rapid customer fulfillment, and provisions of extended payment terms to certain foreign customers.

Currently, we sell our products under purchase orders that are placed with short-term delivery requirements. As a result, we maintain significant levels of inventory and associated production and technical staff in order to meet our obligations. Delays in planned customer orders could result in higher inventory levels and negatively impact our operating results.

Our standard terms require customers to pay for our products in U.S. dollars. For those orders denominated in foreign currencies, we may limit our exposure to losses from foreign currency transactions through forward foreign exchange contracts. To date, sales denominated in foreign currencies have not been significant and we have not entered into any foreign exchange contracts.

Employees

As of April 22, 2004, we employed approximately 140 employees. We believe our employee relations to be good. The majority of our employees are professional or technical personnel who possess training and experience in engineering, computer science, and management. Our future success depends in large part on our ability to retain key technical, marketing, and management personnel, and to attract and retain qualified employees, particularly those highly skilled radio, design, process, and test engineers involved in the development of new products. Competition for such personnel can be intense, and the loss of key employees, as well as the failure to recruit and train additional technical personnel in a timely manner, could have a material adverse effect on our operating results.

5

Table of Contents

Our success depends to a significant extent upon the contribution of our executive officers and other key employees. We have an employee stock option plan whereby key employees can participate in our success.

Risk Factors, Uncertainties and Other Factors that May Affect Results of Operations and Financial Condition

A significant portion of our revenue is derived from the sale of our WTS products to customers in the wireless communications industry, which has experienced significant problems during the past several years. If the wireless communications industry does not continue to improve, our operating results and financial condition could suffer.

Revenue from the sale of our WTS products to customers in the wireless communications industry accounted for 32.5 percent of our revenue in fiscal 2004. These customers include national and regional wireless carriers throughout the world, equipment vendors, and others. The wireless communications industry has historically experienced a dramatic rate of growth both in the United States and internationally. During the past several years, however, many wireless carriers have re-evaluated their network deployment plans in response to downturns in the capital markets, changing perceptions regarding industry growth, the adoption of new wireless technologies, increasing price competition for subscribers, and a general economic slowdown in the United States and internationally. That trend appears to have just recently begun to change as several large carriers in the U.S., Latin America, and South America have started to once again focus on network expansion and next-generation technology deployment. If the rate of growth slows in the wireless communications industry or wireless carriers reduce their capital investments in wireless infrastructure and related test tools offered by our WTS business, our revenue and operating results may be adversely affected.

A significant portion of our revenue is derived from the sale and maintenance of emergency call box systems to governmental customers that continue to experience severe budgetary constraints. If planned projects to install or upgrade call box systems continue to be delayed, our operating results and financial condition could suffer.

Revenue from the sale and maintenance of our emergency call box systems and upgrades accounted for 20.3 percent of our revenues in fiscal 2004. Approximately 78% of our call box revenue is derived from state and local governmental agencies in California, which are currently experiencing severe budgetary constraints. As a result, several of our planned projects to install or upgrade call box systems have been delayed. If the current adverse budgetary conditions of state and local governmental agencies in California persist, we expect significant reductions in spending by our governmental customers, which would likely adversely affect our revenue and operating results.

Failure to adjust our operations due to changing market conditions or failure to accurately estimate demand for our products could adversely affect our operating results.

During the past several years, the spending patterns of many of our WTS customers have been volatile and unpredictable. In addition, consumer demand for our ChargeSource mobile power products has been subject to fluctuations as a result of market acceptance of our recently released products, the timing and size of customer orders and consumer demand for rechargeable mobile electronic devices. Accordingly, it has been difficult for us to forecast the demand for these products. We also are limited in our ability to quickly adapt our manufacturing and related cost structures because a significant portion of our sales and marketing, design and other engineering, and manufacturing costs are fixed. If customer demand for our WTS products or for our ChargeSource mobile power products declines or if we otherwise fail to accurately forecast reduced customer demand, we will likely experience excess capacity, which could adversely affect our operating results. Conversely, if market conditions improve, our manufacturing capacity may not be adequate to fill increased customer demand. As a result, we might not be able to fulfill customer orders in a timely manner, which could adversely affect our customer relationships and operating results.

6

Table of Contents

The products we make are complex and have short life cycles. If we are unable to rapidly and successfully develop and introduce new products, some of our products may become obsolete and our operating results could suffer.

The wireless communications and consumer electronics industries are characterized by rapid technological changes, frequent new product introductions and evolving industry standards. Additionally, our ChargeSource mobile power products have short life cycles, and may become obsolete over relatively short periods of time. Our future success depends on our ability to develop, introduce, and deliver on a timely basis and in sufficient quantity new products, components, and enhancements. The success of any new product offering will depend on several factors, including our ability to:

Development of new products requires high levels of innovation from both our engineers and our component suppliers. Development of a new product often requires a substantial investment before we can determine the commercial viability of the product. If we dedicate a significant amount of resources to the development of products that do not achieve broad market acceptance, our operating results may suffer. Our operating results may also be adversely affected due to the timing of product introductions by competitors, especially when a competitor introduces a new product before our own comparable product is ready to be introduced.

The wireless communications and consumer electronics industries are highly competitive, and our profitability will be adversely affected if we are not able to compete effectively.

The wireless communications and consumer electronics industries in which we sell our products are highly competitive in many areas, including the timing of development and introduction of new products, technology, price, quality, and customer service and support. Our competitors range from some of the respective industries’ largest corporations to many relatively small and highly specialized firms. Many of our competitors possess advantages over us, including greater financial and marketing resources, greater name recognition and larger and more established customer and supplier relationships. Our competitors also may be able to respond more quickly to new or emerging technologies and changes in customer needs. If we do not have the resources or expertise or otherwise fail to develop successful strategies to address these competitive disadvantages, we could lose customers causing our revenue to decline.

The average selling prices of our products may decrease over their sales cycles, especially upon the introduction of new products, which may negatively affect our revenue and operating results.

Our products may experience a reduction in the average selling prices over their respective sales cycles. Further, as we introduce new or next-generation products, sales prices of legacy products may decline substantially. In order to sell products that have a falling average selling price and maintain margins at the same time, we need to continually reduce product and manufacturing costs. There can be no assurances we will be successful in our efforts to reduce these costs. In order to do so, we must carefully manage the price paid for components used in our products, as well as manage our inventory costs to reduce overall product costs. If we are unable to reduce the cost of legacy products as new products are introduced, our average gross margins may decline and adversely affect our operating results.

7

Table of Contents

A significant portion of our revenue is dependent in part upon our relationships with our strategic distribution partners and their performance. If we are unable to successfully manage our relationships with the distributors of our mobile power products, our revenue and operating results could suffer.

Historically, our ChargeSource mobile power products have been distributed by Targus Group International (“Targus”). During the fourth quarter of fiscal 2004 we terminated our relationship with Targus and entered into a strategic agreement with Belkin Corporation (“Belkin”). Under this agreement Belkin is granted exclusive worldwide distribution rights to distribute our ChargeSource products in several strategic end-market categories including electronic retailers, specialty retailers, OEM third-party options and Fortune 1000 corporate customers. However, due to the exclusive nature of our agreement with Belkin, our direct access to certain significant distribution channels has been limited. Accordingly, our success will depend in part upon Belkin’s ability and willingness to effectively and widely distribute our ChargeSource products. If Belkin does not purchase the volume of products that we anticipate, our revenue and results of operations will suffer.

A significant portion of our revenue is derived from a limited number of customers, and any loss of, cancellation or delay in purchases by these customers could cause a significant decrease in our revenue.

We have historically derived a significant portion of our revenue from a limited number of customers. Our three (3) key customers for the fiscal year just completed accounted for $17.8 million of our revenue, or 52.0 percent of our revenue for fiscal 2004. For example, Targus, the former distributor of our ChargeSource mobile power products, accounted for approximately $12.9 million, or 37.6 percent of our revenue in fiscal 2004 and $15.1 million, or 42.3 percent of our revenue in fiscal 2003. Our new distribution agreement with Belkin requires them to purchase minimum quantities from us during the first 18 months of the agreement, however, we cannot assure you that Belkin will be able to meet its purchase commitments, or meet or exceed our historical level of unit sales. If Belkin or any of our other key customers reduces, cancels, or delays orders from us, and we are not able to develop other customers who purchase products at comparable levels, our revenue could decrease significantly. In addition, any difficulty in collecting amounts due from one or more of our key customers would negatively impact our results of operations and financial condition. We expect that a limited number of customers will continue to represent a large percentage of our revenues.

We may experience quality or safety defects in our products that could cause us to institute product recalls, require us to provide replacement products and harm our reputation.

In the course of conducting our business, we experience and attempt to address various quality and safety issues with our products. Often product defects are identified during our design, development, and manufacturing processes, which we are able to correct timely. Sometimes, defects are identified after introduction and shipment of products. For example, in March 2003, we voluntarily initiated a product safety recall of our legacy 70-watt universal AC power adapters, and accrued $0.4 million in expenses related thereto in fiscal 2003 and accrued a $3.2 million credit to Targus recorded as a reduction of revenue in settlement of the recall. $1.1 million of which later was unused and recognized as revenue in fiscal 2004. If we are unable to timely fix defects or adequately address quality control issues, our relationships with our customers may be impaired, our reputation may suffer and we may lose customers. Any of the foregoing could adversely affect our business and results of operations.

Economic, political and other risks associated with our international sales and operations could adversely affect our results of operations.

We currently maintain sales and support operations in the United States, Europe and Latin America. Our international operations accounted for approximately 15.8 percent of our revenue in fiscal 2004. Accordingly, our business is subject to worldwide economic and market conditions and risks generally associated with doing business abroad, such as fluctuating foreign currency exchange rates, weaknesses in the economic conditions in particular countries or regions, the stability of international monetary conditions, tariff and trade policies, domestic and foreign tax policies, foreign governmental regulations, political unrest and disruptions and delays in shipments. These factors, among others, could adversely affect our sales of products and services in international markets.

8

Table of Contents

Additionally, we have limited experience selling our products and services in markets outside the United States and Latin America. However, it is currently our intention to expand our international operations and establish additional sales and support offices in primary international markets. If our international sales efforts are not successful, our results of operations and financial condition could suffer.

Our failure to address laws and regulations governing our government contracts, could adversely affect our business and operating results.

We depend on contracts with state and local governmental agencies for a significant portion of our revenue, and are subject to various laws and regulations that only apply to companies doing business with the government. For example, we supply call box products and provide system installation and long-term maintenance services to regional and municipal transit authorities and other governmental agencies. In fiscal 2004, we derived 20.3 percent of our revenue from contracts with these governmental customers. From time to time we are also subject to investigation for compliance with regulations governing our government contracts. Our failure to comply with any of these laws or regulations could result in suspension of these contracts, or subject us to administrative claims.

Disruptions in our relationships with our suppliers or in our suppliers’ operations could result in shortages of necessary components and adversely affect our operations.

We currently procure, and expect to continue to procure, certain components from single source manufacturers who provide unique component designs or who meet certain quality and performance requirements. In addition, we sometimes purchase customized components from single sources in order to take advantage of volume pricing discounts. The performance of these suppliers is largely outside our control. In the past, we have experienced, and may continue to experience, shortages of important single source components. Our suppliers may fail to timely deliver components or provide components of sufficient quality. If this occurs, we may need to adjust both product designs and production schedules, which could result in delays in the production and delivery of products to our customers. These delays or defects could harm our reputation and impair our customer relationships.

Third parties may claim that we are infringing their intellectual property, and we could suffer significant litigation, settlement or licensing costs and expenses or be prevented from selling certain products.

Third parties have claimed, and may in the future claim, that we are infringing their intellectual property rights. These intellectual property infringement claims, whether we ultimately are found to be infringing any third party’s intellectual property rights or not, are time-consuming, costly to defend and divert resources and management attention away from our operations. Infringement claims by third parties also could subject us to significant damage awards or fines or require us to pay large amounts to settle such claims. Additionally, claims of intellectual property infringement might require us to enter into royalty or license agreements. If we cannot or do not license the infringed technology on acceptable terms or substitute similar technology from other sources, we could be prevented from or restricted in selling our products containing, or manufactured with, the infringed technology.

Third parties may infringe our intellectual property rights, and we may be required to spend significant resources enforcing these rights or otherwise suffer competitive injury.

Our success depends in large part on our proprietary technology. We generally rely upon patent, copyright, trademark, and trade secret laws in the United States and in certain other countries, and rely on confidentiality agreements with our employees, customers, and partners to establish and maintain our intellectual proprietary rights in our proprietary technology. We are required to spend significant resources to monitor and enforce our intellectual property rights; however these rights might not necessarily provide us with a sufficient competitive advantage. Our intellectual proprietary rights could be challenged, invalidated, or circumvented by competitors or others. Our employees, customers or partners could breach our confidentiality agreements, for which we may not have an adequate remedy available. We also may not be able to timely detect the infringement of our intellectual property

9

Table of Contents

rights, which could harm our competitive position. Finally, the rapid pace of technological change in the wireless communications and consumer electronics industries could make certain of our key proprietary technology obsolete or provide us with less of a competitive advantage.

If we suffer the loss of our manufacturing facility due to catastrophe, our operations would be adversely affected.

We have one manufacturing facility, which is located in Irvine, California. Although we carry insurance for property damage, we do not carry insurance or financial reserves for all possible catastrophes, including interruptions or potential losses arising from earthquakes or terrorism. Any significant disruption in our manufacturing operation at the facility, whether due to fire, natural disaster, or otherwise, would have a material adverse effect on our financial condition and operating results.

We depend upon the services of key personnel, and may not be able to attract and retain additional key personnel.

Our success depends to a significant extent on the continued services and experience of our key research, engineering, sales, marketing and executive personnel. If for any reason our key personnel left our employ and we failed to replace a sufficient number of these personnel, we might not be able to maintain or expand our business. Competition for such highly skilled personnel in our wireless communications and consumer electronics industries is intense, and we cannot be certain that we will be able to hire or re-hire sufficiently qualified personnel in adequate numbers to meet the demand for our products and services. If we are unable to identify, hire and integrate these skilled personnel in a timely or cost-efficient manner, our operating results could suffer.

We may not be able to successfully integrate prior or future acquisitions, which could adversely affect our business, financial condition and results of operations.

We have acquired, and are likely to acquire in the future, businesses, products, and technologies that complement or expand our current operations. Acquisitions could require significant capital investments and require us to integrate with companies that have different cultures, management teams and business infrastructure. Depending on the size and complexity of an acquisition, our successful integration of the acquisition could depend on several factors, including:

If market conditions or other factors require us to change our strategic direction, we may fail to realize the expected value from one or more of our acquisitions. Our failure to successfully integrate our acquisitions or realize the expected value from past or future acquisitions could harm our business, financial condition and results of operations.

10

Table of Contents

We may need additional capital in the future to fund the growth of our businesses, which we may not be able to obtain or obtain on acceptable terms.

We currently anticipate that our available capital resources and operating income will be sufficient to meet our expected working capital and capital expenditure requirements for at least the next 12 months. However, we cannot assure you that such resources will be sufficient to fund the long-term growth of our business. In particular, we may experience a negative operating cash flow due to the timing of anticipated sales of our products. We may raise additional funds through public or private debt or equity financings if such financings become available on favorable terms. Or we may seek working capital financing under a revolving line of credit. We cannot assure you that any additional financing we may need will be available on terms favorable to us, or at all. If adequate funds are not available or are not available on acceptable terms, we may not be able to take advantage of unanticipated opportunities, develop new products or otherwise respond to competitive pressures. In any such case, our operating results and financial condition could be adversely affected.

Our quarterly operating results are subject to significant fluctuations and, if our operating results decline or are worse than expected, our stock price could fall.

We have experienced, and expect to continue to experience, significant quarterly fluctuations in revenue and operating results for our WTS business and wireless applications business. Our quarterly operating results may fluctuate for many reasons, including:

Due to these and other factors, our past results are not reliable indicators of our future performance. In addition, a significant portion of our operating expenses is relatively fixed due to sales, engineering and manufacturing overhead. If we experience a decline in revenue, we may be unable to reduce our fixed costs quickly enough to compensate for the decline, which would magnify the adverse impact of such revenue shortfall on our results of operations. If our operating results decline or are below expectations of securities analysts or investors, the market price of our stock may decline significantly.

Our stock price has been and will likely remain highly volatile.

The stock market in general, and the stock prices of technology and wireless communications companies in particular, have experienced fluctuations that have often been unrelated or disproportionate to the operating performance of these companies. Broad market and industry stock price fluctuations may adversely affect the market price of shares of our common stock. The market price of our stock has exhibited significant price fluctuations, which makes our stock unsuitable for many investors. Our stock price may also be affected by the following factors:

11

Table of Contents

Our articles of incorporation and shareholder rights plan could make a potential acquisition that is not approved by our board of directors more difficult.

Provisions of our articles of incorporation and our shareholder rights plan could make it more difficult for a third party to acquire control of us. Our articles of incorporation prohibit the consummation of a merger, reorganization or recapitalization, sale or lease of a substantial amount of assets with, or issuance of equity securities valued at $2.0 million to, a stockholder that owns 10 percent or more of our common stock, unless certain requirements relating to board or shareholder approval are met. Our articles also prohibit shareholder action by written consent, which could make certain changes of control more difficult by requiring the holding of a special meeting of shareholders for purposes of taking shareholder action.

In addition, in February 2003 we adopted a shareholder rights plan whereby, for each outstanding share of common stock, we distributed a preferred stock purchase right entitling the holder to purchase one one-hundredth of a share of preferred stock at an exercise price of $75. If any person or group acquires or makes an offer to acquire 15 percent or more of our common stock, the preferred stock purchase right will become exercisable by persons other than the 15 percent or more person or group, unless our board of directors timely redeems the preferred stock purchase right or has approved the offer. As a result, the preferred stock purchase rights may cause substantial dilution to the ownership of a person or group that attempts to acquire us on terms not approved by our board of directors.

These provisions in our articles of incorporation and our shareholder rights plan could discourage takeover attempts which some shareholders might deem to be in their best interests or in which shareholders would receive a premium for their shares over the then existing market price of our common stock.

The trading volume of our common stock often has been limited and may depress the price for our common stock.

The trading volume of our common stock has been and may continue to be limited. Limited trading volume could depress the price for our common stock because fewer analysts may provide coverage for our stock and because investors might be unwilling to pay a higher market price for a stock which is less liquid. In addition, limited trading volume, along with market and industry stock price fluctuations and other factors affecting our operations, could result in greater volatility in the price of our common stock. A significant decline in our stock price, even if temporary, could result in substantial losses for individual shareholders and could subject us to costly and disruptive securities litigation.

Future changes in financial accounting standards may cause adverse unexpected revenue fluctuations and affect our reported results of operations.

A change in accounting standards could have a significant effect on our reported results and may even affect our reporting of transactions completed before the change is effective. The Financial Accounting Standards Board

12

Table of Contents

has announced its intention to require that companies record compensation expense in the statement of operations for employee stock options using the fair value method. Implementation of this requirement could have a significant negative effect on our reported results or impair our ability to use equity compensation to attract and retain skilled personnel. New pronouncements and varying interpretations of pronouncements have occurred and may occur in the future. Changes to existing rules or the questioning of current practices may adversely affect our reported financial results or the way we conduct our business.

Compliance with changing regulation of corporate governance and public disclosure may result in additional expenses.

Changing laws, regulations and standards relating to corporate governance and public disclosure, including the Sarbanes-Oxley Act of 2002, newly enacted SEC regulations, and Nasdaq Stock Market rules, are creating uncertainty for companies such as ours. We are committed to maintaining high standards of internal controls over financial reporting, corporate governance and public disclosure. As a result, we intend to invest appropriate resources to comply with evolving standards, and this investment may result in increased general and administrative expenses and a diversion of management attention from revenue generating activities to compliance activities.

Our headquarters and primary manufacturing facility is located in Irvine, California. This leased facility consists of approximately 42,000 square feet of office space and approximately 8,000 square feet of manufacturing/ warehouse space. The lease for this facility expires in August 2005. We also lease office space and, in some instances, warehouse space in California, New York, and Mexico. The leases on these facilities expire at various times through June 2007.

During fiscal 2001, the Company sold a business which, among other things, provided airport management services. During the fourth quarter of fiscal 2004, the Company was sued by a tenant at an airport where the Company provided management services pursuant to a contract with the County of Los Angeles (prior to the sale of this business during the 2001 fiscal year). The claimant seeks damages of $2.0 million in addition to other unspecified damages. This matter is in the very early stages and the outcome of this matter is not determinable or estimable. No provision has been made for losses, if any, which may result from the final outcome of this matter.

In addition to the matter discussed above, we are from time to time involved in various legal proceedings incidental to the conduct of our business. We believe that the outcome of all such pending legal proceedings will not in the aggregate have a material adverse effect on our financial condition and operating results.

No matter was submitted during the fourth quarter ended January 31, 2004 to a vote of our security holders.

13

Table of Contents

PART II

Market Information

Our common stock is traded on the Nasdaq National Market^® under the symbol “CMRO.” The following table sets forth for the periods indicated the quarterly high and low closing prices per share as reported by the Nasdaq National Market. These prices represent actual reported sales transactions.

Holders

As of April 22, 2004, there were approximately 388 holders of record of our common stock.

Dividends

We have not paid any cash dividends on our common stock in the last two fiscal years. We anticipate that dividends on our common stock will not be paid for the foreseeable future and that all earnings will be retained for use in our business and for use in repurchasing our common stock pursuant to our stock repurchase program.

Sales of Unregistered Securities

None.

14

Table of Contents

ITEM 6.    SELECTED FINANCIAL DATA

Note:

The net assets of the Company’s EDX reporting unit were sold during fiscal 2004. Accordingly, the results of operations for our EDX reporting unit for fiscal 2001 (the year the division was purchased) through 2003 have been reclassified and separately presented as discontinued operations. Therefore, these amounts will not agree to the previously filed amounts. Additionally, fiscal 2000 through 2003 have been restated for various adjustments as further described in note 2 of our accompanying consolidated financial statements.

15

Table of Contents

The discussion that follows provides analysis and information that management believes is relevant to an assessment and understanding of our consolidated results of operations and financial condition. The following discussion and analysis should be read in conjunction with our consolidated financial statements and accompanying notes thereto included in Part II, Item 8 of this report, and the section entitled “Risk Factors, Uncertainties and Other Factors that May Affect Results of Operations and Financial Condition” included in Part I, Item 1 of this report.

Overview

Comarco, Inc., through its subsidiary Comarco Wireless Technologies, Inc. (collectively, “we,” “Comarco,” or the “Company”), is a leading provider of wireless test solutions for the wireless industry. Comarco also designs and manufactures emergency call box systems and mobile power products for notebook computers, cellular telephones, PDAs, and other handheld devices. Our operations consist solely of the operations of Comarco Wireless Technologies, Inc. (“CWT”).

Our revenue is primarily derived from sales of our wireless test solutions and wireless applications products, and from services related to the maintenance of deployed emergency call box systems. We have two reportable operating segments: wireless test solutions (“WTS”) and wireless applications. See “Segment Reporting” in note 3 of notes to consolidated financial statements included in Part II, Item 8 of this report.

Critical Accounting Policies

We have identified the following as critical accounting policies to our company: revenue recognition, software development costs, accounts receivable, inventory, income taxes, valuation of goodwill, and valuation of long-lived assets.

Revenue Recognition

We recognize product revenue upon shipment of products provided there are no uncertainties regarding customer acceptance, persuasive evidence of an arrangement exists, the sales price is fixed or determinable, and collectibility is reasonably assured. For our wireless test solutions products that are integrated with embedded software, we recognize revenue using the residual method pursuant to requirements of Statement of Position No. 97-2, “Software Revenue Recognition,” and other applicable revenue recognition guidance and interpretations. Under the residual method, we allocate revenue to the undelivered element, typically maintenance, based on its respective fair value, with the fair value determined by the price charged when that element is sold separately. We amortize the revenue allocated to the maintenance element evenly over the term of the maintenance commitment made at the time of sale. We expense as incurred the costs associated with honoring the maintenance commitment.

16

Table of Contents

We recognize service revenue as services are performed. Maintenance revenue from extended warranty sales is deferred and recognized ratably over the term of the maintenance agreement, typically 12 months. Revenue for services under long-term contracts, for engineering services, which ceased operations in the second quarter of fiscal 2003, was recognized using the percentage-of-completion method on the basis of percentage of costs incurred to date on a contract, relative to the estimated total contract costs. Profit estimates on long-term contracts were revised periodically based on changes in circumstances and any losses on contracts were recognized in the period in which such losses became known.

Significant management judgments must be made and used in connection with the recognition of revenue in any accounting period. Material differences may result in the amount and timing of our revenue for any period if our management made different judgments.

Software Development Costs

We capitalize software developed for sale or lease in accordance with Statement of Financial Accounting Standard (“SFAS”) No. 86, “Accounting for Costs of Computer Software to be Sold, Leased, or Otherwise Marketed.” Software costs incurred subsequent to the determination of the technological feasibility of the software product are capitalized. Our policy is to capitalize the costs associated with development of new products but expense the costs associated with subsequent maintenance releases, if any. Significant management judgment is required in determining whether technological feasibility has been achieved for a particular software project. Capitalization ceases and amortization of capitalized costs begins when the software product is available for general release to customers. Capitalized software development costs, net of related amortization, are compared to management’s estimate of projected revenues quarterly to determine if any impairment in value has occurred that would require an adjustment in the carrying value or change in expected useful lives under the guidelines established under SFAS No. 86. We also continually evaluate the recoverability of software acquired through acquisition or by direct purchase of technology.

We had $5.5 million of capitalized software at January 31, 2004, net of accumulated amortization of $3.4 million. Capitalized software amortization expense is included in cost of revenue. The amortization period for the software costs capitalized is the shorter of the economic life of the related product, typically two to four years, or based on expected unit sales under the sales ratio method.

Accounts Receivable

We perform ongoing credit evaluations of our customers and adjust credit limits and related terms based upon payment history and our customers’ current credit worthiness. We continuously monitor collections and payments from our customers and maintain a provision for estimated credit losses based upon our historical experience and any specific customer collection issues that we have identified. While such credit losses have historically been within our expectations and the provisions established, we cannot guarantee that we will continue to experience the same credit loss rates that we have in the past. Since our accounts receivable are concentrated in a relatively few number of customers, a significant change in the liquidity or financial position of any one of these customers could have a material adverse effect on the collectibility of our accounts receivable and our future operating results.

Specifically, our management must make estimates of the uncollectibility of our accounts receivable. Management analyzes specific customer accounts, historical bad debt, trends, customer concentrations, customer credit-worthiness, and current economic trends when evaluating the adequacy of the allowance for doubtful accounts. Significant management judgments and estimates must be made and used in connection with establishing the allowance for doubtful accounts in any accounting period. Material differences may result in the amount and timing of our losses for any period if management made different judgments or utilized different estimates.

Inventory

We value our inventory at the lower of the actual cost to purchase and/or manufacture the inventory (calculated on average costs, which approximates first-in, first-out basis) or the current estimated market value of the

17

Table of Contents

inventory. We regularly review inventory quantities on hand and record a provision for excess and obsolete inventory based primarily on our estimated forecast of product demand and production requirements for the next twelve months. As experienced during fiscal 2003, demand for our products can fluctuate significantly. A significant increase in the demand for our products could result in a short-term increase in the cost of inventory purchases while a significant decrease in demand could result in an increase in the amount of excess inventory on hand. In addition, our industry is characterized by rapid technological change, frequent new product development, and rapid product obsolescence that could result in an increase in the amount of obsolete inventory quantities on hand. Additionally, our forecasts of future product demand may prove to be inaccurate, in which case we may have understated or overstated the provision required for excess and obsolete inventory. In the future, if our inventory were determined to be overvalued, we would be required to recognize such costs in our cost of goods sold at the time of such determination. Therefore, although we make every effort to ensure the accuracy of our forecasts of future product demand, any significant unanticipated changes in demand or technological developments could have a significant impact on the value of our inventory and our operating results.

Income Taxes

We assess our deferred tax assets to determine the amount that we believe is “more likely than not” to be realized. We consider future taxable income and prudent and feasible tax planning strategies in assessing the need for a valuation allowance. Various other indicators are also considered, including the existence of cumulative tax losses during recent years. If the Company can not generate sufficient taxable income during the 2005 fiscal year, it may be necessary to reserve some or all of the deferred tax assets. If we determine that we will not realize all or part of our net deferred tax assets in the future, we will establish a valuation allowance against the deferred tax assets, which will be charged to income tax expense in the period of such determination.

Valuation of Goodwill

Effective February 1, 2002, we implemented SFAS No. 142, “Goodwill and Other Intangible Assets.” SFAS No. 142 establishes new standards for goodwill acquired in a business combination, eliminates amortization of goodwill, and sets forth methods for periodically evaluating goodwill for impairment.

Under SFAS No. 142, goodwill impairment is deemed to exist if the net book value of a reporting unit exceeds its estimated fair value generally determined using a discounted cash flow methodology applied to the particular unit. This methodology differs from our previous policy, in accordance with accounting standards existing at that time, of using undiscounted cash flows on an enterprise-wide basis to determine recoverability. During the second quarter of fiscal 2003, we recorded a non-cash charge of $4.1 million to write down fully the carrying value of the goodwill related to our EDX reporting unit. This reporting unit is included in our wireless test solutions segment for financial reporting purposes, and the related goodwill was generated through our acquisition of EDX Engineering, Inc. in December 2000. Such charge is reflected as a component of discontinued operations. Future impairments of intangible assets, if any, will be recorded as operating expenses.

We assess goodwill for impairment annually during the fourth quarter of each year or on an interim basis whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Factors we consider important that could trigger an impairment review include the following:

The purchase method of accounting for acquisitions requires extensive use of accounting estimates and judgments to allocate the purchase price to the fair value of the net tangible and intangible assets acquired. The

18

Table of Contents

amounts and useful lives assigned to intangible assets impact future amortization. If the assumptions and estimates used to allocate the purchase price are not correct, purchase price adjustments or future asset impairment charges could be required.

Valuation of Long-Lived Assets

We evaluate long-lived assets used in operations, including purchased intangible assets, when indicators of impairment, such as reductions in demand or significant economic slowdowns that negatively impact our customers or markets, are present. Reviews are performed to determine whether the carrying value of assets is impaired based on comparison to the undiscounted expected future cash flows. If the comparison indicates that there is impairment, the impaired asset is written down to fair value, which is typically calculated using a weighted average of the market approach and the discounted expected future cash flows using a discount rate based upon our cost of capital. Impairment is based on the excess of the carrying amount over the fair value of those assets. Significant management judgment is required in the forecast of future operating results that is used in the preparation of expected discounted cash flows. It is reasonably possible that the estimates of anticipated future net revenue, the remaining estimated economic life of the products and technologies, or both, could differ from those used to assess the recoverability of these assets. In that event, additional impairment charges or shortened useful lives of certain long-lived assets could be required.

Results of Operations – Continuing Operations

Wireless Test Solutions

Our WTS business designs and manufactures hardware and software tools for use by wireless carriers, equipment vendors, and others. Radio engineers, network improvement professionals and technicians, and others use these test tools to design, deploy, and optimize wireless networks, and to verify the performance of the wireless networks once deployed.

Management currently considers the following events, trends, and uncertainties to be important to understanding our WTS business:

During the first half of fiscal 2004, we completed the development of our Seven.Five hardware platform and various related software applications, and began shipping products to customers in Europe, North America and Latin America. Seven.Five is a hardware and software solution that is flexible, scalable, and modular allowing our customers to work with all 2G, 2.5G and 3G technologies.

19

Table of Contents

The Seven.Five product family consists of the following:

Wireless Applications

Our wireless applications business designs and manufactures emergency call box systems and mobile power products for notebook computers, cellular telephones, PDAs, and other handheld devices. Our call box products provide emergency communication over existing wireless networks. In addition to the call box products, we provide system installation and long-term maintenance services. Currently, there are approximately 14,000 call boxes that we service and maintain under long-term agreements which expire at various dates through February 2011.

Management currently considers the following events, trends, and uncertainties to be important to understanding our wireless applications business:

Approximately 78 percent of our call box revenue is derived from agencies of California’s state and local governments. The State of California is currently experiencing severe financial challenges. We believe these challenges have created uncertainty with respect to the spending patterns of our California-based customers. As a result, projects and the related contracts to upgrade and expand certain call box systems have been delayed. While we currently believe that these projects will move ahead during fiscal 2005, we are unable to forecast the timing of such events in the near-term.

20

Table of Contents

Our wireless applications business also includes the ChargeSource family of mobile power products. Designed with the needs of the traveling professional in mind, our ChargeSource mobile power products provide a high level of functionality and compatibility in an industry-leading compact design. Our current and planned product offering consists of universal AC/DC, AC, and DC power adapters designed for the right mix of power output and functionality for most retail, OEM, and enterprise customers. Our ChargeSource products are also universal allowing those who use rechargeable electronic devices to carry just one power adapter. By simply changing the compact SmartTip connected to the end of the charging cable, our universal power adapters are capable of charging and powering multiple target devices, including most notebook computers, cellular telephones, PDAs, and other handheld devices.

Until recently, most notebook computers required no more than 70 watts of power to operate. However, the personal computer industry is currently transitioning to notebook computers with increasing power requirements. As power requirements increase, so does the size of the OEM power adapter sold with each notebook computer. To address this industry wide trend, we have developed a family of high-power ChargeSource products that are compatible with most legacy, current, and planned notebook computers. These new ChargeSource products are able to deliver up to 120 watts of power in a very small form factor. We believe our patented electrical designs will continue to be the basis for even higher-power universal power adapters that are expected to meet evolving global standards, including the planned standards of the European Union (“EU”), and the increasing power requirements of the notebook computer OEMs, and allow us to offer customers cutting edge technology without significantly increasing the size or weight of our products. We also expect these higher-power universal power adapters to continue to be significantly smaller and lighter than their OEM counterpart.

Historically, our ChargeSource mobile power products have been distributed by Targus Group International (“Targus”). During the fourth quarter of fiscal 2004 we terminated our relationship with Targus and entered into a strategic agreement with Belkin Corporation (“Belkin”). Under this agreement Belkin is granted exclusive worldwide distribution rights to distribute our ChargeSource products in several strategic end-market categories including electronic retailers, specialty retailers, OEM third party options and Fortune 1000 corporate customers. However, due to the exclusive nature of our agreement with Belkin, our direct access to certain significant distribution channels has been limited.

On March 20, 2003 and in cooperation with the U.S. Consumer Products Safety Commission (“CPSC”), we voluntarily initiated a product safety recall of our legacy ChargeSource 70-watt universal AC power adapters. This product safety recall impacts approximately 125,000 units that were sold in fiscal 2003. Comarco and Targus entered into an agreement to address the impact of the recall action. Under the terms of the agreement Comarco issued a $3.2 million credit to Targus in fiscal 2003 in consideration of a full release. Of the $3.2 million credit issued to Targus in the fourth quarter of fiscal 2003, qualifying product returns totaling $2.1 million were received from Targus through October 31, 2003. During the third quarter of fiscal 2004, the remaining $1.1 million unused credit was recorded as revenue, consistent with the expiration of the right of return and the term of the agreement. Additionally, in the fourth quarter of fiscal 2003 we accrued $183,000 in costs related to the recall action in cost of revenue. We believe that any additional product recall costs will be minor and any such costs will be expensed as incurred.

21

Table of Contents

The following table sets forth certain items as a percentage of revenue from our audited consolidated statements of income for fiscal 2004, 2003, and 2002:

Consolidated

Revenue

Total revenue for fiscal 2004 was $34.3 million compared to $35.7 million for fiscal 2003, a decrease of approximately $1.4 million or 4.0 percent. As discussed below, the decrease is attributable to decreased sales of our wireless application products and services partially offset by increased sales of our WTS products. Total revenue for fiscal 2003 was $35.7 million compared to $49.6 million for fiscal 2002, a decrease of approximately $13.9 million or 28.0 percent. The decrease was due to an $18.1 million decrease in sales of our WTS products and services, partially offset by a $4.2 million increase in sales of our wireless applications products and services.

For fiscal 2004 as compared to the prior year, revenue from products decreased 3.8 percent to $29.2 million while revenue from services decreased 4.8 percent to $5.1 million. The product revenue decrease reflects the decreased demand for our call box products, which declined $4.0 million or 67.2 percent, offset by an increase in sales of our WTS products of $1.9 million or 21.7 percent and an increase in sales of our ChargeSource products of $0.9 million or 5.9 percent, including $1.1 million of revenue recognized in the third quarter of fiscal 2004 related to the reversal of an unused recall credit initially recognized in the fourth quarter of fiscal 2003. The services revenue decrease was due to our exit from the engineering services business during the second quarter of fiscal 2003. Revenue from engineering services totaled $0.9 and $7.5 million for fiscal 2003 and 2002, respectively. The fiscal 2004 services revenue decrease was offset by a $600,000 increase in call box service revenue in the current year.

22

Table of Contents

For fiscal 2003 as compared to the prior year, revenue from products decreased 18.8 percent to $30.4 million, while revenue from services decreased 56.3 percent to $5.3 million. The product revenue decrease reflected the softness in the wireless industry and decreased demand for our legacy WTS products, which declined $11.5 million or 56.7 percent, offset by an increase in sales of our ChargeSource products of $3.6 million or 31.1 percent, net of a $3.2 million credit issued to Targus in conjunction with the product safety recall of our 70-watt universal ChargeSource power adapter and a $0.9 million, or 17.9 percent, increase in call box product sales. See the section below titled “ChargeSource Product Safety Recall” for additional discussion. The services revenue decrease was due to our exit from the engineering services business during the second quarter of fiscal 2003.

Cost of Revenue and Gross Margin

Total cost of revenue for fiscal 2004 decreased $8.3 million or 27.6 percent to $21.7 million. As discussed below, we recorded non-recurring charges in the amount of $7.1 million to cost of sales in the prior fiscal year. As a percentage of revenue, gross margin increased to 36.6 percent compared to 35.8 percent, adjusted for non-recurring charges, for fiscal 2003.

Total cost of revenue for fiscal 2003 was $30.0 million compared to $25.7 million for fiscal 2002, an increase of approximately $4.4 million or 17.0 percent. Cost of revenue for fiscal 2003 included a non-cash inventory impairment charge, totaling approximately $1.3 million and a $5.6 million non-cash write-off of software development costs. These charges are attributable to our wireless test solutions business. See the section below entitled “Asset Impairment Charges” for additional discussion. Cost of revenue for fiscal 2003 also included approximately $0.2 million of costs accrued in connection with the product safety recall of our ChargeSource 70-watt universal power adapters. See the section below entitled “ChargeSource Product Safety Recall” for additional discussion. Excluding the inventory impairment, software development write-off and product safety recall charges, total cost of revenue for fiscal 2003 was $22.9 million. As a percentage of revenue, gross margin for fiscal 2003 decreased to 35.8 percent compared to 48.3 percent for the prior fiscal year. As discussed below, the decrease in gross margin was primarily due to a change in our mix of business, our exit from engineering services, and the negative effect of significantly reduced sales and decreasing gross margins of our historically higher margin wireless test solution products.

Selling, General and Administrative Expenses

Selling, general and administrative expenses increased $1.2 million or 13.4 percent to $9.8 million in fiscal 2004. The increase was due to legal settlements and related fees in the amount of $2.0 million incurred during the first half of fiscal 2004, partially offset by reductions in other indirect costs and reduced legal fees in the third and fourth quarters of fiscal 2004.

Selling, general and administrative costs for fiscal 2003 were $8.7 million compared to $11.2 million for the prior fiscal year, a decrease of $2.5 million or 22.4 percent. This decrease was due to reduced staffing levels, selling expenses, and incentive compensation driven by significantly reduced sales of our WTS products and services. Additionally, in accordance with SFAS No. 142, “Goodwill and Other Intangible Assets,” beginning in fiscal 2003, we no longer amortized goodwill.

As a percentage of revenue, selling, general and administrative costs were 28.8 percent, 24.3 percent, and 22.6 percent for fiscal 2004, 2003, and, 2002, respectively.

Asset Impairment Charges

During fiscal 2003, as a response to reduced demand for legacy WTS products in the wireless marketplace and our strategy of investing available resources in the development of Seven.Five, we analyzed the carrying value of all assets attributable to our WTS business. Based on this analysis, we recorded asset impairment charges totaling $12.5 million during the second quarter of fiscal 2003. The following table sets forth the impaired assets and corresponding impairment charges (in thousands) for fiscal 2003:

23

Table of Contents

In addition to the asset impairment charges above, an inventory impairment charge totaling $1.3 million was recorded as cost of revenue during fiscal 2003. The above impaired assets, as well as the inventory impairment charge, were exclusively related to our legacy 2G wireless test solutions products and did not include any assets related to our engineering services business, which ceased operations during the second quarter of fiscal 2003. The exit costs associated with our exit from the engineering services business totaled $151,000.

ChargeSource Product Safety Recall

In fiscal 2004 and in cooperation with the U.S. CPSC, we announced a voluntary product safety recall of approximately 125,000 detachable plugs used on our ChargeSource 70-watt universal AC power adapter. In conjunction with the product safety recall, the Company and Targus, the exclusive distributor of the ChargeSource products at that time, entered into an agreement addressing the impact of the recall action. Accordingly, we accrued both a $3.2 million credit due to Targus reducing sales and additional recall costs of approximately $0.2 million classified in cost of revenue in the fourth quarter of fiscal 2003. During the third quarter of fiscal 2004 in conjunction with the expiration of the right of return and the term of the agreement, we recognized the unused portion of the credit in the amount of $1.1 million as revenue.

Engineering and Support Expenses

We capitalize costs incurred for the development of software embedded in our wireless test solutions products subsequent to establishing technological feasibility. These capitalized costs are subject to an ongoing assessment of recoverability based on anticipated future revenue and changes in hardware and software technologies. Costs that are capitalized include direct labor and related overhead. Engineering and support costs for fiscal 2004 and 2003 are as follows:

Engineering and support costs, net of capitalized software development costs, for fiscal 2004 were $5.8 million compared to $5.2 million for the prior fiscal year, an increase of approximately $0.6 million. Gross engineering and support costs, before reduction for capitalized software development costs, remained flat at $8.6 million in comparison to fiscal 2003. Engineering costs increased $0.9 million related to higher staffing levels for the development of our newly released ChargeSource products. Support costs decreased $0.9 million related to reduced staffing levels for the wireless test solutions department, consistent with the development and release of the Seven.Five product family, which operates under a single platform.

24

Table of Contents

Engineering and support costs for fiscal 2003 and 2002 are as follows:

Engineering and support costs, net of capitalized software development costs, for fiscal 2003 increased 3.8 percent to $5.2 million compared to fiscal 2002. Gross engineering and support costs, before reduction for capitalized software development costs, decreased $1.9 million in comparison to fiscal 2002. This decrease is a result of our strategy of reducing the cost structure supporting our wireless test solutions business and developing a single flexible product platform. Offsetting this cash savings and consistent with the reduction in the number of on-going software development programs, capitalized software development costs decreased $2.1 million resulting in an increase in engineering and support costs, net of capitalized software development costs, of $0.2 million for fiscal 2003 in comparison to the prior fiscal year.

Other Income, net

Other income, net, consisting primarily of interest income, decreased approximately $0.1 million to $0.2 million for fiscal 2004 compared to the prior fiscal year. This decrease was primarily due to lower invested cash balances and reduced interest rates earned on invested cash balances. Other income decreased $0.5 million to $0.4 million for fiscal 2003 compared to fiscal 2002, primarily as a result of lower invested cash balances for much of fiscal 2003.

Income Tax Expense

The effective tax rate for fiscal 2004, 2003, and 2002 was 35.4 percent, 37.2 percent, and 36.8 percent, respectively. The effective tax rate fluctuates due, in part, to fluctuations in the minority interest in (earnings) loss of subsidiary which is not tax effected.

Wireless Test Solutions

25

Table of Contents

Revenue

Wireless test solutions revenue for fiscal 2004 was $11.2 million compared to $10.1 million for fiscal 2003, an increase of $1.1 million or 10.5 percent. The increase reflects sales of our new product platform, Seven.Five, which was released in the first quarter of fiscal 2004.

Wireless test solutions revenue for fiscal 2003 was $10.1 million compared to $28.2 million for fiscal 2002, a decrease of approximately $18.1 million or 64.2 percent. This decrease primarily reflects the reduced demand for our legacy 2G wireless test solution products, as well as reduced engineering services, which we ceased providing during the second quarter of fiscal 2003. Revenue from engineering services for fiscal 2003 and 2002 totaled $0.9 million and $7.5 million, respectively.

Cost of Revenue and Gross Margin

Wireless test solutions cost of revenue for fiscal 2004 was $7.0 million compared to $13.4 million for fiscal 2003, a decrease of approximately $6.4 million or 47.9 percent. Excluding the inventory impairment charge and software development write-off of $6.9 million recorded in fiscal 2003, gross margin increased 1.8 percent from 35.7 percent to 37.5 percent in fiscal 2004. The increase in margin is attributable to increased absorption of manufacturing overhead expenses and reduced labor costs when viewed as a percentage of revenue, driven by increased sales of our hardware and software tools.

Wireless test solutions cost of revenue for fiscal 2003 was $13.4 million compared to $12.9 million for fiscal 2002, an increase of approximately $0.5 million or 3.6 percent. As discussed above, during fiscal 2003, we recorded non-cash impairment charges totaling approximately $6.9 million. Excluding this asset impairment charge, wireless test solutions cost of revenue for fiscal 2003 was $6.5 million. As a percentage of revenue, gross margin for fiscal 2003 decreased to 35.7 percent compared to 54.3 percent for the prior fiscal year. The decrease in gross margin is primarily due to decreased absorption of fixed costs attributable to dramatically lower revenue.

Wireless Applications

Revenue

Wireless applications revenue for fiscal 2004 was $23.1 million compared to $25.6 million for fiscal 2003, a decrease of $2.5 million or 9.7 percent. The decrease is primarily due to decreased call box products revenue of $4.0 million, partially offset by increased call box service revenue of $0.6 million and ChargeSource product sales of $0.9 million. In fiscal 2003 we completed a Text Telephony (“TTY”) call box upgrade for the hearing impaired for the County of Orange, California, and a system expansion for the Metropolitan Transportation Commission (“MTC”) in California that contributed $2.5 and $1.2 million, respectively, to call box product sales. In fiscal 2004, we had no similar installation or upgrade projects. We believe that the current political and financial challenges facing the State of California have adversely impacted our call box product sales.

26

Table of Contents

In the second quarter of fiscal 2004 we began shipping our newest generation of ChargeSource products, the 120-watt AC/DC and DC adapters. The increase in ChargeSource product sales of $0.9 million includes the $1.1 million unused recall credit issued to our former distributor in conjunction with the product safety recall of our ChargeSource 70-watt universal AC power adapter.

Wireless applications revenue for fiscal 2003 was $25.6 million compared to $21.3 million for fiscal 2002, an increase of approximately $4.3 million or 20.0 percent. This increase was primarily due to increased sales of our ChargeSource mobile power products. Our combined ChargeSource sales increased approximately $3.6 million to $15.2 million for fiscal 2003, net of the $3.2 million credit issued to our exclusive distributor in conjunction with the product safety recall of our ChargeSource 70-watt universal AC power adapter, as discussed above.

All ChargeSource products were distributed exclusively by Targus under non-cancelable commitments during fiscal years 2004, 2003, and 2002. For fiscal 2004, 2003, and 2002, sales to Targus totaled approximately $15.0 million, $15.2 million, and $11.3 million, respectively. Under our new distributor agreement with Belkin, Belkin has certain non-cancelable commitments to purchase our ChargeSource products. In the event Belkin is unable to perform under these commitments due to its inability to take delivery of ordered products and/or pay for such products in a timely manner, we would be required to establish alternative distribution channels. The financial impact of a material change in our relationship with Belkin cannot be precisely quantified, but we believe that a six-to-twelve month disruption in the distribution of our ChargeSource products would have a negative impact on our revenue and operating results, which could also result in decreased liquidity.

Cost of Revenue and Gross Margin

Wireless applications cost of revenue for fiscal 2004 was $14.8 million compared to $16.6 million for fiscal 2003, a decrease of $1.9 million or 11.3 percent. As a percentage of revenue and excluding the recall credit and costs associated with the product safety recall incurred in fiscal 2003, gross margin for fiscal 2004 decreased to 36.1 percent from 43.0 percent. This decrease relates to ramp-up costs associated with the introduction of the ChargeSource 120-watt products.

Wireless applications cost of revenue for fiscal 2003 was $16.6 million compared to $12.7 million for fiscal 2002, an increase of $3.9 million or 30.1 percent. Excluding the cost of the product safety recall, cost of revenue for fiscal 2003 was $16.4 million. As a percentage of revenue and excluding the credit and costs associated with the product safety recall, gross margin for fiscal 2003 increased to 43.0 percent from 40.3 percent for fiscal 2002. The increase in wireless applications gross margin is primarily attributable to several higher-margin call box upgrade projects completed during fiscal 2003.

Discontinued Operations

On January 6, 2004, we sold the assets of the reporting unit EDX. This reporting unit was formerly included in the wireless test solutions segment, and has been classified as discontinued operations.

Income from discontinued operations was $596,000 for fiscal 2004, which includes income from operations of $258,000 on revenue of $1.1 million, plus an after-tax gain of $319,000 on the sale of EDX. The loss from discontinued operations for fiscal 2003 and 2002 was $5.2 million and $324,000, respectively. The loss from discontinued operations for fiscal 2003 included the asset impairment charges in the amount of $6.6 million to write-off the goodwill and intangible assets related to the EDX reporting unit. These charges were offset by a $1.1 million tax benefit. Excluding these items income from discontinued operations would have been $300,000 in fiscal 2003. The loss from discontinued operations for fiscal 2002 included amortization of EDX related goodwill and intangible assets in the amount of $700,000. Excluding amortization expense, income from discontinued operations would have been $100,000 in fiscal 2002.

Restatement of Previously Issued Financial Statements

The Company has restated its previously issued financial statements for the items described below:

Presented below are tables which present the impact of these adjustments to amounts previously reported for fiscal 2003 and 2002:

Fiscal 2003 Statement of Operations