UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

____________________

FORM 10-Q

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

For the quarterly period ended

OCTOBER 31, 2013

OR

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

For the transition period from ______________ to ______________

Commission file number 0-5449

COMARCO, INC.

(Exact name of registrant as specified in its charter)

____________________

California | 95-2088894
(State or other jurisdiction | (I.R.S. Employer
of incorporation or organization) | Identification No.)

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

(Address of principal executive offices and zip code)

(949) 599-7400

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes | √ |  | No |

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

Yes | √ |  | No |

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

Large accelerated filer |  |  | Accelerated filer |  |  | Non-accelerated filer |  |  | Smaller reporting company | √

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

Yes |  |  | No | √

The registrant had 14,684,165 shares of common stock outstanding as of December 12, 2013.

COMARCO, INC. AND SUBSIDIARY

QUARTERLY REPORT ON FORM 10-Q

FOR THE THREE AND NINE MONTHS ENDED OCTOBER 31, 2013

TABLE OF CONTENTS

|  | Page
PART I — FINANCIAL INFORMATION |
ITEM 1. | FINANCIAL STATEMENTS (Unaudited) |
| Condensed Consolidated Balance Sheets as of October 31, 2013 and January 31, 2013 | 3
| Condensed Consolidated Statements of Operations for the Three and Nine Months Ended October 31, 2013 and 2012 | 4
| Condensed Consolidated Statements of Cash Flows for the Nine Months Ended October 31, 2013 and 2012 | 5
| Notes to Condensed Consolidated Financial Statements | 6
ITEM 2. | MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS | 23
ITEM 4. | CONTROLS AND PROCEDURES | 32
PART II — OTHER INFORMATION
ITEM 1. | LEGAL PROCEEDINGS | 33
ITEM 1A. | RISK FACTORS | 33
ITEM 6. | EXHIBITS | 34
SIGNATURES | 35

2

PART I — FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

COMARCO, INC. AND SUBSIDIARY

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except share and par value amounts)

|  | October 31, 2013 |  |  | January 31, 2013 |
|  | (Unaudited) |  |  |  |  |
ASSETS |  |  |  |  |  |  |  |
Current Assets: |  |  |  |  |  |  |  |
Cash and cash equivalents |  | $ | 205 |  |  | $ | 104 |
Accounts receivable due from customers, net of reserves of $0 |  |  | 1,477 |  |  |  | 1,307 |
Accounts receivable due from suppliers, net of reserves of $36 at October 31, 2013 and $24 at January 31, 2013 |  |  | 598 |  |  |  | 1,132 |
Inventory, net of reserves of $631 at January 31, 2013 |  |  | — |  |  |  | 466 |
Other current assets |  |  | 15 |  |  |  | — |
Total current assets |  |  | 2,295 |  |  |  | 3,009 |
Property and equipment, net |  |  | 15 |  |  |  | 120 |
Restricted cash |  |  | 82 |  |  |  | 82 |
Total assets |  | $ | 2,392 |  |  | $ | 3,211 |
LIABILITIES AND SHAREHOLDERS’ DEFICIT |  |  |  |  |  |  |  |
Current Liabilities: |  |  |  |  |  |  |  |
Accounts payable |  | $ | 4,394 |  |  | $ | 3,688 |
Accrued liabilities |  |  | 1,487 |  |  |  | 1,831 |
Loan payable |  |  | — |  |  |  | 2,000 |
Derivative liabilities |  |  | 2,819 |  |  |  | 2,466 |
Total current liabilities |  |  | 8,700 |  |  |  | 9,985 |
Convertible debt, net of discount of $418 at October 31, 2013 |  |  | 1,082 |  |  |  | — |
Total liabilities |  |  | 9,782 |  |  |  | 9,985 |
Commitments and Contingencies |  |  |  |  |  |  |  |
Shareholders’ Deficit: |  |  |  |  |  |  |  |
Preferred stock, no par value, 10,000,000 shares authorized; no shares issued or outstanding at October 31, 2013 and at January 31, 2013, respectively |  |  | — |  |  |  | — |
Common stock, $0.10 par value, 50,625,000 shares authorized; 14,684,165 and 7,635,039 shares issued and outstanding at October 31, 2013 and at January 31, 2013, respectively |  |  | 1,426 |  |  |  | 764 |
Additional paid-in capital |  |  | 16,016 |  |  |  | 15,577 |
Accumulated deficit |  |  | (24,832 | ) |  |  | (23,115 | )
Total shareholders’ deficit |  |  | (7,390 | ) |  |  | (6,774 | )
Total liabilities and shareholders’ deficit |  | $ | 2,392 |  |  | $ | 3,211 |

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

3

COMARCO, INC. AND SUBSIDIARY

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

(In thousands, except per share amounts)

|  | Three Months Ended October 31, |  |  | Nine Months Ended October 31, |
|  | 2013 |  |  | 2012 |  |  | 2013 |  |  | 2012 |
Revenue |  | $ | 1,508 |  |  | $ | 1,135 |  |  | $ | 4,429 |  |  | $ | 5,018 |
Cost of revenue (1) |  |  | 1,567 |  |  |  | 929 |  |  |  | 4,029 |  |  |  | 2,672 |
Gross profit (loss) |  |  | (59 | ) |  |  | 206 |  |  |  | 400 |  |  |  | 2,346 |
Selling, general, and administrative expenses |  |  | 203 |  |  |  | 903 |  |  |  | 1,440 |  |  |  | 2,303 |
Engineering and support expenses |  |  | 69 |  |  |  | 640 |  |  |  | 668 |  |  |  | 1,884 |
|  |  | 272 |  |  |  | 1,543 |  |  |  | 2,108 |  |  |  | 4,187 |
Operating loss |  |  | (331 | ) |  |  | (1,337 | ) |  |  | (1,708 | ) |  |  | (1,841 | )
Interest expense, net |  |  | 106 |  |  |  | 518 |  |  |  | 283 |  |  |  | 573 |
Gain (loss) due to change in fair value of derivative liabilities |  |  | 988 |  |  |  | (389 | ) |  |  | 271 |  |  |  | (389 | )
Other income, net |  |  | — |  |  |  | — |  |  |  | 5 |  |  |  | — |
Income (loss) before income taxes |  |  | 551 |  |  |  | (2,244 | ) |  |  | (1,715 | ) |  |  | (2,803 | )
Income tax expense |  |  | — |  |  |  | — |  |  |  | (2 | ) |  |  | (2 | )
Net income (loss) |  |  | 551 |  |  |  | (2,244 | ) |  |  | (1,717 | ) |  |  | (2,805 | )
Basic and diluted income (loss) per share: |  | $ | 0.04 |  |  | $ | (0.29 | ) |  | $ | (0.12 | ) |  | $ | (0.37 | )
Weighted average common shares outstanding: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Basic |  |  | 14,470 |  |  |  | 7,613 |  |  |  | 14,300 |  |  |  | 7,518 |
Diluted |  |  | 14,544 |  |  |  | 7,613 |  |  |  | 14,300 |  |  |  | 7,518 |
Common shares outstanding |  |  | 14,684 |  |  |  | 7,615 |  |  |  | 14,684 |  |  |  | 7,615 |

| (1) | See Note 11

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

4

COMARCO, INC. AND SUBSIDIARY

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(In thousands)

|  | Nine Months Ended October 31, |
|  | 2013 |  |  | 2012 |
CASH FLOWS FROM OPERATING ACTIVITIES: |  |  |  |  |  |  |  |
Net loss |  | $ | (1,717 | ) |  | $ | (2,805 | )
Adjustments to reconcile net loss from operations to net cash used in operating activities: |  |  |  |  |  |  |  |
Depreciation |  |  | 54 |  |  |  | 75 |
Loss on disposal of property and equipment |  |  | 32 |  |  |  | 11 |
Stock-based compensation |  |  | 71 |  |  |  | 115 |
Amortization of loan discount |  |  | 206 |  |  |  | 492 |
Provision (recovery) related to doubtful accounts receivable |  |  | 12 |  |  |  | (62 | )
Provision for obsolete inventory |  |  | 368 |  |  |  | (709 | )
Change in fair value of derivative liabilities |  |  | (271 | ) |  |  | 389 |
Supplier settlement |  |  | — |  |  |  | (1,443 | )
Changes in operating assets and liabilities: |  |  |  |  |  |  |  |
Accounts receivable due from customers |  |  | (170 | ) |  |  | (188 | )
Accounts receivable due from suppliers |  |  | 522 |  |  |  | (636 | )
Inventory |  |  | 98 |  |  |  | 621 |
Other current assets |  |  | (15 | ) |  |  | 30 |
Accounts payable |  |  | 706 |  |  |  | 1,506 |
Accrued liabilities |  |  | (344 | ) |  |  | 308 |
Net cash used in operating activities |  |  | (448 | ) |  |  | (2,296 | )
CASH FLOWS FROM INVESTING ACTIVITIES: |  |  |  |  |  |  |  |
Purchases of property and equipment |  |  | (9 | ) |  |  | (62 | )
Proceeds from sale of property and equipment |  |  | 28 |  |  |  | — |
Change in restricted cash |  |  | — |  |  |  | 10 |
Net cash provided by (used in) investing activities |  |  | 19 |  |  |  | (52 | )
CASH FLOWS FROM FINANCING ACTIVITIES: |  |  |  |  |  |  |  |
Loan proceeds |  |  | 1,500 |  |  |  | 2,000 |
Loan repayment |  |  | (2,000 | ) |  |  | — |
Net proceeds from common stock issued |  |  | 1,030 |  |  |  | — |
Net cash provided by financing activities |  |  | 530 |  |  |  | 2,000 |
Net increase (decrease) in cash and cash equivalents |  |  | 101 |  |  |  | (348 | )
Cash and cash equivalents, beginning of period |  |  | 104 |  |  |  | 908 |
Cash and cash equivalents, end of period |  | $ | 205 |  |  | $ | 560 |
Noncash investing and financing activities: |  |  |  |  |  |  |  |
Loan discount recorded in connection with issuance of warrants |  | $ | — |  |  | $ | 1,365 |
Debt discount recorded upon issuance of convertible debt |  | $ | 624 |  |  | $ | — |
Issuance of common stock upon the vesting of restricted stock units |  | $ | 19 |  |  | $ | 23 |
Supplemental disclosures of cash flow information: |  |  |  |  |  |  |  |
Cash paid for interest |  | $ | 76 |  |  | $ | — |
Cash paid for income taxes, net of refunds |  | $ | 2 |  |  | $ | 2 |

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

5

COMARCO, INC. AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

1. Organization

Comarco, Inc., through its wholly-owned subsidiary Comarco Wireless Technologies, Inc. (collectively, “we,” “our,” “Comarco,” “us,” or the “Company”), is a developer and designer of innovative technologies and intellectual property currently used in power adapters to power and charge battery powered devices such as laptop computers, tablets, smart phones and readers. 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.

Our business has historically targeted the needs of today’s mobile culture by providing innovative charging solutions for the myriad of battery powered devices used by nearly all consumers today. Our innovative technology allows the consumer to charge multiple devices from a single charger, eliminating the need to carry multiple chargers while traveling. This technology was developed by Comarco and we own an extensive patent portfolio related to this technology. Our patent portfolio is the result of years of research and development to provide charging solutions. During the current fiscal year, we have expanded our patent portfolio, while concurrently exploring other ways to capitalize on our patent portfolio.

Substantially all of our recent revenue has been derived from a single customer, Lenovo Information Products Co., Ltd. (“Lenovo”). However, as previously announced, Lenovo has terminated its relationship with us (see Note 2 and Note 6). We completed our final shipment of product to Lenovo during the third quarter ended October 31, 2013 and anticipate that we will generate no or de minimus revenue in our fourth quarter ending January 31, 2014. We have effectively ceased traditional operations and are now primarily focused on potentially realizing value from our ongoing litigation matters (see Note 2 and Note 11) and exploring opportunities to expand, protect, and monetize our patent portfolio, including through the potential sale or licensing of our patent portfolio. Regardless of whether we generate significant capital infusions from litigation or from a sale or license of our patent portfolio, we may need to obtain additional debt and/or equity financing to meet our working capital needs. There is no assurance that we will prevail in our litigation, succeed in the sale or licensing of our patent portfolio or raise additional debt and/or equity financing and if we are not successful doing so, we may have to evaluate other alternatives or partially, or entirely, cease our operations. We currently have three employees, two executive officers and an accountant.

2. Current Developments, Future Operations, Liquidity and Capital Resources

We have experienced substantial operating losses for the nine months ended October 31, 2013 and 2012 totaling $1.7 million and $1.8 million, respectively. The condensed consolidated financial statements have been prepared assuming that we will continue to operate as a going concern, which contemplates that we will realize our assets and satisfy our liabilities and commitments in the ordinary course of business. Our consolidated financial statements do not reflect any adjustments related to the outcome of this uncertainty. Our future is highly dependent on our ability to successfully resolve our current litigation, capitalize on our portfolio of patents, generate positive cash flows and obtain borrowings or raise capital to meet our liquidity needs.

Our business during fiscal year 2013 and 2014 to date was almost entirely driven by sales of our products to Lenovo. However, as previously announced in a Form 8-K filed with the Securities and Exchange Commission (“SEC”) on August 22, 2013, Lenovo notified us of their intention to cease offering Comarco’s Constellation product, the power adapter Comarco designed and developed for Lenovo, to its corporate clients. We completed shipping product to Lenovo during our third fiscal quarter. As a result of this decision by Lenovo, we anticipate that we will generate no or de minimus revenue in our fourth fiscal quarter ending January 31, 2014. The loss of Lenovo will have a material adverse impact on our future results of operations. We have reduced and/or eliminated certain operating expenses to minimize future losses and cash burn and will continue our efforts in this regard. Our near term objectives include an orderly wind-down of the Lenovo relationship including collection of accounts receivable balances and a focus on preserving our ability to conclude our ongoing litigation with Chicony Power Technology, Co. Ltd. (“Chicony”). (See Note 11 for a description of the Chicony litigation).

6

COMARCO, INC. AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

A positive outcome in our ongoing litigation with Chicony and ACCO Brands USA LLC and its Kensington Computer Products Group division (collectively “Kensington”), described in Note 11, if such an outcome were realized, could not only reduce our accumulated deficit, but could also provide us with a cash infusion. Conversely, a negative outcome or prolonged resolution to our ongoing litigation with either Chicony or Kensington could negatively impact our financial condition and we may not be able to continue as a going concern. However, the outcome of our ongoing litigation matters is not determinable as of the date of filing this report.

Our extensive patent portfolio covering key technical aspects of our products could potentially generate a future revenue stream based upon royalties paid to us by others for the use of some or all of our patents in third party products. We are currently exploring opportunities to expand, protect, and monetize our patent portfolio, including through the sale or licensing of our patent portfolio.

We had negative working capital totaling approximately $6.4 million at October 31, 2013, of which $2.8 million relates to the fair value of derivative liabilities. In order for us to conduct our business for the next twelve months, to continue operations thereafter and to be able to discharge our liabilities and commitments in the normal course of business, we must prevail in our current litigation against Chicony and/or Kensington, raise additional funds, through the sale or licensing of our patent portfolio, or obtain additional debt and/or equity financing to meet our working capital needs. There is no assurance that we will prevail in our litigation against Chicony and/or Kensington, succeed in the sale or licensing of our patent portfolio or raise additional financing and if we are not successful doing so, we may have to evaluate other alternatives or partially, or entirely, cease our operations.

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 shareholders may lose all or part of their investment in our common stock. The condensed consolidated financial statements do not reflect any adjustments related to the outcome of this uncertainty.

3. Summary of Significant Accounting Policies

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

Basis of Presentation

The accompanying condensed consolidated balance sheet as of January 31, 2013, which has been derived from our audited financial statements, and our unaudited interim condensed consolidated financial statements as of October 31, 2013 included herein have been prepared without audit in accordance with accounting principles generally accepted in the United States of America for interim information and with the instructions for Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. The Company believes that the disclosures are adequate to make the information presented not misleading when read in conjunction with the audited consolidated financial statements included in the Company’s annual report on Form 10-K for the year ended January 31, 2013. The accounting policies followed by the Company are set forth in Note 2 to the Company’s audited financial statements included in its Form 10-K for its fiscal year ended January 31, 2013 (the “2013 10-K”), which was filed with the SEC on April 30, 2013 and amended by Amendment No. 1 on Form 10-K/A filed with the SEC on May 31, 2013. The unaudited interim condensed consolidated financial information presented herein reflects all adjustments, consisting only of normal recurring accruals, which are, in the opinion of management, necessary for a fair presentation of the consolidated results for the interim periods presented. The consolidated results for the three and nine months ended October 31, 2013 are not necessarily indicative of the results to be expected for the fiscal year ending January 31, 2014.

7

COMARCO, INC. AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

Cash and Cash Equivalents

All highly liquid investments with original maturity dates of three months or less when acquired are classified as cash and cash equivalents. The fair value of cash and cash equivalents approximates the amounts shown in the unaudited interim condensed 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. We have not historically suffered losses relating to cash and cash equivalents.

Principles of Consolidation

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

Accounts Receivable Due from Customers

We offer unsecured credit terms to customers and perform ongoing credit evaluations of our customers. Accounts receivable balances result primarily from the timing of remittance payments by these customers to the Company. Accounts receivable are stated net of an allowance for doubtful accounts. Management develops its estimate of this reserve 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. Historically, such losses have been within management’s expectations and the reserves established. We do not anticipate any collection issues with the balance currently due from Lenovo.

Accounts Receivable Due from Suppliers

Historically, we were able to source components locally that we would later sell to our contract manufacturers (“CMs”), who build the finished goods, and other suppliers. This was especially the case when new products were initially introduced into production. Sales to our contract manufacturers and other suppliers are excluded from revenue and are recorded as a reduction to cost of revenue. During fiscal 2013, our relationship with Power System Technologies, Ltd. (“Power,” formerly Flextronics Electronics), the CM who built our Constellation product for Lenovo through the end of the third quarter of fiscal 2014 changed and we began procuring all of the component parts in the bill of material. We expect to offset the receivables due from suppliers from amounts we owe these suppliers, in the event we no longer receive cash payments.

Restricted Cash

Our restricted cash balances are secured by separate bank accounts and represent i) a $77,000 letter of credit that serves as the security deposit for our corporate office lease and ii) $5,000 which serves as collateral for credit card chargebacks associated with our internet website.

Use of Estimates

The preparation of unaudited interim condensed consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the unaudited interim condensed consolidated financial statements and the reported amounts of revenue and expenses during the period reported. Actual results could materially differ from those estimates.

8

COMARCO, INC. AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

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

Reclassifications

Certain prior period balances have been reclassified to conform to the current period presentation. The reclassifications have no effect on previously reported results of operations or accumulated deficit.

Impairment or Disposal of Long-lived Assets

We review our long-lived assets for impairment whenever events or changes in circumstances indicate that their carrying amounts may not be recoverable. If the cost basis of a long-lived asset is greater than the projected future undiscounted net cash flows from such asset (excluding interest), an impairment loss is recognized. Impairment losses are calculated as the difference between the cost basis of an asset and its estimated fair value. We recognized impairment charges during the three months ended October 31, 2013 totaling approximately $60,000, which relates to the write-off of all tooling and equipment located at our various contract manufacturer locations in Asia, consistent with the cessation of manufacture of products for our customer Lenovo (see Note 2). Additionally, we sold fully depreciated engineering equipment for $28,000 in cash during the fiscal quarter ended October 31, 2013.

Derivative Liabilities

A derivative is an instrument whose value is “derived” from an underlying instrument or index such as a future, forward, swap, option contract, or other financial instrument with similar characteristics, including certain derivative instruments embedded in other contracts and for hedging activities. As a matter of policy, the Company does not invest in separable financial derivatives or engage in hedging transactions. However, the Company has entered into certain financing transactions in fiscal 2013 and fiscal 2014 that involve financial equity instruments containing certain features that have resulted in the instruments being deemed derivatives. The Company may engage in other similar complex financing transactions in the future, but not with the intention to enter into derivative instruments. Derivatives are measured at fair value using the Monte Carlo simulation pricing model and marked to market through earnings. However, such new and/or complex instruments may have immature or limited markets. As a result, the pricing models used for valuation of derivatives often incorporate significant estimates and assumptions. Changes in these subjective assumptions can materially affect the estimate of the fair value of derivative liabilities and, consequently, the related amount recognized as loss due to change in fair value of derivative liabilities on the condensed consolidated statement of operations. Furthermore, depending on the terms of a derivative, the valuation of derivatives may be removed from the financial statements upon exercise or conversion of the underlying instrument into some other security.

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

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

During the second quarter of fiscal 2013, we adopted the guidance, as codified in Financial Accounting Standards Board ("FASB") Accounting Standards Codification ("ASC") 815-40, Derivatives and Hedging, Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock, that requires us to apply a two-step model in determining whether a financial instrument or an embedded feature is indexed to our own stock and thus enables it to qualify for equity classification. The warrants previously issued to Broadwood Partners, L.P. (“Broadwood”) contain provisions that adjust the exercise price in the event of certain dilutive issuance of our securities. Accordingly, the Company considered the warrants to be subject to price protection and classified them as derivative liabilities at the date of issuance with a fair value of $1.3 million and a corresponding discount to the underlying loan payable.

9

COMARCO, INC. AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

Additionally, during the first quarter of fiscal 2014, we entered into a Loan Agreement with Elkhorn Partners Limited Partnership (“Elkhorn”) which contains convertible provisions that allow Elkhorn to convert the loan into common stock. The conversion price may be adjusted in the event of certain dilutive issuance of our securities. Accordingly, the Company considered the convertible debt to be subject to price protection and created a discount to the underlying loan payable and classified that value as derivative liabilities at the date of issuance with a fair value of $0.6 million (see Notes 9 and 10).

Fair Value of Financial Instruments

Our financial instruments include cash and cash equivalents, accounts receivable due from customers and suppliers, accounts payable, accrued liabilities, convertible debt and derivative liabilities. The carrying amount of cash and cash equivalents, accounts receivable due from customers and suppliers, accounts payable, and accrued liabilities are considered to be representative of their respective fair values due to the short-term nature of those instruments. The carrying amount of our convertible debt, net of discount, approximates fair value since the loan balance is derived from the valuation of the derivative liabilities. The fair value of the derivative liabilities, which are comprised of the warrants issued/issuable to Broadwood, as well as the estimated value of the conversion feature of the Elkhorn loan, at October 31, 2013 was $2.8 million. Derivative liabilities are reported at their estimated fair value, with changes in fair value being reported in current period results of operations.

Legal expense classification

Our legal expenses are classified in either selling, general, and administrative expenses or engineering and support expenses depending on the nature of the legal expense. All legal expenses incurred related to our intellectual property, including associated litigation expense and maintenance of our patent portfolio, are included in engineering and support expenses in our condensed consolidated statement of operations. Legal expenses included in engineering and support expenses for the three and nine months ended October 31, 2013 totaled $34,000 and $311,000, respectively. Legal expenses included in engineering and support expenses for the three and nine months ended October 31, 2012 totaled $423,000 and $1.2 million, respectively. The decreases in the current year expenses relate primarily to changing legal representation for our ongoing intellectual property infringement and enforcement litigation and our entry into an alternative professional fee arrangement in the third quarter of fiscal 2014 related to such representation.

All other legal expenses, including all other litigation expense and public company legal expense are included in selling, general, and administrative expenses in our condensed consolidated statement of operations. Legal expenses included in selling, general, and administrative expenses for the three and nine months ended October 31, 2013 totaled a credit/reversal of $84,000 and expense of $449,000, respectively. Legal expenses included in selling, general, and administrative expenses for the three and nine months ended October 31, 2012 totaled $303,000 and $684,000, respectively. The decrease in the current fiscal year expenses relates to the fact that in the third quarter we entered into an agreement with our insurance carrier and received a one-time, lump sum payment for defense costs related to our Chicony litigation. Additionally, in the third quarter of fiscal 2014, we entered an alternative fee arrangement with our legal counsel representing us in the Chicony matter.

4. Stock-Based Compensation

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

10

COMARCO, INC. AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

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

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

|  | Three Months Ended October 31, |  |  | Nine Months Ended October 31, |
|  | 2013 |  |  | 2012 |  |  | 2013 |  |  | 2012 |
Total stock-based compensation expense |  | $ | 18 |  |  | $ | 39 |  |  | $ | 71 |  |  | $ | 115 |
Impact on basic and diluted earnings per share |  | $ | 0.00 |  |  | $ | 0.00 |  |  | $ | 0.00 |  |  | $ | 0.01 |

The total compensation cost related to nonvested awards not yet recognized is approximately $76,000, which will be expensed over a weighted average remaining life of 17.8 months.

During the three and nine months ended October 31, 2013, no stock options were granted and 420,000 shares of restricted stock were granted. During the three months ended October 31, 2012, 465,000 stock options were granted and no restricted stock was granted. During the nine months ended October 31, 2012, 300,000 restricted stock units were granted and 465,000 stock options were granted. The fair value of the restricted stock granted during the nine months ended October 31, 2013 was estimated using the stock price on the date of the grant of $0.18 and a forfeiture rate of 8.2 percent. The fair value of the restricted stock units granted during the nine months ended October 31, 2012 was estimated using the stock price on the date of the grant of $0.16 and a forfeiture rate of 10.6 percent.

The fair value of the 465,000 options granted under our stock option plans during the first three quarters of fiscal 2013 was estimated on the date of grant using the following weighted average assumptions:

|  | Year-to-date October 31, 2012 |
Weighted average risk-free interest rate |  |  | 0.7 | %
Expected life (in years) |  |  | 5.5 |
Expected stock volatility |  |  | 121 | %
Dividend yield |  | None |
Expected forfeitures |  |  | 8.2 | %

11

COMARCO, INC. AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

The Company’s former employee stock option plan (the “Employee Plan”) expired during May 2005. As a result, no new options could be granted under the plan thereafter. This plan provided for the issuance of up to 825,000 shares of common stock. 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 to 1,100,000 shares. In July 2011, the Company’s shareholders approved the 2011 Equity Incentive Plan (the “2011” Plan) covering 750,000 shares of common stock.

Under both the 2011 and 2005 Plan, the Company may grant stock options, stock appreciation rights, restricted stock, restricted stock units, and performance based awards to employees, consultants and directors. Under all plans, awards vest or become exercisable in installments determined by the compensation committee of the Company’s Board of Directors; however, under the 2005 Plan no option may be exercised prior to one year following the grant of the option. The options granted under the Employee Plan expire as determined by the committee, but no later than ten years and one week after the date of grant (five years for 10 percent shareholders). The options granted under the 2011 and 2005 Plan expire as determined by the committee, but no later than ten years after the date of grant (five years for 10 percent shareholders).

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

Transactions and other information related to stock options granted under these plans for the nine months ended October 31, 2013 are summarized below:

|  | Outstanding Options |
|  | Number of Shares |  |  | Weighted-Average Exercise Price |
Balance, January 31, 2013 |  |  | 764,500 |  |  | $ | 1.48 |
Options granted |  |  | — |  |  |  | — |
Options canceled or expired |  |  | (5,000 | ) |  |  | 8.08 |
Options exercised |  |  | — |  |  |  | — |
Balance, October 31, 2013 |  |  | 759,500 |  |  | $ | 1.44 |
Stock Options Exercisable at October 31, 2013 |  |  | 672,100 |  |  | $ | 1.48 |

Transactions and other information related to restricted stock units (“RSU’s”) granted under these plans for the nine months ended October 31, 2013 are summarized below:

|  | Outstanding Restricted Stock Units |
|  | Number of Shares |  |  | Weighted-Average Stock Price On Grant Date |
Balance, January 31, 2013 |  |  | 304,326 |  |  | $ | 0.20 |
RSU’s granted |  |  | — |  |  |  | — |
RSU’s canceled or expired |  |  | (112,700 | ) |  |  | 0.16 |
Common stock issued |  |  | (191,626 | ) |  |  | 0.20 |
Balance, October 31, 2013 |  |  | — |  |  | $ | — |

12

COMARCO, INC. AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

The RSU’s canceled or expired in the table above represent the difference between the number of shares awarded and the number issued because the recipient elected a net award to cover personal income taxes.

Transactions and other information related to restricted stock granted under these plans for the nine months ended October 31, 2013 are summarized below:

|  | Outstanding Restricted Stock |
|  | Number of Shares |  |  | Weighted-Average Stock Price On Grant Date |
Balance, January 31, 2013 |  |  | — |  |  | $ | — |
Restricted stock granted |  |  | 420,000 |  |  |  | 0.18 |
Restricted stock forfeited |  |  | — |  |  |  | — |
Balance, October 31, 2013 |  |  | 420,000 |  |  | $ | 0.18 |

As of October 31, 2013, the stock awards outstanding have no aggregate intrinsic value, based on a closing market price of $0.17 per share on October 31, 2013. The following table summarizes information about the Company’s stock awards outstanding at October 31, 2013:

|  |  |  |  |  |  | Awards Outstanding |  |  | Awards Exercisable |
| Range of Exercise/Grant Prices |  |  | Number Outstanding |  |  | Weighted-Avg. Remaining Contractual Life (Years) |  |  | Weighted-Avg. Exercise/Grant Price |  |  | Number Exercisable |  |  | Weighted-Avg. Exercise/Grant Price |
| $ | 0.18 | to | 1.20 |  |  |  | 1,103,500 |  |  |  | 4.73 |  |  | $ | 0.45 |  |  |  | 596,100 |  |  | $ | 0.55 |
|  |  | 4.90 |  |  |  |  | 15,000 |  |  |  | 4.33 |  |  |  | 4.90 |  |  |  | 15,000 |  |  |  | 4.90 |
|  | 8.38 | to | 10.43 |  |  |  | 61,000 |  |  |  | 1.93 |  |  |  | 9.68 |  |  |  | 61,000 |  |  |  | 9.68 |
|  |  |  |  |  |  |  | 1,179,500 |  |  |  | 4.58 |  |  |  | 0.99 |  |  |  | 672,100 |  |  |  | 1.48 |

At October 31, 2013, shares available for future grants under the 2011 Plan totaled 35,224.

5. 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 (loss) per share reflects the effects of potentially dilutive securities. Since the Company incurred a net loss for the nine months ended October 31, 2013 and the three and nine months ended October 31, 2012, basic and diluted loss per share for those periods were the same because the inclusion of dilutive potential common shares related to outstanding stock awards in the calculation would have been antidilutive.

Potential common shares of 720,000 relating to outstanding stock awards to directors and employees have been excluded from diluted weighted average common shares for the nine months ended October 31, 2013, as the effect would have been antidilutive. Additionally, for the nine months ended October 31, 2013, the 1,704,546 outstanding warrants issued to Broadwood would have been anti-dilutive. Similarly, potential common shares of 330,000 relating to outstanding stock awards to directors and employees have been excluded from diluted weighted average common shares for the three and nine months ended October 31, 2012, as the effect would have been antidilutive.

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

13

COMARCO, INC. AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

|  | Three Months Ended October 31, |  |  | Nine Months Ended October 31, |
|  | 2013 |  |  | 2012 |  |  | 2013 |  |  | 2012 |
Basic: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Net income (loss) |  | $ | 551 |  |  | $ | (2,244 | ) |  | $ | (1,717 | ) |  | $ | (2,805 | )
Weighted average shares outstanding |  |  | 14,470 |  |  |  | 7,613 |  |  |  | 14,300 |  |  |  | 7,518 |
Basic income (loss) per share |  | $ | 0.04 |  |  | $ | (0.29 | ) |  | $ | (0.12 | ) |  | $ | (0.37 | )
Diluted: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Net income (loss) |  | $ | 551 |  |  | $ | (2,244 | ) |  | $ | (1,717 | ) |  | $ | (2,805 | )
Weighted average shares outstanding |  |  | 14,470 |  |  |  | 7,613 |  |  |  | 14,300 |  |  |  | 7,518 |
Effect of dilutive securities – stock options |  |  | 74 |  |  |  | — |  |  |  | — |  |  |  | — |
Weighted average shares used in the calculation of diluted income (loss) per share |  |  | 14,544 |  |  |  | 7,613 |  |  |  | 14,300 |  |  |  | 7,518 |
Diluted income (loss) per share |  | $ | 0.04 |  |  | $ | (0.29 | ) |  | $ | (0.12 | ) |  | $ | (0.37 | )

6. Customer and Supplier Concentrations

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

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

|  | Three Months Ended October 31, |
|  | 2013 |  |  | 2012 |
|  | (In thousands) |
Total revenue |  | $ | 1,508 |  |  |  | 100 | % |  | $ | 1,135 |  |  |  | 100 | %
Customer concentration: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Lenovo Information Products Co., Ltd. |  |  | 1,465 |  |  |  | 97 | % |  |  | 1,119 |  |  |  | 99 | %
|  | $ | 1,465 |  |  |  | 97 | % |  | $ | 1,119 |  |  |  | 99 | %

|  | Nine Months Ended October 31, |
|  | 2013 |  |  | 2012 |
|  | (In thousands) |
Total revenue |  | $ | 4,429 |  |  |  | 100 | % |  | $ | 5,018 |  |  |  | 100 | %
Customer concentration: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Lenovo Information Products Co., Ltd. |  |  | 4,319 |  |  |  | 98 | % |  |  | 4,913 |  |  |  | 98 | %
|  | $ | 4,319 |  |  |  | 98 | % |  | $ | 4,913 |  |  |  | 98 | %

14

COMARCO, INC. AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

The customers comprising 10 percent or more of the Company’s gross accounts receivable due from customers at either October 31, 2013 or January 31, 2013 are listed below (in thousands):

|  | October 31, 2013 |  |  | January 31, 2013 |
Total gross accounts receivable due from customers |  | $ | 1,477 |  |  |  | 100 | % |  | $ | 1,307 |  |  |  | 100 | %
Customer concentration: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Lenovo Information Products Co., Ltd. |  |  | 1,439 |  |  |  | 97 | % |  |  | 1,291 |  |  |  | 99 | %
|  | $ | 1,439 |  |  |  | 97 | % |  | $ | 1,291 |  |  |  | 99 | %

The suppliers comprising 10 percent or more of the Company’s gross accounts receivable due from suppliers at either July 31, 2013 or January 31, 2013 are listed below (in thousands).

|  | October 31, 2013 |  |  | January 31, 2013 |
Total gross accounts receivable due from suppliers |  | $ | 634 |  |  |  | 100 | % |  | $ | 1,156 |  |  |  | 100 | %
Customer concentration: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Power Systems Technologies, Inc. |  |  | 473 |  |  |  | 75 | % |  |  | 1,008 |  |  |  | 87 | %
Zheng Ge Electrical Co., Ltd. |  |  | 122 |  |  |  | 19 | % |  |  | 122 |  |  |  | 11 | %
|  | $ | 595 |  |  |  | 94 | % |  | $ | 1,130 |  |  |  | 98 | %

The decrease in the receivables due from Power Systems Technologies, Inc. (“Power,” formerly Flextronics Electronics) is driven by an increased frequency in payment in early fiscal 2014 coupled with a reduction in component sales late in the third quarter of fiscal 2014 in conjunction with the final sales to Lenovo, which has caused a drop in the receivable balance as of October 31, 2013.

Zheng Ge Electrical Co., Ltd. (“Zheng Ge”) was a tip supplier for one of our prior product offerings (referred to as the Bronx product), which was subject to a recall during 2010. We previously sourced some of the component parts that Zheng Ge used in the manufacture of the tips. We ceased paying Zheng Ge during the course of the product recall while we investigated the manufacturing defect that caused the recall and, likewise, Zheng Ge ceased paying us.

We expect to offset the receivables due from Power and Zheng Ge from amounts owed, which are included in accrued liabilities in our consolidated balance sheet. Subsequent to the final delivery and sales of our Constellation product to Lenovo, we have attempted to work with Power to collect the outstanding receivable balance, but to date Power has been non-responsive.

The companies comprising 10 percent or more of our gross accounts payable at either October 31, 2013 or January 31, 2013 are listed below (in thousands, except percentages).

|  | October 31, 2013 |  |  | January 31, 2013 |
Total gross accounts payable |  | $ | 4,394 |  |  |  | 100 | % |  | $ | 3,688 |  |  |  | 100 | %
Accounts payable concentration: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Chicony Power Technology, Co. Ltd |  |  | 1,100 |  |  |  | 25 | % |  |  | 1,100 |  |  |  | 30 | %
Pillsbury Winthrop Shaw Pittman, LLP. |  |  | 1,953 |  |  |  | 44 | % |  |  | 1,614 |  |  |  | 44 | %
|  | $ | 3,053 |  |  |  | 69 | % |  | $ | 2,714 |  |  |  | 74 | %

15

COMARCO, INC. AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

Chicony was the manufacturer of the Bronx product, which was subject to a recall during 2010 and we are currently in litigation with Chicony (see Note 11). We have made no payments to this supplier during either fiscal 2014 or 2013. The outcome of such litigation is not determinable at this time and we do not know whether or not we will be obligated to pay this liability. If we prevail in this case, based upon our causes of action, it is likely we will be relieved of this liability. There is no assurance, however, as to the outcome of this litigation (see Note 11).

Pillsbury Winthrop Shaw Pittman, LLP (“Pillsbury”) was our former legal counsel for the Kensington litigation as well as other patent and intellectual property matters (See Note 11). We have made no payments to Pillsbury during fiscal 2014.

Historically, a significant portion of our inventory purchases had been derived from a limited number of contract manufacturers (“CM’s”) and other suppliers. However we ceased procuring inventory during the third quarter of fiscal 2014 in conjunction with the final manufacture and delivery of Constellation units to Lenovo.

7. Inventory

Inventory, net of reserves, consists of the following (in thousands):

|  | October 31, 2013 |  |  | January 31, 2013 |
Raw materials |  | $ | — |  |  | $ | 397 |
Finished goods |  |  | — |  |  |  | 69 |
|  | $ | — |  |  | $ | 466 |

As of January 31, 2013, approximately $720,000 of total gross inventory was located at our corporate headquarters. The remaining balance was located at various contract manufacturer locations in Asia and at a third party inventory warehouse for our customer, Lenovo. During the third quarter of fiscal 2014, we wrote-off all of our remaining inventory balances, representing primarily component inventory in excess of requirements. We also shipped certain components to a liquidator in an attempt to salvage some economic value from these parts, but to date we have not recovered any amounts and expect such recoveries to be minor.

8. Accrued Liabilities

Accrued liabilities consist of the following (in thousands):

|  | October 31, 2013 |  |  | January 31, 2013 |
Accrued payroll and related expenses |  | $ | 51 |  |  | $ | 147 |
Uninvoiced materials and services received |  |  | 1,214 |  |  |  | 1,269 |
Accrued legal and professional fees |  |  | 125 |  |  |  | 169 |
Accrued interest expense |  |  | — |  |  |  | 62 |
Accrued warranty |  |  | 43 |  |  |  | 68 |
Other |  |  | 54 |  |  |  | 116 |
|  | $ | 1,487 |  |  | $ | 1,831 |

At October 31, 2013, approximately $1.1 million or 87 percent of total uninvoiced materials and services of $1.2 million, included in accrued liabilities, were payable to Power and Zheng Ge. At January 31, 2013, approximately $1.1 million or 85 percent of total uninvoiced materials and services of $1.3 million, included in accrued liabilities, were payable to Power and Zheng Ge. We ceased paying Zheng Ge during the course of the Bronx product recall (See Note 6).

16

COMARCO, INC. AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

9. Loan & Related Agreements

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

Secured Loan Agreement with Elkhorn Partners.

The Elkhorn Loan, which is evidenced by a promissory note (the “Elkhorn Note”), issued by the Company to Elkhorn, bears interest at 7% for the first 12 months of the Loan, increasing to 8.5% thereafter and continuing until the Loan is paid in full. The Loan matures on November 30, 2014 (the “Maturity Date”); however, the Company has the right, at its option, to prepay the Elkhorn Loan, in whole or in part, without penalty or premium.

The Elkhorn Loan Agreement provides that if and to the extent the Company does not pay the Elkhorn Loan in full by its Maturity Date, then, Elkhorn will have the right, at its option (but not the obligation), to convert the then unpaid balance of the Loan, in whole or in part, into shares of Company common stock at a conversion price of $0.25 per share. That conversion price is subject to possible adjustment on (i) certain sales of Company common stock at a price lower than $0.25 per share, (ii) stock splits of, stock dividends on and any reclassification of the Company’s outstanding shares, and (iii) certain mergers or reorganizations of the Company, as provided in Article III of the Elkhorn Loan Agreement. This conversion feature creates a derivative liability that is described in Note 10.

The Elkhorn Loan Agreement contains customary representations and warranties of and affirmative and negative covenants on the part of the Company and CWT. The Agreement also provides that the Elkhorn Loan, together with accrued interest, will become immediately due and payable upon the occurrence of an Event of Default, which is defined in the Loan Agreement to include each of the following, among others: (i) a failure of the Company to pay the principal of or accrued interest on the Loan which continues unremedied for three calendar days (except that such grace period shall not apply to amounts due at the Maturity Date of the Loan), (ii) the Company or CWT commits a breach of any of their other material obligations under the Loan Agreement or under any of the Debt Related Agreements (described below) and the breach which remains uncured for a period ranging from 15 days to 30 days (depending on the nature of the breach) following receipt of notice of the breach from Elkhorn; (iii) any of the representations or warranties of the Company or CWT contained in the Loan Agreement prove to have been untrue or incorrect in any material respect, (iv) the Company or CWT fails to pay indebtedness, as such term is defined in the Elkhorn Loan Agreement, in the amount of $200,000 or more owed to any other creditor, (v) one or more judgments are entered against the Company or CWT in an aggregate amount of $200,000 or more, which are not satisfied, discharged, stayed or bonded against within the succeeding 30 days, and (vi) the filing by the Company of a voluntary petition in bankruptcy or the Company’s failure to obtain the dismissal, within 60 days, of an involuntary petition filed against it in bankruptcy, or a receiver or liquidator is appointed over, or an attachment is issued against a substantial part of the assets of the Company or CWT, which in either case remains undismissed for the succeeding thirty (30) days.

Upon the occurrence and during the continuance of an Event of Default, interest on the Loan will accrue at the lesser of (i) 15% per annum or (ii) the highest rate permitted by applicable law.

17

COMARCO, INC. AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

Debt Related Agreements. In connection with the Elkhorn Loan Agreement, the Company and CWT entered into a Security Agreement and the Company entered into a Pledge Agreement (collectively, the “Debt Related Agreements”) with Elkhorn to secure the payment and performance by the Company and CWT of their respective obligations under the Loan Agreement and the Debt Related Agreements. Set forth below is a summary of those Agreements.

Security Agreement. As security for the performance of their respective obligations under the Elkhorn Loan Agreement and the Debt Related Agreements, the Company and CWT have entered into a security agreement (the “Security Agreement”) granting Elkhorn a first priority perfected security interest in all of their assets, including their intellectual property rights. The Security Agreement provides that, on the occurrence and during the continuance of an Event of Default, whether by the Company or CWT, Elkhorn will become entitled to take possession of and to sell the assets of the Company and CWT to the extent necessary to recover the amounts due Elkhorn under the Loan Agreement and any other amounts that may be due and payable to Elkhorn under any of the Debt Related Agreements.

Pledge Agreement. As additional security for the payment and performance of its obligations under the Elkhorn Loan Agreement, the Company has entered into a Pledge Agreement (the “Pledge Agreement”) pursuant to which it has pledged and will deliver possession to Elkhorn of all of CWT’s outstanding shares. The Pledge Agreement provides, among other things, that upon the occurrence and during the continuance of an Event of Default, Elkhorn will become entitled to transfer the CWT shares into its name, to vote those shares and, subject to applicable securities laws, to sell those shares in order to recover amounts owed to it by the Company.

Elkhorn Stock Purchase Agreement

Concurrently with the Company’s entry into the Loan Agreement, the Company and Elkhorn entered into the Elkhorn SPA. Pursuant to that Agreement, the Company sold 6,250,000 shares of its common stock to Elkhorn at a price of $0.16 per share, resulting in an aggregate purchase price of $1.0 million. As noted above, that purchase price compares to an average per share closing price for Comarco’s shares of $0.14 during the five trading days immediately preceding the sale of the shares to Elkhorn, and an average per share closing price of $0.158 for the 29 trading days that that began on January 1, 2013 and ended on February 8, 2013.

The purchase price of $0.16 per share paid by Elkhorn for those shares was determined by arms-length negotiations between Elkhorn and the members of a special committee of the Company’s Board of Directors, comprised of three of the directors who have no affiliation with Elkhorn and no financial interest, other than their interests solely as shareholders of the Company, in either the loan or share transactions with Elkhorn. That per share purchase price was determined based on a number of factors, including the Company’s inability, notwithstanding its best efforts, to raise additional capital from other prospective institutional investors during the six month term of the Broadwood Loan and the recent trading prices of the Company’s shares in the over-the-counter market.

Senior Secured Six Month Term Loan Agreement with Broadwood Partners L.P. (“Broadwood”)

The Company entered into a Senior Secured Six Month Term Loan Agreement dated July 27, 2012 (the “Loan Agreement”) with Broadwood, a significant shareholder of the Company.

Pursuant to that Agreement, Broadwood made a $2,000,000 senior secured six month loan (the “Loan”) to the Company and to CWT, as co-borrower. The loan bore interest at 5% per annum, ranked senior in right of payment to all other indebtedness of the Company and was due and payable in full on January 28, 2013. The Company originally intended to repay the Loan and accrued interest from the $3.0 million in proceeds that was expected to be received from Broadwood in the fourth quarter of fiscal 2013, pursuant to the Broadwood Stock Purchase Agreement (“Broadwood SPA”). As consideration for the Loan and Broadwood’s entry into the SPA, on July 27, 2012 the Company issued stock purchase warrants (the “Warrants”) to Broadwood entitling it to purchase up to a total of 1,704,546 shares of the Company’s common stock (the “Warrant Shares”), at a price of $1.00 per Warrant Share, at any time through July 2020.

18

COMARCO, INC. AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

On January 28, 2013, the maturity date of the loan, the Company was informed by Broadwood, that it was Broadwood’s position that one or more of the conditions precedent to its obligation to purchase the Company’s shares pursuant to the Broadwood SPA had not been satisfied and, as a result, Broadwood would not consummate that purchase and, therefore, the Company would have to repay the loan in cash. The Company’s position is that, contrary to Broadwood’s assertions, all of the conditions under the SPA had been satisfied, and Broadwood’s refusal to purchase 3,000,000 shares of Company common stock, at the price of $1.00 per share, constituted a material breach by Broadwood of its obligations under the Broadwood SPA. As a result, as of the date of filing this report, the Company has not issued any of the 1,000,000 Additional Warrant Shares to Broadwood and each party has reserved its rights under and with respect to the Broadwood SPA and the Broadwood Warrants.

During the first quarter of fiscal 2014, the Company repaid the amounts outstanding under the Broadwood Loan Agreement in full from the Elkhorn proceeds described above.

10. Fair Value Measurements

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

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

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

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

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

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

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

Our fair value measurements at the October 31, 2013 reporting date are classified based on the valuation technique level noted in the table below (in thousands):

Description |  | October 31, 2013 |  |  | Quoted Prices in Active Markets for (Level 1) |  |  | Significant Other Observable (Level 2) |  |  | Significant Unobservable (Level 3) |
Derivative Liabilities |  | $ | 2,819 |  |  | $ | -- |  |  | $ | -- |  |  | $ | 2,819 |

19

COMARCO, INC. AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

The following outlines the significant weighted average assumptions used to estimate the fair value information presented in connection with our outstanding and contingent warrants issued to Broadwood as described in Note 9 utilizing the Monte Carlo simulation model:

|  | October 31, 2013 |  |
Risk free interest rate |  |  | 1.87% |  |
Average expected life (in years) |  |  | 6.74 |  |
Expected volatility |  |  | 113.59% |  |
Expected dividends |  |  | None |  |

The following outlines the significant weighted average assumptions used to estimate the fair value information presented in connection with the derivative liabilities associated with our Elkhorn Loan as described in Note 9 utilizing the Monte Carlo simulation model:

|  | October 31, 2013 |  |
Risk free interest rate |  |  | 0.12% |  |
Average expected life (in years) |  |  | 1.08 |  |
Expected volatility |  |  | 72.43% |  |
Expected dividends |  |  | None |  |

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

|  | January 31, 2013 |  |  | Recorded New Derivative Liabilities |  |  | Change in estimated fair value recognized in results of operations |  |  | October 31, 2013 |
Derivative liabilities |  | $ | 2,466 |  |  | $ | 624 |  |  | $ | (271 | ) |  | $ | 2,819 |

The table below sets forth a summary of changes in the fair value of our Level 3 financial instruments for the nine months ended October 31, 2012 (in thousands):

|  | January 31, 2012 |  |  | Recorded New Derivative Liabilities |  |  | Change in estimated fair value recognized in results of operations |  |  | October 31, 2012 |
Derivative liabilities |  | $ | — |  |  | $ | 1,365 |  |  | $ | 389 |  |  | $ | 1,754 |

11. Commitments and Contingencies

Purchase Commitments with Suppliers

The Company has historically issued purchase orders to its suppliers with delivery dates from four to six weeks from the purchase order date. In addition, the Company has typically provided 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 generally accepts 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. In the third quarter of fiscal 2014, we began the process of cancelling purchase orders beyond the forecasted unit volume contained in Lenovo’s rolling forecast upon the receipt of their notification that it will cease purchasing our product (See Note 2).

20

COMARCO, INC. AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

During the third quarter ended October 31, 2013, we recorded a charge to cost of revenue in the amount of $317,000 related to our remaining inventory balances, representing primarily component inventory in excess of requirements. We also shipped certain components to a liquidator in an attempt to salvage some economic value from these parts, but to date we have not recovered any amounts and expect such recoveries, if any, to be minor.

Executive Severance Agreements

The Company has severance compensation agreements with two executives, our Chief Executive Officer and Chief Accounting Officer. These agreements require the Company to pay these executives, in the event of certain terminations of employment following a change of control of the Company, up to the amount of their then current annual base salary and the amount equal to any bonus which the executive would have earned for the year in which the termination occurs plus the acceleration of unvested options.

Although the contemplated sale of shares of common stock and the issuance of the Warrants and possible issuance of the Additional Warrant Shares by the Company to Broadwood (see Note 9) could result in a change of control for purposes of the severance compensation agreements, each of the executives who are parties to those agreements has waived their rights to receive payments under those agreements in the event that a change of control occurs as a result of the sale of shares and the issuance of Warrants and Additional Warrants to Broadwood.

Additionally, as a result of the Company’s sale of the 6,250,000 shares of common stock to Elkhorn during the first quarter of fiscal 2014 (see Note 9), Elkhorn’s beneficial ownership of the Company increased from approximately 9% to approximately 47% of the Company’s outstanding voting stock as of December 12, 2013, making Elkhorn the Company’s largest shareholder and resulting in a change of control for purposes of the severance compensation agreements. Each of the executives who are parties to those agreements has waived their rights to receive payments under those agreements as a result of the change in Elkhorn’s beneficial ownership of the Company.

Letter of Credit

During the first quarter of fiscal 2010, the Company obtained a $77,000 letter of credit from Silicon Valley Bank (“SVB”) to allow for continuous and unlapsed compliance with a lease provision for the Company’s corporate offices. The letter of credit expires on August 1, 2014.

Legal Proceedings and Contingencies

On April 26, 2011, Chicony, the contract manufacturer of the Bronx product that was the subject of a product recall in 2010, filed a complaint against us for breach of contract, seeking payment of $1.2 million for the alleged non-payment by us of amounts alleged by Chicony to be due it for products purchased from it by the Company. We denied liability and filed a cross-complaint on May 13, 2011 seeking the recovery of damages of $4.9 million caused by Chicony's failure to adhere to our technical specifications when manufacturing the Bronx product, which we believe resulted in the recall of the product. On May 23, 2012, Chicony filed its First Amended Complaint increasing the payment it is seeking from $1.2 million to $1.7 million based on alleged component parts it purchased for the Bronx product, but was unable to use in any other products thereafter. On April 16, 2013, the court approved our first-amended cross-complaint, which adds intentional interference to our complaint and increases the damages we seek to at least $15.0 million. In an effort to resolve this litigation before the previous trial date of April, 2013, we sent Chicony a settlement offer, which has since lapsed without response from Chicony. The trial began on October 21, 2013 and is currently expected to conclude by the end of January, 2014.

21

COMARCO, INC. AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

The outcome of this matter is not determinable as of the date of the filing of this report. We have previously accrued $1.1 million for the possibility that we could incur a liability to Chicony should it prevail in the lawsuit.

In July 2013, in response to our stated desire to have counsel appointed by us representing our consolidated interests across the entirety of our litigation with Chicony, we entered into discussions with our insurance carrier and on August 26, 2013 we entered into an agreement as a means to achieve our desired representation goal.

Pursuant to the agreement, our insurance carrier paid one hundred percent of our defense costs and fifty percent of our expert fees related to the Chicony litigation through August 31, 2013 and we received a one-time, lump-sum payment in exchange for a mutual release and the assumption of sole financial responsibility for any expenses related to our ongoing Chicony litigation subsequent to August 31, 2013. As a result, a single law firm of our choosing now represents us on all matters concerning the Chicony litigation. Additionally, in the third quarter of fiscal 2014, we entered an alternative fee arrangement with our legal counsel representing us in the Chicony matter.

On September 1, 2011, subsequent to receiving an infringement notification from us, ACCO Brands USA LLC and its Kensington Computer Products Group division (collectively “Kensington”) filed a lawsuit against us alleging that five of our patents relating to power technology are invalid and/or not infringed by products made and/or sold by Kensington. On February 29, 2012, we denied these claims and filed a cross-complaint alleging infringement by Kensington of each of these five patents. Efforts to resolve the dispute, by court ordered mediation, have been unsuccessful. A number of these patents are currently the subject of re-examination proceedings initiated by Kensington or other third parties. This matter is ongoing and the outcome is not determinable, however if we do not prevail we will likely not obtain a license agreement to earn future license revenue from products sold by Kensington. Conversely, should we prevail the Company may be awarded a royalty which would generate license revenue to the Company in the future. In the third quarter of fiscal 2014, we changed legal representation for our ongoing Kensington litigation and entered an alternative fee arrangement.

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

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

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

The following discussion and analysis should be read in conjunction with our unaudited interim condensed consolidated financial statements and the related notes and other financial information appearing elsewhere in this quarterly report on Form 10-Q.

Forward-Looking Statements

This report, including the following discussion and analysis, contains forward-looking statements within the meaning of federal securities laws. Words such as “expects,” “anticipates,” “intends,” “plans,” “believes,” “seeks,” and “estimates,” and similar expressions or variations of such words are intended to identify forward-looking statements, but are not deemed to represent an all-inclusive means of identifying forward-looking statements included in this report. Additionally, statements concerning future matters are forward-looking statements.

These forward-looking statements reflect current views about our plans, strategies, and prospects, but are only based on facts and factors known by us as of the date of this report. Consequently, forward-looking statements are inherently subject to risks and uncertainties, and actual results and outcomes may differ materially from the results and outcomes discussed in or anticipated by the forward-looking statements.

Forward-looking statements in this report include those related to our objectives; the orderly wind-down of our relationship with Lenovo Information Products Co., Ltd. (“Lenovo”), including collection of accounts receivable due from Lenovo; matters concerning our ongoing litigation with Chicony Power Technology, Co. Ltd. (“Chicony”) and ACCO Brands USA LLC and its Kensington Computer Products Group division (collectively “Kensington”); opportunities to expand, protect, and monetize our patent portfolio, including through the potential sale or licensing of our patent portfolio; any possibility of a future debt and/or equity financing; and the sufficiency of our cash and cash equivalent balances. Many risk factors and uncertainties may cause our actual financial results to differ materially from those discussed in any such forward-looking statements. Those risk factors and uncertainties include, but are not limited to: the risk that we will be unable to continue our business as a going concern if our internally generated cash flows are not sufficient to fund our operations and we are unable to obtain funds from external sources to make up the resulting cash shortfall; the impact of the loss of Lenovo as a customer; costs and potential adverse determinations in pending litigation; and activities by us and others regarding protection of intellectual property. Although we believe that the assumptions underlying the forward-looking statements are reasonable, any of the assumptions could prove inaccurate and, therefore, we cannot assure that the results contemplated in forward-looking statements will be realized in the timeframe anticipated or at all. In light of the significant uncertainties inherent in the forward-looking information included in this report, the inclusion of such information should not be regarded as a representation by us or any other person that our objectives or plans or that our future financial results or outcomes described in this report will be achieved. Accordingly, investors are cautioned not to place undue reliance on our forward-looking statements. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law.

In addition to the risks, uncertainties, and other factors discussed above or elsewhere in this report, additional risks, uncertainties, and other factors that could cause or contribute to actual results differing materially from those expressed or implied in any forward-looking statements include, without limitation, those set forth under Part I, Item 1A “Risk Factors” in the Company’s Annual Report on Form 10-K for the fiscal year ended January 31, 2013 filed with the SEC and those contained in the Company’s other filings with the SEC. Readers of this report are urged to review the descriptions of the risks, uncertainties and other factors contained in those other reports.

Going Concern Qualification

The Company has experienced pre-tax losses for the nine months ended October 31, 2013 and 2012 totaling $1.7 million and $2.8 million, respectively. Substantially all of our recent revenue has been derived from a single customer, Lenovo. During the third fiscal quarter, the Company received notice from Lenovo that it intends to cease offering Comarco’s Constellation product to its corporate clients. We completed shipping product to Lenovo during our third fiscal quarter. We anticipate that we will generate no or de minimus revenue in our fourth quarter ending January 31, 2014. The Company has negative working capital and uncertainties surrounding the Company’s future ability to generate revenue, obtain borrowings and raise additional capital.

23

We have effectively ceased traditional operations and are now primarily focused on potentially realizing value from our ongoing litigation matters with Chicony and Kensington, as well as exploring opportunities to expand, protect, and monetize our patent portfolio, including through the potential sale or licensing of our patent portfolio. Regardless of whether we generate significant capital infusions from litigation or from a sale or license of our patent portfolio, we may need to obtain additional debt and/or equity financing to meet our working capital needs. There is no assurance that we will prevail in our litigation, succeed in the sale or licensing of our patent portfolio or raise additional debt and/or equity financing and if we are not successful doing so, we may have to evaluate other alternatives or partially, or entirely, cease our operations. We currently have three employees, two executive officers and an accountant.

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 shareholders may lose all or part of their investment in our common stock. The condensed consolidated financial statements contained elsewhere in this report do not reflect any adjustments related to the outcome of this uncertainty.

Basis of Presentation

The condensed consolidated results of our operations presented in this report are not audited and are not necessarily indicative of the results to be expected for the entirety of the fiscal year ending January 31, 2014 or any other interim period during such year. Our fiscal year ends on January 31 and our fiscal quarters end on April 30, July 31, and October 31. Unless otherwise stated, all dates refer to our fiscal year and those fiscal quarters.

Executive Summary

Comarco, Inc., through its wholly-owned subsidiary Comarco Wireless Technologies, Inc. (collectively, “we,” “Comarco,” or the “Company”), is a leading developer and designer of innovative mobile power products. These standalone, multi-function mobile power adapters are used to simultaneously power and charge notebook computers, mobile phones, E-readers, iPads®, iPods®, and many other portable, rechargeable consumer electronic devices. Our operations consist solely of the operations of Comarco Wireless Technologies, Inc. (“CWT”).

In addition to the risks, uncertainties and factors discussed elsewhere in this quarterly report on Form 10-Q and in the Company’s other filings with the SEC, management currently considers the following additional trends, events, and uncertainties to be important to understanding our results of operations for the quarter ended October 31, 2013:

| ● | We are currently analyzing and will continue to analyze a range of alternatives to preserve value for our stakeholders, including, but in no way limited to, exploring additional investment and incremental financing from current and/or new investors, entering litigation partnerships with outside entities with regard to certain current previously disclosed and/or future litigation matters, the engagement of advisors to assist in exploring strategic options for the company as well as identifying potential partnerships for the purpose of monetizing some or all of the Company’s IP portfolio and past, present, and future infringement claims. There can be no assurances that we will be successful in implementing any of these alternatives, or if implemented, that any of these alternatives will successfully preserve or increase shareholder value.

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| ● | On August 19, 2013, we received notification from Lenovo that it is ceasing the sales of the Constellation product, the power adapter Comarco designed and developed for Lenovo. We delivered the remaining units to Lenovo during our third fiscal quarter. As a result of this notification, we anticipate that we will generate no or de minimus revenue during our fourth fiscal quarter.

| ● | On September 23, 2013, we entered into an alternative fee agreement with our legal counsel representing us in the Chicony matter, which we believe will provide us legal counsel through the conclusion of the Chicony proceedings. Similarly on August 6, 2013, we changed our legal representation with respect to our ongoing intellectual infringement and enforcement litigation and entered an alternative fee arrangement in order to reduce our legal expenses.

| ● | On August 26, 2013, we entered into an agreement with our insurance carrier and received a one-time, lump-sum payment in exchange for a mutual release and the assumption of sole financial responsibility for any expenses related to the Chicony matter subsequent to August 31, 2013. Previously, in October 2012, our insurance carrier agreed to defend certain claims brought against us by Chicony, but did not agree to prosecute or pay for any claims we brought against Chicony. As a result, the defense of claims brought against us by Chicony were previously handled by counsel appointed by our insurance carrier at their cost, with any claims we brought against Chicony handled by counsel appointed by us at our cost. In July 2013, in response to our stated desire to have counsel appointed by us representing our consolidated interests across the entirety of our litigation with Chicony, we entered into discussions with our insurance carrier and subsequently entered into the agreement as a means to achieve our desired representation goal.

| ● | On February 11, 2013, we entered into a Secured Loan Agreement (the “Loan Agreement”) with Elkhorn Partners Limited Partnership (“Elkhorn”). Pursuant to the Loan Agreement, on February 11, 2013, Elkhorn made a $1,500,000 senior secured term loan (the “Loan”) to us. The Loan bears interest at 7% per annum for the first year; increasing to 8.5% per annum thereafter, ranks senior in right of payment to all of our other indebtedness, is secured by a first priority security interest in all of the assets of Comarco and CWT, and is due and payable in full on November 30, 2014. See Note 9 to our condensed consolidated financial statements contained elsewhere in this report for additional information regarding the Loan Agreement, the Loan and certain related agreements.

| ● | Concurrent with the execution of the Loan Agreement, Elkhorn entered into a Stock Purchase Agreement with us (the “Stock Purchase Agreement”). Pursuant to that Stock Purchase Agreement, we sold 6,250,000 shares of our common stock to Elkhorn at a price of $0.16 per share, resulting in an aggregate purchase price of $1.0 million. The purchase price of $0.16 per share paid by Elkhorn for those shares was determined by arms-length negotiations between Elkhorn and the members of a special committee of our Board of Directors, comprised of three of the directors who have no affiliation with Elkhorn and no financial interest, other than their interests solely as our shareholders, in either the loan or share transactions with Elkhorn. See Note 9 to our condensed consolidated financial statements contained elsewhere in this report for additional information regarding the Stock Purchase Agreement and certain related agreements.

| ● | As a result of our sale of the 6,250,000 shares of common stock to Elkhorn pursuant to the Elkhorn Stock Purchase Agreement, Elkhorn’s beneficial ownership has increased from approximately 9% to approximately 47% of our outstanding voting stock as of December 12, 2013, making Elkhorn our largest shareholder.

| ● | On January 28, 2013, Broadwood Partners, L.P. (“Broadwood”) informed us of its position that one or more of the conditions precedent to its obligation to purchase shares of our common stock pursuant to the SPA had not been satisfied and, as a result, Broadwood would not consummate that purchase. See Note 9 to our condensed consolidated financial statements contained elsewhere in this report for additional information.

| ● | On July 27, 2012, we entered into a Senior Secured Six Month Term Loan Agreement (the “Prior Loan Agreement”) with Broadwood, a partnership managed by Broadwood Capital, Inc., the general partner of Broadwood. Broadwood is a significant shareholder of the Company. Pursuant to the Loan Agreement, on July 27, 2012, Broadwood made a $2,000,000 senior secured six month loan (the “Prior Loan”) to us. The Prior Loan was repaid on February 11, 2013 from the proceeds received from the Elkhorn Loan and stock purchase described above. See Note 9 to our condensed consolidated financial statements contained elsewhere in this report for additional information regarding the Prior Loan Agreement.

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Critical Accounting Policies

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

An accounting policy is deemed to be critical if it requires an accounting estimate to be made based on assumptions about matters that are highly uncertain at the time the estimate is made, and if different estimates that reasonably could have been used or changes in the accounting estimate that are reasonably likely to occur could materially change the financial statements. Management believes there have been no significant changes during the three and nine months ended October 31, 2013 to the items that we disclosed as our critical accounting policies and estimates in Management’s Discussion and Analysis of Financial Condition and Results of Operations in our annual report on Form 10-K for the fiscal year ended January 31, 2013.

Results of Operations – Continuing Operations

Revenue
(in thousands except % change)

|  | Three Months Ended October 31, |  |  | Nine Months Ended October 31, |  |  | Year over Year % Change |
|  | 2013 |  |  | 2012 |  |  | 2013 |  |  | 2012 |  |  | Three Months |  |  | Nine Months |
Revenue |  | $ | 1,508 |  |  | $ | 1,135 |  |  | $ | 4,429 |  |  | $ | 5,018 |  |  |  | 33 | % |  |  | (12% | )
Operating loss |  | $ | (331 | ) |  | $ | (1,337 | ) |  | $ | (1,708 | ) |  | $ | (1,841 | ) |  |  |  |  |  |  |  |
Net income (loss) |  | $ | 551 |  |  | $ | (2,244 | ) |  | $ | (1,717 | ) |  | $ | (2,805 | ) |  |  |  |  |  |  |  |

Revenue by Region
(in thousands except % change)

|  | Three Months Ended October 31, |  |  | Nine Months Ended October 31, |  |  | Year over Year % Change |
|  | 2013 |  |  | 2012 |  |  | 2013 |  |  | 2012 |  |  | Three Months |  |  | Nine Months |
Revenue: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
North America |  | $ | 75 |  |  | $ | 11 |  |  | $ | 208 |  |  | $ | 57 |  |  |  | 582 | % |  |  | 265 | %
Europe |  |  | 26 |  |  |  | 5 |  |  |  | 38 |  |  |  | 13 |  |  |  | 420 | % |  |  | 192 | %
Asia |  |  | 1,407 |  |  |  | 1,119 |  |  |  | 4,183 |  |  |  | 4,948 |  |  |  | 26 | % |  |  | (15% | )
|  | $ | 1,508 |  |  | $ | 1,135 |  |  | $ | 4,429 |  |  | $ | 5,018 |  |  |  |  |  |  |  |  |

26

Revenue by Customer
(in thousands except % change)

|  | Three Months Ended October 31, |  |  | Nine Months Ended October 31, |  |  | Year over Year % Change |
|  | 2013 |  |  | 2012 |  |  | 2013 |  |  | 2012 |  |  | Three Months |  |  | Nine Months |
|  |  |  |  |  | % of Revenue |  |  |  |  |  |  | % of Revenue |  |  |  |  |  |  | % of Revenue |  |  |  |  |  |  | % of Revenue |  |  |  |  |  |  |  |  |
Revenue: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Dell |  |  | — |  |  |  | — |  |  |  | — |  |  |  | — |  |  |  | — |  |  |  | — |  |  |  | 67 |  |  |  | 1 | % |  |  | — |  |  |  | (100% | )
Lenovo |  |  | 1,465 |  |  |  | 97 | % |  |  | 1,119 |  |  |  | 99 | % |  |  | 4,319 |  |  |  | 98 | % |  |  | 4,913 |  |  |  | 98 | % |  |  | 31 | % |  |  | (12% | )
Other |  |  | 43 |  |  |  | 3 | % |  |  | 16 |  |  |  | 1 | % |  |  | 110 |  |  |  | 2 | % |  |  | 38 |  |  |  | 1 | % |  |  | 169 | % |  |  | 189 | %
|  | $ | 1,508 |  |  |  | 100 | % |  | $ | 1,135 |  |  |  | 100 | % |  | $ | 4,429 |  |  |  | 100 | % |  | $ | 5,018 |  |  |  | 100 | % |  |  | 33 | % |  |  | (12% | )

Revenue for the three months ended October 31, 2013 increased by $0.4 million, or 33 percent. Revenue for the nine months ended October 31, 2013 decreased by $0.6 million or 12 percent. On August 19, 2013, we received notification from Lenovo of its intent to cease offering our products to its customers. We shipped the remaining units to Lenovo during our third fiscal quarter, and we do not expect to receive any further orders or revenue from Lenovo. As previously discussed, we completed the wind down of our Dell business relationship in May 2012. We expect to have no or de minimus revenue in our fourth fiscal quarter.

Cost of Revenue and Gross Margin

(in thousands except
margin and % change)

|  | Three Months Ended October 31, |  |  | Nine Months Ended October 31, |  |  | Year over Year % Change |
|  | 2013 |  |  | 2012 |  |  | 2013 |  |  | 2012 |  |  | Three Months |  |  | Nine Months |
|  |  |  |  |  | % of Total |  |  |  |  |  |  | % of Total |  |  |  |  |  |  | % of Total |  |  |  |  |  |  | % of Total |  |  |  |  |  |  |  |  |
Cost of revenue: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Product cost |  | $ | 1,075 |  |  |  | 69 | % |  | $ | 770 |  |  |  | 83 | % |  | $ | 3,101 |  |  |  | 77 | % |  | $ | 3,420 |  |  |  | 128 | % |  |  | 40 | % |  |  | (9 | %)
Supplier Settlement |  |  | — |  |  |  | — |  |  |  | — |  |  |  | — |  |  |  | — |  |  |  | — |  |  |  | (1,443 | ) |  |  | (54 | %) |  |  | — |  |  |  | (100 | %)
Supply chain overhead |  |  | 175 |  |  |  | 11 | % |  |  | 147 |  |  |  | 16 | % |  |  | 526 |  |  |  | 13 | % |  |  | 611 |  |  |  | 23 | % |  |  | 19 | % |  |  | (14 | %)
Inventory reserve and scrap charges |  |  | 317 |  |  |  | 20 | % |  |  | 12 |  |  |  | 1 | % |  |  | 402 |  |  |  | 10 | % |  |  | 84 |  |  |  | 3 | % |  |  | 2,542 | % |  |  | 379 | %
|  | $ | 1,567 |  |  |  | 100 | % |  | $ | 929 |  |  |  | 100 | % |  | $ | 4,029 |  |  |  | 100 | % |  | $ | 2,672 |  |  |  | 100 | % |  |  | 69 | % |  |  | 51 | %

|  | Three Months Ended October 31, |  |  | Nine Months Ended October 31, |  |  | Year over Year ppt Change |
|  | 2013 |  |  | 2012 |  |  | 2013 |  |  | 2012 |  |  | Three Months |  |  | Nine Months |
Gross margin |  |  | (4% | ) |  |  | 18 | % |  |  | 9 | % |  |  | 47 | % |  |  | (22 | ) |  |  | (38 | )

Cost of revenue for the three and nine months ended October 31, 2013 increased by $0.6 million, or 69 percent, and $1.4 million, or 51 percent, respectively, compared to the corresponding periods of fiscal 2013. The product cost increase of 40 percent for the three months ended October 31, 2013 compared to the comparable period of the prior fiscal year is consistent with the increase in revenue and is also impacted negatively by product mix. The product cost decrease of 9 percent for the nine months ended October 31, 2013 compared to the comparable period of the prior fiscal year is consistent with the decrease in revenue. During the three months ended July 31, 2012 we entered a Settlement Agreement with EDAC Power Electronics, Co. Ltd. (“EDAC”) ending the litigation among the parties. As a direct result of the settlement, we recovered previously incurred product and freight costs and reversed $1.4 million in net liabilities due to EDAC. No similar costs were incurred in the comparable periods of the current fiscal year. During the three months ended October 31, 2013, our supply chain overhead costs increased by $28,000 or 19 percent. The increase is due to the retirement of production and tooling assets located at our contract manufacturer facilities in Asia. During the nine months ended October 31, 2013, our supply chain overhead costs decreased by $85,000, or 14 percent, compared to the corresponding period in fiscal 2013. This decrease was the result of cost cutting relating to personnel and other expenses. The inventory reserve charges for the three and nine months ended October 31, 2013 increased by $305,000 and $318,000, respectively, compared to the comparable periods of the prior fiscal year. In the third quarter of fiscal 2013, we wrote-off all of our remaining inventory balances, representing primarily component inventory in excess of requirements. We also shipped certain components to a liquidator during the third quarter of fiscal 2014 in an attempt to salvage some economic value from these parts, but to date we have not recovered any amounts and expect such recoveries, if any, to be minor.

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Operating Costs and Expenses
(in thousands except % change)

|  | Three Months Ended October 31, |  |  | Nine Months Ended October 31, |  |  | Year over Year % Change |
|  | 2013 |  |  | 2012 |  |  | 2013 |  |  | 2012 |  |  | Three Months |  |  | Nine Months |
|  |  |  |  |  | % of Revenue |  |  |  |  |  |  | % of Revenue |  |  |  |  |  |  | % of Revenue |  |  |  |  |  |  | % of Revenue |  |  |  |  |  |  |  |  |
Operating expenses: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
SG&A expenses, excluding corporate overhead |  | $ | 8 |  |  |  | — |  |  | $ | 80 |  |  |  | 7 | % |  | $ | 33 |  |  |  | 1 | % |  | $ | 190 |  |  |  | 4 | % |  |  | (90% | ) |  |  | (83% | )
Corporate overhead |  |  | 195 |  |  |  | 13 | % |  |  | 823 |  |  |  | 73 | % |  |  | 1,407 |  |  |  | 32 | % |  |  | 2,113 |  |  |  | 42 | % |  |  | (76% | ) |  |  | (33% | )
Engineering and support expenses |  |  | 69 |  |  |  | 5 | % |  |  | 640 |  |  |  | 56 | % |  |  | 668 |  |  |  | 15 | % |  |  | 1,884 |  |  |  | 38 | % |  |  | (89% | ) |  |  | (65% | )
|  | $ | 272 |  |  |  | 18 | % |  | $ | 1,543 |  |  |  | 136 | % |  | $ | 2,108 |  |  |  | 48 | % |  | $ | 4,187 |  |  |  | 84 | % |  |  | (82% | ) |  |  | (50% | )

Selling, general, and administrative (“SG&A”) expenses for the three and nine months ended October 31, 2013 decreased $72,000, or 90 percent and $157,000, or 83 percent, respectively, compared to the corresponding periods of fiscal 2013. We had no employees in our sales and marketing department during the three and nine months end October 31, 2013 and 2012, but during fiscal 2013 we utilized various consultants who were focused on digital media and search engine optimization to assist us with generation of sales on our retail website, which was launched in the fourth quarter of fiscal 2012. During fiscal 2014, the expenses incurred relate mostly to samples for new product for our customer, Lenovo.

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. Corporate overhead decreased $0.6 million and $0.7 million for the three and nine months ended October 31, 2013, respectively, when compared to the corresponding periods of the prior fiscal year. Legal expenses relating to our ongoing Chicony litigation decreased by $475,000 and $388,000, respectively for the three and nine months ended October 31, 2013 compared to the comparable periods of the prior fiscal year. The decrease relates to a settlement received from our insurance carrier in the third quarter of fiscal 2014 as well as our change to an alternative fee arrangement with our legal counsel in the Chicony matter. Additionally, we had a reduction in personnel and related costs of $93,000 and $300,000 for the three and nine months ended October 31, 2013, respectively, compared to the comparable periods of the prior fiscal year due to an overall reduction in headcount.

Engineering and support expenses generally consist of salaries, employer paid benefits, and other personnel related costs of our design engineers and testing and support personnel, as well as facility and IT costs, professional and consulting fees, lab costs, material usages, and travel and related costs incurred in the development and support of our products. Engineering and support expenses for the three and nine months ended October 31, 2013 decreased $0.6 million, or 89 percent, and $1.2 million, or 65 percent, respectively, compared to the corresponding periods in fiscal 2013. The decrease in the current year primarily relates to decreased legal fees relating to the Kensington litigation and other patent infringement matters, due to changes in case activity as well as retention of new legal representation based upon an alternative fee arrangement. These decreases account for $0.4 million and $0.9 million for the three and nine months ended October 31, 2013, respectively, compared to the comparable periods of the prior fiscal year. In the third quarter of fiscal 2014, upon receiving the news from Lenovo of their intention to cease offering our Constellation product, we eliminated all engineering and support positions, resulting in a decrease of personnel costs during the three and nine months ended October 31, 2013 compared to the same periods in fiscal 2013.

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Interest Expense

The current year interest expense relates to interest expense as well as amortization expense of the debt discount on the Elkhorn Loan. The prior year interest expense related to accrued interest as well as amortization of the debt discount on the Broadwood Loan.

During the third quarter of fiscal 2014, we paid approximately $76,000 of interest expense to Elkhorn pursuant to the terms of the Elkhorn Loan.

Gain (loss) Due to Change in Fair Value of Derivative Liabilities

For the three and nine months ended October 31, 2013, we reported a decrease in the fair value of our derivative liabilities of approximately $1.0 million and $0.3 million, respectively. During the three and nine months ended October 31, 2012 we recorded an increase in our derivative liabilities of approximately $0.4 million. (See Note 10 to our condensed consolidated financial statements contained elsewhere in this report).

Other Income (loss), net

Other income (loss), net, generally consists primarily of interest income earned on invested cash balances. Our cash balances yielded negligible interest earnings during the fiscal 2014 and 2013. However, during the first quarter of fiscal 2014 we received $5,000 in proceeds from the State of California from funds that had previously been escheated to the state.

Income Tax Expense

Significant management judgment is required in determining our provision for income taxes, our deferred tax assets and liabilities, and any required valuation allowance. The Company continues to have a fully valued deferred tax asset. This valuation allowance was previously 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 losses and carry forward temporary differences. Due to the losses incurred during the first nine months of fiscal 2014, the adjusted net deferred tax assets remain fully reserved as of October 31, 2013. Based upon a preliminary review, it appears that a Section 382 ownership change may have occurred during fiscal 2014, which may greatly limit the utilization of our net operating loss carry-forwards.

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Liquidity and Capital Resources

Cash and cash equivalents at October 31, 2013 increased $101,000 to $205,000 as compared to $104,000 at January 31, 2013. The following table is a summary of our Condensed Consolidated Statements of Cash Flows.

|  | Nine Months Ended October 31, |
|  | 2013 |  |  | 2012 |
|  | (in thousands) |
Cash provided by (used in): |  |  |  |  |  |  |  |
Operating activities |  | $ | (448 | ) |  | $ | (2,296 | )
Investing activities |  |  | 19 |  |  |  | (52 | )
Financing activities |  |  | 530 |  |  |  | 2,000 |

Operating Activities

Cash used in operating activities was $448,000 for the nine months ended October 31, 2013 and was driven by our operating loss of $1.7 million offset by non-cash inventory scrap charges of $368,000 and loan discount amortization of $206,000. Additionally, the Company had net cash collections from combined receivables of $352,000 and an increase on a combined basis of our accounts payable and accrued liabilities of $362,000.

Cash used in operation was $2.3 million for the nine months ended October 31, 2012 and was driven by our net loss of $2.8 million offset by non-cash amortization of the Broadwood loan discount of $0.5 million, an increase in the fair value of derivative liabilities of $0.4 million and stock-based compensation expense of $0.1 million. Additionally, we had a non-cash settlement with EDAC crediting our cost of revenue in the amount of $1.4 million and total receivable increases of $0.8 million, offset by increases totaling $1.8 million in accounts payable and accrued liabilities.

Investing Activities

During the nine months ended October 31, 2013 and 2012, we purchased $9,000 and $62,000, respectively, of property and equipment, which was primarily tooling and equipment used for the manufacture of our ChargeSource® products. During the third quarter of fiscal 2014 we sold some equipment for $28,000, net.

Financing Activities

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

On July 27, 2012, we entered into a Senior Secured Six Month Term Loan Agreement (the “Broadwood Loan Agreement”) with Broadwood.

Pursuant to the Broadwood Loan Agreement, on July 27, 2012, Broadwood made a $2,000,000 senior secured six month loan (the “Broadwood Loan”) to us. The Broadwood Loan bore interest at 5% per annum, ranked senior in right of payment to all of our other indebtedness, was secured by a first priority security interest granted to Broadwood in all of our assets, and was due and payable in full on January 28, 2013. The Broadwood Loan was paid in full on February 11, 2013 with debt and equity financing secured from Elkhorn.

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Future Operations and Liquidity Requirements for the Next 12 Months

As of October 31, 2013, we had negative working capital of approximately $6.4 million, of which $2.8 million relates to the fair value of derivative liabilities. Additionally, during our third fiscal quarter of fiscal 2014, Lenovo notified us of its intention to cease offering Comarco’s Constellation product to its corporate clients. We completed the delivery of all remaining units to Lenovo during that quarter. In order for us to continue our operations for the next twelve months and to be able to discharge our liabilities and commitments in the normal course of business, it will be necessary for us to successfully conclude and/or prevail in our ongoing litigation and raise additional funds through the sale or licensing of our patent portfolio, or through additional debt and/or equity financing, to meet our cash requirements during the next twelve months. No assurance can be given, however, that we will be successful in meeting those operating objectives or cash requirements.

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 shareholders 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.

There are several factors and events that could significantly affect our cash flows from operations, including, without limitation the following:

| ● | The cost and outcome of ongoing litigation with Chicony, our former contract manufacturer of the Bronx product that was the subject of a product recall, and with Kensington, the maker of competitive power adapters;

| ● | Our ability to raise additional debt or equity financing;

| ● | Our ability to sell or license some or all or our patents;

| ● | Our patent enforcement efforts; and

| ● | The outcome of our dispute with Broadwood.

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

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 shareholders may lose all or part of their investment in our common stock. The consolidated financial statements included in this report do not reflect any adjustments related to the outcome of this uncertainty.

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ITEM 4. CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

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

In accordance with SEC rules, an evaluation was performed under the supervision and with the participation of our Principal Executive Officer and Principal Financial Officer of the effectiveness, as of October 31, 2013, of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) under the Exchange Act). “Internal control over financial reporting” includes those policies and procedures that:

| (1) | pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the issuer;

| (2) | provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the issuer are being made only in accordance with authorizations of management and directors of the issuer; and

| (3) | provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the issuer’s assets that could have a material effect on the financial statements.

In connection with its evaluation, our management has concluded that, as of October 31, 2013, our internal control over financial reporting is not effective in providing reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with United States generally accepted accounting principles. Our management’s finding of ineffective internal control over financial reporting results primarily from a lack of sufficient accounting and information technology staff which results in a lack of segregation of duties necessary for an appropriate system of internal controls. While management believes that the lack of effective internal control over financial reporting during the fiscal quarter ended October 31, 2013 did not result in any particular deficiency in our financial reporting for the fiscal quarter then ended, management believes that the lack of effectiveness of our internal control over financial reporting could result in a failure to provide reliable financial reporting in the future. In order to remedy our existing internal control deficiency, we will need to raise additional capital or improve our working capital position to allow us to hire additional staff.

Internal Control over Financial Reporting

There was no change in our internal control over financial reporting that occurred during the quarter ended October 31, 2013 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

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PART II — OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

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 was the contract manufacturer of the Bronx product that was the subject of a product recall, filed a complaint against us for breach of contract seeking payment of $1.2 million for the alleged non-payment by us for products manufactured by Chicony. We denied liability and filed a cross-complaint on May 13, 2011 seeking the recovery of damages of $4.9 million attributable to Chicony's failure to adhere to our technical specifications when manufacturing the Bronx product, which we believe resulted in the recall of the product. On May 23, 2012, Chicony filed its First Amended Complaint increasing the payment it is seeking from $1.2 million to $1.7 million based on alleged component parts it purchased for the Bronx product, but was unable to use in any other products thereafter. We filed a first-amended cross-complaint which was approved by the court on April 16, 2013, which adds intentional interference to our complaint and increases the damages to at least $15.0 million. The trial began on October 21, 2013 and is expected to conclude by the end of January, 2014. The outcome of this matter is not determinable as of the date of the filing of this report.

Acco Brands USA LLC (“Acco”) vs. Comarco Wireless Technologies, Inc., Case No. 5:11-cv-04378-HRL, U.S. District Court for the Northern District of California. On September 1, 2011, ACCO Brands USA LLC and its Kensington Computer Products Group division (collectively “Kensington”) filed a lawsuit against us alleging that five of our patents relating to power technology are invalid and/or not infringed by products manufactured and/or sold by Kensington. On February 29, 2012, we denied these claims and filed a cross-complaint alleging infringement by Kensington of each of these five patents. Efforts to resolve the dispute, by court ordered mediation, have been unsuccessful. A number of these patents are currently the subject of re-examination proceedings initiated by Kensington or other third parties. This matter is ongoing and the outcome is not determinable as of the date of filing this report.

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

ITEM 1A. RISK FACTORS

Our business, financial condition and operations are subject to a number of factors, risks and uncertainties, including those previously disclosed under Part I. Item 1A “Risk Factors” of our annual report on Form 10-K for the fiscal year ended January 31, 2013 as well as any amendments thereto or additions and changes thereto contained in any subsequent filings of quarterly reports on Form 10-Q or current reports on Form 8-K. The disclosures in our annual report on Form 10-K and our subsequent reports and filings are not necessarily a definitive list of all factors that may affect our business, financial condition and future results of operations. There have been no material changes to the risk factors as disclosed in our annual report on Form 10-K for the fiscal year ended January 31, 2013, as amended or supplemented by our quarterly report on Form 10-Q for the first and second quarters of fiscal 2014, except as set forth below.

.

We have effectively ceased our traditional operations as of the end of the third quarter of fiscal 2014, and are primarily focused on prevailing in our current litigation with Chicony which is expected to conclude by the end of January 2014. The outcome of the trial is uncertain and potentially subject to appeal. Even if we are successful in trial and in any appeal, we would also need to successfully collect whatever damages that might be awarded to the Company.

If we do not prevail in our lawsuit against Chicony, or are unable to sustain our operations through an appeal process, the Company may be required to raise additional capital through proceeds from other litigated matters or debt or equity financing. We cannot be certain that we will prevail or settle in any other ongoing litigation, or that any additional financing we may need will be available on terms acceptable to us, or at all. If we do not receive funds from other litigation matters or secure financing in the future, we may be forced to liquidate our assets or discontinue our operations altogether.

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We entered into separate alternative fee arrangements in our third fiscal quarter with our legal counsel representing us in both the Chicony matter and our ongoing intellectual property infringement and enforcement litigation, and if either of our existing counsel were to resign from representing us, we may not be able to engage new counsel on similar terms, if at all.

If either of our legal firms resigns or, for any reason, is unable to conclude our existing litigation, the Company may not be able to replace counsel on similar terms, if at all. In the event that either of our legal firms resigns and we are unable to replace our legal counsel, we may be unable to conclude our litigation and may be forced to discontinue our operations altogether.

ITEM 6. EXHIBITS

10.1* | Mutual Release of All Claims executed between Comarco, Inc. and Hartford Casualty Insurance Company and Hartford Insurance Company of the Midwest on August 26, 2013.

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

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

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

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

101.INS** | XBRL Instance Document

101.SCH** | XBRL Taxonomy Extension Schema Document

101.CAL** | XBRL Taxonomy Extension Calculation Linkbase Document

101.DEF** | XBRL Taxonomy Definition Linkbase Document

101.LAB** | XBRL Taxonomy Extension Label Linkbase Document

101.PRE** | XBRL Taxonomy Extension Presentation Linkbase Document

* | Portions of this exhibit indicated in the body of the exhibit by “####” have been omitted pursuant to the Company’s request for confidential treatment under Rule 24b-2 of the Securities Exchange Act of 1934, as amended, and the omitted material has been separately filed with the Securities and Exchange Commission.

** | XBRL (Extension Business Reporting Language) information is furnished and filed or a part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, is deemed not filed for purposes of Section 18 of the Securities Exchange Act of 1934, and otherwise is not subject to liability under these sections.

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SIGNATURES

Pursuant to the requirements 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.

|  | COMARCO, INC. |
Date: December 13, 2013 |  | /s/ THOMAS W. LANNI |
|  | Thomas W. Lanni |
|  | President and Chief Executive Officer |
|  | (Principal Executive Officer) |
Date: December 13, 2013 |  | /s/ ALISHA K. CHARLTON |
|  | Alisha K. Charlton |
|  | Vice President and Chief Accounting Officer |
|  | (Principal Financial and Accounting Officer) |

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EXHIBIT INDEX

Exhibit | Description

10.1* | Mutual Release of All Claims executed between Comarco, Inc. and Hartford Casualty Insurance Company and Hartford Insurance Company of the Midwest on August 26, 2013.
31.1 | Certification of Principal Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2 | Certification of Principal Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1 | Certification of Principal Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2 | Certification of Principal Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
101.INS** | XBRL Instance Document
101.SCH** | XBRL Taxonomy Extension Schema Document
101.CAL** | XBRL Taxonomy Extension Calculation Linkbase Document
101.DEF** | XBRL Taxonomy Definition Linkbase Document
101.LAB** | XBRL Taxonomy Extension Label Linkbase Document
101.PRE** | XBRL Taxonomy Extension Presentation Linkbase Document

* | Portions of this exhibit indicated in the body of the exhibit by “####” have been omitted pursuant to the Company’s request for confidential treatment under Rule 24b-2 of the Securities Exchange Act of 1934, as amended, and the omitted material has been separately filed with the Securities and Exchange Commission.

** | XBRL (Extension Business Reporting Language) information is furnished and filed or a part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, is deemed not filed for purposes of Section 18 of the Securities Exchange Act of 1934, and otherwise is not subject to liability under these sections.

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