Back to GetFilings.com

Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

For the quarterly period ended

APRIL 30, 2004

OR

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 and zip code)

(949) 599-7400

(Registrant’s telephone number, including area code)

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 check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

Yes ¨    No þ

The registrant had 7,291,874 shares of common stock outstanding as of June 10, 2004.

Table of Contents

COMARCO, INC. AND SUBSIDIARIES

QUARTERLY REPORT ON FORM 10-Q

FOR THE THREE MONTHS ENDED APRIL 30, 2004

TABLE OF CONTENTS

2

Table of Contents

PART I — FINANCIAL INFORMATION

COMARCO, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited)

(In thousands, except share amounts)

The accompanying notes are an integral part of these condensed consolidated financial statements.

3

Table of Contents

COMARCO, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

(In thousands, except per share amounts)

The accompanying notes are an integral part of these condensed consolidated financial statements.

4

Table of Contents

COMARCO, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(In thousands)

The accompanying notes are an integral part of these condensed consolidated financial statements.

5

Table of Contents

COMARCO, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

Comarco, Inc., through its subsidiary Comarco Wireless Technologies, Inc. (collectively, “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. Comarco Wireless Technologies, Inc. (“CWT”) was incorporated in the State of Delaware in September 1993.

Basis of Presentation:

The interim condensed consolidated financial statements of Comarco included herein have been prepared without audit in accordance with accounting principles generally accepted in the United States of America for interim information and with the instructions for Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. The Company believes that the disclosures are adequate to make the information presented not misleading when read in conjunction with the audited consolidated financial statements included in the Company’s annual report on Form 10-K for the year ended January 31, 2004. The financial information presented herein reflects all adjustments, consisting only of normal recurring accruals, which are, in the opinion of management, necessary for a fair presentation of the results for the interim periods presented. The results for the three months ended April 30, 2004 are not necessarily indicative of the results to be expected for the year ending January 31, 2005.

First Quarter of Fiscal 2004 Restatement:

The first quarter of fiscal 2004, ended April 30, 2003, was restated for the items described below:

6

Table of Contents

COMARCO, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

The net effect of the restatement adjustments increased the Company’s first quarter net loss by $59,000, and increased the net loss per share by less than $.01. Additionally, in the fourth quarter of fiscal 2004, the Company sold the net assets of EDX Engineering (“EDX”) and therefore the EDX operations have been reclassified as discontinued operations for the first quarter of fiscal 2004. The following table presents the impact of the restatement adjustments to amounts previously reported for fiscal 2004 (in thousands):

Stock-Based Compensation:

The Company grants stock options for a fixed number of shares to employees with an exercise price equal to the fair value of the shares at the date of grant. The Company accounts for stock option grants using the intrinsic method in accordance with Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees” and related interpretations in accounting for its stock-based compensation plans. The Company has adopted the disclosure-only provisions of SFAS No. 123, “Accounting for Stock-Based Compensation.” Accordingly, no compensation expense is recognized for the stock option grants. Had compensation cost for the Company’s stock option plans been determined based on the fair value at the grant date for awards during the quarters ended April 30, 2004 and 2003, consistent with the provisions of SFAS No. 123, the Company’s net loss, basic loss per share, and diluted loss per share would have been reduced to the pro forma amounts as follows:

7

Table of Contents

COMARCO, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

The fair value of options granted under the Company’s stock option plans during the three months ended April 30, 2004 and 2003, was estimated on the date of grant using the Black-Scholes option-pricing model utilizing the following weighted average assumptions:

Principles of Consolidation:

The condensed consolidated financial statements of the Company include the accounts of Comarco, Inc., CWT, and wholly owned subsidiaries primarily reported as discontinued operations. All material intercompany balances, transactions, and profits have been eliminated.

Use of Estimates:

The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the condensed consolidated financial statements and the reported amounts of revenue and expenses during the period reported. Actual results could differ from those estimates.

Certain accounting principles require subjective and complex judgments to be used in the preparation of financial statements. Accordingly, a different financial presentation could result depending on the judgments, estimates, or assumptions that are used. Such estimates and assumptions include, but are not specifically limited to, those required in the valuation of long-lived assets, allowance for doubtful accounts, and valuation allowances for deferred tax assets.

Reclassifications:

Certain prior period balances have been reclassified to conform to the current period presentation.

In January 2003, the FASB issued Interpretation No. 46, “Consolidation of Variable Interest Entities, an interpretation of ARB No. 51.” This Interpretation addresses the consolidation by business enterprises of variable interest entities as defined in the Interpretation. The Interpretation applies immediately to variable interests in variable interest entities created after January 31, 2003, and to variable interests in variable interest entities obtained after January 31, 2003. The application of this Interpretation did not have a material effect on our financial statements. The Interpretation requires certain disclosures in financial statements issued after January 31, 2003 if it is reasonably possible that we will consolidate or disclose information about variable interest entities when the Interpretation becomes effective. In October 2003, the FASB deferred the effective date of this Interpretation for pre-existing variable interest entities to no later than February 2004. In December 2003, the FASB issued a revision to FIN No. 46 (FIN No. 46-R), which incorporated the October 2003 deferral provisions and clarified and revised accounting guidance for all variable interest entities. All variable interest entities, regardless of when created, are

8

Table of Contents

COMARCO, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

required to be evaluated under FIN No. 46-R no later than March 31, 2004. The Company has no variable interest entities that require consolidation or disclosure.

In May 2003, FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.” SFAS No. 150 establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both debt and equity and requires an issuer to classify the following instruments as liabilities in its balance sheet:

Certain provisions of SFAS No. 150 are effective immediately. However, generally SFAS No. 150 is effective for financial instruments as of the first interim period beginning after December 15, 2004. SFAS No. 150 is to be implemented by reporting the cumulative effect of a change in accounting principle. Adoption of the provisions that are effective immediately has not had a material impact on the Company’s consolidated financial statements. The Company does not expect the adoption of the not yet effective provisions of SFAS No. 150 will have a material impact on its consolidated financial statements.

During 1992, our Board of Directors authorized a stock repurchase program of up to 3.0 million shares of the Company’s common stock. From program inception through April 30, 2004, the Company has repurchased approximately 2.6 million shares for an average price of $8.22 per share. During the first quarter ended April 30, 2004, the Company did not repurchase any shares of common stock.

The Company calculates basic net earnings (loss) per share by dividing net income (loss) by the weighted-average number of common shares outstanding during the reporting period. Diluted earnings per share reflects the effects of potentially dilutive securities. Since the Company incurred a net loss for the first quarters ended April 30, 2004 and 2003, basic and diluted net loss per share were the same because the inclusion of 28,700 and 24,889 potentially dilutive securities related to outstanding stock options, respectively, would have been antidilutive.

9

Table of Contents

COMARCO, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

Inventory consists of the following (in thousands):

Software development costs consist of the following (in thousands):

Capitalized software development costs for the quarters ended April 30, 2004 and 2003 totaled $0 and $0.8 million, respectively. Amortization of software development costs for the quarters ended April 30, 2004 and 2003 totaled $529,000 and $478,000, respectively, and have been reported in cost of revenue in the accompanying condensed consolidated financial statements. The amortization period for the software costs capitalized is the shorter of the economic life of the related product or based on expected unit sales under the sales ratio method, typically two to four years.

Goodwill and acquired intangible assets consist of the following (in thousands):

10

Table of Contents

COMARCO, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

The following table presents goodwill by reportable segment:

Amortization of definite lived acquired intangible assets for the quarters ended April 30, 2004 and 2003 totaled $108,000 and $88,000, respectively. The Company ceased amortizing goodwill beginning February 1, 2002 upon adoption of SFAS No. 142.

The Company has two reportable operating segments: wireless test solutions and wireless applications. Wireless test solutions designs and manufactures hardware and software tools for use by wireless carriers, equipment vendors, and others. Radio frequency engineers, professional technicians, and others use these tools to design, deploy, and optimize wireless networks, and to verify the performance of the wireless networks once deployed.

Wireless applications designs and manufactures call box systems and mobile power products for notebook computers, cellular telephones, PDAs, and other handheld devices. Call box systems provide emergency communication over existing wireless networks. In addition to the call box products, the Company provides system installation and long-term maintenance services. Currently, approximately 14,000 CWT call boxes are installed, the majority of which are serviced and maintained under long-term agreements, which expire at various times through February 2011.

Performance measurement and resource allocation for the reportable segments are based on many factors. The primary financial measures used are revenue and gross profit. The revenue, gross profit, gross margin, and total assets attributable to these segments are as follows (in thousands):

11

Table of Contents

COMARCO, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

Revenue by geographic area consisted of the following (in thousands):

Purchase Commitments with Suppliers

We generally issue purchase orders to our suppliers with delivery dates from four to six weeks from the purchase order date. In addition, we regularly provide significant suppliers with rolling six-month forecasts of material and finished goods requirements for planning and long-lead time parts procurement purposes only. We are committed to accept delivery of materials pursuant to our purchase orders subject to various contract provisions which allow us to delay receipt of such order or allow us to cancel orders beyond certain agreed lead times. Such cancellations may or may not include cancellation costs payable by us. In the past, we have been required to take delivery of materials from our suppliers that were in excess of our requirements and we have previously recognized charges and expenses related to such excess material. If we are unable to adequately manage our suppliers and adjust such commitments for changes in demand, we may incur additional inventory expenses related to excess and obsolete inventory. Such expenses could have a material adverse effect on our business, results of operations, and financial position.

Legal Contingencies

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. 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.

12

Table of Contents

COMARCO, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

The Company is 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 results of operations and financial position.

13

Table of Contents

The following discussion and analysis should be read in conjunction with our unaudited consolidated financial statements and the related notes and other financial information appearing elsewhere in this Form 10-Q. Readers are also urged to carefully review and consider the various disclosures made by us which attempt to advise interested parties of the factors which affect our business, including without limitation the disclosures made under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and disclosure made in our annual report on Form 10-K for the fiscal year ended January 31, 2004 under the caption “Risk Factors, Uncertainties and Other Factors that May Affect Results of Operations and Financial Condition,” as well as the audited consolidated financial statements and notes thereto also included in our annual report on Form 10-K for the fiscal year ended January 31, 2004.

Forward-Looking Statements

Some of the statements in this report and the documents incorporated herein by reference constitute forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934. These statements relate to future financial performance and involve known and unknown risks, uncertainties, and other factors that may cause our business’s or our industry’s actual results, levels of activity, performance, or achievements to be materially different from those expressed or implied by any forward-looking statements. Such statements include, in particular, statements about our plans, strategies, prospects, changes and trends in our business and the markets in which we operate as described in this report. In some cases, you can identify forward-looking statements by terminology such as “may,” “will,” “could,” “would,” “should,” “expect,” “plan,” “anticipate,” “intend,” “believe,” “estimate,” “forecast,” “predict,” “propose,” “potential,” or “continue” or the negative of those terms or other comparable terminology. These statements are only predictions.

Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance, or achievements. Moreover, neither we, nor any other person, assume responsibility for the accuracy and completeness of the forward-looking statements. We are under no obligation to update any of the forward-looking statements after the filing of this report of Form 10-Q to conform such statements to actual results or to change in our expectations.

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 “Business Segment Information” in Note 10 of notes to unaudited condensed consolidated financial statements included in Part I, Item 1 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.

14

Table of Contents

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 probable. 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.

We recognize service revenue as the services are performed. Maintenance revenue from extended warranty sales is deferred and recognized ratably over the term of the maintenance agreement, typically 12 months.

Significant management judgments must be made and used in connection with the revenue recognized 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 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 new releases, which consist of enhancements or increased functionality of software embedded in our existing products. 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 $5.0 million of capitalized software as of April 30, 2004, net of accumulated amortization of $4.0 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 or based on expected unit sales under the sales ratio method, typically two to four years.

Accounts Receivable

We perform ongoing credit evaluations of our customers and adjust credit limits and related terms based upon payment history and the customer’s 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.

15

Table of Contents

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 market value. We regularly review inventory quantities on hand and record a writedown of excess and obsolete inventory based primarily on our estimated forecast of product demand and production requirements for the next twelve months. As demonstrated during prior periods, 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 quantities 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.

Intangible Assets

We account for goodwill and intangible assets in accordance with SFAS No. 141, “Business Combinations,” and SFAS No. 142, “Goodwill and Other Intangible Assets.” Accordingly, the Company no longer amortizes goodwill from acquisitions, but continues to amortize other acquisition-related intangibles and costs. As of April 30, 2004, we had $2.4 million of goodwill, net recorded in our unaudited condensed consolidated balance sheet.

We performed our annual goodwill impairment analysis at January 31, 2004 and identified no impairment. The impairment review is based on a discounted cash flow approach that uses estimates of future market share and revenue and costs for the reporting units, as well as appropriate discount rates. The estimates used are consistent with the plans and estimates that we use to manage the underlying businesses. However, if we fail to deliver new products for these groups, if the products fail to gain expected market acceptance, or if market conditions in the related businesses are unfavorable, revenue and cost forecasts may not be achieved, and the Company may incur charges for impairment of goodwill.

For intangible assets with definite useful lives, we amortize the cost over the estimated useful lives and assess any impairment by estimating the future cash flow from the associated asset in accordance with SFAS No. 144 “Accounting for the Impairment or Disposal of Long-Lived Assets.” As of April 30, 2004, we had $1.4 million of non-goodwill intangible assets recorded in intangible assets, which includes $0.7 million of software rights and $0.7 million of intellectual property rights.

16

Table of Contents

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.

First Quarter of Fiscal 2004 Restatement:

The first quarter of fiscal 2004, ended April 30, 2003, was restated for various adjustments that are more fully described in Note 2 of notes to unaudited condensed consolidated financial statements included in Part I, Item 1 of this report. The net effect of the restatement adjustments increased the Company’s first quarter net loss by $59,000. Additionally, in the fourth quarter of fiscal 2004, the Company sold the net assets of EDX Engineering (“EDX”) and therefore the EDX operations have been reclassified as discontinued operations for the first quarter of fiscal 2004.

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 frequency engineers, professional technicians, and others use these field 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:

17

Table of Contents

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, we have approximately 14,000 call boxes installed, the majority of which are serviced and maintained 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:

Due to the exclusive nature of our agreement with Belkin, our direct access to certain significant distribution channels may be limited.

Approximately 75 percent of our call box revenue is derived from agencies of California’s state and local governments. The State of California continues to experience 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.

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 SmartTips 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.

18

Table of Contents

The following table sets forth certain items as a percentage of revenue from our condensed consolidated statements of operations for the three months ended April 30, 2004 and 2003. The table and discussion that follows provides information which management believes is relevant to an assessment and understanding of our condensed consolidated results of operations and financial condition. The discussion should be read in conjunction with the condensed consolidated financial statements and accompanying notes thereto included elsewhere herein.

Consolidated

Revenue

Total revenue for first quarter fiscal 2005, which ended April 30, 2004, was $9.1 million compared to $6.2 million for the corresponding quarter of the prior fiscal year, an increase of approximately $2.9 million or 45.8 percent. As discussed below, the increase is attributable to increased sales of our WTS products partially offset by decreased sales of our wireless applications products, specifically ChargeSource products.

19

Table of Contents

For the first quarter of fiscal 2005 as compared to the corresponding period of the prior fiscal year, revenue from product sales increased 54.3 percent to $7.7 million while revenue from services totaled approximately $1.4 million and increased $0.2 million from the first quarter of fiscal 2004. The increase in product revenue is primarily attributable to increased sales of our WTS products, partially offset by decreased sales of our ChargeSource products, which declined $0.7 million or 25.3 percent.

Cost of Revenue and Gross Margin

Total cost of revenue for the first quarter of fiscal 2005 increased $1.8 million or 44.8 percent to $5.8 million. As discussed below, the increase in cost of revenue is attributable to increased sales of our WTS products. As a percentage of revenue, gross margin for the first quarter of fiscal 2005 increased slightly in comparison to the corresponding quarter of fiscal 2004 at 36.1 percent versus 35.7 percent.

Selling, General and Administrative Costs

Selling, general and administrative costs increased $0.4 million or 17.3 percent to $2.6 million for the first quarter of fiscal 2005 in comparison to the corresponding quarter of fiscal 2004. As discussed below, selling, general and administrative costs for the first quarter of fiscal 2005 includes a $0.4 million charge recognized in anticipation of settling a dispute with a significant WTS customer based in Latin America. Excluding this charge, selling, general and administrative costs for the first quarter of fiscal 2005 were comparable to the same for the corresponding quarter of fiscal 2005.

As a percentage of revenue, selling, general and administrative costs were 29.1 percent and 36.2 percent for the quarters ended April 30, 2004 and 2003, respectively.

Engineering and Support Costs

The Company capitalizes costs incurred for the development of software embedded in our WTS 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 the first quarter of fiscal 2005 and 2004 are as follows:

Engineering and support costs, net of capitalized software development costs, for the first quarter of fiscal 2005 were $1.9 million compared to $1.5 million for the corresponding quarter of the prior fiscal year, an increase of approximately $0.4 million. Gross engineering, before reduction for capitalized software development costs, decreased $0.5 million in comparison to fiscal 2003, primarily due to a reduction of staffing and consulting costs related to WTS engineering. In the fourth quarter of fiscal 2004, we no longer incurred expenses that qualified to be capitalized. Support costs increased $0.2 million primarily due to increased travel costs to support our WTS products in the field.

20

Table of Contents

Other Income

Other income, consisting primarily of interest income, decreased approximately $61,000 to $47,000 for the first quarter of fiscal 2005 compared to the first quarter of the prior fiscal year. This decrease was primarily due to lower invested cash balances and reduced interest rates earned on invested cash balances.

Income Tax Expense

The effective tax rate for the first quarter of fiscal 2005 and 2004 was 36.6 percent and 33.8 percent, respectively.

Wireless Test Solutions (“WTS”)

Revenue

Wireless test solutions revenue for the first quarter of fiscal 2005 was $5.3 million compared to $1.6 million for the corresponding quarter of the prior fiscal year, an increase of $3.7 million or 228.3 percent. The increase reflects sales of our new product platform, Seven.Five, which was released in the first quarter of fiscal 2004.

The European marketplace for our WTS products is served by our exclusive reseller SwissQual. All sales to SwissQual are deferred until payment is received. For the first quarter of fiscal 2005, we received payments from SwissQual and recorded the corresponding revenue totaling $2.0 million. Additionally, as of April 30, 2004, approximately $2.2 million of sales to SwissQual has been deferred pending cash collections, which we expect to receive during the second and third quarters of fiscal 2005.

Cost of Revenue and Gross Margin

Wireless test solutions cost of revenue for the first quarter of fiscal 2005 was $3.0 million compared to $1.2 million for the corresponding quarter of the prior fiscal year, an increase of approximately $1.7 million or 141.3 percent. Gross margin for the first quarter of fiscal 2005 increased to 43.8 percent from 23.6 percent for the first quarter of fiscal 2004. The increase in margin is attributable to increased absorption of manufacturing overhead expenses and decreased labor costs when viewed as a percentage of revenue, driven by increased sales of our Seven.Five hardware and software tools.

21

Table of Contents

Wireless Applications

Revenue

Wireless applications revenue for the first quarter of 2005 was $3.8 million compared to $4.6 million for the first quarter of 2004, a decrease of approximately $0.8 million or 18.4 percent. This decrease was due to a $0.7 million decrease in sales of our ChargeSource products and a $0.1 million decrease in sales of our call box products and services. For the first quarter of fiscal 2005, call box revenue was generated from both the sales of products and providing maintenance services under long-term contracts and totaled $0.5 million and $1.2 million, respectively. Sales of call box products tend to fluctuate from quarter to quarter while revenue from the long-term maintenance contracts are relatively comparable quarter to quarter.

Cost of Revenue and Gross Margin

Wireless applications cost of revenue for the first quarter of fiscal 2004 and 2003 was $2.8 million. Gross margin for the first quarter of fiscal 2005 decreased to 25.2 percent from 39.9 percent for the first quarter of fiscal 2004. The decrease in margin is attributable to decreased absorption of manufacturing overhead expenses and other fixed costs related to the manufacture of our ChargeSource products, as well as increased labor costs when viewed as a percentage of revenue, all driven by decreased sales of our ChargeSource products.

Discontinued Operations

On January 6, 2004, Comarco sold the assets of the reporting unit EDX. This reporting unit was formerly included in the wireless test solutions segment.

Additionally, during fiscal 2001, the Company sold its defense and commercial staffing businesses, the non-wireless businesses.

Net loss from discontinued operations was $3,000 for the first quarter of fiscal 2005, and related to expenses incurred for the non-wireless businesses. The net income from discontinued operations for the first quarter of fiscal 2004 was $22,000, on revenue of $242,000 related to EDX.

Liquidity and Capital Resources

The Company has cash and cash equivalents of $14.8 million as of April 30, 2004 and no outstanding debt.

Cash Flows from Operating Activities

Cash provided by operating activities was $0.2 million for the first quarter of fiscal 2005 compared to cash used in operating activities of $0.1 million for the corresponding quarter of the prior fiscal year. Our loss from continuing operations for the first quarter of fiscal 2005 was $0.7 million and was offset by cash collections that reduced accounts receivable and amounts due from SwissQual, our WTS products reseller for the European market place, by $1.8 million and $0.3 million, respectively. Inventory levels during the first quarter of fiscal 2005

22

Table of Contents

increased by $1.3 million as we purchased additional raw materials required for customer purchase orders that are scheduled to be delivered during the second and third quarters of fiscal 2005.

Cash Flows from Investing Activities

Net cash used in investing activities was $0.4 million for the first quarter of fiscal 2005 compared to $1.4 million for the corresponding quarter of the prior fiscal year. For the first quarter of fiscal 2005, capital expenditures for property and equipment constituted substantially all of our cash used in investing activities. For the first quarter of the prior fiscal year and in addition to the $0.5 million expended for property and equipment, we invested $0.8 million in the development of software, which was critical to our products then under development. As previously discussed, we have recently completed the development of our Seven.Five hardware and software product platform and have entered the maintenance and enhancement phase of this product’s life cycle. Accordingly, no amounts related to the development of software have been capitalized during the first quarter of fiscal 2005. We currently have no specific plans that would require us to capitalize qualifying software development costs during the balance of fiscal 2005.

We believe that our existing cash and cash equivalent balances will provide us sufficient funds to satisfy our cash requirements for at least the next twelve months. In addition to our cash and cash equivalent balances, we expect to derive a portion of our liquidity from our cash flows from operations. As discussed above, certain factors and events could negatively affect our cash flows from operations, including:

We are focused on preserving our cash balances by continuously monitoring expenses, identifying cost savings, and investing only in those development programs and products most likely to contribute to our profitability.

Currency Risk

The Company is exposed to the risk of changes in currency exchange rates. As of April 30, 2004, we had no material accounts receivable denominated in foreign currencies. Our standard terms require customers to pay for our products and services 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.

Interest Rate Sensitivity

The primary objective of our investment activities is to preserve principal while at the same time maximizing the income we receive from our investments without significantly increasing risk. Some of the securities that we have invested in may be subject to market risk. This means that a change in prevailing interest rates may cause the principal amount of the investment to fluctuate. For example, if we hold a security that was issued with a fixed interest rate at the then-prevailing rate and the prevailing interest rate later rises, the principal amount of our

23

Table of Contents

investment will probably decline in value. To minimize this risk, we maintain a significant portion of our cash balances in money market funds. In general, money market funds are not subject to interest rate risk because the interest paid on such funds fluctuates with the prevailing interest rate.

We do not hold any derivative financial instruments.

Our cash and cash equivalents have maturities dates of three months or less and the fair value approximates the carrying value in our financial statements.

Equity Price Risk

Our short-term investments consist primarily of balances maintained in a non-qualified deferred compensation plan funded by our executives and directors. We value these investments using the closing market value for the last day of each month. These investments are subject to market price volatility. We reflect these investments on our balance sheet at their market value, with the unrealized gains and losses excluded from reported operations. We have also invested in equity instruments of SwissQual, a privately held company. We evaluate whether any decline in value of certain public and non-public equity investments is other than temporary.

Due to the inherent risk associated with some of our investments, and in light of current stock market conditions, we may incur future losses on the sales, write-downs, or write-offs of our investments. We do not currently hedge against equity price changes.

(a) Evaluation of disclosure controls and procedures

As of the end of the period covered by this report, an evaluation was performed, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of our disclosure controls and procedures pursuant to the Securities Exchange Act of 1934, as amended, Rule 13a-14c. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that, as of the end of the period covered by this report, our disclosure controls and procedures are effective.

(b) Changes in internal controls over financial reporting

In the current quarter, the Company instituted procedures to evaluate vendor specific objective evidence as part of its quarterly closing process to ensure sales of the Company’s WTS products are recorded in accordance with Statement of Position No. 97-2 “Software Revenue Recognition.” The Company is continuing its evaluation of the matters discussed in Item 9A of the Company’s annual report on Form 10-K filed with the Securities and Exchange Commission for the fiscal year ended January 31, 2004.

24

Table of Contents

PART II — OTHER INFORMATION

Pulsar v. Comarco, Inc., et al,

Case No. BC30638, Superior Court of California County of Los Angeles-Central District

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 previously provided management services pursuant to a contract with the County of Los Angeles. The claimant sued for breach of contract, fraud and several other causes of action based on its allegation that it had not been provided a long-term lease as allegedly promised. The claimant seeks damages of $2.0 million in addition to other unspecified damages. 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.

The Company is 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 results of operations and financial position.

None.

None.

None.

In the first quarter of fiscal 2005, the Company adopted procedures for board of director nominations as described in the Company’s 2004 definitive proxy statement, dated May 25, 2004.

None.

25

Table of Contents

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.

26