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COMARCO 10-Q 2014

Documents found in this filing:

  1. 10-Q
  2. Ex-31
  3. Ex-31
  4. Ex-32
  5. Ex-32
  6. Ex-32


UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


 

FORM 10-Q

 

 

X

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended

 

October 31, 2014

 

OR

 

 

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from ______________ to ______________

 

Commission file number 0-5449

 

COMARCO, INC.

(Exact name of registrant as specified in its charter)

 


 

California

95-2088894

(State or other jurisdiction

(I.R.S. Employer

of incorporation or organization)

Identification No.)

 

25541 Commercentre Drive, Suite 250, Lake Forest, California 92630

(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

 

No

 

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). 

Yes

 

No

 

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer

   

Accelerated filer

   

Non-accelerated filer

   

Smaller reporting company

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes

   

No

 

The registrant had 14,684,165 shares of common stock outstanding as of December 15, 2014.

 



 

 
 

 

 

COMARCO, INC. AND SUBSIDIARY

 

QUARTERLY REPORT ON FORM 10-Q

FOR THE THREE AND NINE MONTHS ENDED October 31, 2014

 

 

TABLE OF CONTENTS

 

 

   

Page

PART I — FINANCIAL INFORMATION

 

   

 

ITEM 1.

FINANCIAL STATEMENTS (Unaudited)

 

     
 

Condensed Consolidated Balance Sheets as of October 31, 2014 and January 31, 2014

3
   

 

 

Condensed Consolidated Statements of Operations for the Three Months and Nine Months Ended October 31, 2014 and 2013

4
   

 

 

Condensed Consolidated Statements of Cash Flows for the Nine Months Ended October 31, 2014 and 2013

5
   

 

 

Notes to Condensed Consolidated Financial Statements

6
   

 

ITEM 2.

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

19
   

 

ITEM 4.

CONTROLS AND PROCEDURES

27
     
   

 

PART II — OTHER INFORMATION

 

   

 

ITEM 1.

LEGAL PROCEEDINGS

28
   

 

ITEM 1A.

RISK FACTORS

28
   

 

ITEM 6.

EXHIBITS

29
   

 

SIGNATURES

30

  

 
2

 

 

PART I — FINANCIAL INFORMATION

 

ITEM 1.

FINANCIAL STATEMENTS

 

COMARCO, INC. AND SUBSIDIARY

CONDENSED CONSOLIDATED BALANCE SHEETS

 (In thousands, except share and par value amounts)

 

   

(Unaudited)

         
   

October 31,

   

January 31,

 
   

2014

   

2014

 

ASSETS

               

Current Assets

               

Cash and cash equivalents

  $ 2,442     $ 1,096  

Accounts receivable due from suppliers, net

    122       128  

Other current assets

    23       17  

Total current assets

    2,587       1,241  

Property and equipment, net

    9       14  

Restricted cash

    5       82  

Total assets

  $ 2,601     $ 1,337  
                 

LIABILITIES AND STOCKHOLDERS' DEFICIT

               

Current Liabilities

               

Accounts payable

  $ 746     $ 4,363  

Accrued liabilities

    763       1,012  

Loan payable

    -       1,167  

Derivative liabilities

    -       2,520  

Total current liabilities

    1,509       9,062  

Total liabilities

    1,509       9,062  
                 

Commitments and Contingencies

               
                 

Stockholders' Equity (Deficit):

               

Preferred stock, no par value, 10,000,000 shares authorized; no shares issued or outstanding

    -       -  

Common stock, $0.10 par value, 50,625,000 shares authorized; 14,684,165 shares issued and outstanding at October 31, 2014 and January 31, 2014, respectively

    1,468       1,468  

Additional paid-in capital

    18,310       15,980  

Accumulated deficit

    (18,686 )     (25,173 )

Total stockholders' equity (deficit)

    1,092       (7,725 )

Total liabilities and stockholders' equity

  $ 2,601     $ 1,337  

 

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

 

 
3

 

 

COMARCO, INC. AND SUBSIDIARY

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

(In thousands, except per share amounts)

 

   

Three Months Ended

   

Nine Months Ended

 
   

October 31,

   

October 31,

 
   

2014

   

2013

   

2014

   

2013

 
                                 

Revenue

  $ -     $ 1,508     $ -     $ 4,429  

Cost of revenue

    -       1,567       (1,099 )     4,029  

Gross profit

    -       (59 )     1,099       400  
                                 

Selling, general and administrative expenses

    241       203       835       1,440  

Engineering and support expenses

    89       69       283       668  
      330       272       1,118       2,108  

Operating loss

    (330 )     (331 )     (19 )     (1,708 )

Interest expense, net

    -       (106 )     (380 )     (283 )

Change in fair value of derivative liabilities

    -       988       226       271  

Net Gain on litigation settlement

    -       -       6,662       5  
                                 

Income (loss) from operations before income taxes

    (330 )     551       6,489       (1,715 )

Income tax expense

    -       -       2       2  

Net income (loss)

  $ (330 )   $ 551     $ 6,487     $ (1,717 )
                                 

Basic income (loss) per share:

  $ (0.02 )   $ 0.04     $ 0.44     $ (0.12 )

Diluted income (loss) per share:

  $ (0.02 )   $ 0.04     $ 0.44     $ (0.12 )
                                 

Weighted-average shares outstanding:

                               

Basic

    14,684       14,470       14,684       14,300  

Diluted

    14,886       14,544       14,830       14,300  

 

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

 

 
4

 

 

COMARCO, INC. AND SUBSIDIARY

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(In thousands)

 

   

Nine Months Ended

 
   

October 31,

 
   

2014

   

2013

 
                 

CASH FLOWS FROM OPERATING ACTIVITIES:

               

Net income (loss)

  $ 6,487     $ (1,717 )

Adjustments to reconcile net loss from continuing operations to net cash used in operating activities:

               

Depreciation and amortization

    5       54  

Loss on sale/retirement of property and equipment

    -       32  

Amortization of loan discount

    333       206  

Stock-based compensation expense

    36       71  

Provision for doubtful accounts receivable

    6       12  

Provision for obsolete inventory

    -       368  

Change in fair value of derivative liabilities

    (226 )     (271 )

Changes in operating assets and liabilities

               

Accounts receivable due from customers

    -       (170 )

Accounts receivable due from suppliers

    -       522  

Inventory

    -       98  

Other assets

    (6 )     (15 )

Accounts payable

    (3,617 )     706  

Accrued liabilities

    (249 )     (344 )

Net cash provided by (used in) operating activities

    2,769       (448 )
                 

CASH FLOWS FROM INVESTING ACTIVITIES:

               

Purchases of property and equipment

    -       (9 )

Change in restricted cash

    77       28  

Net cash provided by investing activites

    77       19  
                 
                 

CASH FLOWS FROM FINANCING ACTIVITIES:

               

Loan proceeds

    -       1,500  

Loan repayment

    (1,500 )     (2,000 )

Net proceeds from common stock issued

    -       1,030  

Net cash (used in) provided by financing activities

    (1,500 )     530  
                 

Net increase in cash and cash equivalents

    1,346       101  

Cash and cash equivalents, beginning of period

    1,096       104  

Cash and cash equivalents, end of period

  $ 2,442     $ 205  
                 

Noncash investing and financing activities:

               

Debt discount recorded upon issuance of convertible debt

  $ -     $ 624  

Issurance of common stock upon the vesting of restricted stock units

  $ -     $ 19  
                 

Supplementary disclosures of cash flow information:

               

Cash paid for interest

  $ 68     $ 76  

Cash paid for income taxes, net of refunds

  $ 2     $ 2  

 

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

 

 
5

 

 

COMARCO, INC. AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

 

1.

Organization

 

Comarco, Inc. was incorporated in California in 1960 and its common stock has been publicly traded since 1971, when it was spun-off from Genge Industries, Inc. Comarco Inc.’s wholly-owned subsidiary, Comarco Wireless Technologies, Inc. (“CWT”), was incorporated in the state of Delaware in September 1993. Comarco and CWT are collectively referred to as “we,” “us,” “our,” “Comarco,” or the “Company”.

 

 

2.

Current Developments, Future Operations, Liquidity and Capital Resources

 

The condensed financial statements have been prepared assuming that we will continue to operate as a going concern, which contemplates that we will realize returns on our assets and satisfy our liabilities and commitments in the ordinary course of business. Our consolidated financial statements do not reflect any adjustments related to the outcome of which uncertainty. Our future is highly dependent on our ability to successfully resolve our current litigation, capitalize on our portfolio of patents, generate positive cash flows and/or obtain borrowings or raise capital to meet our liquidity needs.

  

As previously announced in August 2013, Lenovo Information Products Co., Ltd. (“Lenovo”), our only material customer, notified us of their intention to cease offering our Constellation product, the power adapter we designed and developed for Lenovo, and terminated its relationship with us. We completed shipping product to Lenovo during our third quarter ended November 30, 2013. The loss of Lenovo as a customer has had a material adverse impact on our results of operations. We have reduced and/or eliminated certain operating expenses to minimize future losses and cash burn and will continue our efforts in this regard.

 

Two of our recent litigation matters have concluded. In the Chicony Power Technology, Co. Ltd., (“Chicony”) matter, effective as of May 15, 2014, Chicony entered into a settlement agreement with us that dismissed all claims between the two parties arising from the litigation. Pursuant to the terms of the settlement agreement, Chicony agreed to pay us $7.6 million in lieu of the jury’s net award of $9.7 million or any other related costs or fees. Settlement amounts of $4.0 million and $3.6 million were paid on May 16, 2014 and May 30, 2014, respectively. Of the $7.6 million, we received $6.5 million, net of $1.1 million in attorneys’ fees and other costs. In connection with the settlement, certain contract manufacturer costs payable to Chicony totaling $1.1 million were discharged and reflected as a reduction of cost of revenues. In our litigation with ACCO Brands USA LLC and its Computer Products Group division (collectively “Kensington”), on February 4, 2014, we entered into a confidential settlement and licensing agreement with an effective date of February 1, 2014 that dismisses all claims between the two parties arising from this matter.

 

We believe that our patent portfolio covering key technical aspects of our products could potentially generate a future revenue stream based upon royalties paid to us by others for the use of some or all of our patents in third party products. We continue to explore opportunities to expand, protect, and monetize our patent portfolio, including through the sale or licensing of our patent portfolio. We may or may not resume our traditional activities of providing innovative charging solutions for battery powered devices. There are no assurances that any of these possible opportunities or activities will occur or be successful.

 

We are currently generating de minimis revenues and have ceased traditional operations. Our future is highly dependent on our ability to successfully resolve our current litigation, capitalize on our portfolio of patents, generate positive cash flows and obtain borrowings or raise capital to meet our future liquidity needs.

 

We continue to analyze a range of alternatives to build and/or preserve value for its stakeholders, including, but not limited to, exploring additional investment and incremental financing from current and/or new investors, the engagement of advisors to assist in exploring strategic options for us as well as identifying potential partnerships for the purpose of monetizing some or all of the our patent portfolio and past, present, and future infringement claims. There can be no assurances that we will be successful in implementing any of these alternatives, or if implemented, that any of these alternatives will successfully preserve or increase shareholder value.  

 
6

 

 

COMARCO, INC. AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

 

3.

Summary of Significant Accounting Policies

 

The summary of our significant accounting policies presented below is designed to assist the reader in understanding our condensed consolidated financial statements.

 

Basis of Presentation

 

The accompanying condensed consolidated balance sheet as of January 31, 2014, which has been derived from our audited financial statements, and our unaudited interim condensed consolidated financial statements as of October 31, 2014 included herein have been prepared without audit in accordance with accounting principles generally accepted in the United States of America (“GAAP”) 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 (“GAAP”) 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, 2014. The accounting policies followed by the Company are set forth in Note 2 to the Company’s audited financial statements included in its Form 10-K for its fiscal year ended January 31, 2014 (the “2014 10-K”), which was filed with the SEC on April 30, 2014. The unaudited interim condensed consolidated 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 consolidated results for the interim periods presented. The consolidated results for the three and nine months ended October 31, 2014 are not necessarily indicative of the results to be expected for the fiscal year ending January 31, 2015.

 

Principles of Consolidation

 

The unaudited interim condensed consolidated financial statements of the Company include the accounts of Comarco, Inc. and CWT, its wholly owned subsidiary. All material intercompany balances, transactions, and profits and losses have been eliminated.

 

Cash and Cash Equivalents

 

All highly liquid investments with original maturity dates of three months or less when acquired are classified as cash and cash equivalents. The fair value of cash and cash equivalents approximates the amounts shown in the consolidated financial statements. Cash and cash equivalents are generally maintained in uninsured accounts, typically Eurodollar deposits with daily liquidity, which are subject to investment risk including possible loss of principal invested.

 

Accounts Receivable Due from Suppliers

 

Oftentimes we were able to source components locally that we later sold to our contract manufacturers, who built the finished goods, and other suppliers. This was especially the case when new products were initially introduced into production. Sales to our contract manufacturers (or “CMs”) and other suppliers were excluded from revenue and were recorded as a reduction to cost of revenue.

 

 
7

 

 

COMARCO, INC. AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

 

Restricted Cash

 

Our restricted cash balances are secured by separate bank accounts and represents $5,000 which serves as collateral for credit card chargebacks associated with our internet website.

 

Use of Estimates

 

The preparation of consolidated financial statements in conformity with GAAP 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 consolidated financial statements, and the reported amounts of revenue and expenses during the periods reported. Actual results could materially 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 assessment of the impairment of long-lived assets, allowance for doubtful accounts, valuation allowances for deferred tax assets, valuation of derivative liabilities and determination of stock-based compensation.

 

Derivative Liabilities

 

A derivative is an instrument whose value is “derived” from an underlying instrument or index such as a future, forward, swap, option contract, or other financial instrument with similar characteristics, including certain derivative instruments embedded in other contracts and for hedging activities. As a matter of policy, the Company does not invest in separable financial derivatives or engage in hedging transactions. However, the Company entered into certain financing transactions in fiscal 2013 that involved financial equity instruments containing certain features that have resulted in the instruments being deemed derivatives. The Company may engage in other similar complex financing transactions in the future, but not with the intention to enter into derivative instruments. Derivatives are measured at fair value using the Monte Carlo simulation pricing model and marked to market through earnings. However, such new and/or complex instruments may have immature or limited markets. As a result, the pricing models used for valuation of derivatives often incorporate significant estimates and assumptions. Changes in these subjective assumptions can materially affect the estimate of the fair value of derivative liabilities and, consequently, the related amount recognized as loss due to change in fair value of derivative liabilities on the consolidated statement of operations. Furthermore, depending on the terms of a derivative, the valuation of derivatives may be removed from the financial statements upon exercise or conversion of the underlying instrument into some other security.

 

We evaluate free-standing derivative instruments to properly classify such instruments within stockholders’ equity or as liabilities in our financial statements. Our policy is to settle instruments indexed to our common shares on a first-in-first-out basis.

 

The classification of a derivative instrument is reassessed at each balance sheet date. If the classification changes as a result of events during a reporting period, the instrument is reclassified as of the date of the event that caused the reclassification. There is no limit on the number of times a contract may be reclassified.

 

During the second quarter of fiscal 2013, we adopted the guidance, as codified in Financial Accounting Standards Board ("FASB") Accounting Standards Codification ("ASC") 815-40, Derivatives and HedgingAccounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock,that requires us to apply a two-step model in determining whether a financial instrument or an embedded feature is indexed to our own stock and thus enables it to qualify for equity classification. The warrants issued to Broadwood Partners, L.P. (“Broadwood”) contained provisions that adjusted the exercise price in the event of certain dilutive issuance of our securities (see Note 8). Accordingly, the Company considered the warrants to be subject to price protection and classified them as derivative liabilities at the date of issuance with a fair value of $1.4 million and a corresponding discount to the underlying loan payable (see Note 8). On August 13, 2014, we entered into an an Amendment and Release Agreement that canceled and replaced the Broadwood warrants. Accordingly, the derivative liability associated with the Broadwood warrants was reversed on the cancellation date and the replacement warrants, which qualified for classification as equity, were added to additional paid in capital.  

 

 
8

 

 

COMARCO, INC. AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

 

Additionally, during the first quarter of fiscal 2014, we entered into a Loan Agreement with Elkhorn Partners Limited Partnership (“Elkhorn”) which contains convertible provisions that allow Elkhorn to convert the loan into common stock. The conversion price could have been adjusted in the event of certain dilutive issuance of our securities. Accordingly, the Company considered the convertible debt to be subject to price protection and created a discount to the underlying loan payable and classified that fair value as derivative liabilities at the date of issuance with a fair value of $0.6 million (see Note 8). On June 3, 2014, the Company repaid the Elkhorn Loan in full and as a result, the discount to the loan payable and related derivative liability were extinguished and charged to earnings for the nine months period ended October 31, 2014. 

 

Fair Value of Financial Instruments

 

Our financial instruments include cash and cash equivalents, accounts receivable due from customers and suppliers, accounts payable, accrued liabilities, a short-term loan and derivative liabilities. The carrying amount of cash and cash equivalents, accounts receivable, accounts payable, and accrued liabilities are considered to be representative of their respective fair values because of the short-term nature of those instruments.

 

Legal expense classification

 

Our legal expenses are classified in either selling, general, and administrative expenses or engineering and support expenses depending on the nature of the legal expense. All legal expenses incurred related to our intellectual property, including associated litigation expense and maintenance of our patent portfolio, are included in engineering and support expenses in our consolidated statement of operations. All other legal expenses, including all other litigation expense and public company legal expense are included in selling, general, and administrative expenses in our consolidated statement of operations.

 

 

4.

Stock-Based Compensation

 

We grant stock awards for a fixed number of shares to employees, consultants, and directors pursuant to the Company’s shareholder-approved equity incentive plans.

 

We account for stock-based compensation using the modified prospective method, which requires measurement of compensation cost for all stock awards at fair value on date of grant and recognition of compensation over the service period for awards expected to vest. The fair value of stock options is determined using a Lattice Binomial model for options with performance-based vesting tied to the Company’s stock price and the Black-Scholes valuation model for options with ratable term vesting. Both the Lattice Binomial and Black-Scholes valuation models require the input of subjective assumptions. These assumptions include estimating the length of time optionees will retain their vested stock options before exercising them (the “expected term”), the estimated volatility of our common stock price over the expected term, and the number of awards that will ultimately not complete their vesting requirements (“forfeitures”). Changes in these subjective assumptions can materially affect the estimate of fair value of stock-based compensation and, consequently, the related amount recognized as an expense on the consolidated statements of operations. As required under applicable accounting rules, we review our valuation assumptions at each grant date and, as a result, we are likely to change our valuation assumptions used to value stock-based awards granted in future periods. The values derived from using either the Lattice Binomial or the Black-Scholes model are recognized as an expense over the vesting period, net of estimated forfeitures. The estimation of stock awards that will ultimately vest requires significant judgment. Actual results, and future changes in estimates, may differ from our current estimates.

 

 
9

 

 

COMARCO, INC. AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

 

The compensation expense recognized is summarized in the table below (in thousands except per share amounts):

 

   

Three Months Ended

   

Nine Months Ended

 
   

October 31,

   

October 31,

 
   

2014

   

2013

   

2014

   

2013

 

Stock-based compensation expense

  $ 12     $ 18     $ 36     $ 71  

Impact on basic and diluted earnings per share

  $ (0.00 )   $ (0.00 )   $ (0.00 )   $ (0.00 )

 

The total compensation cost related to nonvested awards not yet recognized is approximately $20,000, which will be expensed over a weighted average remaining life of 5 months.

 

During the three and nine months ended October 31, 2014, no stock awards were granted. During the three and nine months ended October 31, 2013, no stock options were granted and 420,000 shares of restricted stock were granted. 

 

The Company’s former employee stock option plan (the “Prior Employee Plan”) expired during May 2005. As a result, no new options could be granted under the plan thereafter. This plan provided for the issuance of up to 825,000 shares of common stock. In December 2005, the Board of Directors approved and adopted the Company’s 2005 Equity Incentive Plan (the “2005 Plan”) covering 450,000 shares of common stock. The 2005 Plan was approved by the Company’s shareholders at its annual shareholders’ meeting in June 2006, and subsequently amended at its annual shareholders’ meeting in June 2008 to increase the number of shares issuable under the plan from 450,000 to 1,100,000 shares. In July 2011, the Company’s shareholders approved the 2011 Equity Incentive Plan (the “2011 Plan”) covering 750,000 shares of common stock, as well as the shares that remained available for issuance under the 2005 Plan plus shares that were the subject of outstanding awards under the 2005 Plan, which again become available for grant under that plan. Thus, the 2011 Plan combines the 2011 Plan and the 2005 Plan. Under the 2011 Plan, we may grant stock options, stock appreciation rights, restricted stock, restricted stock units, and performance based awards to employees, consultants and directors. In addition, under the 2011 Plan, awards vest or become exercisable in installments determined by the compensation committee of our Board of Directors. The options granted under Prior Employee Plan expire as determined by the committee, but no later than ten years and one week after the date of grant (five years for 10 percent shareholders). The options granted under the 2011 and 2005 Plan expire as determined by the committee, but no later than ten years after the date of grant (five years for 10 percent shareholders). The options granted under the 2011 and 2005 Plan expire as determined by the committee, but no later than ten years after the date of grant (five years for 10 percent shareholders).

 

In the aggregate, Comarco has stock-based compensation plans under which outside directors, consultants, and employees are eligible to receive stock options and other equity-based awards. The stock option plans provide that officers, key employees, directors and consultants may be granted options to purchase up to 2,675,000 shares of common stock of the Company at not less than 100 percent of the fair market value at the date of grant, unless the grantee is a 10 percent shareholder of the Company, in which case the price must not be less than 110 percent of the fair market value.

 

 
10

 

 

COMARCO, INC. AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

 

Transactions and other information related to stock options granted under these plans for the nine months ended October 31, 2014 are summarized below:

 

   

Outstanding Options

 
           

Weighted-Ave.

 
   

Number of

   

Exercise

 
   

Shares

   

Price

 

Balance, January 31, 2014

    638,500     $ 1.22  

Options granted

    -       -  

Options canceled or expired

    (38,500 )     5.32  

Options exercise

    -       -  

Balance, October 31, 2014

    600,000     $ 0.96  

Stock Options Exercisable at October 31, 2014

    560,000     $ 0.95  

 

Transactions and other information related to restricted stock granted under these plans for the nine months ended October 31, 2014 are summarized below:

 

   

Outstanding Restricted

 
   

Stock Units

 
           

Weighted-Ave.

 
   

Number of

   

Exercise

 
   

Shares

   

Price

 

Balance, January 31, 2014

    420,000     $ 0.18  

Restricted stock granted

    -       -  

Restricted stock forfeited

    (30,000 )     0.18  

Balance, October 31, 2014

    390,000     $ 0.18  

 

As of October 31, 2014, the stock awards outstanding have an aggregate intrinsic value of $0, based on a closing market price of $0.17 per share on October 31, 2014. The following table summarizes information about the Company’s stock awards outstanding at October 31, 2014:

 

         

Awards Outstanding

   

Options Exercisable

 
                 

Weighted-Ave.

                         
 

Range of

   

Number

   

Remaining

   

Weighted-Ave.

   

Number

   

Weighted-Ave.

 
 

Exercise/Grant Prices

   

Outstanding

   

Contractual Life

   

Exercise/Grant Price

   

Exercisable

   

Exercise Price

 
  $ 0.40       465,000       7.95     $ 0.40       465,000     $ 0.40  
  $ 1.09       100,000       4.03       1.09       60,000       1.09  
  $ 4.90       15,000       3.33       4.90       15,000       4.90  
  $ 10.43       20,000       1.64       10.43       20,000       10.43  
            600,000               0.96       560,000       0.95  

 

At October 31, 2014, shares available for future grants under the 2011 Plan totaled 35,224.

 

5.

Net Income (Loss) Per Share

 

The Company calculates basic income (loss) per share by dividing net income (loss) by the weighted-average number of common shares outstanding during the reporting period. Diluted earnings (loss) per share reflects the effects of potentially dilutive securities. Since the Company incurred a net loss for the nine months ended October 31, 2013, basic and diluted loss per share for this period was the same because the inclusion of dilutive potential common shares related to outstanding stock awards in the calculation would have been antidilutive.

 

Potential common shares of 720,000 relating to outstanding stock awards to directors and employees have been excluded from diluted weighted average common shares for the nine months ended October 31, 2013, as the effect would have been antidilutive. Additionally, for the nine months ended October 31, 2013, the 1,704,546 outstanding warrants issued to Broadwood would have been anti-dilutive.

 

 
11

 

 

COMARCO, INC. AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

 

The following table presents reconciliations of the numerators and denominators of the basic and diluted loss per share computations for net loss. In the tables below, “Net income (loss)” represents the numerator and “Shares” represents the denominator (in thousands, except per share amounts):

 

   

Three Months Ended October 31,

   

Nine Months Ended October 31,

 
   

2014

   

2013

   

2014

   

2013

 
                                 

Net income (loss)

  $ (330 )   $ 551     $ 6,487     $ (1,717 )

Basic net income (loss) per share:

                               

Weighted-average shares outstanding-Basic

    14,684       14,470       14,684       14,300  

Basic net income (loss) per share

  $ (0.02 )   $ 0.04     $ 0.44     $ (0.12 )

Diluted net inome (loss) per share:

                               

Weighted average shares outstanding - basic

    14,684       14,470       14,684       14,300  

Effect of potentially dilutive securities

    202       74       146       -  

Weighted average shares outstanding - diluted

    14,886       14,544       14,830       14,300  

Diluted net income (loss) per share

  $ (0.02 )   $ 0.04     $ 0.44     $ (0.12 )

 

 

6.

Customer and Supplier Concentrations

 

Substantially all of the Company’s revenue was derived from a single customer, Lenovo, in fiscal 2014. As discussed in Note 2 above, in August 2013, Lenovo notified us of their intention to cease offering Comarco’s product to its customers. We shipped approximately 20,000 of our Constellation units to Lenovo and 11,000 field replacement units to Lenovo affiliates during our third quarter of fiscal 2014, and we have no further orders from Lenovo or their affiliates. The loss of Lenovo has had a material adverse impact on our revenues and results of operations.

 

The customers providing 10 percent or more of the Company’s revenue for any of the periods presented below are listed here:

 

   

(in thousands, except percentages)

 
   

Three Months Ended October 31,

   

Nine Months Ended October 31,

 
   

2014

   

2013

   

2014

   

2013

 

Total revenue

  $ -       0 %   $ 1,508       100 %   $ -       0 %   $ 4,429       100 %
                                                                 

Customer concentration:

                                                               

Lenovo Information Products Co., Ltd.

    -       0 %     1,465       97 %     -       0 %     4,319       98 %
    $ -       0 %   $ 1,465       97 %   $ -       0 %   $ 4,319       98 %

 

The suppliers comprising 10 percent or more of the Company’s gross accounts receivable due from suppliers at either October 31, 2014 or January 31, 2014 are listed below (in thousands, except percentages).

 

   

As of October 31,

   

As of January 31,

 
   

2014

   

2014

 

Total gross accounts receivable due from suppliers

  $ 122       100 %   $ 128       100 %

Accounts receivable concentration:

                               

Zheng Ge Electrical Co., Ltd.

  $ 122       100 %   $ 122       95 %
    $ 122       100 %   $ 122       95 %

 

 
12

 

 

COMARCO, INC. AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

 

Zheng Ge Electrical Co., Ltd. (“Zheng Ge”) was a tip supplier for the Bronx product, which was subject to a recall. We previously sourced some of the component parts that Zheng Ge used in the manufacture of the tips. We ceased paying Zheng Ge during the course of the product recall while we investigated the manufacturing defect which ultimately caused the recall and, likewise, Zheng Ge ceased paying us.

 

The companies comprising 10 percent or more of our gross accounts payable at either October 31, 2014 or January 31, 2014 are listed below (in thousands, except percentages).

 

   

As of October 31,

   

As of January 31,

 
   

2014

   

2014

 
                                 

Total gross accounts payable

  $ 746       100 %   $ 4,363       100 %

Supplier concentration:

                               

Chicony Power Technology, Co. Ltd.

  $ -       0 %   $ 1,100       25 %

Pillsbury Winthrop Shaw Pittman, LLP

    432       58 %     1,953       45 %
    $ 432       58 %   $ 3,053       70 %

 

Chicony Power Technology, Co. Ltd., (“Chicony”) was the manufacturer of the Bronx product, which was subject to a recall. We had been in litigation with Chicony (see Note 10). Effective May 15, 2014, Chicony entered into a settlement agreement with us that dismissed all claims between the two parties arising from the litigation. Pursuant to the terms of the settlement agreement, Chicony agreed to pay us $7.6 million in cash in lieu of the previous jury net award of $9.7 million or any other related costs or fees. $4.0 million of the settlement amount was paid on May 16, 2014, with the balance of $3.6 million paid on May 30, 2014. As a result of the settlement agreement, $1.1 million of contract manufacturer obligations to Chicony have been legally dismissed and reversed as of July 31, 2014. The dismissed obligations are reflected in Cost of Revenues for the nine months ended October 31, 2014.

 

Pillsbury Winthrop Shaw Pittman, LLP (“Pillsbury”) was our former legal counsel for the Kensington litigation as well as other patent and intellectual property matters (see Note 10). On May 28, 2014, we entered into an agreement with Pillsbury in which we paid Pillsbury a lump sum of $1.5 million and the remaining balance of $0.4 million (“the Balance”) was modified and is to be paid, if at all, in the event Comarco obtains any monetary recovery, whether through settlement, judgment or otherwise, from or as a result of the Targus Lawsuit and/or any of the additional lawsuits. The amount payable shall be equal to the Balance plus 20% per annum, compounded annually from the Effective Date of May 28, 2014. In connection with this partial repayment, no gain was recognized.

 

7.

Accrued Liabilities

 

Accrued liabilities consist of the following (in thousands):

 

   

October 31,

   

January 31,

 
   

2014

   

2014

 
                 

Uninvoiced materials and services received

  $ 331     $ 458  

Accrued legal and professional fees

    78       161  

Accrued payroll and related expenses

    31       58  

Accrued warranty

    20       20  

Other

    303       315  
    $ 763     $ 1,012  

 

 
13

 

 

COMARCO, INC. AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

  

As of October 31, 2014, approximately $0.3 million or 98 percent of total uninvoiced materials and services of $0.3 million, respectively, included in accrued liabilities, were payable to Zheng Ge Electrical Co. Ltd. (“Zheng Ge”).

 

8.

Loan and Related Agreements

 

Secured Loan Agreement with Elkhorn Partners.

 

On February 11, 2013, the Company and Elkhorn Partners Limited Partnership (“Elkhorn”), entered into a Secured Loan Agreement (the “Elkhorn Loan Agreement”) and a Stock Purchase Agreement (the “Elkhorn SPA”), and certain related agreements, which are described below (collectively, the “Elkhorn Agreements”). Pursuant to those Elkhorn Agreements, Elkhorn made a $1.5 million senior secured loan to the Company with a maturity date of November 30, 2014 and purchased a total of 6,250,000 shares of the Company’s common stock at a cash purchase price of $0.16 per share, generating an additional $1.0 million of cash for the Company. The average of the closing prices of the Company’s common stock in the over-the-counter market for the five trading days immediately preceding February 11, 2013 was $0.14 per share and, for the 29 trading days that began on January 2, 2013 and ended on February 8, 2013, was $0.158 per share. On February 11, 2013, the Company used approximately $2.1 million of the proceeds of $2.5 million from the Elkhorn Loan and the sale of the shares to Elkhorn to pay the entire principal amount of and all accrued interest on the Broadwood Loan. On June 3, 2014, the Company repaid the Elkhorn Loan Agreement in full.

  

The Elkhorn Loan, which was evidenced by a promissory note (the “Elkhorn Loan”), issued by the Company to Elkhorn, bore interest at 7% for the first 12 months of the Elkhorn Loan, increasing to 8.5% thereafter and continuing until the Elkhorn Loan was paid in full.

 

The Elkhorn Loan Agreement provided that if and to the extent the Company did not pay the Elkhorn Loan in full by its Maturity Date, then, Elkhorn would have had the right, at its option (but not the obligation), to convert the then unpaid balance of the Elkhorn Loan, in whole or in part, into shares of Company common stock at a conversion price of $0.25 per share. That conversion price was subject to possible adjustment on (i) certain sales of Company common stock at a price lower than $0.25 per share, (ii) stock splits of, stock dividends on and any reclassification of the Company’s outstanding shares, and (iii) certain mergers or reorganizations of the Company, as provided in Article III of the Elkhorn Loan Agreement. This conversion feature created a derivative liability that is described in Note 9.

 

Elkhorn Stock Purchase Agreement

 

Concurrently with the Company’s entry into the Elkhorn Loan Agreement, the Company and Elkhorn entered into the Elkhorn SPA Agreement. Pursuant to that Elkhorn SPA Agreement, the Company sold 6,250,000 shares of its common stock to Elkhorn at a price of $0.16 per share, resulting in an aggregate purchase price of $1.0 million.

 

Senior Secured Six Month Term Loan Agreement and Stock Purchase Agreement

 

The Company entered into a Senior Secured Six Month Term Loan Agreement dated July 27, 2012 (the “Broadwood Loan Agreement”) with Broadwood, a partnership managed by Broadwood Capital, Inc., the general partner of Broadwood. Broadwood is a significant shareholder of the Company.

 

Pursuant to that Broadwood Loan Agreement, Broadwood made a $2,000,000 senior secured six month loan (the “Broadwood Loan”) to the Company and to CWT, as co-borrower. The Broadwood Loan bore interest at 5% per annum, ranked senior in right of payment to all other indebtedness of the Company and was due and payable in full on January 28, 2013.

 

 
14

 

 

COMARCO, INC. AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

 

Stock Purchase Agreement and Stock Purchase Warrants

 

Concurrently with the execution of the Broadwood Loan Agreement, the Company and Broadwood entered into the Broadwood SPA. That agreement provided for the purchase by Broadwood of up to 3,000,000 shares of the Company’s common stock (the “Shares”), at a price of $1.00 per Share, subject to the following conditions: (i) during the six month term of the Broadwood Loan, the Company would use its best commercial efforts to raise at least $3.0 million from the sale of additional equity securities to other investors, which could include other shareholders of the Company, and (ii) the Company remained in compliance with its covenants under the Broadwood Loan Agreement. The Broadwood SPA provided that if, at any time between July 27, 2012 and July 27, 2013, the Company sold any shares of its common stock (or sells or issues securities that are convertible or exercisable into shares of common stock) at a price less than $1.00 per share, the Company would be required to issue outright to Broadwood, without additional consideration from it, a number of additional Shares (the “Make-Whole Shares”) sufficient to reduce the per share price paid by Broadwood for the total number of the Shares and Make-Whole Shares issued under the Broadwood SPA to that lower price.

 

As consideration for the Broadwood Loan and Broadwood’s entry into the Broadwood SPA, on July 27, 2012 the Company issued stock purchase warrants (the “Warrants”) to Broadwood entitling it to purchase up to a total of 1,704,546 shares of the Company’s common stock (the “Warrant Shares”), at a price of $1.00 per Warrant Share, at any time through July 2020.

 

On July 27, 2012, the Company also entered into a Warrant Commitment Letter, which provided that if the Company raised less than $3.0 million from sales of equity securities to other investors during the six month term of the Broadwood Loan, then Broadwood will receive an additional Warrant (the “Additional Warrant”) entitling it to purchase, also at a price of $1.00 per share, an amount of shares of the Company’s common stock to be determined based on a formula in the Warrant Commitment Letter, with such amount not to exceed 1,000,000 additional shares (the amount of such additional shares, “Additional Warrant Shares”). The exercise price is to be adjusted if the Company completed subsequent financings at less than the current exercise price as described below.

 

The Warrants, including the Additional Warrant, provide that if the Company sold shares of its common stock (or any securities that were convertible or exercisable into shares of Company common stock) at a price less than $1.00 per share, then, subject to certain exceptions (including grants of stock incentives and sales of shares to officers, employees or directors under the Company’s equity incentive plans and issuances of shares in business acquisitions), the exercise price of the Warrants, including the Additional Warrant, then outstanding would be reduced to that lower price and the number of Warrant Shares purchasable by Broadwood on exercise of the Warrants and the Additional Warrant will be proportionately increased. The Warrants and the Additional Warrant were accounted for as derivative liabilities resulting from the instruments’ price protection features.

 

The Warrants and the Additional Warrant (collectively, the “Broadwood Warrants”) also grant to Broadwood the right to require the Company (i) to register the Warrant Shares under the Securities Act of 1933, as amended (the “Securities Act”) for possible resale and (ii) to include the Warrant Shares in any registration statement that the Company may file to register, under the Securities Act, the sale of Company shares for cash.

 

The Company was informed by Broadwood on January 28, 2013, that it was Broadwood’s position that one or more of the conditions precedent to its obligation to purchase the Company’s shares pursuant to the Broadwood SPA had not been satisfied and, as a result, Broadwood would not consummate that purchase.

 

The Company’s position was that, contrary to Broadwood’s assertions, all of the conditions under the Broadwood SPA had been satisfied, and Broadwood’s refusal to purchase 3,000,000 shares of Company common stock, at the price of $1.00 per share, constituted a material breach by Broadwood of its obligations under the Broadwood SPA. As a result, as of the date of filing this report, the Company had not issued any Additional Warrant Shares to Broadwood and each party had reserved its rights under and with respect to the Broadwood SPA and the Broadwood Warrants.

 

On August 13, 2014, the Company and Broadwood entered into an Amendment and Release Agreement that resolves the disputes between the Company and Broadwood concerning the Stock and Warrant Documents and related matters. Pursuant to the Amendment and Release Agreement, the Company issued Broadwood a new stock purchase warrant (“New Warrant”) entitling it to purchase up to a total of 2,350,000 shares of the Company’s common stock, at a price of $0.16 per share, in exchange for cancellation of the Original Warrants and any obligation of the Company to issue the Additional Warrant. The New Warrant expires on July 27, 2020. In addition, the Company and Broadwood released each other from any and all claims concerning the Stock and Warrant Documents and related matters. The derivative liability associated with the Broadwood warrants was reversed on the cancellation date.The replacement warrants qualified for classification as equity and added to additional paid – in capital. 

 

 
15

 

 

COMARCO, INC. AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

 

9.

Fair Value Measurements

 

We follow FASB ASC 820, "Fair Value Measurements and Disclosures" (“ASC 820”), in connection with assets and liabilities measured at fair value on a recurring basis subsequent to initial recognition. The guidance applies to our derivative liabilities. We had no assets or liabilities measured at fair value on a non-recurring basis for any period reported.

 

ASC 820 requires that assets and liabilities carried at fair value will be classified and disclosed in one of the following three categories. We measure the fair value of applicable financial and non-financial assets based on the following fair value hierarchy:

 

Level 1: Quoted market prices in active markets for identical assets or liabilities.

 

Level 2: Observable market based inputs or unobservable inputs that are corroborated by market data.

 

Level 3: Unobservable inputs that are not corroborated by market data.

 

The hierarchy noted above requires us to minimize the use of unobservable inputs and to use observable market data, if available, when determining fair value.

 

The fair value of our recorded derivative liabilities is determined based on unobservable inputs that are not corroborated by market data, which is a Level 3 classification. We record derivative liabilities on our balance sheet at fair value with changes in fair value recorded in our consolidated statements of operations.

 

The table below sets forth a summary of changes in the fair value of our Level 3 financial instruments for the nine months ended October 31, 2014 (in thousands):

 

            Change in estimated    

Change in estimated

         
           

fair value recognized

   

fair value recognized

         
   

February 1,

   

in results of

   

in equity due to

   

October 31,

 

Description

 

2014

   

operations

   

replacement

   

2014

 
                                 

Broadwood warrants

  $ 2,426     $ (132 )   $ (2,294 )   $ -  

Elkhorn conversion features

    94       (94 )     -       -  
    $ 2,520     $ (226 )   $ (2,294 )   $ -  

 

On August 13, 2014, the Company entered into an Amendment and Release Agreement that canceled of the Broadwood warrants. The derivative liability associated with the Broadwood warrants was reversed on the cancellation date.The replacement warrants qualified for classification as equity and added to additional paid – in capital. 

 

On June 3, 2014, the Company repaid the Elkhorn Loan in full and as a result, the discount to the loan payable and related derivative liability were extinguished and charged to earnings.

 

 
16

 

 

COMARCO, INC. AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

 

The table below sets forth a summary of changes in the fair value of our Level 3 financial instruments for the nine months ended October 31, 2013 (in thousands):

 

   

February 1,
2013

   

Recorded New Derivative
Liabilities

   

Change in estimated fair value recognized in results of operations

   

October 31,
2013

 
                                 

Derivative liabilities

  $ 2,466     $ 624     $ (271 )   $ 2,819  

 

 

10.

Commitments and Contingencies

 

Executive Severance Commitments

 

We have a severance compensation agreement with our key executive. This agreement requires us to pay this executive, in the event of a termination of employment following a change of control of the Company or other circumstances, the amount of his then current annual base salary and the amount of any bonus amount the executive would have achieved for the year in which the termination occurs plus the acceleration of unvested options. We have not recorded any liability in the consolidated financial statements for this agreement.

 

Additionally, as a result of the Company’s sale of the 6,250,000 shares of common stock to Elkhorn (see Note 8), Elkhorn’s beneficial ownership of the Company has increased from approximately 9% to approximately 49% of the Company’s outstanding voting stock, making Elkhorn the Company’s largest shareholder and resulting in a change of control for purposes of the severance compensation agreement. The executive who is party to this agreement has waived his right to receive payments under this agreement as a result of the change in Elkhorn’s beneficial ownership of the Company.

 

Executive and Board of Directors Compensation

 

On November 2, 2013, the Company approved a deferred compensation plan for its Chief Executive Officer and Board of Directors. As of October 31, 2014, no compensation expense has been accrued under this deferred compensation plan as its goal has not yet been attained.

 

Legal Contingencies

 

On March 10, 2014, we filed a lawsuit against Targus Group International, Inc. for patent infringement, breach of contract, intentional interference with contract, violation of business and professional codes, misrepresentation and fraudulent concealment. We are seeking damages of at least $17 million. Although we intend to vigorously pursue our rights in this case, the outcome of this matter is not determinable as of the date of this report.

 

On April 26, 2011, Chicony, the contract manufacturer of the Bronx product that was the subject of a product recall, filed a complaint against us for breach of contract, seeking payment of $1.2 million for the alleged non-payment by us of amounts alleged by Chicony to be due it for products purchased from it by the Company. We denied liability and filed a cross-complaint on May 13, 2011 seeking the recovery of damages of $4.9 million caused by Chicony's failure to adhere to our technical specifications when manufacturing the Bronx product, which we believe resulted in the recall of the product. On April 16, 2013, the court approved our first-amended cross-complaint, which added intentional interference to our complaint and increased the damages we were seeking to at least $15.0 million. The trial date was held in October, 2013. In an effort to resolve this litigation before the previous trial date of April, 2013, we sent Chicony a settlement offer, which has since lapsed. On February 4, 2014, a jury returned a verdict in our favor and awarded us damages of approximately $10.8 million, offset by previously accrued liabilities of $1.1 million for a net award of approximately $9.7 million. Effective as of May 15, 2014, Chicony entered into a settlement agreement with us that dismisses all claims between the parties arising from the litigation referenced above. Pursuant to the terms of the settlement agreement, Chicony agreed to pay us $7.6 million in lieu of the jury’s net award of $9.7 million or any other related costs or fees. $4.0 million of the settlement amount was paid to us on May 16, 2014, with the balance of $3.6 million paid to us on June 2, 2014. We recorded a gain of $7.6 million associated with this settlement in the quarter ended July 31, 2014. As a result of the settlement agreement, the $1.1 million payable to Chicony for contract manufacturing costs has been legally dismissed and discharged and recorded as an offset to Cost of Revenues in the quarter ended July 31, 2014.

 

 
17

 

 

COMARCO, INC. AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

 

Further pursuant to the settlement agreement, each party released the other and its affiliates from any and all claims related to the subject matter of the litigation and we covenanted not to sue Chicony on the next 500,000 power adapters sold by Chicony after May 15, 2014 that we allege infringe on our intellectual property rights. The settlement agreement also contains other representations, warranties and covenants of both parties that are customary for an agreement of this type.

 

On September 1, 2011, subsequent to receiving an infringement notification from us, ACCO Brands USA LLC and its Kensington Computer Products Group division (collectively “Kensington”) filed a lawsuit against us alleging that five of our patents relating to power technology are invalid and/or not infringed by products made and/or sold by Kensington. On February 29, 2012, we denied these claims and filed a cross-complaint alleging infringement by Kensington of each of these five patents. A number of these patents are currently the subject of re-examination proceedings initiated by Kensington or other third parties. On February 4, 2014, Kensington entered into a settlement and licensing agreement with the Company with an effective date of February 1, 2014 that dismisses all claims between the two parties arising from the litigation referenced above.

 

On March 6, 2012, we filed a lawsuit against EDAC Power Electronics Co. Ltd (“EDAC”) for breach of contract seeking payment of $2.5 million for the failure to deliver goods ordered by us in the time, place, manner and price indicated by each purchase order. As previously reported, the parties entered into a Settlement Agreement on July 24, 2012, ending the litigation between the parties. The settlement involved no cash payments by either of the parties, but allowed us to recover previously incurred product and freight costs and to discharge net liabilities of $1.4 million from our consolidated balance sheet that would otherwise have been due to EDAC had it prevailed in the lawsuit. The settlement resulted in a decrease to cost of revenue of $1.4 million during the fiscal year ended January 31, 2013.

 

In addition to the pending matters described above, we are, from time to time, involved in various legal proceedings incidental to the conduct of our business. We are unable to predict the ultimate outcome of these matters.

 

 
18

 

  

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 interim condensed consolidated financial statements and the related notes and other financial information appearing elsewhere in this quarterly report on Form 10-Q.

 

Forward-Looking Statements

 

The condensed financial statements have been prepared assuming that we will continue to operate as a going concern, which contemplates that we will realize value from our assets and satisfy our liabilities and commitments in the ordinary course of business. Our consolidated financial statements do not reflect any adjustments related to the outcome of this uncertainty. Our future is highly dependent on our ability to successfully resolve our current litigation, capitalize on our portfolio of patents, generate positive cash flows and obtain borrowings or raise capital to meet our liquidity needs. 

 

This report on Form 10-Q, including the section entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” contains statements relating to our future plans and developments, financial goals and operating performance that are based on our current beliefs and assumptions. These statements constitute “forward-looking statements” within the meaning of federal securities laws. Words such as “expects,” “anticipates,” “intends,” “plans,” “believes,” “seeks,” “estimates,” “could,” “may,” “should,” and similar expressions or variations of such words are intended to identify forward-looking statements, but are not deemed to represent an all-inclusive means of identifying forward-looking statements as denoted in this report. Additionally, statements concerning future matters are forward-looking statements.

 

Although forward-looking statements in this report reflect the good faith judgment of our management, such statements are only based on facts and factors known by us as of the date of this report. Consequently, forward-looking statements are inherently subject to risks and uncertainties and actual results and outcomes may differ materially from the results and outcomes discussed in or anticipated by the forward-looking statements. Factors that could cause or contribute to such differences in results and outcomes include, without limitation, those specifically addressed under the section below entitled “Risk Factors,” as well as those discussed elsewhere in this report and in our other filings” with the Securities and Exchange Commission, or the SEC. Readers are urged not to place undue reliance on these forward-looking statements, which speak only as of the date of this report.

 

We undertake no obligation to revise or update any forward-looking statements in order to reflect any event or circumstance that may arise after the date of this report, whether as a result of new information, future events or otherwise, except as required by law. Readers are urged to carefully review and consider the various disclosures made throughout the entirety of this report, which attempt to advise interested parties of the risks and factors that may affect our business, financial condition, results of operations, and prospects.

 

In addition to the risks, uncertainties, and other factors discussed above or elsewhere in this report, additional risks, uncertainties, and other factors that could cause or contribute to actual results differing materially from those expressed or implied in any forward-looking statements include, without limitation, those set forth under Part I, Item 1A “Risk Factors” in the Company’s Annual Report on Form 10-K for the fiscal year ended January 31, 2014 filed with the SEC and those contained in the Company’s other filings with the SEC. Readers of this report are urged to review the descriptions of the risks, uncertainties and other factors contained in those other reports.

 

Going Concern Qualification

 

The condensed financial statements have been prepared assuming that we will continue to operate as a going concern, which contemplates that we will realize value from our assets and satisfy our liabilities and commitments in the ordinary course of business. Our consolidated financial statements do not reflect any adjustments related to the outcome of this uncertainty. Our future is highly dependent on our ability to successfully resolve our current litigation, capitalize on our portfolio of patents, generate positive cash flows and obtain borrowings or raise capital to meet our liquidity needs. 

 

We generated de minimis revenue during the first nine months ended October 31, 2014. As previously announced in August 2013, Lenovo Information Products Co., Ltd. (“Lenovo”), our only material customer, notified us of their intention to cease offering our Constellation product, the power adapter we designed and developed for Lenovo, and terminated its relationship with us. We completed shipping product to Lenovo during our third quarter ended November 30, 2013. The loss of Lenovo as a customer has had a material adverse impact on our results of operations. We have reduced and/or eliminated certain operating expenses to minimize future losses and cash burn and will continue our efforts in this regard.

 

Two of our recent litigation matters have concluded. In the Chicony Power Technology, Co. Ltd., (“Chicony”) matter, effective as of May 15, 2014, Chicony entered into a settlement agreement with us that dismissed all claims between the two parties arising from the litigation. Pursuant to the terms of the settlement agreement, Chicony agreed to pay us $7.6 million in lieu of the jury’s net award of $9.7 million or any other related costs or fees. $4.0 million of the settlement amount was paid on May 16, 2014, with the balance of $3.6 million paid on May 30, 2014. Of the $7.6 million, we received $6.5 million, net of attorneys’ fees and other costs. In our litigation with ACCO Brands USA LLC and its Computer Products Group division (collectively “Kensington”), on February 4, 2014, we entered into a settlement and licensing agreement with an effective date of February 1, 2014 that dismisses all claims between the two parties arising from this matter. As part of the settlement and licensing agreement with Kensington, we recorded $0.2 million in other income, net during the nine months ended October 31, 2014.

 

 
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We believe our patent portfolio covering key technical aspects of our products could potentially generate a future revenue stream based upon royalties paid to us by others for the use of some or all of our patents in third party products. We continue to explore opportunities to expand, protect, and monetize our patent portfolio, including through the sale or licensing of our patent portfolio. In the future, we may resume our traditional activities, if and when possible. However, there are no assurances that any of these possible opportunities will occur or be successful.

 

We had working capital totaling approximately $1.1 million as of October 31, 2014. We believe that this working capital will allow us to discharge liabilities and commitments in the normal course of business over the next twelve months.  

 

We continue to analyze a range of alternatives to build and/or preserve value for its stakeholders, including, but not limited to, exploring additional investment and incremental financing from current and/or new investors, the engagement of advisors to assist in exploring strategic options for us as well as identifying potential partnerships for the purpose of monetizing some or all of the our patent portfolio and past, present, and future infringement claims. There can be no assurances that we will be successful in implementing any of these alternatives, or if implemented, that any of these alternatives will successfully preserve or increase shareholder value. 

 

Basis of Presentation

 

The condensed consolidated results of our operations presented in this report are not audited and are not necessarily indicative of the results to be expected for the entirety of the fiscal year ending January 31, 2015 or any other interim period during such year. Our fiscal year ends on January 31 and our fiscal quarters end on April 30, July 31, and October 31. Unless otherwise stated, all dates refer to our fiscal year and those fiscal quarters.

 

Executive Summary

 

Comarco, Inc. was incorporated in California in 1960 and its common stock has been publicly traded since 1971, when it was spun-off from Genge Industries, Inc. Comarco Inc.’s wholly-owned subsidiary Comarco Wireless Technologies, Inc. (“CWT”) was incorporated in the state of Delaware in September 1993. Comarco and CWT are collectively referred to as “we,” “us,” “our,” “Comarco,” or the “Company”.

 

Through the third quarter of fiscal year 2014, we developed and designed innovative technologies and intellectual property that was used in power adapters to power and charge battery powered devices such as laptop computers, tablets, smart phones and readers. In August 19, 2013, Lenovo, our only material customer, informed us that it intended to cease offering our Constellation product, the power adapter we designed and developed for Lenovo. Sales of the Constellation product to Lenovo accounted for materially all of our revenue for the fiscal year 2014, and terminated its relationship with us. We anticipate that we will generate de minimis revenue in future periods from the development, design, distribution or sale of any products. We have effectively suspended traditional operations and are now primarily focused on realizing the potential value from our ongoing litigation as well as exploring opportunities to expand, protect, and monetize our patent portfolio, including through the potential sale or licensing of our patent portfolio.

 

 
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In addition to the risks, uncertainties and factors discussed elsewhere in this quarterly report on Form 10-Q and in the Company’s other filings with the SEC, management currently considers the following additional trends, events, and uncertainties to be important to understanding our results of operations for the nine months and quarter ended October 31, 2014:

 

 

Effective as of May 15, 2014, Chicony entered into a settlement agreement with us that dismissed all claims between the parties arising from the litigation referenced above. Pursuant to the terms of the settlement agreement, Chicony agreed to pay us $7.6 million in lieu of the jury’s net award of $9.7 million or any other related costs or fees. $4.0 million of the settlement amount was paid to us on May 16, 2014, with the balance of $3.6 million paid to us on June 2, 2014.

 

 

We are currently analyzing and will continue to analyze a range of alternatives to preserve and/or build value for our stakeholders, including, but not limited to, exploring additional investment and incremental financing from current and/or new investors, the engagement of advisors to assist in exploring strategic options for us as well as identifying potential partnerships for the purpose of monetizing some or all of our patent portfolio and past, present, and future infringement claims. There can be no assurances that we will be successful in implementing any of these alternatives, or if implemented, that any of these alternatives will successfully preserve or increase shareholder value.

 

 

We generated de minimis revenue for nine months ended October 31, 2014 compared to $4.4 million for nine months ended October 31, 2013. The decrease is attributable to decreased sales to our principal customer Lenovo. In the third quarter of fiscal 2014, Lenovo terminated its relationship with us. We completed our final shipment of product to Lenovo during the third quarter ended October 31, 2013. We anticipate that we will generate de minimis revenue from the development, design, distribution or sale of any products.

 

 

On March 10, 2014, we filed a lawsuit against Targus Group International, Inc. (“Targus”) for patent infringement, breach of contract, intentional interference with contract, violation of business and professional codes, misrepresentation and fraudulent concealment. We are seeking damages of at least $17 million. However, the outcome of this matter is not determinable as of the date of this report.

 

 

We were previously party to litigation with ACCO Brands USA LLC and its Kensington Computer Products Group division (collectively “Kensington”). On February 4, 2014, Kensington entered into a settlement and licensing agreement with us with an effective date of February 1, 2014 that dismisses all claims between the two parties arising from this matter.

 

 

On August 6, 2013, we changed our legal representation with respect to our ongoing intellectual infringement and enforcement litigation and entered an alternative fee arrangement in order to reduce our legal expenses.

 

 

On February 11, 2013, we entered into a Secured Loan Agreement (the “Loan Agreement”) with Elkhorn Partners Limited Partnership (“Elkhorn”). Pursuant to the Loan Agreement, on February 11, 2013, Elkhorn made a $1,500,000 senior secured term loan (the “Elkhorn Loan”) to us.  The Elkhorn Loan bore interest at 7% per annum for the first year; increasing to 8.5% per annum thereafter, ranked senior in right of payment to all of our other indebtedness, was secured by a first priority security interest in all of the assets of Comarco and CWT, and was due and payable in full on November 30, 2014. See Note 8 to our consolidated financial statements contained elsewhere in this report for additional information regarding the Loan Agreement, the Loan and certain related agreements. On June 3, 2014, the Company repaid the Elkhorn Loan in full.

 

 
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Concurrent with the execution of the Loan Agreement, Elkhorn entered into a Stock Purchase Agreement with us (the “Stock Purchase Agreement”). Pursuant to that Stock Purchase Agreement, we sold 6,250,000 shares of our common stock to Elkhorn at a price of $0.16 per share, resulting in an aggregate purchase price of $1.0 million. The purchase price of $0.16 per share paid by Elkhorn for those shares was determined by arms-length negotiations between Elkhorn and the members of a special committee of our Board of Directors, comprised of three of the directors who have no affiliation with Elkhorn and no financial interest, other than their interests solely as our shareholders, in either the loan or share transactions with Elkhorn. See Note 8 to our consolidated financial statements contained elsewhere in this report for additional information regarding the Stock Purchase Agreement and certain related agreements.

 

 

As a result of our sale of the 6,250,000 shares of common stock to Elkhorn pursuant to the Elkhorn Stock Purchase Agreement, Elkhorn’s beneficial ownership increased from approximately 9% to approximately 49% of our outstanding voting stock, making Elkhorn our largest shareholder.

 

 

On August 13, 2014, the Company and Broadwood entered into an Amendment and Release Agreement that resolves the disputes between the Company and Broadwood concerning the Stock and Warrant Documents and related matters. Pursuant to the Amendment and Release Agreement, the Company issued Broadwood a new stock purchase warrant (“New Warrant”) entitling it to purchase up to a total of 2,350,000 shares of the Company’s common stock, at a price of $0.16 per share, in exchange for cancellation of the Original Warrants and any obligation of the Company to issue the Additional Warrant. The New Warrant expires on July 27, 2020. In addition, the Company and Broadwood released each other from any and all claims concerning the Stock and Warrant Documents and related matters.

 

Critical Accounting Policies

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations is based upon our unaudited interim condensed consolidated financial statements appearing elsewhere in this report, which have been prepared in accordance with GAAP. The preparation of these unaudited interim condensed consolidated financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, and expenses, and related disclosure of contingent assets and liabilities. Management bases its estimates on historical experience and on various other assumptions that it believes to be reasonable under the circumstances. The results of these estimates form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ materially from our estimates.

 

An accounting policy is deemed to be critical if it requires an accounting estimate to be made based on assumptions about matters that are highly uncertain at the time the estimate is made, and if different estimates that reasonably could have been used or changes in the accounting estimate that are reasonably likely to occur could materially change the financial statements. Management believes there have been no significant changes during the nine months ended October 31, 2014 to the items that we disclosed as our critical accounting policies and estimates in Management’s Discussion and Analysis of Financial Condition and Results of Operations in our annual report on Form 10-K for the fiscal year ended January 31, 2014.

 

 
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Results of Operations

 

The following tables set forth certain items as a percentage of revenue from our unaudited interim condensed consolidated statements of operations for the three and nine months ended October 31, 2014 and 2013:

 

   

(in thousands)

   

(in thousands)

                 
   

Three Months Ended October 31,

   

Nine Months Ended October 31,

   

Year over Year

 
   

2014

   

2013

   

2014

   

2013

   

Three Months

   

Nine Months

 
                                                 

Revenue

  $ -     $ 1,508     $ -     $ 4,429       -100 %     -100 %

Operating loss

  $ (330 )   $ (331 )   $ (19 )   $ (1,708 )     0 %     -99 %

Net income(loss)

  $ (330 )   $ 551     $ 6,487     $ (1,717 )     -160 %     -478 %

 

Revenue by Geographic Region

 

   

(in thousands)

   

(in thousands)

                 
   

Three Months Ended October 31,

   

Nine Months Ended October 31,

   

Year over Year

 
   

2014

   

2013

   

2014

   

2013

   

Three Months

   

Nine Months

 
                                                 

Revenue:

                                               

Asia-Pacific

  $ -     $ 1,407     $ -     $ 4,183       -100 %     -100 %

North America

    -       75       -       208       -100 %     -100 %

Europe

    -       26       -       38       -100 %     -100 %
    $ -     $ 1,508     $ -     $ 4,429       -100 %     -100 %

 

The revenue by geographic region is determined by the ship to address. Sales to Lenovo, our former customer, were shipped to a fulfillment center in China, but their customers, the end-users of our products, are located domestically, as well as internationally.

 

Revenue by Customer

 

   

(in thousands)

   

(in thousands)

                 
   

Three Months Ended October 31,

   

Nine Months Ended October 31,

   

Year over Year

 
   

2014

   

2013

   

2014

   

2013

   

Three Months

   

Nine Months

 
                                                 

Revenue:

                                               

Lenovo

  $ -     $ 1,465     $ -     $ 4,319       -100 %     -100 %

Other

    -       43       -       110       -100 %     -100 %
    $ -     $ 1,508     $ -     $ 4,429       -100 %     -100 %

 

Revenue was $0 for the three and nine months ended October 31, 2014, a decrease of $1.5 million and $4.4 million, respectively, compared to the corresponding periods of fiscal 2014. Substantially all of the revenue shown for “Asia-Pacific” in the table above was from Lenovo. In August 2013, we received notification from Lenovo of its intent to cease offering our products to its customers. We shipped the remaining units to Lenovo during our third fiscal quarter of fiscal 2014, and we do not expect to receive any further orders or revenue from Lenovo.

 

 
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Cost of Revenue and Gross Margin

 

   

(in thousands)

   

(in thousands)

                 
   

Three Months Ended October 31,

   

Nine Months Ended October 31,

                 
   

2014

   

2013

   

2014

   

2013

   

Year over Year

 
           

% of Total

           

% of Total

           

% of Total

           

% of Total

   

Three Months

   

Nine Months

 

Cost of Revenue:

                                                                               

Product costs

  $ -       0 %   $ 1,075       69 %   $ -       0 %   $ 3,101       77 %     -100 %     -100 %

Supplier Settlement

    -       0 %     -       0 %     (1,099 )     100 %     -       0 %     0 %     0 %

Supply chain overhead

    -       0 %     175       11 %     -       0 %     526       13 %     -100 %     -100 %

Inventory reserve and scrap charges

    -       0 %     317       20 %     -       0 %     402       10 %     -100 %     -100 %
    $ -       0 %   $ 1,567       100 %   $ (1,099 )     100 %   $ 4,029       100 %     -100 %     -127 %

 

Cost of revenue for the three and nine months ended October 31, 2014 decreased by $1.6 million and $5.1 million, respectively, compared to the corresponding periods of fiscal 2014. The decrease is a result of us having $0 in revenue during those periods and the settlement agreement with Chicony on May 14, 2014. As a result of this settlement agreement, the previously accrued obligation of $1.1 million to Chicony was legally dismissed and was reversed during the nine months ended October 31, 2014.

 

Operating Costs and Expenses

 

   

(in thousands)

   

(in thousands)

                 
   

Three Months Ended October 31,

   

Nine Months Ended October 31,

                 
   

2014

   

2013

   

2014

   

2013

   

Year over Year

 
           

% of Rev

           

% of Rev

           

% of Rev

           

% of Rev

   

Three Months

   

Nine Months

 

Operating expenses:

                                                                               

Selling, general and administrative expenses, excluding corporate overhead

  $ 132       0 %   $ 8       1 %   $ 532       0 %   $ 190       4 %     1550 %     180 %

Corporate overhead

    109       0 %     195       13 %     303       0 %     2,113       48 %     -44 %     -86 %

Engineering and support expenses

    89       0 %     69       5 %     283       0 %     1,884       43 %     29 %     -85 %
    $ 330       0 %   $ 272       18 %   $ 1,118       0 %   $ 4,187       95 %     21 %     -73 %

 

Selling, general, and administrative (“SG&A”) expenses for the three and nine months ended October 31, 2014 remained consistent at $0.3 million and decreased by $3.0 million, respectively, as compared to the corresponding periods of fiscal 2014. We had no employees in our sales and marketing department during the three and nine months ended October 31, 2014.

 

Corporate overhead consists of the salary of our one employee, our Chief Executive Officer and President, as well as professional fees, directors’ fees, and other costs and expenses attributable to being a public company.

 

For the three and nine months ended October 31, 2014, engineering and support expenses consisted of legal expenses incurred related to our intellectual property, including associated litigation expense and maintenance of our patent portfolio.

 

In the three and nine months ended October 31, 2013, engineering and support expenses consisted of salaries, employer paid benefits, and other personnel related costs of our design engineers and testing and support personnel, as well as facility and IT costs, professional and consulting fees, lab costs, material usages, and travel and related costs incurred in the development and support of our products.

 

Interest Expense

 

The current and prior year interest expense relates to interest expense as well as amortization expense of the debt discount on the Elkhorn Loan. On June 3, 2014, the Company repaid the Elkhorn Loan in full.  

 

 
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Other Income, net

 

During the three and nine months ended October 31, 2014, other income, net, consisted of $0 and $6.7 million, respectively. During the nine months ended October 31, 2014, we settled and were paid $7.6 million from Chicony in lieu of the jury’s net award of $9.7 million. As a result of this settlement agreement, the previously accrued obligation of $1.1 million to Chicony was legally dismissed and was reversed during the nine months ended October 31, 2014. In addition, we received $0.2 million from a settlement and licensing agreement during the nine months ended October 31, 2014.

 

During the nine months ended October 31, 2013, other income, net, consisted of $5,000 in proceeds from the State of California from funds that had previously been escheated to the state.

 

Income Tax Expense

 

Significant management judgment is required in determining our provision for income taxes, our deferred tax assets and liabilities and any required valuation allowance. We continue to maintain a full valuation allowance on the entire deferred tax asset balance. This valuation allowance was established based on management’s overall assessment of risks and uncertainties related to our future ability to realize, and hence, utilize certain deferred tax assets, primarily consisting of net operating loss carry forwards and temporary differences. Due to the current and prior years’ operating losses, the adjusted net deferred tax assets remained fully reserved as of October 31, 2014.

  

Liquidity and Capital Resources

 

Cash and cash equivalents at October 31, 2014 increased $1.3 million to $2.4 million as compared to $205,000 at October 31, 2013. The following table is a summary of our Condensed Consolidated Statements of Cash Flows.

 

   

(in thousands)

 
   

Nine Months Ended October 31,

 
   

2014

   

2013

 
                 

Cash provided by (used in):

               

Operating activities

  $ 2,769     $ (448 )

Investing activites

  $ 77     $ 19  

Financing activities

  $ (1,500 )   $ 530  

 

Operating Activities

 

Cash provided by operating activities was $2.8 million for the nine months ended October 31, 2014 and was primarily driven by our net income of $8.8 million offset by cash used to pay accounts payable of $3.6 million and non-cash change in the fair value of derivative liability of $2.5 million.

 

Cash used in operating activities of $0.5 million for the nine months ended October 31, 2013 and was driven by our operating loss of $1.7 million offset by non-cash inventory scrap charges of $368,000 and loan discount amortization of $206,000. Additionally, the Company had net cash collections from combined receivables of $352,000 and an increase on a combined basis of our accounts payable and accrued liabilities of $362,000.

 

Investing Activities

 

During the nine months ended October 31, 2014, our letter of credit that served as the security deposit for our corporate office lease expired.

 

 
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During the nine months ended October 31, 2013, we purchased $9,000 of property and equipment, which was primarily tooling and equipment used for the manufacture of our ChargeSource® products. During the third quarter of fiscal 2014 we sold some equipment for $28,000, net.

 

Financing Activities

 

On June 3, 2014, the Company repaid the amounts outstanding under the Elkhorn Loan Agreement (described below) in full of $1.5 million.

 

On February 11, 2013, we and Elkhorn Partners Limited Partnership (“Elkhorn”), entered into a Secured Loan Agreement (the “Elkhorn Loan Agreement”) and a Stock Purchase Agreement (the “Elkhorn SPA”), and certain related agreements (collectively, the “Elkhorn Agreements”). Pursuant to those agreements, Elkhorn made a $1.5 million senior secured loan to us with a maturity date of November 30, 2014 (the “Elkhorn Loan”) and purchased a total of 6,250,000 shares of our common stock at a cash purchase price of $0.16 per share, generating an additional $1.0 million of cash for the Company. On February 11, 2013, we used approximately $2.1 million of the proceeds of $2.5 million from the Elkhorn Loan and the sale of the shares to Elkhorn to pay the entire principal amount of and all accrued interest on the Broadwood Loan.

 

Uncertainties Regarding Future Operations and Liquidity Requirements for the Next 12 Months

 

As of October 31, 2014, we had working capital of approximately $1.1 million. We believe that this working capital will allow us to discharge liabilities and commitments in the normal course of business over the next twelve months. However, as discussed elsewhere in this report, we are currently generating de minimis revenues and have ceased traditional operations. Our future is highly dependent on our ability to successfully resolve our current litigation, capitalize on our portfolio of patents, generate positive cash flows and obtain borrowings or raise capital to meet our future liquidity needs.

 

 
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ITEM 4.

CONTROLS AND PROCEDURES

 

Evaluation of Disclosure Controls and Procedures

 

We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our reports under the Securities Exchange Act of 1934, as amended (the “Exchange Act”) is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to management, including our Chief Executive Officer (Principal Executive Officer) and Chief Accounting Officer (Principal Financial Officer), to allow timely decisions regarding required disclosure. In designing and evaluating our disclosure controls and procedures, our management recognized that any system of controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, as ours are designed to do, and management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

 

In accordance with SEC rules, an evaluation was performed under the supervision and with the participation of our Principal Executive Officer and Principal Financial Officer of the effectiveness, as of October 31, 2014, of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) under the Exchange Act). “Internal control over financial reporting” includes those policies and procedures that: 

 

 

(1)

pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the issuer;

 

 

(2)

provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the issuer are being made only in accordance with authorizations of management and directors of the issuer; and

 

 

(3)

provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the issuer’s assets that could have a material effect on the financial statements.  

 

In connection with its evaluation, our management has concluded that, as of July 31, 2014, our internal control over financial reporting is not effective in providing reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with GAAP. Our management’s finding of ineffective internal control over financial reporting results primarily from a lack of sufficient accounting and information technology staff which results in a lack of segregation of duties necessary for an appropriate system of internal controls. While management believes that the lack of effective internal control over financial reporting during the fiscal quarter ended October 31, 2014 did not result in any particular deficiency in our financial reporting for the fiscal quarter then ended, management believes that the lack of effectiveness of our internal control over financial reporting could result in a failure to provide reliable financial reporting in the future. In order to remedy our existing internal control deficiency, we will need to raise additional capital or improve our working capital position to allow us to hire additional staff. 

 

 Internal Control over Financial Reporting

 

There was no change in our internal control over financial reporting that occurred during the quarter ended October 31, 2014 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

 
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PART II — OTHER INFORMATION

 

ITEM 1.

LEGAL PROCEEDINGS

 

Comarco, Inc. vs. Targus Group International, Inc., Case No. 8:14-cv-00361, Superior Court of California County of Orange – Central Justice Center.  On March 10, 2014, we filed a lawsuit against Targus Group International, Inc. (“Targus”) for patent infringement, breach of contract, intentional interference with contract, violation of business and professional codes, misrepresentation and fraudulent concealment (the “Federal Action”). Targus sought reexamination the patents at issue. The Federal Action was voluntarily dismissed without prejudice to re-filing the federal claims.  A state court action for Breach of Contract, Fraudulent Concealment, Unfair Competition and Accounting was then filed in the Orange County Superior Court on June 5, 2014 (the “State Court Action”).  On December 4, 2014, the Court ordered the State Court Action into Arbitration.  Comarco seeks $17,000,000 in damages as well as accounting and injunctive relief.

 

Chicony Power Technology Co., LTD., (“Chicony”) vs. Comarco, Inc., Case No. 30-2011-00470249, Superior Court of California County of Orange – Central Justice Center.  

Effective as of May 15, 2014, Chicony entered into a settlement agreement with us that dismisses all claims between the parties arising from the litigation referenced above. Pursuant to the terms of the settlement agreement, Chicony agreed to pay us $7.6 million in lieu of the jury’s net award of $9.7 million or any other related costs or fees. $4.0 million of the settlement amount was paid to us on May 16, 2014, with the balance of $3.6 million paid to us on June 2, 2014.

 

Further pursuant to the settlement agreement, each party released the other and its affiliates from any and all claims related to the subject matter of the litigation and we covenanted not to sue Chicony on the next 500,000 power adapters sold by Chicony after May 15, 2014 that we allege infringe on our intellectual property rights. The settlement agreement also contains other representations, warranties and covenants of both parties that are customary for an agreement of this type.

 

Acco Brands USA LLC (“Acco”) vs. Comarco Wireless Technologies, Inc., Case No. 5:11-cv-04378-HRL, U.S. District Court for the Northern District of California. On September 1, 2011, ACCO Brands USA LLC and its Kensington Computer Products Group division (collectively “Kensington”) filed a lawsuit against us alleging that five of our patents relating to power technology are invalid and/or not infringed by products manufactured and/or sold by Kensington. On February 29, 2012, we denied these claims and filed a cross-complaint alleging infringement by Kensington of each of these five patents. Efforts to resolve the dispute, by court ordered mediation, have been unsuccessful. The trial date was scheduled for early 2014 and then postponed to mid-2014. On February 4, 2014, Kensington entered into a settlement and licensing agreement with the Company with an effective date of February 1, 2014 that dismisses all claims between the two parties arising from this matter.

 

Comarco Inc. vs. EDAC Electronics Co. Ltd. (“EDAC”) Case No. 30-2012-00551827, Superior Court of California County of Orange – Central Justice Center. On March 6, 2012, we filed a lawsuit against EDAC for breach of contract seeking payment of $2.5 million for failure to deliver goods we ordered in the time, place, manner and price indicated by each purchase order. We entered a Settlement and Mutual Release on July 24, 2012, which ended the litigation among the parties. The settlement involved no cash payments by either party, but allowed us to reverse $1.4 million of net liabilities payable to EDAC.

 

In addition to the matters described above, we are from time to time involved in various legal proceedings incidental to the conduct of our business. The legal proceedings potentially cover a variety of allegations spanning our entire business. We are unable to predict the ultimate outcome of all such matters.

 

 

ITEM 1A.

RISK FACTORS

 

Our business, financial condition and operations are subject to a number of factors, risks and uncertainties, including those previously disclosed under Part I. Item 1A “Risk Factors” of our annual report on Form 10-K for the fiscal year ended January 31, 2014 as well as any amendments thereto or additions and changes thereto contained in any subsequent filings of quarterly reports on Form 10-Q or current reports on Form 8-K. The disclosures in our annual report on Form 10-K and our subsequent reports and filings are not necessarily a definitive list of all factors that may affect our business, financial condition and future results of operations. There have been no material changes to the risk factors as disclosed in our annual report on Form 10-K for the fiscal year ended January 31, 2014

 

 
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ITEM 6.

EXHIBITS

 

10.1

Amendment and Release Agreement, dated August 13, 2014, by and among Broadwood Partners, L.P., Comarco, Inc. and Comarco Wireless Technologies, Inc. (incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed with the SEC on August 18, 2014)

   

10.2

Amended and Restated Common Stock Purchase Warrant, dated August 13, 2014, issued by Comarco, Inc. to Broadwood Partners, L.P. (incorporated by reference to Exhibit 10.2 to the Company’s Current Report on Form 8-K filed with the SEC on August 18, 2014)

   

31.1 *

Certification of Principal Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

   

31.2 *

Certification of Principal Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

   

32.1 *

Certification of Principal Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

   

32.2 *

Certification of Principal Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

   

101.INS**

XBRL Instance Document