UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

____________________

FORM 10-Q

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

For the quarterly period ended

April 30, 2014

OR

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

For the transition period from ______________ to ______________

Commission file number 0-5449

COMARCO, INC.

(Exact name of registrant as specified in its charter)

____________________

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

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

(Address of principal executive offices and zip code)

(949) 599-7400

(Registrant’s telephone number, including area code)

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

Yes | √ |  | No |

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

Yes | √ |  | No |

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

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

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

Yes |  |  | No | √

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

COMARCO, INC. AND SUBSIDIARY

QUARTERLY REPORT ON FORM 10-Q

FOR THE THREE MONTHS ENDED APRIL 30, 2014

TABLE OF CONTENTS

PART I — FINANCIAL INFORMATION | Page
ITEM 1. | FINANCIAL STATEMENTS (Unaudited) |
| Condensed Consolidated Balance Sheets as of April 30, 2014 and January 31, 2014 | 3
| Condensed Consolidated Statements of Operations for the Three Months Ended April 30, 2014 and 2013 | 4
| Condensed Consolidated Statements of Cash Flows for the Three Months Ended April 30, 2014 and 2013 | 5
| Notes to Condensed Consolidated Financial Statements | 6
ITEM 2. | MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS | 22
ITEM 4. | CONTROLS AND PROCEDURES | 30
PART II — OTHER INFORMATION |
ITEM 1. | LEGAL PROCEEDINGS | 31
ITEM 1A. | RISK FACTORS | 31
ITEM 6. | EXHIBITS | 32
SIGNATURES |  | 33

2

PART I — FINANCIAL INFORMATION

ITEM 1. | FINANCIAL STATEMENTS

COMARCO, INC. AND SUBSIDIARY

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except share and par value amounts)

|  | (Unaudited) |  |  |  |  |
|  | April 30, |  |  | January 31, |
|  | 2014 |  |  | 2014 |
ASSETS |  |  |  |  |  |  |  |
Current Assets |  |  |  |  |  |  |  |
Cash and cash equivalents |  | $ | 704 |  |  | $ | 1,096 |
Accounts receivable due from suppliers, net of reserves of $0 |  |  | 128 |  |  |  | 128 |
Other current assets |  |  | 45 |  |  |  | 17 |
Total current assets |  |  | 877 |  |  |  | 1,241 |
Property and equipment, net |  |  | 12 |  |  |  | 14 |
Restricted cash |  |  | 82 |  |  |  | 82 |
Total assets |  | $ | 971 |  |  | $ | 1,337 |
LIABILITIES AND STOCKHOLDERS' DEFICIT |  |  |  |  |  |  |  |
Current Liabilities |  |  |  |  |  |  |  |
Accounts payable |  | $ | 4,310 |  |  | $ | 4,363 |
Accrued liabilities |  |  | 911 |  |  |  | 1,012 |
Loan payable |  |  | 1,256 |  |  |  | 1,167 |
Derivative liabilities |  |  | 3,525 |  |  |  | 2,520 |
Total current liabilities |  |  | 10,002 |  |  |  | 9,062 |
Total liabilities |  |  | 10,002 |  |  |  | 9,062 |
Commitments and Contingencies |  |  |  |  |  |  |  |
Stockholders' Deficit: |  |  |  |  |  |  |  |
Preferred stock, no par value, 10,000,000 shares authorized; no shares issued or outstanding |  |  | - |  |  |  | - |
Common stock, $0.10 par value, 50,625,000 shares authorized; 14,684,165 and 14,684,165 shares issued and outstanding at April 30, 2014 January 31, 2014, respectively |  |  | 1,468 |  |  |  | 1,468 |
Additional paid-in capital |  |  | 15,992 |  |  |  | 15,980 |
Accumulated deficit |  |  | (26,491 | ) |  |  | (25,173 | )
Total stockholders' deficit |  |  | (9,031 | ) |  |  | (7,725 | )
Total liabilities and stockholders' deficit |  | $ | 971 |  |  | $ | 1,337 |

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

3

COMARCO, INC. AND SUBSIDIARY

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

(In thousands, except per share amounts)

|  | Three Months Ended April 30, |
|  | 2014 |  |  | 2013 |
Revenue |  | $ | - |  |  | $ | 1,413 |
Cost of revenue |  |  | - |  |  |  | 1,120 |
Gross profit |  |  | - |  |  |  | 293 |
Selling, general and administrative expenses |  |  | 331 |  |  |  | 648 |
Engineering and support expenses |  |  | 60 |  |  |  | 279 |
|  |  | 391 |  |  |  | 927 |
Operating loss |  |  | (391 | ) |  |  | (634 | )
Interest expense, net |  |  | (122 | ) |  |  | (78 | )
Loss due to change of derivative liabilities |  |  | (1,005 | ) |  |  | (767 | )
Other income, net |  |  | 200 |  |  |  | 5 |
Loss from operations before income taxes |  |  | (1,318 | ) |  |  | (1,474 | )
Income tax expense |  |  | - |  |  |  | - |
Net loss |  | $ | (1,318 | ) |  | $ | (1,474 | )
Basic loss per share: |  | $ | (0.09 | ) |  | $ | (0.11 | )
Diluted loss per share: |  | $ | (0.09 | ) |  | $ | (0.11 | )
Weighted-average shares outstanding: |  |  |  |  |  |  |  |
Basic |  |  | 14,684 |  |  |  | 13,851 |
Diluted |  |  | 14,684 |  |  |  | 13,851 |

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)

|  | Three Months Ended April 30, |
|  | 2014 |  |  | 2013 |
CASH FLOWS FROM OPERATING ACTIVITIES: |  |  |  |  |  |  |  |
Net loss |  | $ | (1,318 | ) |  | $ | (1,474 | )
Adjustments to reconcile net loss from continuing operations to net cash provided by (used in) operating activities: |  |  |  |  |  |  |  |
Depreciation and amortization |  |  | 2 |  |  |  | 20 |
Amortization of loan discount |  |  | 89 |  |  |  | 55 |
Stock-based compensation expense |  |  | 12 |  |  |  | 27 |
Provision for obsolete inventory |  |  | - |  |  |  | (3 | )
Change in fair value of derivative liabilities |  |  | 1,005 |  |  |  | 767 |
Changes in operating assets and liabilities |  |  |  |  |  |  |  |
Accounts receivable due from customers and suppliers |  |  | - |  |  |  | (221 | )
Inventory |  |  | - |  |  |  | (135 | )
Other assets |  |  | (28 | ) |  |  | (38 | )
Accounts payable |  |  | (53 | ) |  |  | 126 |
Accrued liabilities |  |  | (101 | ) |  |  | 621 |
Net cash used in operating activities |  |  | (392 | ) |  |  | (255 | )
CASH FLOWS FROM INVESTING ACTIVITIES: |  |  |  |  |  |  |  |
Purchases of property and equipment |  |  | - |  |  |  | (4 | )
Net cash used in investing activites |  |  | - |  |  |  | (4 | )
CASH FLOWS FROM FINANCING ACTIVITIES: |  |  |  |  |  |  |  |
Loan proceeds |  |  | - |  |  |  | 1,500 |
Loan repayment |  |  | - |  |  |  | (2,000 | )
Net proceeds from common stock issued |  |  | - |  |  |  | 1,030 |
Net cash provided by financing activities |  |  | - |  |  |  | 530 |
Net (decrease) increase in cash and cash equivalents |  |  | (392 | ) |  |  | 271 |
Cash and cash equivalents, beginning of period |  |  | 1,096 |  |  |  | 104 |
Cash and cash equivalents, end of period |  | $ | 704 |  |  | $ | 375 |
Noncash investing and financing activities: |  |  |  |  |  |  |  |
Debt discount recorded upon issuance of convertible debt |  | $ | - |  |  | $ | 624 |
Issurance of common stock upon the vesting of restricted stock units |  | $ | - |  |  | $ | 19 |
Supplementary disclosures of cash flow information: |  |  |  |  |  |  |  |
Cash paid for interest |  | $ | - |  |  | $ | - |
Cash paid for income taxes, net of refunds |  | $ | - |  |  | $ | - |

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

5

COMARCO, INC. AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

1. | Organization

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

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

We have experienced substantial operating losses for three months ended April 30, 2014 and 2013 totaling approximately $1.3 million and $1.5 million, respectively. The condensed 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.

We generated de minimus revenue during the first three months ended April 30, 2014. As previously announced in August 2013, Lenovo notified us of their intention to cease offering our Constellation product, the power adapter we designed and developed for Lenovo and terminated its relationship with us. We completed shipping product to Lenovo during our third quarter ended November 30, 2013. The loss of Lenovo as a customer has had a material adverse impact on our 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.

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

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

We had negative working capital totaling approximately $9.1 million as of April 30, 2014, of which $3.5 million relates to the fair value of derivative liabilities. We believe that the $6.5 million net settlement reference above will allow us to discharge liabilities and commitments in the normal course of business over the next twelve months.

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

6

COMARCO, INC. AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

3. | Summary of Significant Accounting Policies

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

Basis of Presentation

The accompanying condensed consolidated balance sheet as of April 30, 2014, which has been derived from our audited financial statements, and our unaudited interim condensed consolidated financial statements as of April 30, 2014 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, 2014. The accounting policies followed by the Company are set forth in Note 2 to the Company’s audited financial statements included in its Form 10-K for its fiscal year ended January 31, 2014 (the “2014 10-K”), which was filed with the SEC on April 30, 2014. The unaudited interim condensed consolidated financial information presented herein reflects all adjustments, consisting only of normal recurring accruals, which are, in the opinion of management, necessary for a fair presentation of the consolidated results for the interim periods presented. The consolidated results for the three months ended April 30, 2014 are not necessarily indicative of the results to be expected for the fiscal year ending January 31, 2015.

Principles of Consolidation

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

Cash and Cash Equivalents

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

Accounts Receivable Due from Customers

Our management monitors collections and payments from our customers and maintains a provision for estimated credit losses based upon our historical experience and any specific customer collection issues that we have identified. Management analyzes specific customer accounts and establishes reserves for uncollectible receivables based upon specific identification of account balances that have indications of uncertainty of collection. Indications of uncertainty of collections may include the customer’s inability to pay, customer dissatisfaction, or other factors. Significant management judgments and estimates must be made and used in connection with establishing the allowance for doubtful accounts in any accounting period. Because our accounts receivable are concentrated in a relatively few number of customers, a significant change in the liquidity or financial position of any one of these customers could have a material adverse effect on the collectability of our accounts receivable and our future operating results. As of both April 30, 2014 and January 31, 2014, we have $40,000 reserved as an allowance for doubtful accounts.

Accounts Receivable Due from Suppliers

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

7

COMARCO, INC. AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

Restricted Cash

Our restricted cash balances are secured by separate bank accounts and 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 consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements, and the reported amounts of revenue and expenses during the periods reported. Actual results could materially differ from those estimates.

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

Derivative Liabilities

A derivative is an instrument whose value is “derived” from an underlying instrument or index such as a future, forward, swap, option contract, or other financial instrument with similar characteristics, including certain derivative instruments embedded in other contracts and for hedging activities. As a matter of policy, the Company does not invest in separable financial derivatives or engage in hedging transactions. However, the Company entered into certain financing transactions in fiscal 2013 that 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 consolidated statement of operations. Furthermore, depending on the terms of a derivative, the valuation of derivatives may be removed from the financial statements upon exercise or conversion of the underlying instrument into some other security.

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

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

During the second quarter of fiscal 2013, we adopted the guidance, as codified in Financial Accounting Standards Board ("FASB") Accounting Standards Codification ("ASC") 815-40, Derivatives and 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 issued to Broadwood Partners, L.P. (“Broadwood”) contain provisions that adjust the exercise price in the event of certain dilutive issuance of our securities (see Note 8). Accordingly, the Company considered the warrants to be subject to price protection and classified them as derivative liabilities at the date of issuance with a fair value of $1.4 million and a corresponding discount to the underlying loan payable (see Note 8). 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 Note 8).

8

COMARCO, INC. AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

Fair Value of Financial Instruments

Our financial instruments include cash and cash equivalents, accounts receivable due from customers and suppliers, accounts payable, accrued liabilities, a short-term loan and derivative liabilities. The carrying amount of cash and cash equivalents, accounts receivable, accounts payable, and accrued liabilities are considered to be representative of their respective fair values because of the short-term nature of those instruments. The carrying amount of our loan, net of discount, approximates fair value since the loan balance is derived from the valuation of the derivative liabilities discussed below. The fair value of the derivative liabilities, which are comprised of the warrants issued/issuable to Broadwood and conversion and anti-dilutive features embedded in the Elkhorn Convertible Note, at April 30, 2014 was $3.5 million. Warrants and the conversion features classified as 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 consolidated statement of operations. All other legal expenses, including all other litigation expense and public company legal expense are included in selling, general, and administrative expenses in our consolidated statement of operations.

4. | Stock-Based Compensation

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

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

9

COMARCO, INC. AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

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

|  | Three Months Ended April 30, |
|  | 2014 |  |  | 2013 |
Stock-based compensation expense |  | $ | 12 |  |  | $ | 27 |
Impact on basic and diluted earnings per share |  | $ | (0.00 | ) |  | $ | (0.00 | )

The total compensation cost related to nonvested awards not yet recognized is approximately $35,000, which will be expensed over a weighted average remaining life of 11 months.

During the three months ended April 30, 2014 and 2013, no stock awards were granted.

The Company’s former employee stock option plan (the “Prior Employee Plan”) expired during May 2005. As a result, no new options could be granted under the plan thereafter. This plan provided for the issuance of up to 825,000 shares of common stock. As of January 31, 2013, the Prior Employee Plan had 25,000 stock options outstanding. In December 2005, the Board of Directors approved and adopted the Company’s 2005 Equity Incentive Plan (the “2005 Plan”) covering 450,000 shares of common stock. The 2005 Plan was approved by the Company’s shareholders at its annual shareholders’ meeting in June 2006, and subsequently amended at its annual shareholders’ meeting in June 2008 to increase the number of shares issuable under the plan from 450,000 to 1,100,000 shares. In July 2011, the Company’s shareholders approved the 2011 Equity Incentive Plan (the “2011 Plan”) covering 750,000 shares of common stock, as well as the shares that remained available for issuance under the 2005 Plan plus shares that were the subject of outstanding awards under the 2005 Plan, which again become available for grant under that plan. Thus, the 2011 Plan combines the 2011 Plan and the 2005 Plan. Under the 2011 Plan, we may grant stock options, stock appreciation rights, restricted stock, restricted stock units, and performance based awards to employees, consultants and directors. In addition, under the 2011 Plan, awards vest or become exercisable in installments determined by the compensation committee of our Board of Directors. The options granted under Prior Employee Plan expire as determined by the committee, but no later than ten years and one week after the date of grant (five years for 10 percent shareholders). The options granted under the 2011 and 2005 Plan expire as determined by the committee, but no later than ten years after the date of grant (five years for 10 percent shareholders). The options granted under the 2011 and 2005 Plan expire as determined by the committee, but no later than ten years after the date of grant (five years for 10 percent shareholders).

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

10

COMARCO, INC. AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

Transactions and other information related to stock options granted under these plans for the three months ended April 30, 2014 are summarized below:

|  | Outstanding Options |
|  | Number of Shares |  |  | Weighted-Ave. Exercise Price |
Balance, January 31, 2014 |  |  | 638,500 |  |  | $ | 1.22 |
Options granted |  |  | - |  |  |  |  |
Options canceled or expired |  |  | (38,500 | ) |  |  | 5.32 |
Options exercise |  |  | - |  |  |  |  |
Balance, April 30, 2014 |  |  | 600,000 |  |  | $ | 1.13 |
Stock Options Exercisable at April 30, 2014 |  |  | 560,000 |  |  | $ | 0.95 |

Transactions and other information related to restricted stock granted under these plans for the three months ended April 30, 2014 are summarized below:

Outstanding Restricted Stock |  | Outstanding Restricted Stock |
|  | Number of Shares |  |  | Weighted-Average Stock Price on Grant Date |
Balance, January 31, 2014 |  | $ | 420,000 |  |  | $ | 0.18 |
Restricted Stock Granted |  |  | - |  |  |  | - |
Restricted Stock Forfeited |  |  | (30,000 | ) |  |  | 0.18 |
Balance, April 30, 2014 |  | $ | 390,000 |  |  | $ | 0.18 |

11

At April 30, 2014, the restriced stock awards outstanding have an aggregative intrinsic value of $15,600, based on a closing price of $0.22 per share on April 30, 2104.

As of April 30, 2014, the stock awards outstanding have an aggregate intrinsic value of $6,000, based on a closing market price of $0.22 per share on April 30, 2014. The following table summarizes information about the Company’s stock awards outstanding at April 30, 2014:

|  |  |  | Awards Outstanding |  |  | Options Exercisable |
Range of Exercise/Grant Prices |  |  | Number Outstanding |  |  | Weighted-Ave. Remaining Contractual Life |  |  | Weighted-Ave. Exercise/Grant Price |  |  | Number Exercisable |  |  | Weighted-Ave. Exercise Price |
$ | 0.40 |  |  |  | 465,000 |  |  |  | 8.45 |  |  | $ | 0.40 |  |  |  | 465,000 |  |  | $ | 0.40 |
$ | 1.09 |  |  |  | 100,000 |  |  |  | 4.54 |  |  |  | 1.09 |  |  |  | 60,000 |  |  |  | 1.09 |
$ | 4.90 |  |  |  | 15,000 |  |  |  | 3.84 |  |  |  | 4.90 |  |  |  | 15,000 |  |  |  | 4.90 |
$ | 10.43 |  |  |  | 20,000 |  |  |  | 2.14 |  |  |  | 10.25 |  |  |  | 20,000 |  |  |  | 10.43 |
|  |  |  |  | 600,000 |  |  |  |  |  |  |  | 1.13 |  |  |  | 560,000 |  |  |  | 0.95 |

At April 30, 2014, shares available for future grants under the 2011 Plan totaled 35,224.

5. | 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 three months ended April 30, 2014 and 2013, 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 278,926 relating to outstanding stock awards to directors and employees have been excluded from diluted weighted average common shares for the three months ended April 30, 2014, as the effect would have been antidilutive. Similarly, potential common shares of 1,068,826 relating to outstanding stock awards to directors and employees have been excluded from diluted weighted average common shares for the three months ended April 30, 2013, as the effect would have been antidilutive.

12

COMARCO, INC. AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

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

|  | Three Months Ended April 30, |
|  | 2014 |  |  | 2013 |
Net loss |  | $ | (1,318 | ) |  | $ | (1,474 | )
Basic net loss per share: |  |  |  |  |  |  |  |
Weighted-average shares outstanding-Basic |  |  | 14,684 |  |  |  | 13,851 |
Basic net loss per share |  | $ | (0.09 | ) |  | $ | (0.11 | )
Diluted net loss per share: |  |  |  |  |  |  |  |
Weighted average shares outstanding - basic |  |  | 14,684 |  |  |  | 13,851 |
Weighted average shares outstanding - diluted |  |  | 14,684 |  |  |  | 13,851 |
Diluted loss per share |  | $ | (0.09 | ) |  | $ | (0.11 | )

6. | Customer and Supplier Concentrations

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

|  | (in thousands, except percentages) |
|  | Three Months Ended April 30, |
|  | 2014 |  |  |  | 2013 |
Total revenue |  | $ | - |  |  |  | 0 | % |  |  | $ | 1,413 |  |  |  | 100 | %
Customer concentration: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Lenovo Information Products Co., Ltd. |  | $ | - |  |  |  | 0 | % |  |  |  | 1,378 |  |  |  | 98 | %
|  | $ | - |  |  |  | 0 | % |  |  | $ | 1,378 |  |  |  | 98 | %

13

COMARCO, INC. AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

The suppliers comprising 10 percent or more of the Company’s gross accounts receivable due from suppliers at either April 30, 2014 or January 31, 2014 are listed below (in thousands, except percentages).

|  | As of April 30, |  |  | As of January 31, |
|  | 2014 |  |  | 2014 |
Total gross accounts receivable due from suppliers |  | $ | 128 |  |  |  | 100 | % |  | $ | 128 |  |  |  | 100 | %
Customer concentration: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Zheng Ge Electrical Co., Ltd. |  | $ | 122 |  |  |  | 95 | % |  | $ | 122 |  |  |  | 95 | %
|  | $ | 122 |  |  |  | 95 | % |  | $ | 122 |  |  |  | 95 | %

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

The companies comprising 10 percent or more of our gross accounts payable at either April 30, 2014 or January 31, 2014 are listed below (in thousands, except percentages).

|  | As of April 30, |  |  | As of January 31, |
|  | 2014 |  |  | 2014 |
Total gross accounts payable |  | $ | 4,310 |  |  |  | 100 | % |  | $ | 4,363 |  |  |  | 100 | %
Supplier concentration: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Chicony Power Technology, Co. Ltd. |  | $ | 1,100 |  |  |  | 26 | % |  | $ | 1,100 |  |  |  | 25 | %
Pillsbury Winthrop Shaw Pittman, LLP |  |  | 1,953 |  |  |  | 45 | % |  |  | 1,953 |  |  |  | 45 | %
|  | $ | 3,053 |  |  |  | 71 | % |  | $ | 3,053 |  |  |  | 70 | %

Chicony Power Technology, Co. Ltd., (“Chicony”) was the manufacturer of the Bronx product, which was subject to a recall. We had been in litigation with Chicony (see Note 10). We made no payments to this supplier during either three months ended April 30, 2014 and during fiscal 2014. Effective May 15, 2014, Chicony entered into a settlement agreement with us that dismissed all claims between the two parties arising from the litigation. Pursuant to the terms of the settlement agreement, Chicony agreed to pay us $7.6 million in lieu of the previous jury net award of $9.7 million or any other related costs or fees. $4.0 million of the settlement amount was paid on May 16, 2014, with the balance of $3.6 million paid May 30, 2014. As a result of the settlement agreement, the $1.1 million obligation to Chicony referenced above has been legally dismissed and will be reversed during the second quarter of fiscal 2015.

Pillsbury Winthrop Shaw Pittman, LLP (“Pillsbury”) was our former legal counsel for the Kensington litigation as well as other patent and intellectual property matters (See Note 10). We have made no payments to Pillsbury during fiscal 2015. On May 28, 2014, we entered into an agreement with Pillsbury that settled the liabilities referenced above.

14

COMARCO, INC. AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

7. | Accrued Liabilities

Accrued liabilities consist of the following (in thousands):

|  | April 30, 2014 |  |  | January 31, 2014 |
Uninvoiced materials and services received |  | $ | 458 |  |  | $ | 458 |
Accrued legal and professional fees |  |  | 112 |  |  |  | 161 |
Accrued payroll and related expenses |  |  | 45 |  |  |  | 58 |
Accrued warranty |  |  | 20 |  |  |  | 20 |
Other |  |  | 276 |  |  |  | 315 |
|  | $ | 911 |  |  | $ | 1,012 |

As of April 30, 2014 and January 31, 2014, approximately $0.3 million or 70 percent of total uninvoiced materials and services of $0.5 million, respectively, included in accrued liabilities, was payable Zheng Ge Electrical Co. Ltd. (“Zheng Ge”).

8. | Loan & Related Agreements

Secured Loan Agreement with Elkhorn Partners.

On February 11, 2013, the Company and Elkhorn Partners Limited Partnership (“Elkhorn”), entered into a Secured Loan Agreement (the “Elkhorn Loan Agreement”) and a Stock Purchase Agreement (the “Elkhorn SPA”), and certain related agreements, which are described below (collectively, the “Elkhorn Agreements”). Pursuant to those Elkhorn Agreements, Elkhorn 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. On June 3, 2014, the Company repaid the amounts outstanding under the Elkhorn Loan Agreement in full.

The Elkhorn Loan, which is evidenced by a promissory note (the “Elkhorn Loan”), issued by the Company to Elkhorn, bears interest at 7% for the first 12 months of the Elkhorn Loan, increasing to 8.5% thereafter and continuing until the Elkhorn Loan is paid in full. The Elkhorn 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. On February 11, 2013, the Company used approximately $2.1 million of the proceeds of $2.5 million from the Elkhorn Loan and the sale of the shares to Elkhorn to pay the entire principal amount of and all accrued interest on the Broadwood Loan. On June 3, 2014, the Company repaid the amounts outstanding under the Elkhorn Loan Agreement in full.

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 Elkhorn Loan, in whole or in part, into shares of Company common stock at a conversion price of $0.25 per share. That conversion price 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 9.

15

COMARCO, INC. AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

The Elkhorn Loan Agreement contains customary representations and warranties of and affirmative and negative covenants on the part of the Company and CWT. The Elkhorn 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 Elkhorn Loan Agreement to include each of the following, among others: (i) a failure of the Company to pay the principal or accrued interest on the Elkhorn Loan which continues remedied 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 Elkhorn 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 Elkhorn 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 Elkhorn Loan will accrue at the lesser of (i) 15% per annum or (ii) the highest rate permitted by applicable law.

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

16

COMARCO, INC. AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

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 and Stock Purchase Agreement

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

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

On January 28, 2013, the maturity date of the Broadwood 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 Broadwood Loan in cash. On February 11, 2013, the Company repaid the amounts outstanding under the Broadwood Loan Agreement in full.

Stock Purchase Agreement and Stock Purchase Warrants

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

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

17

COMARCO, INC. AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

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

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

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

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

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

9. | Fair Value Measurements

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

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

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

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

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

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

18

COMARCO, INC. AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

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

The hierarchy noted above requires the Company to minimize the use of unobservable inputs and to use observable market data, if available, when determining fair value. There were no transfers between Level 1, Level 2 and/or Level 3 during the first quarter of fiscal 2015. Our fair value measurements at the April 30, 2014 reporting date are classified based on the valuation technique level noted in the table below (in thousands):

Description |  | April 30, 2014 |  |  | Quoted Prices in Active Markets for (Level 1) |  |  | Significant Other Observable (Level 2) |  |  | Significant Unobservable (Level 3) |
Derivative Liabilties |  | $ | 3,525 |  |  | $ | - |  |  | $ | - |  |  | $ | 3,525 |

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 warrants as described in Note 8 utilizing the Monte Carlo simulation model:

|  | April 30, 2014 |
Risk free interest rate |  | 2.04% |
Average expected life (years) |  | 6.24 |
Expected volatility |  | 120.03% |
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 8 utilizing the Monte Carlo simulation model:

|  | April 30, 2014 |
Risk free interest rate |  | 0.06% |
Average expected life (years) |  | 0.59 |
Expected volatility |  | 82.31% |
Expected dividends |  | None |

19

COMARCO, INC. AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

The table below sets forth a summary of changes in the fair value of our Level 3 financial instruments for the three months ended April 30, 2014 (in thousands):

Description |  | February 1, 2014 |  |  | Recorded new Derivative Liabilities |  |  | Change in estimated fair value recognized in results of operations |  |  | April 30, 2014 |
Broadwood warrants |  | $ | 2,426 |  |  | $ | - |  |  | $ | 799 |  |  | $ | 3,225 |
Elkhorn conversion features |  |  | 94 |  |  |  | 0 |  |  |  | 206 |  |  |  | 300 |
|  | $ | 2,520 |  |  | $ | - |  |  | $ | 1,005 |  |  | $ | 3,525 |

The table below sets forth a summary of changes in the fair value of our Level 3 financial instruments for the three months ended April 30, 2013 (in thousands):

|  | February 1, 2013 |  |  | Recorded New Derivative Liabilities |  |  | Change in estimated fair value recognized in results of operations |  |  | April 30, 2013 |
Derivative liabilities |  | $ | 2,466 |  |  | $ | 624 |  |  | $ | 767 |  |  | $ | 3,857 |

10. | Commitments and Contingencies

Executive Severance Commitments

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

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 could result in a change of control for purposes of the severance compensation agreements, the executive who is party to this agreement has waived his right to receive payments under this agreement 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.

20

COMARCO, INC. AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

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

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.

Executive and Board of Directors Compensation

On November 2, 2013, the Company approved a deferred compensation plan for its Chief Executive Officer and Board of Directors. As of April 30, 2014, no compensation expense has been accrued under this deferred compensation plan as its goal was not achieved.

Legal Contingencies

On April 26, 2011, Chicony, the contract manufacturer of the Bronx product that was the subject of a product recall, filed a complaint against us for breach of contract, seeking payment of $1.2 million for the alleged non-payment by us of amounts alleged by Chicony to be due it for products purchased from it by the Company. We denied liability and filed a cross-complaint on May 13, 2011 seeking the recovery of damages of $4.9 million caused by Chicony's failure to adhere to our technical specifications when manufacturing the Bronx product, which we believe resulted in the recall of the product. On April 16, 2013, the court approved our first-amended cross-complaint, which added intentional interference to our complaint and increased the damages we were seeking to at least $15.0 million. The trial date was held in October, 2013. In an effort to resolve this litigation before the previous trial date of April, 2013, we sent Chicony a settlement offer, which has since lapsed. On February 4, 2014, a jury returned a verdict in our favor and awarded us damages of approximately $10.8 million, offset by previously accrued liabilities of $1.1 million for a net award of approximately $9.7 million. Effective as of May 15, 2014, Chicony entered into a settlement agreement with us that dismisses all claims between the parties arising from the litigation referenced above. Pursuant to the terms of the settlement agreement, Chicony agreed to pay us $7.6 million in lieu of the jury’s net award of $9.7 million or any other related costs or fees. $4.0 million of the settlement amount was paid to us on May 16, 2014, with the balance of $3.6 million paid to us on June 2, 2014. As the gain contingency was not realized as of April 30, 2014, we will record a gain of $7.6 million associated with this settlement in the quarter ended July 31, 2014.

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

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

21

COMARCO, INC. AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

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

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

11. | Subsequent Events

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

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

On May 28, 2014, we entered into an agreement with Pillsbury that settled the liabilities referenced in Note 6.

On June 3, 2014, the Company repaid the amounts outstanding under the Elkhorn Loan Agreement in full.

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

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

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

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

Going Concern Qualification

We have experienced substantial operating losses for three months ended April 30, 2014 and 2013 totaling approximately $1.3 million and $1.5 million, respectively. The condensed 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.

We generated de minimus revenue during the first three months ended April 30, 2014. As previously announced in August 2013, Lenovo notified us of their intention to cease offering our Constellation product, the power adapter we designed and developed for Lenovo and terminated its relationship with us. We completed shipping product to Lenovo during our third quarter ended November 30, 2013. The loss of Lenovo as a customer 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.

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Two of our ongoing litigation matters have concluded. In the Chicony Power Technology, Co. Ltd., (“Chicony”) matter, effective as of May 15, 2014, Chicony entered into a settlement agreement with us that dismissed all claims between the two parties arising from the litigation. Pursuant to the terms of the settlement agreement, Chicony agreed to pay us $7.6 million in lieu of the jury’s net award of $9.7 million or any other related costs or fees. $4.0 million of the settlement amount was paid to us on May 16, 2014, with the balance of $3.6 million paid to us on June 2, 2014. $1.1 million of the $7.6 million was immediately paid to our attorneys. In our litigation with ACCO Brands USA LLC and its Computer Products Group division (collectively “Kensington”)Kensington matter, on February 4, 2014, Comarco and Kensington entered into a settlement and licensing agreement with an effective date of February 1, 2014 that dismisses all claims between the two parties arising from this matter.

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

We had negative working capital totaling approximately $9.1 million as of April 30, 2014, of which $3.5 million relates to the fair value of derivative liabilities. We believe that the $7.6 million settlement reference above will allow us to discharge liabilities and commitments in the normal course of business over the next twelve months.

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

Basis of Presentation

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

Executive Summary

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

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

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In addition to the risks, uncertainties and factors discussed elsewhere in this quarterly report on Form 10-Q and in the Company’s other filings with the SEC, management currently considers the following additional trends, events, and uncertainties to be important to understanding our results of operations for the quarter ended April 30, 2014:

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

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

| ● | We generated de minimus revenue for three months ended April 30, 2014 compared to $1.4 million for three months ended April 30, 2013. The decrease is attributable to decreased sales to our principal customer Lenovo. In the third quarter of fiscal 2014, Lenovo terminated its relationship with us. We completed our final shipment of product to Lenovo during the third quarter ended October 31, 2013. We anticipate that we will generate de minimus revenue from the development, design, distribution or sale of any products until we settle our current litigation and are able to resume traditional operations.

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

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

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

| ● | On February 11, 2013, we entered into a Secured Loan Agreement (the “Loan Agreement”) with Elkhorn Partners Limited Partnership (“Elkhorn”). Pursuant to the Loan Agreement, on February 11, 2013, Elkhorn made a $1,500,000 senior secured term loan (the “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 8 to our consolidated financial statements contained elsewhere in this report for additional information regarding the Loan Agreement, the Loan and certain related agreements. On June 3, 2014, the Company repaid the amounts outstanding under the Elkhorn Loan Agreement in full.

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

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

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 months ended April 30, 2014 to the items that we disclosed as our critical accounting policies and estimates in Management’s Discussion and Analysis of Financial Condition and Results of Operations in our annual report on Form 10-K for the fiscal year ended January 31, 2014.

Results of Operations

The following tables set forth certain items as a percentage of revenue from our unaudited interim condensed consolidated statements of operations for the three months ended April 30, 2014 and 2013:

|  | (in thousands) Three Months Ended April 30, |  |  |  |  |
|  | 2014 |  |  | 2013 |  |  | % Change |
Revenue |  | $ | - |  |  | $ | 1,413 |  |  |  | -100 | %
Operating loss |  | $ | (391 | ) |  | $ | (634 | ) |  |  | -38 | %
Net loss |  | $ | (1,318 | ) |  | $ | (1,474 | ) |  |  | -11 | %

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Revenue

Revenue by Geographic Region

|  | (in thousands) Three Months Ended April 30, |
|  | 2014 |  |  | 2013 |
Revenue: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Asia-Pacific |  | $ | - |  |  |  | 0 | % |  | $ | 1,364 |  |  |  | 97 | %
North America |  |  | - |  |  |  | 0 | % |  |  | 46 |  |  |  | 3 | %
Europe |  |  | - |  |  |  | 0 | % |  |  | 3 |  |  |  | 0 | %
|  | $ | - |  |  |  | 0 | % |  | $ | 1,413 |  |  |  | 100 | %

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

Revenue by Customer

|  | (in thousands) Three Months Ended April 30, |  |  |  |  |
|  | 2014 |  |  | 2013 |  |  | % Change |
Revenue: |  |  |  |  |  |  |  |  |  |  |  |
Lenovo |  | $ | - |  |  | $ | 1,378 |  |  |  | -100 | %
Other |  |  | - |  |  |  | 35 |  |  |  | -100 | %
|  | $ | - |  |  | $ | 1,413 |  |  |  | -100 | %

Revenue for the three months ended April 30, 2014 decreased by $1.4 million, or 100 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 of fiscal 2014, and we do not expect to receive any further orders or revenue from Lenovo.

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Cost of Revenue and Gross Margin

|  | (in thousands) Three Months Ended April 30, |  |  |  |  |
|  | 2014 |  |  | 2013 |  |  | % Change |
|  |  |  |  |  | % of Total |  |  |  |  |  |  | % of Total |  |  |  |  |
Cost of Revenue: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Product costs |  | $ | - |  |  |  | 0 | % |  | $ | 960 |  |  |  | 86 | % |  |  | -100 | %
Supply chain overhead |  |  | - |  |  |  | 0 | % |  |  | 160 |  |  |  | 14 | % |  |  | -100 | %
Inventory reserve and scrap charges |  |  | - |  |  |  | 0 | % |  |  | - |  |  |  | 0 | % |  |  | 0 | %
|  | $ | - |  |  |  | 0 | % |  | $ | 1,120 |  |  |  | 100 | % |  |  | -100 | %

|  | Three Months Ended April 30, |  |  |  |  |
|  | 2014 |  |  | 2013 |  |  | % Change |
Gross profit percent |  |  | 0 | % |  |  | 21 | % |  |  | -21 | %

Cost of revenue for the three months ended April 30, 2014 decreased by $1.1 million, or 100 percent compared to the corresponding period of fiscal 2014. The decrease is a result of the decrease in revenues.

Operating Costs and Expenses

|  | (in thousands) Three Months Ended April 30, |  |  |  |  |
|  | 2014 |  |  | 2013 |  |  | % Change |
|  |  |  |  |  | % of Rev |  |  |  |  |  |  | % of Rev |  |  |  |  |
Operating expenses: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Selling, general and administrative expenses, excluding corporate overhead |  | $ | 227 |  |  |  | 0 | % |  | $ | 18 |  |  |  | 1 | % |  |  | 1161 | %
Corporate overhead |  |  | 104 |  |  |  | 0 | % |  |  | 630 |  |  |  | 45 | % |  |  | -83 | %
Engineering and support expenses |  |  | 60 |  |  |  | 0 | % |  |  | 279 |  |  |  | 20 | % |  |  | -78 | %
|  | $ | 391 |  |  |  | 0 | % |  | $ | 927 |  |  |  | 66 | % |  |  | -58 | %

Selling, general, and administrative (“SG&A”) expenses for the three months ended April 30, 2014 decreased $536,000, or 58 percent compared to the corresponding period of fiscal 2014. We had no employees in our sales and marketing department during the three months end April 30, 2014.

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

For the three months ended April 30, 2014, engineering and support expenses consisted of legal expenses incurred related to our intellectual property, including associated litigation expense and maintenance of our patent portfolio. In the three months ended April 30, 2013, engineering and support expenses consisted of salaries, employer paid benefits, and other personnel related costs of our design engineers and testing and support personnel, as well as facility and IT costs, professional and consulting fees, lab costs, material usages, and travel and related costs incurred in the development and support of our products.

Interest Expense

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

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During the three months ended April 30, 2014 and 2013, we expensed approximately $0.1 million and $78,000 of interest expense to Elkhorn pursuant to the terms of the Elkhorn Loan.

Loss Due to Change in Fair Value of Derivative Liabilities

For the three months ended April 30, 2014 and 2013, we reported a loss due to the change in the fair value of our derivative liabilities of approximately $1.0 million and $0.8 million, respectively.

Other Income, net

During the three months ended April 30, 2014, other income, net, consisted of $0.2 million from a settlement and licensing agreement.

During the three months ended April 30, 2013, other income, net, consisted of $5,000 in proceeds from the State of California from funds that had previously been escheated to the state.

Income Tax Expense

Significant management judgment is required in determining our provision for income taxes, our deferred tax assets and liabilities and any required valuation allowance. We continue to maintain a full valuation allowance on the entire deferred tax asset balance. This valuation allowance was established based on management’s overall assessment of risks and uncertainties related to our future ability to realize, and hence, utilize certain deferred tax assets, primarily consisting of net operating loss carry forwards and temporary differences. Due to the current and prior years’ operating losses, the adjusted net deferred tax assets remained fully reserved as of April 30, 2014. We are reviewing whether a Section 382 ownership change may have occurred as a result of the Elkhorn transaction in fiscal 2014 (Part I, Item 1, Note 8). If this transaction results in an ownership change, it would substantially limit our research and experimentation credits and net operating loss carryforwards.

Liquidity and Capital Resources

Cash and cash equivalents at April 30, 2014 decreased $0.4 million to $0.7 million as compared to $0.4 million at April 30, 2013. The following table is a summary of our Condensed Consolidated Statements of Cash Flows.

|  | (in thousands) Three Months Ended April 30, |
|  | 2014 |  |  | 2013 |
Cash provided by (used in): |  |  |  |  |  |  |  |
Operating activities |  | $ | (392 | ) |  | $ | (255 | )
Investing activites |  | $ | - |  |  | $ | (4 | )
Financing activities |  | $ | - |  |  | $ | 530 |

Operating Activities

Cash used in operating activities was $0.4 million for the three months ended April 30, 2014 and was primarily driven by our net loss of $1.3 million offset by change in fair value of derivative liabilities of $1.0 million.

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Cash used in operating activities of $0.3 million for the three months ended April 30, 2013 was primarily attributable to our net loss of $1.5 million, offset by the increase in the value of our derivative liabilities of $0.8 million. Additionally, our accounts payable and accrued liabilities increased by $0.7 million, and our receivables increased by $0.2 million.

Investing Activities

We had no investing activities during the three months ended April 30, 2014.

During the three months ended April 30, 2013, we purchased $4,000 of property and equipment, which was primarily tooling and equipment used for the manufacture of our ChargeSource® products.

Financing Activities

We had no financing activities during the three months ended April 30, 2014.

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 June 3, 2014, the Company repaid the amounts outstanding under the Elkhorn Loan Agreement in full.

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

As of April 30, 2014, we had negative working capital of approximately $9.1 million, of which $3.5 million relates to the fair value of derivative liabilities. Effective as of May 15, 2014, Chicony entered into a settlement agreement with us that dismisses all claims between the parties arising from the litigation referenced above. Pursuant to the terms of the settlement agreement, Chicony agreed to pay us $7.6 million in lieu of the jury’s net award of $9.7 million or any other related costs or fees. $4.0 million of the settlement amount was paid to us on May 16, 2014, with the balance of $3.6 million paid to us on May 30, 2014. Of the $7.6 million, we received $6.5 million, net of attorneys' fees and other costs. We believe that the $6.5 million net settlement will allow us to discharge liabilities and commitments in the normal course of business over the next twelve months.

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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 April 30, 2014, of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) under the Exchange Act). “Internal control over financial reporting” includes those policies and procedures that:

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

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

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

In connection with its evaluation, our management has concluded that, as of April 30, 2014, our internal control over financial reporting is not effective in providing reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with 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 April 30, 2014 did not result in any particular deficiency in our financial reporting for the fiscal quarter then ended, management believes that the lack of effectiveness of our internal control over financial reporting could result in a failure to provide reliable financial reporting in the future. In order to remedy our existing internal control deficiency, we will need to raise additional capital or improve our working capital position to allow us to hire additional staff.

Internal Control over Financial Reporting

There was no change in our internal control over financial reporting that occurred during the quarter ended April 30, 2014 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

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PART II — OTHER INFORMATION

ITEM 1. | LEGAL PROCEEDINGS

Comarco, Inc. vs. Targus Group International, Inc., Case No. 8:14-cv-00361, Superior Court of California County of Orange – Central Justice Center. On March 10, 2014, we filed a lawsuit against Targus for patent infringement, breach of contract, intentional interference with contract, violation of business and professional codes, misrepresentation and fraudulent concealment. Although we intend to vigorously pursue our rights in this case, the outcome of this matter is not determinable as of the date of this report.

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

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

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

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

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

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

ITEM 1A. | RISK FACTORS

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

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ITEM 6. | EXHIBITS

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

______________

** | 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: June 16, 2014 | /s/ THOMAS W. LANNI |
| Thomas W. Lanni |
| President and Chief Executive Officer |
| (Principal Executive Officer) |

Date: June 16, 2014 | /s/ JANET N. GUTKIN |
| Janet N. Gutkin |
| Chief Accounting Officer |
| (Principal Financial and Accounting Officer) |

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EXHIBIT INDEX

Exhibit | Description

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

______________

** | 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.

34