ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
ITEM 2.
ITEM 2. PROPERTIES
Our headquarters are located in Lake Forest, California. This leased facility consists of approximately 25,000 square feet of office space and approximately 5,000 square feet of manufacturing and warehouse space. The lease for this facility expires in August 2011. In conjunction with the sale of WTS to Ascom in January 2009, we entered into a sublease agreement whereby Ascom leases approximately 48 percent of the leased facility, including all of the manufacturing and warehouse space.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
Chicony Power Technology Co., LTD., (“Chicony”) vs. Comarco, Inc., Case No. 30-2011-00470249, Superior Court of California County of Orange - Central Justice Center. On April 26, 2011, Chicony, which is the contract manufacturer of the Bronx product that is the subject of the Recall, filed a complaint against us for breach of contract seeking payment of $1.2 million for the alleged non-payment by us of products manufactured by Chicony. We deny liability and intend to vigorously defend the lawsuit. We also intend to file a cross-complaint seeking the recovery of damages 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. The outcome of this matter is not determinable as of the date of the filing of this report.
Mark Chapman (“Chapman”) vs. Comarco Wireless Technologies, Inc., Case No. 73-166-03168-09 02 FEZA-C, American Arbitration Association. On July 15, 2009, a former officer and employee of the Company filed a demand for arbitration against the Company with the American Arbitration Association claiming that he is entitled to a payment pursuant to the terms of a written Severance Compensation Agreement as well as reimbursement for his attorneys’ fees relating to this claim. The Severance Compensation Agreement provides that in the event the employee is terminated by the Company without “Cause” (as defined in such agreement), or ceases to be employed by the Company for reasons other than because of death, disability, retirement or Cause, or the employee terminates his employment with us for “Good Reason” (as defined in such agreement), in each case, within 24 months following a “Change of Control” (as defined in such agreement), the employee would be entitled
to receive a lump sum cash payment equal to the sum of his annual base salary plus his annual incentive compensation bonus that would be payable assuming 100 percent satisfaction of all performance goals. The former officer and employee claims that the January 2009 sale of our WTS business to Ascom constituted a Change of Control and that he is entitled to the specified payment because he ceased to be employed by the Company as a result of such transaction, although his employment was assumed by Ascom in essentially the same capacity following the consummation of the transaction. The Company reached a settlement with the former officer and employee in June 2010. Pursuant to the settlement, Comarco paid the former officer and employee $508,000 during the second quarter of fiscal 2011, which amount included reimbursement for attorney and professional fees. Such amount is included in income (loss) from discontinued operations in the accompanying condensed consolidated statements of operations.
In addition to the matters described above, the Company is from time to time involved in various legal proceedings incidental to the conduct of its business. The legal proceedings potentially cover a variety of allegations spanning our entire business. Although the outcome of legal proceedings is inherently uncertain, the Company believes that the outcome of all such legal proceedings will not in the aggregate have a material adverse effect on its consolidated results of operations and financial position.
ITEM 4.
ITEM 4. [REMOVED AND RESERVED]
PART II
ITEM 5.
ITEM 5.
MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Market Information
Our common stock was traded on the Nasdaq Global Market under the symbol “CMRO” until November 11, 2010. Commencing on November 12, 2010 our common stock traded on the Nasdaq Capital Market and effective January 6, 2011 our common stock traded on the OTC:BB under the symbol “CMRO:PK.” The following table sets forth for the periods indicated the quarterly high and low closing prices per share as reported by each of the respective markets on which our stock was traded. These prices represent actual reported sales transactions.
Holders
As of March 30, 2011, there were 307 holders of record of our common stock.
Dividends
We did not declare any dividends during fiscal 2011 or fiscal 2010. We do not expect to pay cash dividends in the near future, as we intend to retain any future earnings to fund working capital and operations. Any determinations to pay dividends in the future will be at the discretion of our board of directors.
Repurchases
We did not repurchase any securities during fiscal 2011 or fiscal 2010.
Securities Authorized For Issuance Under Equity Compensation Plans
The information regarding securities authorized for issuance under our equity compensation plans is set forth in Item 12 of this report and is incorporated herein by this reference.
ITEM 7.
ITEM 7.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and notes thereto included in Item 8 of this report as well as our risk factors included in Item 1A of this report. The following discussion contains forward-looking statements. See “Cautionary Note Regarding Forward-Looking Statements” included in Item 1 of this report.
Overview
Comarco, Inc., through its wholly owned subsidiary Comarco Wireless Technologies, Inc. (collectively, “we,” “us,” “our,” “Comarco,” or the “Company”), is a leading designer and manufacturer of standalone mobile power adapters used to power and charge notebook computers, mobile phones, BlackBerry® smartphones, iPods®, and many other portable, rechargeable handheld devices. Our operations consist solely of the operations of Comarco Wireless Technologies, Inc. (“CWT”).
Prior to fiscal 2010, Comarco was also a provider of wireless test solutions for the wireless industry, as well as a provider of emergency call boxes and related maintenance services. We entered fiscal year 2009 with an
objective to focus on our ChargeSource® business and to maximize the value of our WTS and Call Box businesses. The assessment of our strategic initiatives with respect to these businesses culminated in the sale of these two businesses during fiscal 2009.
Company Trends and Uncertainties
Designed with the needs of the mobile professional in mind, our ChargeSource® standalone mobile power adapters provide a high level of functionality and compatibility in an industry-leading compact design. Our current and planned ChargeSource® product offerings consist of standalone AC/DC, AC, and DC power adapters designed for the right mix of power output and functionality for most retail, OEM, and enterprise customers. Our ChargeSource® products are programmable, allowing those who use rechargeable electronic devices to carry just one power adapter to support multiple electronic devices. By simply changing the compact SmartTip® connected to the end of the output cable, our standalone power adapters are capable of simultaneously charging and powering multiple devices from all major consumer electronics companies, including most notebook computers, mobile phones, BlackBerry® smartphones, iPods®, and many other portable, rechargeable consumer electronic devices without requiring a peripheral product or extra cable.
Personal computer manufacturers continue to design and manufacture notebook computers with enhanced functionality and features. These notebook computers generally have greater power requirements. As power requirements increase, so generally does the size of the OEM power adapter sold with each notebook computer. To address this industry-wide trend, we have developed a family of compact high-power ChargeSource® standalone power adapters that are compatible with most legacy, current, and planned notebook computers. These new standalone power adapters are able to deliver up to 120 watts of power in a very small form factor or compact size.
Management currently considers the following additional trends, events, and uncertainties to be important to an understanding of our business:
•
On January 25, 2011 the Company received written notification from Targus Group International, Inc. (“Targus”) of its non-renewal of the Strategic Product Development and Supply Agreement (the “Targus Agreement”). Although Targus confirmed its desire to continue a business relationship with Comarco in its written notification, the nature of our future business relationship remains unclear. At this time, future sales to Targus are uncertain. Approximately 67 percent of our revenue for fiscal 2011 was from sales to Targus.
•
On April 30, 2010, the United States Consumer Product Safety Commission (“CPSC”) announced a product safety recall (the “Recall”) concerning approximately 500,000 units of our ChargeSource 90-watt universal AC power adapter sold to our distributer, Targus, from June 2009 through March 2010. Currently, approximately 155,000 total units have been returned from the distribution channel and approximately 4,000 units have been returned from consumers. We have established a recall website and hotline to enable consumers to determine if they have a unit subject to the Recall. We have established a process to replace and repair the affected units. Due to the Recall, we accrued a $0.3 million and $4.0 million charge to cost of revenue in the fourth quarter of fiscal 2011 and fiscal 2010, respectively, as an estimate of the cost to replace the affected units and $0.6 million charge to selling, general and administrative costs in the fourth quarter of fiscal 2010 expected to be incurred related to the Recall. Actual amounts may differ materially from our current estimates based on many factors, including the number of qualifying 90-watt universal power adapters returned to Comarco by Targus and their customers, primarily consumer electronics retailers and end-user consumers in connection with the Recall. Also, the estimate is based on Comarco’s assessment of Targus’ and Comarco’s respective obligations regarding returned product. As of the filing date of this report, Targus and Comarco have not reached full agreement with respect to such matters and, in the event that agreement is not reached on certain matters, it could result in a material increase in the costs of the Recall to Comarco. As a result, the actual amounts incurred by Comarco as a result of the Recall may differ materially from the amount of reserves Comarco established as a result of the Recall. However, the Company believes that it has accrued for substantially all of its material financial obligations with respect to the Recall.
•
In an abundance of caution, during the latter part of the first quarter of fiscal 2011, Comarco ceased production of its Manhattan product to allow it time to verify that the product did not contain defects similar to the one which caused the Recall. Comarco successfully completed its verification process and resumed manufacturing and volume shipping Manhattan units late in the first quarter.
Following the Recall, we began volume shipping our Manhattan ChargeSource® products to Targus, under the Targus Agreement. Sales of our Manhattan product to Targus accounted for revenue of $5.3 million, $10.0 million and $3.1 million for our first, second and third fiscal quarters of fiscal 2011, respectively. We shipped minimal quantities of our Manhattan product during the fourth quarter of fiscal 2011. Additionally, since the notification we received from Targus of the non-renewal of the Targus Agreement, we have received no further purchase orders and future sales to Targus are uncertain.
•
Late in the third quarter of fiscal 2011, we took action to significantly reduce expenses. These actions included a significant reduction in both personnel expenses and other expenses across all departments.
•
Our ChargeSource® products are based on proprietary patented construction technology that enables the production of slim and light power sources for many rechargeable mobile devices from standard wall outlets, as well as power outlets in airplanes, cars, and other modes of transportation.
•
Reducing our product costs is important to our continuing efforts to improve our margins and we are continually in negotiations with our contract manufacturers in this regard.
•
We are focused on preserving our cash balances by monitoring expenses, identifying costs savings, and investing only in those development programs and products that we believe will most likely contribute to our profitability.
Critical Accounting Policies
The preparation of our consolidated financial statements requires us to apply accounting policies and make certain estimates and judgments. All of our significant accounting policies are presented in Note 2 of the notes to the Consolidated Financial Statements in Item 8 of this report. Of our significant accounting policies, we believe the following are the most significant and involve a higher degree of uncertainty, subjectivity, and judgments. These policies involve estimates and judgments that are inherently uncertain. Changes in these estimates and judgments may significantly impact our annual and quarterly operating results.
Revenue Recognition
We recognize product revenue upon shipment provided there are no uncertainties regarding customer acceptance, persuasive evidence of an arrangement exists, the sales price is fixed or determinable, and collectability is probable. Generally, our products are shipped FOB named point of shipment, whether it is Lake Forest, which is the location of our corporate headquarters, or China, the shipping point of our contract manufacturers.
Stock-based Compensation
We recognize compensation costs for all stock-based awards made to employees, consultants, and directors. The fair value of stock based awards is estimated on the date of grant, and is recognized as expense ratably over the requisite service period. We currently use either a Lattice Binomial or the Black-Scholes option-pricing model to estimate the fair value of our share-based payments. Both the Lattice Binomial and the Black-Scholes
option-pricing model are based on a number of assumptions, including expected volatility, expected forfeiture rates, expected life, risk-free interest rate and expected dividends. The prevailing difference between the two models is the Lattice Binomial model’s ability to enhance the simple assumptions that underlie the Black-Sholes model. The Lattice Binomial model allows for assumptions such as risk-free rate of interest, volatility and exercise rate to vary over time reflecting a more realistic pattern of economic and behavioral occurrences. If the assumptions change under either model, stock-based compensation may differ significantly from what we have recorded in the past.
Accounts Receivable
We perform ongoing credit evaluations of our customers and adjust credit limits and related terms based upon payment history and the customer’s current credit worthiness. We continually monitor collections and payments from our customers and maintain a provision for estimated credit losses based upon our historical experience and any specific customer collection issues that we have identified. While such credit losses have historically been within our expectations and the provisions established, we cannot guarantee that we will continue to experience the same credit loss rates that we have in the past. Because our accounts receivable are concentrated in a relatively few number of customers, a significant change in the liquidity or financial position of any one of these customers could have a material adverse effect on the collectability of our accounts receivable and our future operating results.
Specifically, our management must make estimates of the collectability of our accounts receivable. Management analyzes specific customer accounts and establishes reserves for uncollectible receivables based upon specific identification of account balances that have indications of uncertainty of collection. Indications of uncertainty of collections may include the customer’s inability to pay, customer dissatisfaction, or other factors. Significant management judgments and estimates must be made and used in connection with establishing the allowance for doubtful accounts in any accounting period. Material differences may result in the amount and timing of our losses for any period if management made different judgments or utilized different estimates.
Valuation of Inventory
We value inventory at the lower of the actual cost to purchase and/or manufacture the inventory (calculated on average costs, which approximates first-in, first-out basis) or market value. We regularly review inventory quantities on hand and record a write down of excess and obsolete inventory based primarily on excess quantities on hand based upon historical and forecasted component usage. As demonstrated during prior periods, demand for our products can fluctuate significantly. A significant increase in the demand for our products could result in a short-term increase in the cost of inventory purchases while a significant decrease in demand could result in an increase in the amount of excess inventory quantities on hand. In addition, our industry is characterized by rapid technological change, frequent new product development, and rapid product obsolescence that could result in an increase in the amount of obsolete inventory quantities on hand. In the future, if our inventory were determined to be overvalued, we would be required to recognize such costs in our cost of revenue at the time of such determination. Therefore, any significant unanticipated changes in demand or technological developments could have a significant impact on the value of our inventory and our operating results.
Income Taxes
We are required to estimate our provision for income taxes in each of the tax jurisdictions in which we conduct business. This process involves estimating our actual current tax expense in conjunction with the evaluation and measurement of temporary differences resulting from differing treatment of certain items for tax and accounting purposes. These temporary timing differences result in the establishment of deferred tax assets and liabilities, which are recorded on a net basis and included in our consolidated balance sheets. We then assess on a periodic basis the probability that our net deferred tax assets, if any, will be recovered. If after evaluating all of the positive and negative evidence, a conclusion is made that it is more likely than not that some portion or all of the net deferred tax assets will not be recovered, a valuation allowance is provided with a corresponding charge to tax expense to reserve the portion of the deferred tax assets which are estimated to be more likely than not to be realized.
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 January 31, 2011.
Valuation of Long-Lived Assets
We evaluate long-lived assets used in operations when indicators of impairment, such as reductions in demand or significant economic slowdowns that negatively impact our customers or markets, are present. Reviews are performed to determine whether the carrying value of assets is impaired based on comparison to the undiscounted expected future cash flows. If the comparison indicates that there is impairment, the impaired asset is written down to fair value, which is typically calculated using a weighted average of the market approach and the discounted expected future cash flows using a discount rate based upon our cost of capital. Impairment is based on the excess of the carrying amount over the fair value of those assets. Significant management judgment is required in the forecast of future operating results that is used in the preparation of expected discounted cash flows. It is reasonably possible that the estimates of anticipated future net revenue, the remaining estimated economic life of the products and technologies, or both, could differ from those used to assess the recoverability of these assets. In that event, additional impairment charges or shortened useful lives of certain long-lived assets could be required.
Warranty Costs
We provide limited warranties for ChargeSource® products for a period generally not to exceed 24 months. We accrue for the estimated cost of warranties at the time revenue is recognized. The accrual is a fixed rate which is consistent with our actual claims experience. Should actual warranty claim rates differ from our estimates, revisions to the liability would be required.
We recorded an accrual of $0.3 million and $4.6 million related to the Recall during the fourth quarter of fiscal 2011 and fiscal 2010, respectively. Significant management judgments and estimates have been made to determine the amount of the Recall accrual. Any significant changes in the actual number of Recall returns compared to the estimated number of returns or in the actual costs of any the items that have been estimated, which includes our cost to repair the units as well as transportation costs, communication, fulfillment, professional and administrative services, could have a significant impact on our operating results.
Results of Operations-Continuing Operations
The following tables set forth certain items as a percentage of revenue from our audited consolidated statements of operations for fiscal 2011 and fiscal 2010:
Revenue
The fiscal 2011 increase in revenue of $2.5 million is attributable to increases in revenue relating to shipments to both Lenovo and Targus as well as the introduction of a 90 watt DC adapter sold exclusively to Dell beginning in May 2010. In June 2009, we began shipping a 90-watt AC adapter to Targus under the Targus Agreement. Although revenue from Targus for fiscal 2011 increased in the aggregate, sales to Targus declined significantly in the second half of fiscal 2011. We currently have no existing unfulfilled purchase orders for delivery of our product to Targus. Revenue for fiscal 2011 also includes shipments of the Company’s retail “Slim and Light” power adapter to Lenovo which commenced late in the third quarter of fiscal 2010.
Cost of Revenue and Gross Margin
The fiscal 2011 increase in the total cost of revenue of $0.9 million compared to fiscal 2010 is attributable to higher product costs, freight, expedite and other costs, supply chain overhead and inventory reserve and scrap charges incurred during fiscal 2011 offset by a decline in Recall accruals. The product costs incurred in fiscal 2011
increased by $2.8 million or 16 percent compared to fiscal 2010 which is generally consistent with our 10 percent increase in revenue. Additionally, in the fourth quarter of fiscal 2011, the Company recorded $0.6 million in product costs for re-worked Bronx product that was shipped to Targus during the fourth quarter of fiscal 2011. The revenue associated with that shipment, in the amount of $0.9 million, remains deferred at fiscal year end. The Company did not generate a positive gross margin on the sale of its ChargeSource® products until the second quarter of fiscal 2010 and gross margins improved with the introduction of the 90-watt AC product sold to Targus. The margins for products distributed into retail channels through our exclusive relationship with Targus are higher when compared to products developed for OEM customers due to certain design requirements of our OEM customers.
As previously discussed, we announced a voluntary product safety recall of approximately 500,000 units of our ChargeSource 90-watt universal AC power adapter sold to our distributer, Targus. Included in the cost of revenue recorded in the fourth quarter of fiscal 2011 and fiscal 2010, is an accrual for the estimated product costs associated with the Recall of $0.3 million and $4.0 million, respectively.
The supply chain overhead expenses increased $0.7 million or 30 percent in fiscal 2011 compared to fiscal 2010. In the fourth quarter of fiscal 2011, in conjunction with the notification received from Targus of the non-renewal of the Targus Agreement and the resulting uncertainty relating to the volume of future sales to Targus, we accelerated the depreciation on all Manhattan related tooling and equipment, which accounts for approximately $0.3 million of the increase. The remaining increase is primarily due to additional personnel needed in the first half of the fiscal year to assist with procurement of component inventory that has become increasingly difficult to source at our desired prices and within our desired lead times. We also added staff in the first half of the fiscal year to assist with the management of our growing number of contract manufacturers. As previously discussed, late in the third quarter of fiscal 2011, we reduced personnel related and other expenses across all departments.
The fiscal 2011 increase in freight, expedite and other charges of $0.8 million relates to shipments to Dell, our newest OEM customer, as well as approximately $0.7 million in costs incurred to expedite delivery of Manhattan units to Targus in the second quarter of fiscal 2011, primarily as a result of our temporary production cessation which occurred in the first quarter of fiscal 2011 as a result of the Recall. We incurred $150,000 in similar costs in the fourth quarter of fiscal 2010 to air freight the initial Manhattan units to Targus. Additionally, during fiscal 2011 we have incurred freight costs of approximately $0.4 million to fulfill Dell orders. As Dell has worldwide inventory hubs, our shipping costs have increased due to the lower per shipment volume required by these various locations.
The inventory reserve and scrap charges of $0.6 million recorded in fiscal 2011 relate primarily to reserves established for Manhattan inventory as a result of the correspondence received from Targus. Inventory reserve and scrap charges of $0.4 million were recorded in fiscal 2010 primarily related to engineering design changes incurred during the development of our newly released products as well as reserves for component inventory used in legacy product.
Operating Costs and Expenses
The fiscal 2011 decrease in selling, general and administrative expenses of $0.8 million compared to fiscal 2010 relates primarily to decreased legal fees related to the iGo litigation, which was dismissed during the second quarter of fiscal 2010. We incurred legal fees in fiscal 2010 of $0.5 million with no similar expenses incurred in the
current fiscal year. We also had a decrease of $0.1 million in consulting and outside sales representative expenses. Additionally, in the prior fiscal year we recorded a bad debt expense of $0.1 million with no similar expense incurred in the current fiscal year.
Corporate overhead consists of salaries and other personnel-related expenses of our accounting and finance, human resources and benefits, and other administrative personnel, as well as professional fees, directors’ fees, and other costs and expenses attributable to being a public company. When expressed as a percentage of revenue, corporate overhead decreased to 13 percent in fiscal 2011 compared to 17 percent in fiscal 2010. The decrease of $0.7 million for the year ended January 31, 2011 relates primarily to decreased legal and professional fees of $0.6 million compared to the same period of fiscal 2010. During the fourth quarter of fiscal 2010 we accrued $0.6 million in legal and professional fees relating to the Recall. We incurred no similar expenses in fiscal 2011.
Engineering and support expenses generally consist of salaries, employer paid benefits, and other personnel related costs of our engineers and testing 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. The fiscal 2011 decrease in engineering and support costs includes approximately $0.2 million and $0.6 million, respectively, in decreased personnel costs and decreased material usage and lab fees in support of our on-going efforts to develop new products for our retail and OEM accessories channels. Offsetting these decreases is an increase in legal fees of $0.2 million incurred in connection with intellectual property matters during fiscal 2011.
Other Income (Loss), Net
Other income (loss), net, consists primarily of interest income earned on invested cash balances offset by interest expense related to our credit facility. During fiscal 2011, we earned $20,000 in interest income and incurred $126,000 in interest expense and loan origination fees related to our credit facility. During fiscal 2010, we earned $73,000 in interest income but incurred $74,000 in interest expense and loan origination fees related to our credit facility.
Income Tax Benefit
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 January 31, 2011.
During fiscal 2011, the Company recorded a net loss of $6.0 million and recorded an income tax benefit of $75,000 to its continuing operations. The tax benefit recorded in fiscal 2011 relates to a reduction of $33,000 in our recorded tax liability in conjunction with the normal expiration of the statute of limitations in various states and an adjustment to our income tax receivable of $42,000 upon the filing of our consolidated tax returns for the fiscal year ended January 31, 2010. The net deferred tax asset of $15.1 million, $3.9 million of which relates to net operating losses created in fiscal 2011, continues to be fully reserved at January 31, 2011.
During fiscal 2010, the Company recorded a net loss of $7.4 million and recorded an income tax benefit of $264,000 on a combined basis. The net deferred tax asset of $12.8 million, $1.8 million of which relates to net operating losses created in fiscal 2010 was fully reserved.
Discontinued Operations, net of income taxes
Income from Discontinued Operations - Call Box
(in thousands except change)
On July 10, 2008, the Company executed an asset purchase agreement to sell the assets of its call box business for $2.7 million in cash. The transaction closed on July 10, 2008.
The fiscal 2010 pre-tax loss from the call box discontinued operations incurred in fiscal 2010 of $25,000, and after tax loss of $15,000, relates primarily to adjustments to the assets acquired and liabilities assumed by Case Systems, Inc., the buyer of the Call Box business segment. There were no similar expenses incurred in fiscal 2011 and we do not expect to incur any future costs related to the sale of the Call Box business.
Income from Discontinued Operations - Wireless Test Solutions
(in thousands except change)
The sale of the wireless test solutions business was completed on January 6, 2009, which resulted in a pre-tax gain of $5.9 million.
The aggregate purchase price paid to Comarco in connection with the transaction was $12.8 million in cash, with $1.3 million of the proceeds placed in escrow for one year from the closing date as security for general indemnification rights. The full amount of the proceeds placed in escrow were released in January 2010.
The fiscal 2011 loss from WTS discontinued operations of $0.6 million relates to a settlement with a former officer and employee of the WTS business, whereby Comarco agreed to pay the former employee $0.5 million which amount included reimbursement for attorney and professional fees. The remaining loss relates primarily to Comarco’s legal fees incurred relating to the matter.
Liquidity and Capital Resources
The following table is a summary of our Consolidated Statements of Cash Flows:
Cash Flows from Operating Activities
The cash used in operating activities during fiscal 2011 of $3.2 million relates to our net loss of $6.0 million and is offset by non-cash depreciation of $1.1 million. Accounts receivable collections from customers totaled $7.2 million in fiscal 2011. This source of cash is offset by a combined net decrease in accrued liabilities and accounts payable of $5.4 million related to supplier payments as well as Recall related expenditures and an increase in inventory of $0.5 million.
The cash used in operating activities during fiscal 2010 of $4.5 million relates to our net loss from continuing operations of $8.2 million, offset by cash provided from discontinued operations of $0.8 million. Additionally, combined accounts receivable increased by $7.7 million due to increased sales in fiscal 2010. These uses of cash are offset by non-cash depreciation, increases in accrued liabilities, and stock based compensation of $0.8 million, $9.0 million, and $0.3 million, respectively.
In conjunction with the Recall, the Company accrued a $0.3 million and $4.0 million charge to cost of revenue in the fourth quarter of fiscal 2011 and fiscal 2010, respectively as an estimate of the cost to replace the affected units and a $0.6 million charge to selling, general and administrative costs expected to be incurred related to the Recall in the fourth quarter of fiscal 2010.
Our methodology for estimating the costs associated with the Recall involved estimating future costs to be incurred to replace the recalled adapters based on expected returns and estimated costs to conduct the Recall, particularly communication, replacement, and transportations costs. Our replacement and transportation cost estimates include costs for component parts and labor; we also obtained third party cost quotes for communication, fulfillment and administration services. Also, included in the estimate is Comarco’s assessment of Targus’ and Comarco’s respective obligations regarding returned product. As of the filing date of this report, Targus and Comarco have not reached full agreement with respect to such matters. Although the Recall is ongoing, the Company believes that it has accrued for substantially all of its material financial obligations with respect to the Recall. It is possible that, the Company’s estimates for the costs of the Recall may be less than the actual costs that will ultimately be incurred. If the actual costs of the Recall exceed the Company’s estimates for the costs of the Recall, the Company’s operations and financial condition might be materially adversely affected.
Cash Flows from Investing Activities
During fiscal 2011, we spent $0.5 million in capital equipment purchases, which primarily related to purchases of tooling and other equipment used by our contract manufacturers and engineers for the manufacture and design of our ChargeSource® products.
During fiscal 2010, we spent $0.6 million in capital equipment purchases, which primarily related to tooling and other equipment used by our contract manufacturers and engineers for the manufacture and design of our ChargeSource® products. Additionally, the $77,000 certificate of deposit which was security for our letter of credit was eliminated and replaced by a letter of credit secured by our line of credit with Silicon Valley Bank (“SVB”).
Cash Flows from Financing Activities; Credit Facility
During fiscal 2011, we incurred $69,000 in loan origination fees. During fiscal 2010, we borrowed $1.0 million against our credit facility with SVB and incurred $43,000 in loan origination fees.
On February 11, 2009, the Company entered into a Loan and Security Agreement with SVB (the “Loan Agreement”). The Loan Agreement was subsequently renewed on February 8, 2010 and again on February 9, 2011. The credit facility matures, and any outstanding principal balance is payable in full, on February 9, 2012. We currently pay interest on the outstanding principal balance under the Loan Agreement at an interest rate of 3.25% above the Wall Street Journal Prime Rate; provided that the interest rate in effect on any day shall not be less than 6.5% per annum.
Under the Loan Agreement, the Company may borrow up to (a) the lesser of (i) $10,000,000 or (ii) 80 percent of the Company’s eligible accounts receivable minus (b) the amount of any outstanding principal balance of any advances made by SVB under the Loan Agreement. The Company must maintain a quick ratio of 1.25 to 1.0 as its primary financial covenant and must also comply with certain monthly reporting covenants. As of January 31, 2011 the Company had borrowed $1.0 million under the Loan Agreement. As of the same date, the Company was in not compliance with the quick ratio covenant in the Loan Agreement and had $1.4 million in remaining unused borrowing availability. The Company’s quick ratio at January 31, 2011 and 2010 was 1.11 to 1.00 and 1.45 to 1.00, respectively.
Subsequent to the fiscal year-end ended January 31, 2011, the Company repaid the amounts outstanding under the Loan Agreement in full. As of the date of this filing, we have no borrowings outstanding under the Loan Agreement and we are in negotiations with SVB regarding future amendments to the Loan Agreement. We cannot be certain that we will be able to make any additional borrowings under the Loan Agreement on terms acceptable to us, or at all.
Liquidity Requirements for the Next 12 Months
As of January 31, 2011, our working capital was $3.4 million. In order for us to continue operations beyond the next twelve months and be able to discharge our liabilities and commitments in the normal course of business, we must increase sales; establish profitable operations through both increased sales and a reduction of operating expenses; and potentially raise additional funds, through either debt and/or equity financing to meet our working capital needs. We cannot guarantee that we will be able to increase sales, reduce expenses or obtain additional funds when needed or that such funds, if available, will be obtainable on satisfactory terms. If we are unable to increase sales, reduce expenses or raise sufficient additional capital, we may be unable to continue to fund our operations, develop our products or realize value from our assets and discharge our liabilities in the normal course of business. These uncertainties raise substantial doubt about our ability to continue as a going concern. If we become unable to continue as a going concern, we may have to liquidate our assets, and might realize significantly less than the values at which they are carried on our financial statements, and stockholders may lose all or part of their investment in our common stock. The consolidated financial statements do not reflect any adjustments related to the outcome of this uncertainty.
As discussed above, there are several factors and events that could significantly affect our cash flows from operations, including, without limitation the following:
•
Our future business relationship with Targus, if any.
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Our ability to reduce inventory commitments in response to reduced Targus sales.
•
Our ability to borrow against our credit facility based on our compliance with certain financial covenants or as a result of a changes in our borrowing base due to fluctuations in our eligible receivables.
•
Whether we incur costs and expenses as a result of the Recall in excess of the reserves we established for the Recall, including as a result of reaching an agreement with Targus concerning the respective obligations of the parties regarding returned products.
•
The outcome of litigation with our contract manufacturer of the Bronx product, the subject product under the Recall.
•
The ability of our contract manufacturers of our ChargeSource® products to manufacture our products at the level currently anticipated, and the ability of our ChargeSource® products to meet any required specifications.
•
The timing of the development, delivery or release of our ChargeSource® products.
The Company’s cash balance at March 31, 2011 was $4.8 million. We are currently focused on preserving our cash balances by monitoring expenses, identifying cost savings, and investing only in those development programs and products that we believe will most likely contribute to our potential future profitability. As we execute on our current strategy, however, we may require further debt and/or equity capital to fund our working capital needs. In particular, we have experienced, and anticipate that we may experience a negative operating cash flow in the future. We may attempt to raise additional funds through public or private debt or equity financings if such financings become available on acceptable terms, or we may seek to borrow additional amounts under our credit facility. We cannot be certain that any additional financing we may need will be available on terms acceptable to us, or at all. If adequate funds are not available or are not available on acceptable terms, we may not be able to take advantage of opportunities, develop new products or otherwise respond to competitive pressures, and our operating results and financial condition could be adversely affected. The Company is also considering the possibility of licensing its technology to a third party or liquidating its current inventory as a source of future capital.
Contractual Obligations
In the course of our business operations, we incur certain commitments to make future payments under contracts such as operating leases and purchase orders. Payments under these contracts are summarized as follows as of January 31, 2011 (in thousands):
We generally issue purchase orders to our suppliers with delivery dates from four to six weeks from the purchase order date. In addition, we regularly provide significant suppliers with rolling six-month forecasts of material and finished goods requirements for planning and long-lead time parts procurement purposes only. We are committed to accepting delivery of materials pursuant to our purchase orders subject to various contract provisions that allow us to delay receipt of such order or allow us to cancel orders beyond certain agreed lead times. Such cancellations may or may not include cancellation costs payable by us. In the past, we have been required to take delivery of materials from our suppliers that were in excess of our requirements and we have previously recognized charges and expenses related to such excess material. If we are unable to adequately manage our suppliers and adjust such commitments for changes in demand, we may incur additional inventory expenses related to excess and obsolete inventory. Such expenses could have a material adverse effect on our business, results of operations, and financial position. Our fixed purchase commitments at January 31, 2011 totaled $8.1 million, of which $0.4 million was cancelable as of January 31, 2011.
In addition to the amounts shown in the table above, we have unrecognized tax benefits in the amount of $0.5 million which we are uncertain as to if or when such amounts may be settled.
We have severance compensation and employment agreements with several key executives. These agreements require us to pay these executives, in the event of a termination of employment following a change of control of the Company or other circumstances, up to 18 months of their then current annual base salary and the amount of any bonus amount the executive would have achieved for the current year. The exact amount of this contingent obligation is not known and accordingly has not been recorded in the consolidated financial statements.
Recent Accounting Pronouncements
In May 2009, the Financial Accounting Standards Board (“FASB”) established general standards for accounting and disclosure of events that occur after the balance sheet date but before the financial statements are issued or available to be issued. The pronouncement required the disclosure of the date through which an entity has evaluated subsequent events and the basis for that date, whether that date represents the date the financial statements were issued or were available to be issued. On February 24, 2010, the FASB amended this standard whereby SEC filers, like the Company, are required by GAAP to evaluate subsequent events through the date its financial statements are issued, but are no longer required to disclose in the financial statements that the Company has done so or disclose the date through which subsequent events have been evaluated.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not applicable.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
COMARCO, INC. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
All other schedules are omitted because the required information is not present in amounts sufficient to require submission of the schedule or because the information required is included in the consolidated financial statements or the notes thereto.
Report of Independent Registered Public Accounting Firm
Board of Directors and Stockholders
Comarco, Inc.
Lake Forest, California:
We have audited the accompanying consolidated balance sheets of Comarco, Inc. (the “Company”) as of January 31, 2011 and 2010, and the related consolidated statements of operations, stockholders’ equity, and cash flows for the years then ended. We have also audited the information in the schedule listed in the accompanying index included under Item 15. These consolidated financial statements and this schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements and this schedule based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements and schedule are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits include consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements and schedule, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements and schedule. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Comarco, Inc. at January 31, 2011 and 2010, and the consolidated results of its operations and its cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America.
Also, in our opinion, the information in the schedule presents fairly, in all material respects, the information set forth therein.
The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 2 to the consolidated financial statements, the Company has suffered recurring losses from operations, has had declining working capital and uncertainties surrounding the Company’s ability to borrow under its credit facility. These factors, among others, raise substantial doubt about its ability to continue as a going concern. Management’s plans in regard to these matters are also described in Note 2. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.
Costa Mesa, California
April 29, 2011
COMARCO, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
COMARCO, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
COMARCO, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(In thousands, except share data)
COMARCO, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
1. Organization
Comarco, Inc., through its wholly owned subsidiary Comarco Wireless Technologies, Inc. (collectively, “we,” “Comarco,” or the “Company”), is a leading designer and manufacturer of standalone mobile power adapters used to power and charge notebook computers, mobile phones, BlackBerry® smartphones, iPods®, and many other portable, rechargeable handheld devices. Our operations consist solely of the operations of Comarco Wireless Technologies, Inc. (“CWT”), which was incorporated in the state of Delaware in September 1993. 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.
2. Summary of Significant Accounting Policies
Principles of Consolidation
The consolidated financial statements of the Company include the accounts of Comarco, Inc. and CWT. All material intercompany balances, transactions, and profits have been eliminated.
Future Operations, Liquidity and Capital Resources
The Company has experienced substantial pre-tax losses from operations for fiscal 2011 and fiscal 2010 totaling $5.4 million and $9.0 million, respectively. The consolidated financial statements have been prepared assuming that the Company will continue to operate as a going concern, which contemplates that the Company will realize its assets and satisfy its liabilities and commitments in the ordinary course of business. The Company’s future is highly dependent on its ability to sell its products at a profit and its ultimate return to overall profitability. To accomplish this, the Company must increase the sales volumes of its current and newly designed ChargeSource® products to absorb fixed administrative and contract manufacturing overhead. The Company took a significant step towards addressing this concern with the execution of its Strategic Product Development and Supply Agreement (the “Targus Agreement”) with Targus Group International, Inc. (“Targus”) dated March 16, 2009, pursuant to which the Company began shipment of ChargeSource® products to Targus during the second quarter of fiscal 2010. However, on January 25, 2011, the Company received written notification from Targus of non-renewal of the Targus Agreement. Although Targus confirmed its desire to continue a business relationship with Comarco in its written notification, the nature of our future business relationship remains unclear. At this time, future sales to Targus are uncertain. If the Company is unable to sell its products to Targus at or above the volumes achieved in the past, and if the Company is unable to replace these sales with sales to another customer, the Company’s operations and financial condition would be adversely affected. The Company is currently in discussions with another computer original equipment manufacturer (“OEM”), to expand the sales of our OEM-branded accessories. Further, the Company is continually in discussions with our existing OEM customers in an attempt to drive increased sales through either the introduction of new products or possible “in-the-box” placement.
The Company had working capital totaling approximately $3.4 million at January 31, 2011. Management believes that the Company’s cash and cash equivalent balance of $6.4 million and accounts receivable due from customers of $3.6 million at January 31, 2011 will be sufficient to meet the Company’s expected working capital and capital expenditure requirements as the Company’s business is currently conducted for the next twelve months. However, in order for us to conduct our business for the next twelve months and to continue operations thereafter and be able to discharge our liabilities and commitments in the normal course of business, we must increase sales; reduce operating expenses; and potentially raise additional funds, through either debt and/or equity financing to meet our working capital needs.We may also need to borrow additional amounts under the Loan Agreement. The Company’s ability to borrow under the Loan Agreement has been limited by its failure to comply with certain financial covenants and the reduction in its borrowing base due to a decrease in its eligible receivables. Subsequent to the fiscal year-end ended January 31, 2011, the Company repaid the Loan Agreement in full. As of the date of this filing, the Company has no borrowings outstanding under its credit facility. We cannot be certain that we will be able to make any additional borrowings under the Loan Agreement on terms acceptable to us, or at all.
In addition, if the Company does not have adequate sales, either in its retail segment and /or increasing sales in its OEM business, the Company’s liquidity would likely be materially adversely impacted. Through January 31, 2011, the Company has spent $4.9 million in net cash outlays for repaired and replaced units, relating to the
Recall. Although the Recall is ongoing, the Company believes that it has accrued for substantially all of its material financial obligations with respect to this matter.
The Company may require further debt and/or equity capital to fund its working capital needs. The inability to access these funds when needed could have a material adverse effect on the Company’s operations and financial condition. The Company is also considering the possibility of licensing its technology to a third party or liquidating its current inventory as a source of future capital.
The Company’s immediate need to replace the Targus revenues, as well as the uncertainties surrounding its ability to borrow under the Loan Agreement and to raise additional debt or equity funding, raises substantial doubt about its ability to continue as a going concern. The Company cannot guarantee that it will be able to increase sales, reduce expenses, borrow additional funds under the Loan Agreement, or obtain additional funds when needed or that such funds, if available, will be obtainable on terms satisfactory to the Company. If the Company is unable to increase sales, reduce expenses, borrow additional funds under the Loan Agreement, or raise sufficient additional capital, it may be unable to continue to fund its operations, develop its products or realize value from its assets and discharge its liabilities in the normal course of business. These uncertainties raise substantial doubt about the Company’s ability to continue as a going concern. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.
Use of Estimates
The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements, and the reported amounts of revenue and expenses during the years 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, reserves for inventory obsolescence, reserves for estimated warranty costs including product recall costs, valuation allowances for deferred tax assets, and determination of stock-based compensation.
During the fourth quarter of fiscal 2010, the Company recorded an accrual of $4.6 million related to a product safety recall (the “Recall”) announced during the first quarter of fiscal 2011. Our methodology for estimating the recall costs involved estimating future costs to be incurred to replace the recalled adapters based on expected returns and the costs to conduct the recall, particularly communication, replacement, and transportation costs. Our replacement and transportation cost estimates include costs for component parts and labor; we also obtained third party cost quotes for communication, fulfillment and administration services. Actual amounts may differ materially from our current estimates based on many factors, including the number of qualifying 90-watt universal power adapters returned to Comarco by Targus and their customers, primarily consumer electronics retailers and end-user consumers in connection with the Recall. Also, included in the estimate is Comarco’s assessment of Targus’ and Comarco’s respective obligations regarding returned product. As of the filing date of this report, Targus and Comarco have not reached full agreement with respect to such matters. During the fourth quarter of fiscal 2011, the Company recorded an additional accrual of $0.3 million related to the Recall. Although the Recall is ongoing, the Company believes that it has accrued for substantially all of its material financial obligations with respect to the Recall. It is possible that, the Company’s estimates for the costs of the Recall may be less than the actual costs that will ultimately be incurred. If the actual costs of the Recall exceed the Company’s estimates for the costs of the Recall, the Company’s operations and financial condition might be materially adversely affected.
Revenue Recognition
Revenue from product sales is recognized upon shipment of products provided there are no uncertainties regarding customer acceptance, persuasive evidence of an arrangement exists, the sales price is fixed or determinable, and collectability is probable. Generally, the Company’s products are shipped FOB named point of
shipment, whether it is Lake Forest, which is the location of the Company’s corporate headquarters, or China, the shipping point for the Company’s contract manufacturers.
Cash and Cash Equivalents
All highly liquid investments with remaining 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 the Company is able to source components locally that it later sells to its contract manufacturers, who build the finished goods, and other suppliers. This is especially the case when new products are initially introduced into production. Sales to the Company’s contract manufacturers and other suppliers are excluded from revenue and are recorded as a reduction to cost of revenue.
Inventory
Inventory is valued at the lower of cost (calculated on average cost, which approximates first-in, first-out basis) or market value.
Property and Equipment
Property and equipment are stated at cost less accumulated depreciation and amortization. Additions, improvements, and major renewals are capitalized; maintenance, repairs, and minor renewals are expensed as incurred. Depreciation and amortization is calculated on a straight-line basis over the expected useful lives of the property and equipment. The expected useful lives of office furnishings and fixtures are five to seven years, and of equipment and purchased software are two to five years. The expected useful life of tooling equipment, molds used for pre-production and mass production of our power adapters, is 18 months. The expected useful life of leasehold improvements, which is included in office furnishings and fixtures, is the lesser of the term of the lease or five years.
The Company evaluates property and equipment for impairment when indicators of impairment are present and the undiscounted cash flows estimated to be generated by those assets are less than the assets’ carrying amounts. Factors considered important which could trigger an impairment review include, but are not limited to, significant underperformance relative to expected historical or projected future operating results, significant changes in the manner of use of the assets or the strategy for the Company’s overall business, and significant negative industry or economic trends. If such assets are identified to be impaired, the impairment to be recognized is the amount by which the carrying value of the asset exceeds the fair value of the asset. During the fourth quarter of fiscal 2011, in conjunction with receiving the non-renewal notice from Targus of the Targus Agreement, we accelerated $279,000 of depreciation expense related to tooling and other equipment used in the manufacture of the Manhattan product.
Assets to be disposed of are separately presented in the consolidated balance sheets and reported at the lower of the carrying amount or fair value less costs to sell, and are no longer depreciated.
Research and Development Costs
Research and development costs are charged to expense as incurred and are included in engineering and support costs. During fiscal 2011 and fiscal 2010, the Company incurred approximately $3.2 million and $3.7 million in research and development expense, respectively.
Income Taxes
As part of the process of preparing its consolidated financial statements, the Company is required to estimate its provision for income taxes in each of the tax jurisdictions in which it conducts business. This process involves estimating the Company’s actual current tax expense in conjunction with the evaluation and measurement of temporary differences resulting from differing treatment of certain items for tax and accounting purposes. These
temporary timing differences result in the establishment of deferred tax assets and liabilities, which are recorded on a net basis and included in the Company’s consolidated balance sheets. On a periodic basis, the Company assesses the probability that its net deferred tax assets, if any, will be recovered. If after evaluating all of the positive and negative evidence, a conclusion is made that it is more likely than not that some portion or all of the net deferred tax assets will not be recovered, a valuation allowance is provided with a corresponding charge to tax expense to reserve the portion of the deferred tax assets which are estimated to be more likely than not to be realized.
Significant management judgment is required in determining the Company’s provision for income taxes, its deferred tax assets and liabilities, and any required valuation allowance. The Company continues 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 the Company’s 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 remain fully reserved as of January 31, 2011.
The Company adopted the uncertain tax provisions of the Income Taxes Topic of the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (the “Codification”) on February 1, 2007, which interpretation clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements and prescribes a recognition threshold and measurement criteria for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The topic also provides guidance on de-recognition, classification, interest, and penalties, accounting in interim periods, disclosure, and transition.
During fiscal 2011, the Company recorded a net loss of $6.0 million and recorded an income tax benefit of $75,000 to its continuing operations. The tax benefit recorded in fiscal 2011 relates to a reduction of $33,000 in our recorded tax liability in conjunction with the normal expiration of the statute of limitations in various states and an adjustment to our income tax receivable of $42,000 upon the filing of our consolidated tax returns for the fiscal year ended January 31, 2010. The net deferred tax asset of $15.1 million, $3.9 million of which relates to net operating losses created in fiscal 2011, at January 31, 2011 continues to be fully reserved.
During fiscal 2010, the Company recorded a net loss of $7.4 million and recorded an income tax benefit of $264,000 on a combined basis. The Company recorded income tax expense of $0.5 million to its discontinued operations and income tax benefit of $0.8 million to its continuing operations. The net deferred tax asset of $12.8 million, $1.8 million of which relates to net operating losses created in fiscal 2010, at January 31, 2010 continues to be fully reserved.
Warranty Costs
The Company provides limited warranties for ChargeSource® products for a period generally not to exceed 24 months. The Company accrues for the estimated cost of warranties at the time revenue is recognized. The accrual is a fixed rate which is consistent with the Company’s actual claims experience. Should actual warranty claim rates differ from the Company’s estimates, revisions to the liability would be required.
During, the fourth quarter of fiscal 2010, the Company recorded an accrual of $4.6 million related to the Recall. During the fourth quarter of fiscal 2011, the Company recorded an additional accrual of $0.3 million related to the Recall. Although the Recall is ongoing, the Company believes that it has accrued for substantially all of its material financial obligations with respect to the Recall. Should the actual costs incurred related to the Recall be more or less than the amounts accrued, adjustments to the liability would be required.
Concentrations of Credit Risk
The Company’s cash and cash equivalents are principally on deposit in a non-insured short-term asset management account at a large financial institution. Accounts receivable potentially subject the Company to concentrations of credit risk. The Company’s customer base is comprised primarily of two companies (see Note 4). The Company generally does not require collateral for accounts receivable. When required, the Company maintains allowances for credit losses, and to date such losses have been within management’s expectations. Once a specific account receivable has been reserved for as potentially uncollectible, the Company’s policy is to continue to pursue collections for a period of up to one year prior to recording a receivable write-off.
Earnings (Loss) Per Common Share
Basic earnings (loss) per share is computed by dividing net income (loss) by the weighted average number of common shares outstanding during the period excluding the dilutive effect of potential common stock, which for the Company consists solely of stock awards. Diluted earnings per share reflects the dilution that would result from the exercise of all dilutive stock awards outstanding during the period. The effect of such potential common stock is computed using the treasury stock method (see Note 13).
Stock-Based Compensation
The Company grants stock options with an exercise price equal to the fair value of the shares at the date of grant and restricted stock units for a fixed number of shares to employees, consultants and outside directors.
The Company accounts 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.
During fiscal 2011, 80,000 restricted stock units were granted and 10,000 stock options were granted. The fair value of the restricted stock units granted during fiscal 2011 was estimated using the stock price on the date of the grant of $2.35 and a forfeiture rate of 8.2 percent. During fiscal 2010, the Company granted 69,204 restricted stock units and no stock options were granted. The fair value of the restricted stock units granted during fiscal 2010 was estimated using the stock price on the date of the grant of $2.89 and a forfeiture rate of 8.2 percent. 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 model require the input of subjective assumptions including estimating the length of time employees will retain their vested stock options before exercising them (the “expected term”), the estimated volatility of the common stock price over the expected term, and the number of options 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. The Company reviews its valuation assumptions at each grant date and, as a result, is likely to change its valuation assumptions used to value stock-based awards granted in future periods. The values derived from using either the Lattice Binomial or Black-Scholes model are recognized as 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 materially differ from the Company’s current estimates.
The stock-based compensation expense recognized under ASC Topic 718 is summarized in the table below (in thousands except per share amounts):
The total compensation cost related to nonvested awards not yet recognized is approximately $0.4 million, which will be expensed over a weighted average remaining life of 24.6 months.
The fair value of the 10,000 options granted under the Company’s stock option plans during fiscal 2011 was estimated on the date of grant using the following weighted average assumptions:
Fair Value of Financial Instruments
The Company’s financial instruments include cash and cash equivalents, accounts receivable, accounts payable, accrued liabilities, and a line of credit. 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. The carrying amount of the Company’s line of credit approximates fair value since the interest rate approximates the market rate for debt securities with similar terms and risk characteristics.
Reclassifications
Certain prior period balances have been reclassified to conform to the current period presentation.
Recently Adopted Accounting Pronouncements:
In May 2009, the FASB established general standards for accounting and disclosure of events that occur after the balance sheet date but before the financial statements are issued or available to be issued. The pronouncement required the disclosure of the date through which an entity has evaluated subsequent events and the basis for that date, whether that date represents the date the financial statements were issued or were available to be issued. On February 24, 2010, the FASB amended this standard whereby SEC filers, like the Company, are required by GAAP to evaluate subsequent events through the date its financial statements are issued, but are no longer required to disclose in the financial statements that the Company has done so or disclose the date through which subsequent events have been evaluated.
3. Discontinued Operations
Call Box
On July 10, 2008, the Company executed an asset purchase agreement to sell the assets of its call box business for $2.7 million in cash. The transaction closed on July 10, 2008.
During fiscal 2010, the Company incurred a pre-tax loss of $25,000, and an after tax loss of $15,000, related primarily to adjustments to the assets acquired and liabilities assumed by Case Systems, Inc., the buyer of the call box business. These amounts were expensed and paid by the end of the second quarter of fiscal 2010. There were no similar expenses incurred in fiscal 2011 and we do not expect to incur any future costs related to the sale of the Call Box business.
Wireless Test Solutions (“WTS”)
The Company entered into an Asset Purchase Agreement on September 26, 2008 with Ascom Holding AG and its subsidiary Ascom Inc. to sell the WTS business and related assets. Comarco’s shareholders approved the transaction on November 26, 2008 with approximately 85 percent of the Company’s shareholders voting in favor of the transaction. The transaction closed on January 6, 2009. The results of the WTS business are now presented as discontinued operations for all periods in the consolidated financial statements.
The aggregate purchase price paid to Comarco in connection with the transaction was $12,750,000 in cash, with $1,275,000 of the proceeds placed in escrow for one year from the closing date as security for general indemnification rights. The proceeds placed in escrow were released in January, 2010.
The fiscal 2011 loss from WTS discontinued operations of $601,000 relates to a settlement with a former officer and employee of the WTS business, whereby Comarco agreed to pay the former employee $508,000 which amount included reimbursement for attorney and professional fees. The remaining loss relates primarily to Comarco’s legal fees incurred relating to the matter.
Operating results of the WTS discontinued operations are as follows (in thousands):
4. Customer and Supplier Concentrations
A significant portion of the Company’s revenue is derived from a limited number of customers. The loss of one or more of our significant customers would have a material impact on our revenues and results of operations. The customers providing 10 percent or more of the company’s revenue for either of the years ended January 31, 2011 and 2010 are listed below (in thousands, except percentages).
In March 2009, the Company entered into the Targus Agreement. The Company began shipments to Targus under the Targus Agreement during the second quarter of fiscal 2010. As previously described, on January 25, 2011, Targus provided the Company with written notification of non-renewal of the Targus Agreement.
The Company’s revenues by geographic location for the years ended January 31, 2011 and 2010 are listed below (in thousands).
The customers comprising 10 percent or more of the Company’s gross accounts receivable at either January 31, 2011 or 2010 are listed below (in thousands, except percentages).
A significant portion of our inventory purchases is derived from a limited number of contract manufacturers and other suppliers. The loss of one or more of our significant suppliers could adversely affect our operations. For the year ended January 31, 2011, two of our contract manufacturers provided an aggregate of 81 percent of total product costs. For the year ended January 31, 2010, three of our contract manufacturers provided an aggregate of 93 percent of total product costs.
At January 31, 2011 and 2010, approximately $660,000 and $534,000, or 13 and 47 percent, respectively, of the Company’s accounts payable was payable to Flextronics Electronics, one of our contract manufacturers. Additionally, at January 31, 2011 approximately $2.6 million or 51 percent and $1.1 million or 21 percent of the Company’s total accounts payable was due to Edac Power Electronics Co. Ltd. and Chicony Power Technology, Co. Ltd., (“Chicony”) respectively, two additional contract manufacturers. At January 31, 2011, approximately $729,000 or 45 percent of total uninvoiced materials and services of $1.6 million, included in accrued liabilities were payable to Flextronics Electronics and Zhengge Electrical Co. Ltd. At January 31, 2010, approximately $5.0 million or 92 percent of total uninvoiced materials and services of $5.4 million, included in accrued liabilities were payable to Chicony Power Technology, Co. Ltd., Flextronics Electronics, and Edac Power Electronics Co. Ltd.
5. Accounts Receivable Due From Customers
Accounts receivable due from customers consist of the following (in thousands):
6. Inventory
Inventory, net of reserves, consists of the following (in thousands):
As of January 31, 2011, approximately $501,000 of total inventory was located at our corporate headquarters. The remaining balance is located at various contract manufacturer locations in China. During the fourth quarter of fiscal 2011, the Company recorded additional inventory reserves of $0.4 million related to inventory of our Manhattan product.
7. Property and Equipment
Property and equipment consist of the following (in thousands):
As of January 31, 2011, equipment with a net book value of approximately $211,000, primarily tooling and fixtures, was located at various contract manufacturer locations in China.
During fiscal 2011, nearly fully depreciated equipment with a cost basis of $881,000 was retired through a process of physical inspection and management inquiry. Additionally, during the fourth quarter of fiscal 2011, Manhattan related tooling with a cost basis of $558,000 was fully depreciated in conjunction with receiving the notification from Targus regarding non-renewal of the Targus Agreement and the resulting uncertainty of future sales of this product, resulting in a charge of $0.3 million to cost of revenue in the fourth quarter of fiscal 2011 .
During fiscal 2010, nearly fully depreciated equipment, purchased software, and furnishings with a cost basis of $647,000, $59,000 and $8,000, respectively were retired through a process of physical inspection and management inquiry.
Depreciation and amortization expense for fiscal 2011 and fiscal 2010 totaled $1.1 million and $0.8 million, respectively.
8. Accrued Liabilities
Accrued liabilities consist of the following (in thousands):
9. Warranty Arrangements
The Company records an accrual for estimated warranty costs as products are sold. These amounts are recorded in accrued liabilities in the consolidated balance sheets. Warranty costs are estimated based on periodic analysis of historical experience. Changes in the estimated warranty accruals are recorded when the change in estimate is identified. During fiscal 2011 and fiscal 2010, the Company recorded an accrual of $0.3 million and $4.6 million, respectively related to the Recall announced during the first quarter of fiscal 2011. A summary of the warranty accrual activity is shown in the table below (in thousands):
10. Loan Agreement
On February 11, 2009, the Company entered into a Loan and Security Agreement (the “Loan Agreement”) with Silicon Valley Bank (“SVB”). The credit facility was renewed on February 8, 2010 and again on February 9, 2011 (see Note 16) and matures, on February 9, 2012, at which time, any outstanding principal balance is payable in full.
Under the Loan Agreement, as in effect during fiscal 2011, the Company may borrow up to (a) the lesser of (i) $10,000,000 or (ii) 80 percent of the Company’s eligible accounts receivable minus (b) the amount of any outstanding principal balance of any advances made by SVB under the Loan Agreement. Through the second quarter of fiscal 2011, the Company had to maintain a quick ratio of 1.5 to 1.0 as its primary financial covenant and also had to comply with certain monthly reporting covenants. During the third quarter of fiscal 2011, the Company entered into a second amendment to the Loan Agreement with SVB whereby the quick ratio covenant was amended to 1.25 to 1.00 as of July 31, 2010. The Amendment also waived the Company’s failure to comply with the existing quick ratio financial covenant set forth in the Loan Agreement for the compliance periods ended April 30, 2010, May 31, 2010 and June 30, 2010.
During the second quarter of fiscal 2010, the Company borrowed $1,000,000 under the Loan Agreement, which remained outstanding at January 31, 2011. Additionally, under this Loan Agreement, we have one letter of credit outstanding in the amount of $77,000. The Company’s obligations under the Loan Agreement are secured by a first priority perfected security interest in Borrower’s assets, including intellectual property. Amounts borrowed under the Loan Agreement in fiscal 2011 bear interest at a floating per annum rate equal to 2.5% above SVB’s prime rate; provided that the interest rate in effect on any day shall not be less than 5.5% per annum. As of January 31, 2011, the Company was in not compliance with the covenants in the Loan Agreement and had $1.4 million in remaining unused borrowing availability. The Company’s quick ratio at January 31, 2011 was 1.11 to 1.00.
Subsequent to the fiscal year-end ended January 31, 2011, the Company repaid the amounts outstanding under the Loan Agreement in full. As of the date of this filing, we have no borrowings outstanding under the Loan Agreement and we are in negotiations with SVB regarding future amendments to the Loan Agreement. We cannot be certain that we will be able to make any additional borrowings under the Loan Agreement on terms acceptable to us, or at all.
11. Income Taxes
Income tax benefit on a consolidated basis consists of the following amounts (in thousands):
The effective income tax rate on loss from continuing operations differs from the United States statutory income tax rates for the reasons set forth in the table below (dollars in thousands).
The total income tax expense (benefit) recorded for the years ended January 31, 2011 and 2010 was as follows (in thousands):
The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and liabilities at January 31, 2011 and 2010 are as follows (in thousands):
The Company has federal and state research and experimentation credit carryforwards of $1.3 million and $1.6 million, which expire through 2030 and indefinitely, respectively. The Company has a net operating loss carryforward of $27.5 million for federal and $26.6 million for state, which expire through 2030 and 2020, respectively.
In assessing the probability that deferred tax assets will benefit future periods, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income. There was a $15.1 million valuation allowance for deferred tax assets as of January 31, 2011, an increase of $2.4 million during the fiscal year, based on management’s overall assessment of risks and uncertainties related to the Company’s future ability to realize, and hence utilize, the deferred tax assets.
A reconciliation of the beginning balance of the Company’s unrecognized tax benefits and the ending amount of unrecognized tax benefit is as follows (in thousands):
The unrecognized tax benefits recorded above, if reversed, would not impact our effective tax rate since we maintain a full valuation allowance against our deferred tax asset. The Company recognizes interest and penalties associated with unrecognized tax benefits in the income tax expense line item of the consolidated statement of operations.
The Company and its subsidiary, CWT, file income tax returns in the U.S. federal jurisdiction and in certain state jurisdictions. With few exceptions, the Company is no longer subject to U.S. federal examinations or state income tax examinations by tax authorities for years before 2005 in those jurisdictions where returns have been filed.
12. Stock Compensation
Comarco, Inc. has stock-based compensation plans under which directors, consultants and employees receive stock options and other equity-based awards. The employee stock option plans and a director stock option plan provide that officers, key employees, consultants and directors may be granted awards to purchase up to 2,562,500 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 optionee 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.
The director stock-based compensation plan (the “Director Plan”) expired in December 2010, and the Company’s former employee stock option plan (the “Employee Plan”) expired during May 2005. These plans provide for 637,500 and 825,000 shares issuable, respectively. During 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 shares to 1,100,000 shares.
Under the 2005 Plan, the Company may grant stock options, stock appreciation rights, restricted stock, restricted stock units, and performance based awards. Under all plans, awards vest or become exercisable in installments determined by the compensation committee of the Company’s Board of Directors unless vesting occurs based on achievement of performance measures, as defined. The options granted under the Director Plan and the Employee Plan expire as determined by the Compensation Committee, but no later than ten years and one week after the date of grant (five years for 10 percent shareholders). The awards granted under the 2005 Plan expire as determined by the Compensation Committee, but no later than ten years after the date of grant (five years for 10 percent shareholders).
Transactions and other information relating to these plans for the years ended January 31, 2011 and 2010 are summarized below:
The weighted-average fair value of awards granted during fiscal 2011 and fiscal 2010 was $2.32 and $2.89 per share, respectively.
The following table summarizes information about stock awards outstanding at January 31, 2011:
There were 480,532 stock options exercisable at January 31, 2011 at a weighted-average exercise price of $4.75. Shares available under the plans for future grants at January 31, 2011 were 96,772.
13. Earnings (Loss) Per Share
The Company calculates basic earnings (loss) per share by dividing net income (loss) by the weighted average number of common shares outstanding during the reporting period. Diluted earnings per share reflect the effects of potentially dilutive securities. Since the Company incurred a net loss for the fiscal years ended January 31, 2011 and 2010, basic and diluted loss per share were the same because the inclusion of 223,225 and 222,436 potential common shares related to outstanding stock awards in the calculation would have been antidilutive. The summary of the basic and diluted earnings per share computations is as follows (in thousands, except per share data):
14. Employee Benefit Plans
The Company has a Savings and Retirement Plan (the “Plan”) that provides benefits to eligible employees. Under the Plan, as restated effective January 1, 2010, employees are eligible to participate on the first of the month following 30 days of employment, provided they are at least 18 years of age, by contributing between 1 percent and 20 percent of pre-tax earnings. Company contributions match employee contributions at levels as specified in the Plan document. In addition, the Company may contribute a portion of its net profits as determined by the Board of Directors. Company contributions, which consist of matching contributions, with respect to the Plan for the years ended January 31, 2011 and 2010 were approximately $0.1 million each fiscal year. During fiscal 2011 and fiscal 2010 the Company made matching contributions of $110,000 and $0 respectively, through forfeited matching funds previously contributed to the Plan.
The Company has obligations to match employee contributions made to the Company’s Plan. Generally, the Company’s obligation is equal to 100 percent of up to 5 percent of employees’ contribution amounts. If the Company is unable to meet the requisite matching, the Company’s Plan may need to be amended.
15. Commitments and Contingencies
Rental commitments under non-cancelable operating leases, principally on the Company’s office space, were $0.2 million at January 31, 2011, payable as follows (in thousands):
Certain of the rental commitments are subject to increases based on the change in the Consumer Price Index. Rental expense for the years ended January 31, 2011 and 2010 was approximately $0.4 in each fiscal year.
In conjunction with the sale of WTS, the Company entered into a sublease with Ascom Inc., for the portion of the corporate offices they occupy. This sublease is co-terminous with the Company’s lease, and will offset the operating lease amounts above by approximately $107,000 for fiscal 2012.
Purchase Commitments with Suppliers
The Company generally issues purchase orders to its suppliers with delivery dates from four to six weeks from the purchase order date. In addition, the Company regularly provides significant suppliers with rolling six-month forecasts of material and finished goods requirements for planning and long-lead time parts procurement purposes only. The Company is committed to accept delivery of materials pursuant to its purchase orders subject to various contract provisions that allow it to delay receipt of such order or allow it to cancel orders beyond certain agreed lead times. Such cancellations may or may not include cancellation costs payable by the Company. In the past, the Company has been required to take delivery of materials from its suppliers that were in excess of its requirements and the Company has previously recognized charges and expenses related to such excess material. If the Company is unable to adequately manage its suppliers and adjust such commitments for changes in demand, it may incur additional inventory expenses related to excess and obsolete inventory. Such expenses could have a material adverse effect on the Company’s business, results of operations, and financial position. The Company’s fixed purchase commitments at January 31, 2011 totaled $8.1 million, of which approximately $0.4 million was cancelable as of January 31, 2011.
Executive Severance Commitments
The Company has severance compensation and employment agreements with several key executives. These agreements require the Company to pay these executives, in the event of a termination of employment following a change of control of the Company or other circumstances, up to the amount of one and a half times their 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 invested options. The exact amount of this contingent obligation is not known and accordingly has not been recorded in the consolidated financial statements.
Letter of Credit
During the first quarter of fiscal 2010, the Company obtained a $77,000 letter of credit from SVB to allow for continuous and unlapsed compliance with a lease provision for the Company’s corporate offices. The letter of credit from SVB is treated as a reduction in available borrowings available to the Company under the Loan Agreement.
Legal Contingencies
On April 26, 2011, Chicony, which is the contract manufacturer of the Bronx product that is the subject of the Recall, filed a complaint against the Company for breach of contract seeking payment of $1.2 million for the alleged non-payment by us of products manufactured by Chicony. The Company denies liability and intends to vigorously defend the lawsuit. The Company also intends to file a cross-complaint seeking the recovery of damages caused by Chicony’s failure to adhere to our technical specifications when manufacturing the Bronx product, which the Company believes resulted in the Recall of the product. The outcome of this matter is not determinable as of the date of the filing of this report.
On July 15, 2009, a former officer and employee of the Company filed a demand for arbitration against the Company with the American Arbitration Association claiming that he is entitled to a payment pursuant to the terms of a written Severance Compensation Agreement as well as reimbursement for his attorneys’ fees relating to this claim. The Severance Compensation Agreement provides that in the event the employee is terminated by the Company without “Cause” (as defined in such agreement), or ceases to be employed by the Company for reasons other than because of death, disability, retirement or Cause, or the employee terminates his employment with us for “Good Reason” (as defined in such agreement), in each case, within 24 months following a “Change of Control” (as defined in such agreement), the employee would be entitled to receive a lump sum cash payment equal to the sum of his annual base salary plus his annual incentive compensation bonus that would be payable assuming 100 percent satisfaction of all performance goals. The former officer and employee claims that the Company’s January 2009 sale of its WTS business to Ascom and/or a change in the composition of the Board of Directors of the Company
constituted a Change of Control and that he is entitled to the specified payment because he ceased to be employed by the Company as a result of such transaction, although his employment was assumed by Ascom in essentially the same capacity following the consummation of the transaction. The Company reached a settlement with the former officer and employee in June, 2010. Pursuant to the settlement, Comarco paid the former officer and employee $508,000 during the second quarter of fiscal 2011 which amount included reimbursement for attorney and professional fees. Such amount is included in income (loss) from discontinued operations in the accompanying condensed consolidated statements of operations.
In addition to the matters described above, the Company is from time to time involved in various legal proceedings incidental to the conduct of its business. The Company believes that the outcome of all such legal proceedings will not, in the aggregate, have a material adverse effect on its consolidated results of operations and financial position.
16. Subsequent Events
Third Amendment to Loan Agreement
On February 9, 2011, the Company entered into the Third Amendment to the Loan and Security Agreement (the “Loan Agreement”) with SVB. The credit facility matures, and any outstanding principal balance is payable in full, on February 9, 2012.
Under the Loan Agreement, as amended, the Company may borrow up to (a) the lesser of (i) $10,000,000 or (ii) 80 percent of the Company’s eligible accounts receivable minus (b) the amount of any outstanding principal balance of any advances made by SVB under the line of credit. The Company must maintain a quick ratio of 1.25 to 1.0 as its primary financial covenant and must also comply with certain monthly reporting covenants. Amounts borrowed under the Loan Agreement bear interest at a rate of 3.25% above the Wall Street Journal Prime Rate; provided that the interest rate in effect on any day shall not be less than 6.5% per annum.
Subsequent to the fiscal year ended January 31, 2011, Comarco repaid the amounts outstanding under the Loan Agreement in full. As of the date of this filing, we have no borrowings outstanding under the Loan Agreement and we are in negotiations with SVB regarding future amendments to the Loan Agreement.
Termination of President and Chief Executive Officer
Effective April 5, 2011, the Board of Directors terminated the employment of Samuel M. Inman, III, as the Company’s President and CEO. Pursuant to his employment agreement, that termination also constitutes the resignation of his position as a director of the Company.
Resignation of Vice President and Chief Financial Officer
On April 14, 2011, Winston E. Hickman submitted to the Company his resignation as the Company’s Vice President and Chief Financial Officer. That resignation was effective as of April 15, 2011, but Mr. Hickman will remain in the Company’s employ until May 6, 2011.
Appointment of Interim Chief Executive Officer
On April 5, 2011, the Board of Directors appointed Fredrik Torstensson to serve as interim President and Chief Executive Officer until it can appoint a permanent replacement.
Appointment of Chief Accounting Officer
On April 19, 2011, the Board of Directors appointed Alisha K. Charlton to serve as the Company’s Chief Accounting Officer. Ms. Charlton is currently serving the Company as the principal financial officer and principal accounting officer.
ITEM 9.
ITEM 9.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Resignation of Independent Registered Public Accounting Firm
As previously reported by us in a current report on Form 8-K that was filed with the SEC on April 11, 2011 (the “Current Report”), On April 5, 2011, BDO USA, LLP (“BDO”) provided written correspondence to the Company that they decline to stand for re-appointment after completion of the current audit.
BDO’s reports on Comarco’s consolidated financial statements as of and for the year ended January 31, 2010 and 2009, did not contain an adverse opinion or disclaimer of opinion nor were they qualified or modified as to uncertainty, audit scope or accounting principles. During Comarco’s fiscal years ended January 31, 2010 and 2009, there were no disagreements between Comarco and BDO on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedure which, if not resolved to BDO’s satisfaction, would have caused BDO to make reference to the matter of the disagreement in connection with its reports.
During the fiscal years ended January 31, 2010 and 2009 and through the date of BDO’s correspondence, none of the reportable events described under Item 304 (a)(1)(v) of Regulation S-K occurred.
Comarco provided BDO with a copy of this disclosure. A copy of BDO’s letter to the Securities & Exchange Commission dated April 6, 2011, stating their agreement with the statements in this disclosure is attached as Exhibit 16.1 to the Current Report.
Engagement of New Independent Registered Public Accounting Firm
As previously reported by us in a current report on Form 8-K that was filed with the SEC on April 22, 2011, on April 20, 2011, we engaged Squar, Milner, Peterson, Miranda & Williamson, LLP (“Squar Milner”) as the Company’s independent registered public accounting firm for the fiscal year ending January 31, 2012, to conduct reviews of the Company’s quarterly reports on Form 10-Q for the first three quarters of fiscal 2012 and to conduct the audit of our annual consolidated financial statements for fiscal 2012. Squar Milner’s engagement was unanimously approved by our Audit Committee.
During our fiscal years ended January 31, 2010 and 2011, respectively and the subsequent period ended April 20, 2011 (the date Squar Milner was engaged by us), neither Comarco nor anyone acting on its behalf consulted Squar Milner regarding either: (i) the application of accounting principles to a specified transaction, either completed or proposed or the type of audit opinion that might be rendered on Comarco’s financial statements, or (ii) any “disagreement” (as defined in Item 304(a)(1)(iv) of Regulation S-K) or “reportable event” as described in Item 304(a)(1)(v) of Regulation S-K.
ITEM 9A.
ITEM 9A.
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 the periodic reports that we file or submit with the SEC 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 rules and forms of the SEC, and that such information is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required disclosure.
Our management, under the supervision and with the participation of our principal executive officer and principal financial officer, evaluated the effectiveness of our disclosure controls and procedures as such term is defined under Rules 13a-15(e) and 15(d)-15(e) promulgated under the Exchange Act as of the end of the period covered by this report. Based upon this evaluation, our management, including our principal executive officer and principal financial officer, as more fully explained below, have identified a control deficiency that we have determined represents a material weakness in our internal control over financial reporting as of January 31, 2011. Due to the identification of this material weakness in internal control over financial reporting, our principal executive officer and principal financial officer concluded that, as of January 31, 2011, our disclosure controls and procedures were not effective.
Management’s Report on Internal Control over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined under Rule 13a-15(f) promulgated under the Exchange Act. The Company’s internal control over financial reporting is a process designed under the supervision of the Company’s principal executive officer and principal financial officer, and effected by the Company’s Board of Directors, management, and other personnel. These internal controls are designed to provide reasonable assurance that the reported financial information is presented fairly and in accordance with GAAP, that disclosures are adequate, and that the judgments inherent in the preparation of financial statements are reasonable. There are inherent limitations in the effectiveness of any system of internal control, including the possibility of human error and overriding of controls. Consequently, an effective internal control system can only provide reasonable, not absolute, assurance with respect to reporting financial information. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Our internal control over financial reporting includes 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 Company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of consolidated financial statements in accordance with GAAP, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Company’s assets that could have a material effect on the consolidated financial statements.
Management conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework and criteria established in Internal Control - Integrated Framework, issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation, management concluded that our internal control over financial reporting was ineffective as of January 31, 2011. The material weakness is as follows:
The Company failed to apply appropriate accounting literature related to a non-routine transaction which resulted in a material adjustment to the consolidated financial statements.
Management’s Remediation Initiatives
As of the time of filing this report, our management has completed the implementation of its remediation efforts related to the period-end financial close process, which include the following:
During the fourth quarter ended January 31, 2011, we recorded an adjustment to correct the material weakness identified above. In addition, in the future, we will consult with outside professionals to assist us in evaluating the proper accounting treatment for complex and/or non-routine transactions.
Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that misstatements due to either error or fraud will not occur at all or that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision making can be faulty and that breakdowns can occur because of simple error or mistake. The design of any system of controls is based in part on certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Projections of any evaluation of controls effectiveness to future periods are subject to risks.
Because we are a smaller reporting company, the rules and regulations of the SEC do not require that we include a report of our independent registered public accounting firm regarding our internal control over financial reporting.
Changes in Internal Control Over Financial Reporting
During the fourth quarter of the fiscal year ended January 31, 2011, except for the material weakness in our internal control over financial reporting discussed aboe, there were no changes in our internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
None.
PART III
ITEM 10.
ITEM 10.
DIRECTORS, EXECUTIVE OFFICERS, AND CORPORATE GOVERNANCE
Executive Officers
Set forth below is information, as of April 29, 2011, regarding our current executive officers:
Name and Age
Current Title
Fredrik Torstennson, 41
Interim President & CEO (principal executive officer); Vice President of Sales & Marketing
Thomas W. Lanni, 58
Vice President & Chief Technology Officer
Donald L. McKeefery, 49
Vice President - Manufacturing & Operations
Alisha K. Charlton, 41
Chief Accounting Officer (principal financial officer and principal accounting officer)
Fredrik Torstensson. Mr. Torstensson was appointed Interim President and Chief Executive Officer in April 2011 and will serve in this capacity until the Board of Directors is able to complete its search for a permanent Chief Executive Officer. He originally joined the Company in 2003 as Vice President of Sales and Marketing. He will continue to serve in this capacity during his appointment as Interim President and Chief Executive Officer. Mr. Torstensson has more than 15 years of experience in international sales and marketing, product management and executive management. From August 2002 to July 2003, he was Vice President of International Sales and Marketing at Kyocera Wireless. From 1999 to August 2003, he was General Manager for North America and Executive Vice President of Sales and Marketing for OZ Communication, a mobile applications development company. From 1996 to 1999, he was the Director of Business Development with Ericsson, a provider of telecommunication and data communication systems.
Thomas W. Lanni. Mr. Lanni joined the Company in 1994 as General Manager for the ChargeSource Division and was appointed Vice President and Chief Technology Officer in February 2004. Mr. Lanni has more than 27 years of experience with the technology of power systems. From 1992 to 1994, he was President of Power Conversion Technologies, Inc. (“PCTI”), a company that provides advanced power electronics solutions to military and commercial industrial customers. From 1987 to 1992, he was Vice President of Engineering at Bruno New York Industries, Inc., a military weaponry specialist firm. From 1982 to 1987, he was Engineering Group Leader at Aerospace Avionics, Inc., a company whose various manufacturing activities are carried out through its Aerospace, Specialty Engineering, Medical and Detection divisions.
Donald L. McKeefery. Mr. McKeefery joined the Company in February 2005 as Director of Operations for the Wireless Test Solutions and Call Box Divisions (both of which were sold during fiscal 2009), and was promoted to Vice President - Manufacturing & Operations in May 2008. From August 1997 to February 2005, Mr. McKeefery held various management positions with Western Digital Corporation, a company that designs, manufactures and sells hard drives for the computer and consumer industries. From January 1996 to August 1997, he was the North American Service Manager for EDAP Technomed, Inc. (now EDAP TMS S.A.), a company that designs, manufactures and sells minimally invasive medical devices for the treatment of urological diseases to hospitals, clinics and private practices. From 1989 to 1996, he held various positions in the manufacturing division of Beckman Instruments, Inc. (now Beckman Coulter, Inc.), a leading provider of clinical and biomedical devices.
Alisha K. Charlton. Ms. Charlton joined the Company in October 2000 as Assistant Controller, became Corporate Controller in May 2003, and was promoted to Vice President, Corporate Controller and Secretary in
March 2008. She was appointed to the position of Chief Accounting Officer in April 2011, and, in that capacity, is currently serving as both the Company’s principal accounting officer and principal financial officer. Before joining the Company, Ms. Charlton held various accounting and finance positions with CKE Restaurants, Inc. from 1995 to 2000, including Director, Controller of Santa Barbara Restaurant Group, Inc., a CKE affiliate. Prior to joining CKE, Ms. Charlton was a certified public accountant and supervisor with KPMG Peat Marwick (now KPMG LLP).
With the exception of the information regarding our executive officers set forth above, the information required by this Item is incorporated herein by reference to our definitive Proxy Statement, which will be filed within 120 days of January 31, 2011, and delivered to stockholders in connection with our annual meeting of stockholders.
The information required by this Item is incorporated herein by reference to our definitive Proxy Statement, which will be filed within 120 days of January 31, 2011, and delivered to stockholders in connection with our annual meeting of stockholders.
ITEM 12.
ITEM 12.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
Securities Authorized for Issuance Under Equity Compensation Plans
The following table sets forth certain information with respect to our equity compensation plans as of January 31, 2011.
With the exception of the information regarding securities authorized for issuance under our equity compensation plans set forth above, the information required by this Item 12 is incorporated herein by reference to our definitive Proxy Statement, which will be filed within 120 days of January 31, 2011, and delivered to stockholders in connection with our annual meeting of stockholders.
ITEM 13.
ITEM 13.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
The information required by this Item is incorporated herein by reference to our definitive Proxy Statement, which will be filed within 120 days of January 31, 2011, and delivered to stockholders in connection with our annual meeting of stockholders.
ITEM 14.
ITEM 14.
PRINCIPAL ACCOUNTANT FEES AND SERVICES
See discussion under Item 9 regarding our independent registered public accounting firm.The other information required by this Item is incorporated herein by reference to our definitive Proxy Statement, which will be filed within 120 days of January 31, 2011, and delivered to stockholders in connection with our annual meeting of stockholders.
PART IV
ITEM 15.
ITEM 15.
EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
The following additional information for the years ended January 31, 2011 and 2010 is submitted herewith:
II Valuation and Qualifying Accounts
All other schedules are omitted because the required information is not present in amounts sufficient to require submission of the schedule or because the information required is included in the consolidated financial statements or the notes thereto.

Filed herewith.
*
These exhibits are identified as management contracts or compensatory plans or arrangements of the registrant pursuant to Item 15 of Form 10-K.
**
Confidential Treatment has been requested with respect to certain provisions of this agreement.
Omitted portions have been filed separately with the SEC.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on April 29, 2011.
POWER OF ATTORNEY
We, the undersigned directors and officers of Comarco, Inc., do hereby constitute and appoint Fredrik Torstensson, as our true and lawful attorney-in-fact and agent with power of substitution, to do any and all acts and things in our name and behalf in our capacities as directors and officers and to execute any and all instruments for us and in our names in the capacities indicated below, which such attorney-in-fact and agent may deem necessary or advisable to enable said corporation to comply with the Securities Exchange Act of 1934, as amended, and any rules, regulations and requirements of the Securities and Exchange Commission, in connection with this Annual Report on Form 10-K, including specifically but without limitation, power and authority to sign for us or any of us in our names in the capacities indicated below, any and all amendments hereto; and we do hereby ratify and confirm all that said attorney-in-fact and agent, shall do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
COMARCO, INC. AND SUBSIDIARIES
SCHEDULE II-VALUATION AND QUALIFYING ACCOUNTS
Years Ended January 31, 2011 and 2010
(In thousands)
INDEX TO EXHIBITS
Exhibit Description

Filed herewith.
*
These exhibits are identified as management contracts or compensatory plans or arrangements of the Registrant pursuant to Item 15 of Form 10-K.
**
Confidential Treatment has been requested with respect to certain provisions of this agreement.
Omitted portions have been filed separately with the SEC.