Recent Accounting Pronouncements

In February 2016, the Financial Accounting Standards Board “FASB” issued ASU 2016-02, Leases (Topic 842) (“ASU 2016-02”), which is intended to improve financial reporting about leasing transactions. The new guidance will require lessees to recognize on their balance sheets the assets and liabilities for the rights and obligations created by leases and to disclose key information about the leasing arrangements. ASU 2016-02 is effective for interim and annual periods beginning after December 15, 2018, with early adoption permitted. ASU 2016-02 is effective for us in the first quarter of fiscal 2020. As we do not have any long-term leases, we do not expect the adoption of this updated authoritative guidance to have a significant impact on our consolidated financial statements.

In May 2014, the FASB issued Accounting Standards Update (ASU) 2014-09, Revenue from Contracts with Customers, issued as a new Topic, ASC Topic 606 (ASU 2014-09). The new revenue recognition standard provides a five-step analysis of transactions to determine when and how revenue is recognized. The premise of the guidance is that a Company should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. ASU 2014-09 can be adopted by the Company either retrospectively or as a cumulative-effect adjustment as of the date of adoption. On April 1, 2015, the FASB decided to defer the effective date of the new revenue standard by one year. For public entities, the update is effective for financial statements issued for fiscal years beginning after December 15, 2018. ASU 2014-09 is effective for us in the first quarter of fiscal 2020. As we are not generating any ongoing revenue we do not expect the adoption of this updated authoritative guidance to have a significant impact on our consolidated financial statements.

We do not believe that any other recently issued, but not yet effective accounting standards, if adopted, would have a material impact on our consolidated financial statements.

Subsequent Events

Management has evaluated events subsequent to July 31, 2017 through the date the accompanying consolidated financial statements were filed with the Securities and Exchange Commission for transactions and other events that may require adjustment of and/or disclosure in such financial statements.

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

COMARCO, INC. AND SUBSIDIARY

NOTES TOCONDENSEDCONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

We account for stock-based compensation using the modified prospective method, which requires measurement of compensation cost for all stock awards at fair value on date of grant and recognition of compensation over the service period for awards expected to vest. The fair value of stock options is determined using a Lattice Binomial model for options with performance-based vesting tied to our stock price and the Black-Scholes valuation model for options with ratable term vesting. Both the Lattice Binomial and Black-ScholesThe valuation models requiremodel requires 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.

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):

The total compensation cost related to nonvestedunvested awards not yet recognized is approximately $40,000.$6,750 and is expected to fully vest and be recognized as compensation expense by the third quarter of fiscal year 2018.

During the ninethree and six months ended OctoberJuly 31, 2017 and 2016, 396,189no stock options and no restricted stock units were granted.During the nine months ended October 31, 2015, 350,000 stock options were granted and no restricted stock units were granted. The fair value of the options granted under our stock option plans during the nine months ended October 31, 2016 and 2015 was estimated on the date of grant using the following weighted average assumptions:

We calculate basic (loss) income per share by dividing net (loss) income by the weighted-average number of common shares outstanding during the reporting period. Diluted (loss) income per share reflects the effects of potentially dilutive securities.potential common shares. Because we incurred a net loss for the three and ninesix months ended OctoberJuly 31, 2015,2017, basic and diluted loss per share for this period waswere the same because the inclusion of dilutive potential common shares related to outstanding stock awards in the calculation would have been dilutive. For the three and six months ended July 31, 2016, basic and diluted income per share was the same as all potential common shares were antidilutive.

Potential common shares of 3,110,6703,190,000 and 3,095,2053,073,736 relating to outstanding warrants and to stock awards to directors and our employee as well as stock purchase warrant to Broadwood, have been excluded from diluted weighted average common shares for the three and ninesix months ended OctoberJuly 31, 2017 and 2016, respectively, as the effect would have been antidilutive.

Potential common shares of 787,912 and 662,868 relating to outstanding stock awards to directors and our employee, respectively, have been excluded from diluted weighted average common shares for the three and nine months endedOctober 31, 2015, as the effect would have been antidilutive.

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

The companies comprising 10 percent or more of our gross accounts payable at either October 31, 2016 and January 31, 2016 are listed below (in thousands, except percentages).

Pillsbury was our former legal counsel for the Kensington litigation as well as other patent and intellectual property matters (see Note 8). On May 28, 2014, we entered into an agreement with Pillsbury in which we paid Pillsbury a lump sum of $1.5 million with the remaining contingent balance of $0.4 million (the “Contingent Balance”) to be paid, if at all, in the event we obtain any monetary recovery, whether through settlement, judgment or otherwise, after May 28, 2014 from or as a result of any of our current or future lawsuits related to our intellectual property. In connection with the $1.5 million lump-sum partial repayment, no gain was recognized. In April 2016, we paid Pillsbury approximately $0.4 million as a result of the settlement agreement with Targus. The remaining Contingent Balance is approximately $0.1 million. The total amount payable is equal to the Contingent Balance plus 20% per annum, compounded annually from May 28, 2014.

Accrued liabilities consist of the following as of July 31, 2017 and January 31, 2017 (in thousands):

On September 11, 2017, we entered into subscription agreements (the “Subscription Agreements”) with our two largest existing shareholders, Broadwood Partners, L.P. (“Broadwood”) and Elkhorn Partners Limited Partnership (“Elkhorn”), pursuant to which Broadwood and Elkhorn subscribed for and purchased 5,000,000 and 2,000,000 shares, respectively, of our Series A Contingent Convertible Preferred Stock (“Series A Preferred Stock”) at a purchase price of $0.10 per share. The purchase of the Series A Preferred Stock closed on September 12, 2017, resulting in gross proceeds to the Company of $700,000. The Subscription Agreements also provide that upon the earlier of a Triggering Event (as described below) or immediately prior to the liquidation, dissolution or winding up of the Company (subject to the provisions of the Series A Preferred Stock), we will issue Broadwood and Elkhorn, for no additional consideration, warrants (the “Warrants”) to purchase 18,026,500 shares and 7,210,600 shares, respectively, of our common stock (“Common Stock”). If issued, the Warrants will have a term of eight years from the date of issuance and an exercise price of $0.05 per share of Common Stock. As defined in the certificate of determination for the Series A Preferred Stock, “Triggering Event” includes, among other things, (a) the Court of Appeals for the Federal Circuit (or other court of appeals with appropriate jurisdiction) overturns the decision of the PTAB issued on February 22, 2017 (the “PTAB Decision”) regarding obviousness of our 933 Patent, (b) the Court of Appeals for the Federal Circuit (or other court of appeals with appropriate jurisdiction) requires that the PTAB review and reconsider the PTAB Decision, (c) the United States Supreme Court decision in the case of Oil States Energy Services, LLC vs. Greene’s Energy Group, LLC (or in any subsequent case brought before the United States Supreme Court) declares the Inter Parties Review process unconstitutional or otherwise reaches a decision resulting in the vacating or invalidity of the PTAB Decision, provided that such United States Supreme Court decision is made prior to a Court of Appeals action described in foregoing subparts (a) or (b), or (d) the Company receives cumulative incremental additional funds from any source, other than borrowings or the issuance of securities, after September 6, 2017 in an amount at or in excess of $700,000.

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 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 addressedreferenced 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.(“SEC”). Readers are urged not to place undue reliance on these forward-looking statements, which speak onlyreflect information 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, 20162017 (the “2016“2017 Form 10-K”) 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

The condensed financial statementsAs of July 31, 2017, we had negative working capital of $169,000. We have been prepared assuming thatceased traditional operations and our currently generating no revenue. As discussed in Note 8 of the Condensed Consolidated Financial Statements included elsewhere in this report, on September 12, 2017, we sold 7,000,000 shares of our Series A Participating Preferred Stock for gross proceeds to us in the amount of $700,000 (“Series A Financing”). We believe the proceeds from our Series A Financing will provide us sufficient capital to allow us to discharge our liabilities and commitments in the normal course of business over the next twelve months. However, our ability to continue to operate as a going concern which contemplatesbeyond that we will realize value from our assets and satisfy our liabilities and commitments in the ordinary course of business. Our consolidated financial statements do not reflect any adjustments related to the outcome of this uncertainty. Our futureperiod is highly dependent on our ability to successfully resolve our current litigation, capitalize onmonetize our portfolio of patents, generate positive cash flows andflow and/or obtain borrowings or raise additional capital to meet our liquidity needs..

We are primarilyOur business is currently focused on potentially realizing value from our ongoing or future IP enforcement actions and other litigation as well as further exploring opportunities to further expand, protect, and monetize our patent portfolio, including through the potential sale or licensing of some of all of our patent portfolio.

On February 13, 2015, we filed a lawsuit against Best Buy Co., Inc. (“Best Buy”) for patent infringement under the patent laws of the United States. The complaint alleges that certain Best Buy power charging products sold in the United States under the Rocketfish brand infringe our patented intellectual property. Best Buy’s supplier Battery Biz Inc (“Battery Biz”) petitioned the USPTO to institute an IPR proceeding which was granted on August 23, 2016. On October 28, 2016 we entered into a mutual settlement agreement with Best Buy and Battery Biz dismissing our claims against them for certain of our patents in return for terminating the IPR proceeding.

On February 3, 2015, we filed a lawsuit against Apple, Inc. (“Apple”) for patent infringement. The complaint alleges that Apple products sold in the United States utilizing the Apple Lightning® power supply adapter system, including most iPad®, iPhone®, and iPod® products, infringe ourthe Company’s patented intellectual property. This lawsuit represents our most significant enforcement effort to date, and, together with the Targus and Best Buy lawsuits described above,elsewhere in this document, demonstrates our ongoing and accelerated efforts to methodically pursue those companies that we believe have infringed on the intellectual property estate that we have developed over the last 20 years. Although we intend to vigorously pursue our rights in this case,In September of 2015, Apple filed a petition with the outcome of this matter is not determinable asPatent Trial and Appeal Board (the “PTAB”) of the dateUnited States Patent and Trademark Office requesting Inter Partes Review of this report.our U.S. Patent No. 8,492,933 B2 (the “933 Patent”). On February 22, 2017, the PTAB issued its finding, ruling in Apple’s favor. We believe the PTAB erred in its ruling, and we are appealing the ruling to the Court of Appeals for the Federal Circuit. We estimate that the appeals process will require approximately 12 months to run its course. While we believe that the proceeds from our Series A Financing should provide us sufficient capital to pursue the appeal for the next 12 months, it is possible that we may require incremental financing to pursue the appeal to conclusion, particularly if the appeals process runs longer than anticipated. If we require additional financing, there can be no assurance that we will be able to obtain requisite financing on acceptable terms, if at all.

On March 10, 2014,February 13, 2015, we filed a lawsuit in federal court against Targus Group International, Inc. (“Targus”)Best Buy for patent infringement breach of contract, intentional interference with contract, violation of business and professional codes, misrepresentation and fraudulent concealment. On March 26, 2016, we entered into a confidential settlement and license agreement with Targus that resolves all claims arising fromunder the aforementioned litigation.

Pursuant to the termspatent laws of the settlement agreement, we granted Targus a world-wide license to make, use, sell and distribute Licensed Products (as defined below), as well as a sublicense to have Licensed Products manufactured by third parties solely forUnited States. The complaint alleges that certain Best Buy power charging products sold in the benefit of and sale to Targus. In addition, we granted Targus, for a limited number of units, the right to make, use, sell and distribute Licensed Products for third-party original equipment manufacturers (“OEMs”). “Licensed Products” means any power adaptor or power supply incorporating patents or other intellectual property owned or licensed by us.

In exchange for the license grantedUnited States under the settlement agreement, Targus paid usRocketfish brand infringe the Company’s patented intellectual property. Best Buy’s supplier Battery Biz filed a one-time, lump-sum payment on April 1, 2016, plus future per-unit royalty payments if Targus exceeds the limit on Licensed Products that Targus may sell to OEMs under the settlement agreement. We have been granted confidential treatment from the SEC related to the one-time payment, the calculation of royalty payments and the OEM unit limit pursuant to a confidential treatment request filed by uspetition with the SEC.

We believe that our patent portfolio covering key technical aspects of our products could potentially generatePTAB requesting aninter partes review. Their request was granted. The parties subsequently settled resulting in a future revenue stream based upon royalties paid to us by others for the use of some or all of our patents in third party products. We continue to explore opportunities to expand, protect, and monetize our patent portfolio, including through the sale or licensing of our patent portfolio. In the future, we may resume our traditional activities, if and when possible. However, there are no assurances that anydismissal of the foregoing possible opportunities or activities will occur or be successful.

We had working capitalaction against Best Buy and termination of approximately $0.5 million as of October 31, 2016, which includes liabilities related to the remaining balance owed to our former counsel Pillsbury Winthrop Shaw Pittman, LLP (“Pillsbury”). The $0.1 million remaining balance to Pillsbury is a contingent obligation (the “Contingent Balance”) that will be paid, if at all, in the event we obtain any monetary recovery, whether through settlement, judgment or otherwise, from or as a result of any of our current or future lawsuits related to our intellectual property (see Note 6). During the first quarter of fiscal 2017, we paid Pillsbury $0.4 million as a result of the Settlement Agreement with Targus and we owe a Contingent Balance of approximately $0.1 million. The total amount payable is to equal to the Contingent Balance plus 20% per annum, compounded annually from May 28, 2014. During the quarter ended July 31, 2016, we recorded a reduction of accounts receivable of $0.1 million, which was deemed to be uncollectable, and a reduction of accounts payable of $0.6 million that were due from and due to Zheng Ge, a former supplier of the Company. The de-recognition of the accounts payable liability was recorded based on the lapsing of the statute of limitation laws applicable to the underlying contracts, as supported by a legal opinion obtained by the Company specific to jurisdictions of the underlying contracts. As the original costs related to the material purchased from Zheng Ge were charged to cost of sales, the write off of the related liability, net of the charge related to the write off of the previously outstanding accounts receivable, was recorded as a reduction to cost of sales in the condensed consolidated statement of operations.inter partes review. We believe that our working capital will allow us to discharge non-contingent liabilities in the normal course of business over the next twelve months.

We are currently generating no revenues and have ceased traditional operations. Our future is highly dependent on our ability to successfully resolve our current litigation, capitalize on our portfolio of patents, generate positive cash flows and/or obtain borrowings or raise capital to meet our future liquidity needs.

We have and will continue to analyze alternatives to build and/or preserve value for our stakeholders, including, but not limited to, exploring additional investment and incremental financing from current and/or new investors, the engagement of advisors to assist in exploring strategic options for us as well as identifying potential partnerships for the purpose ofto monetizing some or all of the our patent portfolio and past, present, and future infringement claims. However, there can be no assurances that we will be successful in identifying and/or 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, 20172018 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”.

We are primarily focused on potentially realizing value from our ongoing IP enforcement actions and other litigation as well as exploring opportunities to further 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 three and ninesix months ended OctoberJuly 31, 2017 and 2016: