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 JULY 31, 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  x    No  ¨

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

The registrant had 7,340,216 shares of common stock outstanding as of September 10, 2004.

Table of Contents

COMAR CO, INC. AND SUBSIDIARIES

QUARTERLY REPORT ON FORM 10-Q

FOR THE THREE AND SIX MONTHS ENDED JULY 31, 2004

TABLE OF CONTENTS

2

Table of Contents

PART I — FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

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)

1. Organization

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.

2. Summary of Significant Accounting Policies

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 and six months ended July 31, 2004 are not necessarily indicative of the results to be expected for the year ending January 31, 2005.

Prior Year Restatement of Quarterly Results (Fiscal 2004):

The consolidated financial statements for the three and six months ended July 31, 2003 were restated as of January 31, 2004 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 net loss by $17,000, and $76,000 for the three and six months ended July 31, 2003 and increased the net loss per share by $0.01 for the three and six months ended July 31, 2003. 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):

7

Table of Contents

COMARCO, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

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 three and six months ended July 31, 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:

The fair value of options granted under the Company’s stock option plans during the six months ended July 31, 2004 and 2003, was estimated on the date of grant using the Black-Scholes option-pricing model utilizing the following weighted average assumptions:

Deferred Income Taxes:

Deferred income taxes, reflecting the impact of temporary differences between assets and liabilities recognized for financial reporting purposes, are based on tax law currently enacted. The Company assesses on a periodic basis the probability that the net deferred tax assets will be recovered. If after evaluating all of the positive and negative evidence, a conclusion is made that it is more likely than not that some portion or all of the net deferred tax assets will not be recovered, a valuation allowance is provided with a corresponding charge to tax expense to reserve the portion of the deferred tax assets which are estimated to be more likely than not to be realized.

During the second quarter of fiscal 2005, the Company considered both positive and negative evidence in determining the need for a valuation allowance against the net deferred tax assets. The Company’s second quarter results were less than previously expected. As of July 31, 2004, for the first time in recent history the Company has incurred cumulative losses, excluding certain non-recurring items, for a three year period. This event has been determined to be a significant element of negative evidence. While the Company expects to be profitable in the future, the projections of future profitability are based on assumptions that are not objectively verifiable. With this in mind, the negative evidence was considered to outweigh the positive evidence and the Company concluded that its net deferred tax asset should be fully reserved at the conclusion of the second quarter of the 2005 fiscal year. Accordingly, during the second quarter of fiscal 2005, a valuation allowance was established totaling approximately $2.9 million, or the entire deferred tax asset balance. Net deferred tax assets as of July 31, 2004 were zero.

8

Table of Contents

COMARCO, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

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.

3. Recent Accounting Pronouncements

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:

9

Table of Contents

COMARCO, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

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.

4. Stockholders’ Equity

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 July 31, 2004, the Company has repurchased approximately 2.6 million shares for an average price of $8.22 per share. During the three and six months ended July 31, 2004, the Company did not repurchase any shares of its common stock.

5. Earnings (Loss) Per Share

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 three and six months ended July 31, 2004 and 2003, basic and diluted net loss per share were the same.

Potential common shares related to stock options of 4,659 and 15,028 have been excluded from diluted weighted average common shares for the three and six months ended July 31, 2004, as the effect would have been anti-dilutive. Similarly, potential common shares of 24,339 and 24,731 have been excluded from diluted weighted average common shares for the three and six months ended July 31, 2003, as the effect would have been anti-dilutive.

6. Inventory

Inventory consists of the following (in thousands):

10

Table of Contents

COMARCO, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

7. Software Development Costs, Net

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

Amortization of software development costs for the three months ended July 31, 2004 and 2003 totaled $488,000 and $705,000, respectively. For the six months ended July 31, 2004 and 2003, amortization of software development costs totaled $1.0 million and $1.2 million, respectively. Amortization of software development costs has 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.

8. Goodwill and Acquired Intangible Assets, Net

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

The following table presents goodwill by reportable segment:

11

Table of Contents

COMARCO, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

The following table presents the future expected amortization of the definite-lived intangible assets (in thousands):

Amortization of definite lived acquired intangible assets for the three months ended July 31, 2004 and 2003 totaled $128,000 and $54,000, respectively. For the six months ended July 31, 2004 and 2003, amortization of definite lived acquired intangible assets totaled $236,000 and $142,000 respectively. The Company ceased amortizing goodwill beginning February 1, 2002 upon adoption of SFAS No. 142, (“Goodwill and Other Intangible Assets.”)

9. Business Segment Information

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):

12

Table of Contents

COMARCO, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

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

10. Commitments and Contingencies

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.

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 consolidated results of operations, financial position or cash flows.

13

Table of Contents

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

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 changes 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 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.

During the second quarter of fiscal 2005 and as more fully described in Note 2 of notes to unaudited consolidated financial statements included in Part I, Item 1 of this report, we concluded that the net deferred tax asset should be fully reserved and established a valuation allowance accordingly. As indicated by the results of our net deferred tax asset assessment, we evaluated our capitalized software development cost for impairment and concluded no impairment charge was required as of July 31, 2004.

We had $4.5 million of capitalized software as of July 31, 2004, net of accumulated amortization of $4.5 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 collectibility 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 write down 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

As part of the process of preparing our condensed consolidated financial statements we are required to estimate our provision for income taxes in each of the tax jurisdictions in which we conduct business. This process involves estimating our actual current tax expense in conjunction with the evaluation and measurement of temporary differences resulting from differing treatment of certain items for tax and accounting purposes. These temporary timing differences result in the establishment of deferred tax assets and liabilities, which are recorded on a net basis and included in our condensed consolidated balance sheet. We then assess on a periodic basis the probability that our net deferred tax assets will be recovered. If after evaluating all of the positive and negative evidence, a conclusion is made that it is more likely than not that some portion or all of the net deferred tax assets will not be recovered, a valuation allowance is provided with a corresponding charge to tax expense to reserve the portion of the deferred tax assets which are estimated to be not more likely than not to be realized.

Significant management judgment is required in determining our provision for income taxes, our deferred tax assets and liabilities and any required valuation allowance. Our second quarter results were less than previously expected. As of July 31, 2004, for the first time in recent history we have incurred cumulative losses, excluding certain non-recurring items, for a three year period. This event has been determined to be a significant element of negative evidence. While the Company expects to be profitable in the future, the projections of future profitability, as is the case with most forecasts, can not be objectively verified. With this in mind, the negative evidence was considered to outweigh the positive evidence and we concluded that the net deferred tax assets should be fully reserved at the conclusion of the second quarter of the 2005 fiscal year. Accordingly, during the second quarter of fiscal 2005, a valuation allowance was established totaling approximately $2.9 million, or the entire deferred tax asset balance.

16

Table of Contents

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 July 31, 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.

During the second quarter of fiscal 2005 and as more fully described in Note 2 of notes to unaudited consolidated financial statements included in Part I, Item 1 of this report, we concluded that the net deferred tax asset should be fully reserved and established a valuation allowance accordingly. As indicated by the results of our net deferred tax asset assessment, we evaluated our intangible assets for impairment and concluded no impairment charge was required as of July 31, 2004.

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 July 31, 2004, we had $1.5 million of non-goodwill intangible assets recorded in intangible assets, which includes $0.7 million of software rights and $0.8 million of intellectual property rights.

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.

During the second quarter of fiscal 2005 and as more fully described in Note 2 of notes to unaudited consolidated financial statements included in Part I, Item 1 of this report, we concluded that the net deferred tax asset should be fully reserved and established a valuation allowance accordingly. As indicated by the results of our net deferred tax asset assessment, we evaluated our long-lived assets for impairment and concluded no impairment charge was required as of July 31, 2004.

Prior Year Restatement of Quarterly Results (Fiscal 2004):

The consolidated financial statements for the three and six months ended July 31, 2003 were restated as of January 31, 2004 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 second quarter net loss by $17,000 and increased the year-to-date net loss by $76,000. 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 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.

17

Table of Contents

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

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.

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.

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

18

Table of Contents

fiscal 2005, we entered into another supply agreement with a national tier-one distributor of consumer electronics to distribute certain of our ChargeSource products to “Big Box” retailers and other channels. We have received firm orders and currently expect to start shipping under this supply agreement during the fourth quarter of fiscal 2005. Due to certain terms of this supply agreement, our direct access to certain significant distribution channels may be limited.

The following table sets forth certain items as a percentage of revenue from our condensed consolidated statements of operations for the three and six months ended July 31, 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.