##### Table of Contents

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



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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



JULY 31, 2003



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)



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



2 Cromwell, Irvine,
California 92618

(Address of principal executive offices and zip code)



(949) 599-7400

(Registrants telephone number, including area code)



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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 þ        No ̈



Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

Yes ̈No þ



The registrant had 7,160,801 shares of common stock outstanding as of September 10, 2003.



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##### Table of Contents

COMARCO, INC. AND SUBSIDIARIES



QUARTERLY REPORT ON FORM 10-Q

FOR THE THREE AND SIX MONTHS ENDED JULY 31, 2003



TABLE OF CONTENTS



|                               |  |                                                                                                           |  | Page
|------------------------------ |  | --------------------------------------------------------------------------------------------------------- |  | ----
|PART I  FINANCIAL INFORMATION |  |                                                                                                          
|                               |  |                                                                                                          
|ITEM 1.                        |  | FINANCIAL STATEMENTS                                                                                      |  |     
|                               |  |                                                                                                          
|                               |  | Condensed Consolidated Balance Sheets as of July 31, 2003 and January 31, 2003                            |  | 3   
|                               |  |                                                                                                          
|                               |  | Condensed Consolidated Statements of Operations for the Three and Six Months Ended July 31, 2003 and 2002 |  | 4   
|                               |  |                                                                                                          
|                               |  | Condensed Consolidated Statements of Cash Flows for the Six Months Ended July 31, 2003 and 2002           |  | 5   
|                               |  |                                                                                                          
|                               |  | Notes to Condensed Consolidated Financial Statements                                                      |  | 6   
|                               |  |                                                                                                          
|ITEM 2.                        |  | MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS                     |  | 16  
|                               |  |                                                                                                          
|ITEM 3.                        |  | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                                                |  | 26  
|                               |  |                                                                                                          
|ITEM 4.                        |  | CONTROLS AND PROCEDURES                                                                                   |  | 27  
|                               | 
|PART II  OTHER INFORMATION    |  |                                                                                                          
|                               |  |                                                                                                          
|ITEM 1.                        |  | LEGAL PROCEEDINGS                                                                                         |  | 28  
|                               |  |                                                                                                          
|ITEM 2.                        |  | CHANGES IN SECURITIES AND USE OF PROCEEDS                                                                 |  | 29  
|                               |  |                                                                                                          
|ITEM 3.                        |  | DEFAULTS UPON SENIOR SECURITIES                                                                           |  | 29  
|                               |  |                                                                                                          
|ITEM 4.                        |  | SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS                                                       |  | 29  
|                               |  |                                                                                                          
|ITEM 5.                        |  | OTHER INFORMATION                                                                                         |  | 30  
|                               |  |                                                                                                          
|ITEM 6.                        |  | EXHIBITS AND REPORTS ON FORM 8-K                                                                          |  | 30  
|                               | 
|SIGNATURES                     |  | 31                                                                                                       



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##### Table of Contents

PART I  FINANCIAL INFORMATION



ITEM
1.    FINANCIAL STATEMENTS



COMARCO,
INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited)

(In thousands, except share data)



|                                                                                                                                                            |  | July 31, 2003 |        | January 31, 2003
|----------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------- | ------ | ----------------
|                                                                                                                                                            |  |               |        |                 
|ASSETS                                                                                                                                                      |  |               |        |                 
|Current Assets:                                                                                                                                             |  |               |        |                 
|Cash and cash equivalents                                                                                                                                   |  | $             | 18,880 |                 
|Short-term investments                                                                                                                                      |  |               | 2,386  |                 
|Accounts receivable, net                                                                                                                                    |  |               | 2,532  |                 
|Inventory                                                                                                                                                   |  |               | 3,769  |                 
|Deferred tax assets, net                                                                                                                                    |  |               | 4,153  |                 
|Other current assets                                                                                                                                        |  |               | 1,402  |                 
|                                                                                                                                                            |  |               |        |                 
|Total current assets                                                                                                                                        |  |               | 33,122 |                 
|                                                                                                                                                            |  |              
|Property and equipment, net                                                                                                                                 |  |               | 3,588  |                 
|Capitalized software development costs, net                                                                                                                 |  |               | 6,103  |                 
|Goodwill, net                                                                                                                                               |  |               | 2,845  |                 
|Acquired intangible assets, net                                                                                                                             |  |               | 791    |                 
|Other assets                                                                                                                                                |  |               | 1,133  |                 
|                                                                                                                                                            |  |               |        |                 
|                                                                                                                                                            |  | $             | 47,582 |                 
|                                                                                                                                                            |  |               |        |                 
|LIABILITIES AND STOCKHOLDERS EQUITY                                                                                                                        |  |               |        |                 
|Current Liabilities:                                                                                                                                        |  |               |        |                 
|Accounts payable                                                                                                                                            |  | $             | 688    |                 
|Deferred revenue                                                                                                                                            |  |               | 2,494  |                 
|Accrued liabilities                                                                                                                                         |  |               | 5,794  |                 
|                                                                                                                                                            |  |               |        |                 
|Total current liabilities                                                                                                                                   |  |               | 8,976  |                 
|                                                                                                                                                            |  |              
|Deferred compensation                                                                                                                                       |  |               | 2,386  |                 
|Deferred tax liabilities, net                                                                                                                               |  |               | 914    |                 
|Minority interest                                                                                                                                           |  |               | 159    |                 
|Stockholders equity:                                                                                                                                       |  |               |        |                 
|Preferred stock, no par value, 10,000,000 shares authorized, no shares outstanding at July 31, 2003 and January 31,
2003                                    |  |               |       |                 
|Common stock, $0.10 par value, 50,625,000 shares authorized, 7,160,801 and 7,049,565 shares outstanding at July 31, 2003 and
January 31, 2003, respectively |  |               | 716    |                 
|Additional paid-in capital                                                                                                                                  |  |               | 11,985 |                 
|Retained earnings                                                                                                                                           |  |               | 22,446 |                 
|                                                                                                                                                            |  |               |        |                 
|Total stockholders equity                                                                                                                                  |  |               | 35,147 |                 
|                                                                                                                                                            |  |               |        |                 
|                                                                                                                                                            |  | $             | 47,582 |                 
|                                                                                                                                                            |  |               |        |                 



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



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##### Table of Contents

COMARCO, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

(In thousands, except
per share amounts)



|                                                                    |  | Three Months EndedJuly 31, |        |   | Six Months EndedJuly 31, |  
|------------------------------------------------------------------- |  | -------------------------- | ------ | - | ------------------------ | -
|                                                                    |  | 2003                       |        |   | 2002                     |  
|Revenue                                                             |  | $                          | 5,525  |   |                          | $
|Cost of revenue                                                     |  |                            | 4,308  |   |                          |  
|                                                                    |  |                            |        |   |                          |  
|Gross profit                                                        |  |                            | 1,217  |   |                          |  
|Selling, general and administrative costs                           |  |                            | 3,438  |   |                          |  
|Asset impairment charges                                            |  |                            |       |   |                          |  
|Engineering and support costs                                       |  |                            | 1,431  |   |                          |  
|                                                                    |  |                            |        |   |                          |  
|Operating loss                                                      |  |                            | (3,652 | ) |                          |  
|Other income, net                                                   |  |                            | 58     |   |                          |  
|Minority interest                                                   |  |                            | 28     |   |                          |  
|                                                                    |  |                            |        |   |                          |  
|Loss before income taxes                                            |  |                            | (3,566 | ) |                          |  
|Income tax benefit                                                  |  |                            | (1,312 | ) |                          |  
|                                                                    |  |                            |        |   |                          |  
|Net loss before cumulative effect of change in accounting principle |  |                            | (2,254 | ) |                          |  
|Cumulative effect of change in accounting principle                 |  |                            |       |   |                          |  
|                                                                    |  |                            |        |   |                          |  
|Net loss                                                            |  | $                          | (2,254 | ) |                          | $
|                                                                    |  |                            |        |   |                          |  
|Net loss per share  basic and diluted:                             |  |                            |        |   |                          |  
|Net loss before cumulative effect of change in accounting principle |  | $                          | (0.31  | ) |                          | $
|Cumulative effect of change in accounting principle                 |  | $                          |       |   |                          | $
|                                                                    |  |                            |        |   |                          |  
|Net loss per share  basic and diluted                              |  | $                          | (0.31  | ) |                          | $
|                                                                    |  |                            |        |   |                          |  
|Basic and diluted weighted average common shares                    |  |                            | 7,161  |   |                          |  
|                                                                    |  |                            |        |   |                          |  



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



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##### Table of Contents

COMARCO, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(In thousands)



|                                                                                          |  | Six Months EndedJuly 31, |       
|----------------------------------------------------------------------------------------- |  | ------------------------ | ------
|                                                                                          |  | 2003                     |       
|CASH FLOWS FROM OPERATING ACTIVITIES:                                                     |  |                          |       
|Net loss                                                                                  |  | $                        | (3,072
|Adjustments to reconcile net loss to net cash provided by (used in) operating activities: |  |                          |       
|Depreciation and amortization                                                             |  |                          | 2,281 
|Tax benefit from exercise of stock options                                                |  |                          | 99    
|Deferred income taxes                                                                     |  |                          | (1,368
|Asset impairment charges                                                                  |  |                          |      
|Loss on disposal of property and equipment                                                |  |                          | 23    
|Cumulative effect of change in accounting principle                                       |  |                          |      
|Provision for doubtful accounts receivable                                                |  |                          | 13    
|Provision for obsolete inventory                                                          |  |                          | (254  
|Minority interest in loss of subsidiary                                                   |  |                          | (50   
|Changes in operating assets and liabilities:                                              |  |                          |       
|Decrease in trading securities                                                            |  |                          |      
|Decrease (increase) in accounts receivable                                                |  |                          | (492  
|Decrease (increase) in inventory                                                          |  |                          | 141   
|Decrease (increase) in other assets                                                       |  |                          |      
|Deferred compensation                                                                     |  |                          |      
|Increase in accounts payable                                                              |  |                          | 378   
|Decrease in deferred revenue                                                              |  |                          | (1,058
|Decrease in accrued liabilities                                                           |  |                          | (23   
|                                                                                          |  |                          |       
|Net cash provided by (used in) operating activities                                       |  |                          | (3,382
|                                                                                          |  |                          |       
|CASH FLOWS FROM INVESTING ACTIVITIES:                                                     |  |                          |       
|Proceeds from sales of property and equipment                                             |  |                          |      
|Purchases of property and equipment                                                       |  |                          | (1,102
|Acquired intangible assets                                                                |  |                          | (161  
|Capitalized software development costs                                                    |  |                          | (1,728
|                                                                                          |  |                          |       
|Net cash used in investing activities                                                     |  |                          | (2,991
|                                                                                          |  |                          |       
|CASH FLOWS FROM FINANCING ACTIVITIES:                                                     |  |                          |       
|Net proceeds from issuance of common stock                                                |  |                          |      
|Net proceeds from issuance of subsidiary common stock                                     |  |                          | 89    
|Purchase of common stock                                                                  |  |                          | (195  
|                                                                                          |  |                          |       
|Net cash used in financing activities                                                     |  |                          | (106  
|                                                                                          |  |                          |       
|Net increase (decrease) in cash and cash equivalents  continuing operations              |  |                          | (6,479
|Net increase (decrease) in cash and cash equivalents  discontinued operations            |  |                          | (28   
|                                                                                          |  |                          |       
|Net increase (decrease) in cash and cash equivalents                                      |  |                          | (6,507
|Cash and cash equivalents, beginning of period                                            |  |                          | 25,387
|                                                                                          |  |                          |       
|Cash and cash equivalents, end of period                                                  |  | $                        | 18,880
|                                                                                          |  |                          |       
|Supplemental disclosures of cash flow information:                                        |  |                          |       
|Cash paid for interest                                                                    |  | $                        |      
|                                                                                          |  |                          |       
|Cash paid for income taxes                                                                |  | $                        | 2     
|                                                                                          |  |                          |       



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



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##### Table of Contents

COMARCO, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)



|1. |  | Organization
|-- |  | ------------



Comarco, Inc., through its subsidiary Comarco Wireless Technologies, Inc. (collectively, Comarco or the Company), is a leading
provider of wireless field test applications for the wireless industry. Comarco also designs and manufactures emergency call box systems and mobile power products for notebook computers, cellular telephones, PDAs, and other handheld devices. Comarco
Wireless Technologies, Inc. (CWT) was incorporated in the state of Delaware in September 1993. During October 1999, the Company embarked on a plan to divest its non-wireless businesses, which included the defense and commercial staffing
businesses. The divestiture plan was completed during November 2000. Accordingly, the Companys continuing operations consist solely of the operations of CWT.



|2. |  | Summary of Significant Accounting Policies
|-- |  | ------------------------------------------



Basis of Presentation:



The interim condensed consolidated financial statements of Comarco included herein have been prepared without audit in accordance with generally accepted
accounting principles 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, 2003. The 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 results for the interim periods presented. The results for the three and six months ended July 31, 2003 are not necessarily indicative of the results to be expected for the year ending January 31, 2004.



Stock-Based Compensation:



The Company grants stock options for a fixed number of shares to employees
with an exercise price equal to the fair value of the shares at the date of grant. The Company accounts for stock option grants using the intrinsic value method in accordance with Accounting Principles Board (APB) Opinion No. 25,
Accounting for Stock Issued to Employees and FASB Interpretation No. 44 (FIN 44), Accounting for Certain Transactions Involving Stock-Based Compensation, an Interpretation of APB Opinion No. 25 and related
interpretations in accounting for its stock-based compensation plans. The Company has adopted the disclosure-only provisions of SFAS No. 123, Accounting for Stock-Based Compensation. Accordingly, no compensation expense has been
recognized for the stock option grants. Had compensation cost for the Companys stock option plans been determined based on the fair value at the grant date for awards during the three and six months ended July 31, 2003 and 2002 consistent with
the provisions of SFAS No. 123, the Companys Net Loss, Basic Loss Per Share, and Diluted Loss Per Share would have been reduced to the pro forma amounts as follows (in thousands, except per share amounts):



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##### Table of Contents

COMARCO, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)

(UNAUDITED)



|                                                                                                                                            |  | Three Months EndedJuly 31, |        |   | Six Months EndedJuly 31, |  
|------------------------------------------------------------------------------------------------------------------------------------------- |  | -------------------------- | ------ | - | ------------------------ | -
|                                                                                                                                            |  | 2003                       |        |   | 2002                     |  
|Net loss:                                                                                                                                   |  |                            |        |   |                          |  
|As reported                                                                                                                                 |  | $                          | (2,254 | ) |                          | $
|Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related
tax effects |  |                            | (154   | ) |                          |  
|                                                                                                                                            |  |                            |        |   |                          |  
|Pro forma                                                                                                                                   |  | $                          | (2,408 | ) |                          | $
|                                                                                                                                            |  |                            |        |   |                          |  
|Loss per common share  basic:                                                                                                              |  |                            |        |   |                          |  
|As reported                                                                                                                                 |  | $                          | (0.31  | ) |                          | $
|Pro forma                                                                                                                                   |  |                            | (0.34  | ) |                          |  
|Loss per common share  diluted:                                                                                                            |  |                            |        |   |                          |  
|As reported                                                                                                                                 |  | $                          | (0.31  | ) |                          | $
|Pro forma                                                                                                                                   |  |                            | (0.34  | ) |                          |  



The fair value of
options granted under the Companys stock option plans during the six months ended July 31, 2003 and 2002 were estimated on the date of grant using the Black-Scholes option-pricing model utilizing the following weighted average assumptions:



|                                         |  | Six Months Ended July 31, |  
|---------------------------------------- |  | ------------------------- | -
|                                         |  | 2003                      |  
|Weighted average risk-free interest rate |  | 2.6                       | %
|Expected life (in years)                 |  | 6                         |  
|Expected stock volatility                |  | 44.0                      | %
|Dividend yield                           |  | None                      |  



Principles of Consolidation:



The condensed consolidated financial statements of the
Company include the accounts of Comarco, Inc., CWT, and wholly owned subsidiaries primarily reported as discontinued operations. All material intercompany balances, transactions, and profits have been eliminated.



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 condensed consolidated financial
statements and the reported amounts of revenue and expenses during the period reported. Actual results could 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 valuation of long-lived assets, allowance for
doubtful accounts, and valuation allowances for deferred tax assets.



Reclassifications:



Certain prior period
balances have been reclassified to conform to the current period presentation.



|3. |  | Recent Accounting Pronouncements
|-- |  | --------------------------------



In June 2002, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 146,
Accounting for Exit or Disposal Activities. SFAS No. 146 addresses the recognition, measurement, and reporting of costs associated with exit and disposal activities, including restructuring activities. SFAS No. 146 also addresses
recognition of certain costs related to terminating a contract that is not a capital lease, costs to consolidate facilities or relocate employees and termination of benefits provided to employees that are involuntarily terminated under the terms of
a one-time benefit arrangement that is not an ongoing benefit arrangement or an individual deferred compensation contract. SFAS No. 146 is effective for exit or disposal



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COMARCO, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)

(UNAUDITED)



activities that are initiated after December 31, 2002. The Company adopted the provisions of SFAS No. 146 as of
February 1, 2003, and such adoption did not have a material effect on the Companys consolidated results of operations or financial position.



In October 2002, the Emerging Issues Task Force (EITF) issued EITF Issue No. 00-21, Revenue Arrangements with Multiple
Deliverables. The EITF indicated that this guidance is effective for revenue arrangements entered into in fiscal periods beginning after June 15, 2003. The adoption of EITF Issue No. 00-21 did not have a material effect on the Companys
consolidated results of operations or financial position because the Companys qualifying arrangements are treated in a manner consistent with the stated provisions.



In November 2002, the FASB issued Interpretation No. 45, Guarantors Accounting and Disclosure Requirements for
Guarantees, Including Indirect Guarantees of Indebtedness to Others, an interpretation of FASB Statements No. 5, 57 and 107 and a rescission of FASB Interpretation No. 34 (FIN No. 45). FIN No. 45 elaborates on the disclosures to be
made by a guarantor in its interim and annual financial statements about its obligations under guarantees issued. FIN No. 45 also clarifies that a guarantor is required to recognize, at inception of a guarantee, a liability for the fair value of the
obligation undertaken. The initial recognition and measurement provisions of FIN No. 45 are applicable to guarantees issued or modified after December 31, 2002. The Company adopted the disclosure provisions of FIN No. 45 effective February 1, 2003.
Such adoption did not have a material impact on the Companys consolidated results of operations or financial position.



In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based Compensation  Transition and Disclosure, an amendment of FASB
Statement No. 123. SFAS No. 148 amends SFAS No. 123, Accounting for Stock-Based Compensation, to provide alternative methods of transition for a voluntary change to the fair value method of accounting for stock-based employee
compensation. In addition, SFAS No. 148 amends the disclosure requirements of SFAS No. 123 to require prominent disclosures in both annual and interim financial statements. Certain of the disclosure modifications are required for fiscal years ending
after December 15, 2002 and are included in the notes to the accompanying condensed consolidated financial statements.



In January 2003, the FASB issued Interpretation No. 46, Consolidation of Variable Interest Entities, an interpretation of ARB No. 51 (FIN No.
46). FIN No. 46 addresses the consolidation by business enterprises of variable interest entities as defined in the Interpretation. FIN No. 46 applies immediately to variable interests in variable interest entities created after January
31, 2003, and to variable interests in variable interest entities obtained after January 31, 2003. The application of FIN No. 46 did not have a material effect on the Companys consolidated results of operations or financial position. The
Company has no variable interest entities that would require disclosure or consolidation under FIN No. 46.



In April 2003, FASB issued SFAS No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities. SFAS No. 149 (1)
clarifies under what circumstances a contract with an initial net investment meets the characteristic of a derivative discussed in paragraph 6(b) of Statement 133, (2) clarifies when a derivative contains a financing component, (3) amends the
definition of an underlying to conform it to language used in FIN 45, and (4) amends certain other existing pronouncements, which will collectively result in more consistent reporting of contracts as either derivatives or hybrid instruments. SFAS
No. 149 is effective for contracts and hedging relationships entered into or modified after June 30, 2003. The adoption of SFAS No. 149 did not have a material impact on the Companys consolidated financial statements as the Company has not
entered into any derivative or hedging transactions.



In May
2003, FASB issued SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity. SFAS No. 150 establishes standards for how an issuer classifies and



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COMARCO, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)

(UNAUDITED)



measures certain financial instruments with characteristics of both debt and equity and requires an issuer to
classify the following instruments as liabilities in its balance sheet:



| |  |  | A financial instrument issued in the form of shares that is mandatorily redeemable and embodies an unconditional obligation that requires the issuer to redeem it by transferring its
assets at a specified or determinable date or upon an event that is certain to occur;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | A financial instrument, other than an outstanding share, that embodies an obligation to repurchase the issuers equity shares, or is indexed to such an obligation, and requires
the issuer to settle the obligation by transferring assets; and
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | A financial instrument that embodies an unconditional obligation that the issuer must settle by issuing a variable number of its equity shares if the monetary value of the
obligation is based solely or predominantly on (1) a fixed monetary amount, (2) variations in something other than the fair value of the issuers equity shares, or (3) variations inversely related to changes in the fair value of the
issuers equity shares.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



SFAS No. 150 is
effective for financial instruments entered into or modified after May 31, 2003 and is effective for all other financial instruments as of the first interim period beginning after June 15, 2003. SFAS No. 150 is to be implemented by reporting the
cumulative effect of a change in accounting principle. The Company does not expect the adoption of SFAS No. 150 will have a material impact on its consolidated financial statements.



|4. |  | Stockholders Equity
|-- |  | --------------------



During 1992, our Board of Directors authorized a stock repurchase program of up to 3.0 million shares of the Companys common stock. From program
inception through July 31, 2003, the Company has repurchased approximately 2.6 million shares for an average price of $8.22 per share. During the second quarter ended July 31, 2003, the Company repurchased 3,640 shares of common stock in the open
market for an average price of $7.32 per share.



|5. |  | ChargeSource Product Recall
|-- |  | ---------------------------



In cooperation with the Consumer Products Safety Commission, on March 20, 2003, Comarco voluntarily initiated a product safety recall of certain of its
ChargeSource AC power adapters. This product safety recall impacts approximately 125,000 units that were sold in fiscal 2003. Comarco and Targus Group International (Targus), the Companys distributor of ChargeSource products,
entered into an agreement to address the impact of the recall action. Under the terms of the agreement Comarco issued a $3.2 million credit to Targus in fiscal 2003 in consideration of a full release. Additionally, the Company accrued $554,000 in
costs related to the recall action.



The following table
presents a reconciliation of the use of the product recall accrual (in thousands):



|Product Recall Liability 1/31/03 |  |  |  | Adjustments |  |  |  | Payments |  |  |  | Product Recall Liability 7/31/03
|-------------------------------- |  |  |  | ----------- |  |  |  | -------- |  |  |  | --------------------------------
|$554                             |  |  |  |            |  |  |  | $(249)   |  |  |  | $305                            
|                                 |  |  |  |             |  |  |  |          |  |  |  |                                 



The product recall
liability is included in accrued liabilities in the accompanying condensed consolidated balance sheets. The Company believes that the balance remaining as of July 31, 2003 is adequate to cover additional product recall costs expected to be paid.



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COMARCO, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)

(UNAUDITED)



Additionally, of the $3.2 million credit issued to Targus in the fourth quarter of fiscal 2003,
returns totaling $1.9 million have been received from Targus through July 31, 2003.



|6. |  | Income (Loss) Per Share
|-- |  | -----------------------



The Company calculates earnings (loss) per share in accordance with SFAS No. 128, Earnings Per Share. Under SFAS No. 128, basic earnings
(loss) per share is calculated 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 and six months ended July 31, 2003 and July 31, 2002, basic and diluted loss per share were the same because the inclusion of potential common shares in the calculation would have been antidilutive.



Potential common shares of 24,339 and 24,731 have been
excluded from diluted weighted average common shares for the three and six months ended July 31, 2003, as the effect would have been antidilutive. Similarly, potential common shares of 39,300 and 49,463 have been excluded from diluted weighted
average common shares for the three and six months ended July 31, 2002, 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. In the
tables below, Loss represents the numerator and Shares represents the denominator (in thousands, except per share amounts):



|                                                                                            |  | Three Months EndedJuly 31, |        |   | Six Months EndedJuly 31, |  
|------------------------------------------------------------------------------------------- |  | -------------------------- | ------ | - | ------------------------ | -
|                                                                                            |  | 2003                       |        |   | 2002                     |  
|Basic and diluted:                                                                          |  |                            |        |   |                          |  
|Net loss before cumulative effect of change in accounting principle                         |  | $                          | (2,254 | ) |                          | $
|Weighted average shares outstanding                                                         |  |                            | 7,161  |   |                          |  
|                                                                                            |  |                            |        |   |                          |  
|Basic and diluted loss per share before cumulative effect of change in accounting principle |  | $                          | (0.31  | ) |                          | $
|                                                                                            |  |                            |        |   |                          |  
|Cumulative effect of change in accounting principle                                         |  | $                          |       |   |                          | $
|Weighted average shares outstanding                                                         |  |                            | 7,161  |   |                          |  
|                                                                                            |  |                            |        |   |                          |  
|Basic and diluted loss per share from cumulative effect of change in accounting principle   |  | $                          |       |   |                          | $
|                                                                                            |  |                            |        |   |                          |  
|Net loss                                                                                    |  | $                          | (2,254 | ) |                          | $
|Weighted average shares outstanding                                                         |  |                            | 7,161  |   |                          |  
|                                                                                            |  |                            |        |   |                          |  
|Basic and diluted loss per share                                                            |  | $                          | (0.31  | ) |                          | $
|                                                                                            |  |                            |        |   |                          |  



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COMARCO, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)

(UNAUDITED)



|7. |  | Inventory
|-- |  | ---------



Inventory consists of the following (in thousands):



|                 |  | July 31, 2003 |       | January 31, 2003
|---------------- |  | ------------- | ----- | ----------------
|Raw materials    |  | $             | 2,795 |                 
|Work in progress |  |               | 104   |                 
|Finished goods   |  |               | 870   |                 
|                 |  |               |       |                 
|                 |  | $             | 3,769 |                 
|                 |  |               |       |                 



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COMARCO, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)

(UNAUDITED)



Inventories are net of write downs for excess and obsolete inventory of approximately $2.3 million
and $2.6 million as of July 31, 2003 and January 31, 2003, respectively. The Company regularly reviews inventory quantities on hand and records a write down for excess and obsolete inventory based primarily on historical usage, forecasted product
demand, and production requirements for the next twelve months.



|8. |  | Capitalized Software Development Costs, Net
|-- |  | -------------------------------------------



Capitalized software development costs consist of the following (in thousands):



|                                       |  | July 31, 2003 |        |   | January 31, 2003 |  
|-------------------------------------- |  | ------------- | ------ | - | ---------------- | -
|Capitalized software development costs |  | $             | 7,934  |   |                  | $
|Less: accumulated amortization         |  |               | (1,831 | ) |                  |  
|                                       |  |               |        |   |                  |  
|                                       |  | $             | 6,103  |   |                  | $
|                                       |  |               |        |   |                  |  



Amortization of
software development costs for the three months ended July 31, 2003 and 2002 totaled $0.7 million and $1.2 million, respectively. For the six months ended July 31, 2003 and 2002, amortization of software development costs totaled $1.2 million and
$2.1 million, respectively. Amortization of software development costs has been reported in cost of revenue in the accompanying condensed consolidated financial statements.



Additionally, during the first quarter of fiscal 2004, fully amortized software development costs totaling $3.2 million and
the corresponding accumulated amortization were retired.



|9. |  | Goodwill and Acquired Intangible Assets, Net
|-- |  | --------------------------------------------



Goodwill and acquired intangible assets consist of the following (in thousands):



|                               |  | July 31, 2003 |       |   | January 31, 2003 |  
|------------------------------ |  | ------------- | ----- | - | ---------------- | -
|Goodwill                       |  | $             | 3,248 |   |                  | $
|Less: accumulated amortization |  |               | (403  | ) |                  |  
|                               |  |               |       |   |                  |  
|                               |  | $             | 2,845 |   |                  | $
|                               |  |               |       |   |                  |  
|                               |  |              
|Acquired intangible assets     |  | $             | 1,613 |   |                  | $
|Less: accumulated amortization |  |               | (822  | ) |                  |  
|                               |  |               |       |   |                  |  
|                               |  | $             | 791   |   |                  | $
|                               |  |               |       |   |                  |  



Amortization of
definite-lived acquired intangible assets for the three months ended July 31, 2003 and 2002 totaled $38,000 and $88,000, respectively. Amortization of definite-lived acquired intangible assets for the six months ended July 31, 2003 and 2002 totaled
$77,000 and $176,000, respectively. The Company ceased amortizing goodwill beginning February 1, 2002 upon adoption of SFAS No. 142.



|10. |  | Customer Concentrations
|--- |  | -----------------------



The Companys sales have historically been concentrated with a small number of customers. During the three months ended July 31, 2003 and 2002, sales
to customers that accounted for 10 percent or more of revenues for the period totaled $2.0 million and $4.6 million, respectively. Sales to Targus accounted for approximately 11 percent and 34 percent of total revenue for the three months ended July
31, 2003 and 2002, respectively. During the three months ended July 31, 2003, two



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COMARCO, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)

(UNAUDITED)



customers in addition to Targus accounted for approximately 10 percent and 14 percent of total revenue for the second
quarter. For the three months ended July 31, 2002, one customer in addition to Targus accounted for approximately 12 percent of total revenue.



For the six months ended July 31, 2003 and 2002, sales to customers that accounted for 10 percent or more of revenue for the period totaled $2.2 million
and $6.7 million, respectively. Sales to Targus accounted for approximately 18 percent and 38 percent of total revenues during those periods, respectively. For the six months ended July 31, 2003 and 2002, no other customer constituted more than 10
percent of revenue.



As of July 31, 2003, approximately 30
percent of total accounts receivable related to one customer that accounted for 10 percent or more of Comarcos total revenue. The loss of, or reduction in, sales to any of these customers could have a material adverse effect on the
Companys business, results of operations, and financial position.



|11. |  | Business Segment Information
|--- |  | ----------------------------



The Company has two reportable operating segments: wireless test solutions and wireless applications.



Wireless test solutions designs and manufactures hardware and software tools
for use by wireless carriers, equipment vendors, and others. Radio frequency engineers, professional technicians, and others use these tools to design, deploy, and optimize wireless networks, and to verify the performance of the wireless networks
once deployed.



Wireless applications designs and manufactures
call box systems and mobile power products for notebook computers, cellular telephones, PDAs, and other handheld devices. Call box systems provide emergency communication over existing wireless networks. In addition to the call box products, the
Company provides system installation and long-term maintenance services. Currently, approximately 14,000 call boxes are installed, the majority of which are serviced and maintained under long-term agreements, which expire at various dates through
February 2011.



Performance measurement and resource allocation
for the reportable segments are based on many factors. The primary financial measures used are revenue and gross profit. The revenue, gross profit, gross margin, and total assets attributable to these segments are as follows (in thousands):



|                    |  | Three Months Ended July 31, 2003 |       |   | Three Months Ended July 31, 2002 |  
|------------------- |  | -------------------------------- | ----- | - | -------------------------------- | -
|                    |  | Wireless Test Solutions          |       |   | Wireless Applications            |  
|Revenue             |  | $                                | 2,480 |   |                                  | $
|Cost of revenue     |  |                                  | 1,191 |   |                                  |  
|                    |  |                                  |       |   |                                  |  
|Gross profit (loss) |  | $                                | 1,289 |   |                                  | $
|                    |  |                                  |       |   |                                  |  
|Gross margin        |  |                                  | 52.0  | % |                                  |  
|                    |  |                                  |       |   |                                  |  
|                    |  |                                 
|                    |  | Six Months Ended July 31, 2003   |       |   | Six Months Ended July 31, 2002   |  
|                    |  | Wireless Test Solutions          |       |   | Wireless Applications            |  
|Revenue             |  | $                                | 4,334 |   |                                  | $
|Cost of revenue     |  |                                  | 2,379 |   |                                  |  
|                    |  |                                  |       |   |                                  |  
|Gross profit        |  | $                                | 1,955 |   |                                  | $
|                    |  |                                  |       |   |                                  |  
|Gross margin        |  |                                  | 45.1  | % |                                  |  
|                    |  |                                  |       |   |                                  |  



|                        |  | Wireless TestSolutions |        | WirelessApplications |   | Corporate |  | Total
|----------------------- |  | ---------------------- | ------ | -------------------- | - | --------- |  | -----
|Assets at July 31, 2003 |  | $                      | 13,450 |                      | $ | 10,053    |  | $    
|                        |  |                        |        |                      |   |           |  |      
|Assets at July 31, 2002 |  | $                      | 14,424 |                      | $ | 14,090    |  | $    
|                        |  |                        |        |                      |   |           |  |      



Revenue by geographic
area consists of the following (in thousands):



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COMARCO, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)

(UNAUDITED)



|              |  | Three Months Ended July 31, |       | Six Months Ended July 31,
|------------- |  | --------------------------- | ----- | -------------------------
|              |  | 2003                        |       | 2002                     
|North America |  | $                           | 3,728 |                          
|Europe        |  |                             | 1,170 |                          
|Asia          |  |                             | 127   |                          
|Latin America |  |                             | 500   |                          
|              |  |                             |       |                          
|              |  | $                           | 5,525 |                          
|              |  |                             |       |                          



|12. |  | Commitments and Contingencies
|--- |  | -----------------------------



Purchase Commitments with Suppliers



We generally issue purchase orders to our suppliers with delivery dates from four to six weeks from the purchase order date. In addition, we regularly
provide significant suppliers with rolling six-month forecasts of material and finished goods requirements for planning and long-lead time parts procurement purposes only. We are committed to accept delivery of materials pursuant to our purchase
orders subject to various contract provisions which allow us to delay receipt of such order or allow us to cancel orders beyond certain agreed lead times. Such cancellations may or may not include cancellation costs payable by us. In the past, we
have been required to take delivery of materials from our suppliers that were in excess of our requirements and we have previously recognized charges and expenses related to such excess material. If we are unable to adequately manage our suppliers
and adjust such commitments for changes in demand, we may incur additional inventory expenses related to excess and obsolete inventory. Such expenses could have a material adverse effect on our business, results of operations, and financial
position.



Legal Contingencies



Comarco was named as a defendant in two lawsuits filed by Mobility
Electronics, Inc. (Mobility), and subsequently the Company filed two actions against Mobility and affiliates as further discussed below.



Mobility commenced proceedings for patent infringement against the Company and CWT with respect to CWTs ChargeSource power supply products (the
Mobility Action). The Company was first served with Mobilitys amended complaint on August 10, 2001. In addition to asserting that the Company and CWT have infringed a Mobility patent, the amended complaint seeks declaratory
judgment that three of CWTs power-supply related patents are either invalid or not infringed by power supplies produced or to be produced by Mobility.



On June 21, 2002, CWT filed an action for patent infringement against the Xtend Micro Products, Inc. (Xtend) and its parent entity, iGo
Corporation (iGo). CWT alleges that certain patents owned by CWT are infringed by Xtends PowerXtender and AC Adapter power supply products as well as other power supply and power adapter products and related accessories. On July 15, 2002, Xtend and iGo
answered the complaint denying the allegations in CWTs complaint and asserting a number of affirmative defenses. Xtend and iGo have indicated in court filings that they will seek to have this case transferred to and consolidated with the
Mobility Action because this case involves two of the patents involved in the Mobility Action, and Mobility and iGo have recently merged into a single corporate entity.



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COMARCO, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)

(UNAUDITED)



On January 31, 2003, CWT filed an action for patent infringement against Mobility Electronics, Inc.,
Hipro Electronics Co. Ltd., and iGo Corporation with regard to a universal power adapter called Juice. Defendant Hipro manufactures Juice for Mobility, which in turn offers it for sale through its wholly owned subsidiary iGo Corporation.
On February 27, 2003, Mobility and iGo answered the complaint while Hipro filed a motion to dismiss based on lack of personal jurisdiction and improper service.



Effective July 12, 2003, all the parties to all three actions entered into a settlement agreement. All three actions are being dismissed. Under the
terms of the settlement agreement, the Company was not required to make any payment. Mobility and CWT cross-licensed certain patent rights related to powering electronic devices, including certain patent rights relating to automatic programmability
and combination AC/DC capability.



Los Angeles County Service
Authority for Freeway Emergencies (LASAFE) filed an action against CWT on June 10, 2002, relating to two contracts between LASAFE and CWT concerning call box systems manufactured by CWT, upgraded by CWT to comply with the Americans with
Disabilities Act (ADA), and maintained by CWT until its contractual obligations to provide maintenance expired. On August 2, 2002, LASAFE filed a first amended complaint. The complaint includes eight counts. In the first five counts
LASAFE alleges CWT breached its contractual obligations and implied warranties by failing to properly maintain and repair the call box systems and failing to provide certain deliverables to LASAFE. In the last three counts LASAFE alleges that a
patent owned by CWT should be assigned to LASAFE, and CWT should compensate LASAFE because an LASAFE employee is the true inventor of the invention claimed in the patent. The complaint seeks an unspecified amount of actual and punitive damages,
ownership of the patent, an order that CWT specifically perform its obligations under the contracts, recovery of attorneys fees, and an audit to determine the number of allegedly infringing call boxes.



On August 16, 2002, CWT filed an answer and a motion to dismiss the first
five counts founded in state contract and warranty law on the grounds that the Federal District Court lacks jurisdiction over the state law claims, which was subsequently granted. On November 7, 2002, LASAFE filed a complaint in state court alleging
the five causes of action that were dismissed in the federal court action. Specifically, LASAFE alleges that CWT breached its contractual obligations and implied warranties by failing to properly maintain and repair the call box systems and failing
to provide certain deliverables to LASAFE, and seeks over $1 million in damages. On January 9, 2003, CWT filed its answer and a cross-complaint asserting causes of action for breach of contract and breach of the implied covenant of good faith and
fair dealing based on LASAFEs failure to pay CWT all monies due under a contract with LASAFE and LASAFEs conduct during the course of the contract.



On June 3, 2003, the parties mediated the disputes involved in the federal and the state actions and reached a tentative settlement agreement. The
LASAFE board approved such a settlement, the parties are currently working on drafting the formal settlement agreement, and the federal and state cases have been stayed. The estimated cost of the proposed settlement has been recorded as cost of
revenue and did not have a material impact on the Companys consolidated results of operations and financial position. No additional costs are expected to be incurred.



In February 2003, Steven C. Dixon filed suit against Circuit City Stores, Inc.; Belkin Corporation; Targus, Inc.; and
Tecnozone Enterprises, LLC. The complaint alleged that power supply products supplied to Circuit City for resale by Belkin, Targus, and Tecnozone infringed United States Patent No. 6,064,177 (the 177 patent). ChargeSource power supply products
supplied to Targus by Comarco Wireless Technologies, Inc. were among the products at issue. In June 2003, this case was settled and dismissed with prejudice. No additional costs related to this matter are expected be incurred.



The Company is from time to time involved in various legal proceedings
incidental to the conduct of our business. We believe that the outcome of all other such pending legal proceedings will not in the aggregate have a material adverse effect on our results of operations and financial position.



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##### Table of Contents

|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 the condensed consolidated financial statements and
notes thereto included elsewhere in this quarterly report on Form 10-Q. This report contains forward-looking statements. These statements relate to future events or our future financial performance. In some cases, you can identify forward-looking
statements by terminology such as may, will, should, expect, plan, anticipate, believe, estimate, predict, potential or
continue, the negative of such terms, or other comparable terminology. These statements are only predictions. Actual events or results may differ materially. Important factors which may cause actual results to differ materially from the
forward-looking statements are described in the section entitled Risk Factors in Part I, Item 1 of the our report on Form 10-K for the year ended January 31, 2003, and other risks identified from time to time in our filings with the
Securities and Exchange Commission, press releases, and other communications.



Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance, or achievements. Moreover, neither any other
person nor we assume responsibility for the accuracy and completeness of the forward-looking statements. We undertake no obligation to revise or update publicly any forward-looking statements for any reason.



Overview



Comarco, Inc., through its subsidiary Comarco Wireless Technologies, Inc. (collectively, Comarco, or the
Company), is a leading provider of field test applications for the wireless industry. Comarco also designs and manufactures emergency call box systems and mobile power products for notebook computers, cellular telephones, PDAs, and other
handheld devices. Our operations consist solely of the operations of Comarco Wireless Technologies, Inc. (CWT).



Results of Operations



We have two reportable operating segments: wireless test solutions and wireless applications.



Wireless Test Solutions



Our wireless test solutions business designs and manufactures hardware and software tools for use by wireless carriers,
equipment vendors, and others. Radio frequency engineers, professional technicians, and others use these field test applications to design, deploy, and optimize wireless networks, and to verify the performance of the wireless networks once deployed.
The downturn in the wireless industry has reduced overall demand for our wireless test solutions products, and continues to make it difficult for us to forecast our wireless test solutions operations for fiscal 2004.



During the first half of fiscal 2004, we completed the development of our
Seven.Five hardware and various related software applications, and have begun shipping products to customers in Europe, North America and Latin America. Seven.Five is a mobile test platform that is adaptable to many test applications. It provides
wireless infrastructure analysis, benchmarking and optimization for 2G, 2.5G and 3G network deployments. We expect to complete the development of additional Seven.Five software applications during the second half of fiscal 2004.



The Seven.Five family consists of the following members:



| |  |  | Seven.Five Solo: Suited for network deployment activities, Solo is a single calling module product available with a family of audio and data QoS algorithms. It is an
entry-level product, capable of seamless migration to the Seven.Five Duo.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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##### Table of Contents

| |  |  | Seven.Five Duo: As networks mature, the power of a calling module plus a scanner is necessary to quickly and efficiently optimize networks. Duo supports up to two calling
modules, which can have mixed technologies, and one multi-band, multi-technology RF scanner. A portability kit is available for in-building needs.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Seven.Five Multi: Designed for flexibility and scalability, Seven.Five Multi can house up to any combination of six calling modules or scanners in each chassis. Multiple
chassis can be combined to allow for up to 96 calling modules. The customer can mix and match technologies for benchmarking applications or configure a system with similar technologies for optimization activities. Multi is also available with a
portability kit for in-building and pedestrian testing needs.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Seven.Five Multi-Band, Multi-Technology RF Scanner: The most advanced and accurate scanner for field-test applications. Capable of lightning-fast scans (over 3000 channels
per second) in multiple frequency bands, with multiple technologies, doing DVCC, BSIC and PN decoding simultaneously. The scanner offers spectrum analyzer-type measurements and full baseband decoding for GSM 850/900/1800/1900, EDGE, IS-136, CDMA2000
and WCDMA.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Seven.Five Data Extractor (DX): A very complete and easy-to-use software application that allows operators to produce comprehensive benchmarking reports, as well as perform
desktop network optimization using all of the data collected by the Seven.Five hardware. DX includes a variety of features for data administration, filtering capability, analysis, statistics, integrated mapping and generation of reports, as well as
an interface (ODBC) for third-party software.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Wireless
Applications



Our wireless applications business designs
and manufactures emergency call box systems and mobile power products for notebook computers, cellular telephones, PDAs, and other handheld devices. Our call box products provide emergency communication over existing wireless networks. In addition
to the call box products, we provide system installation and long-term maintenance services. Currently, we have approximately 14,000 call boxes installed, the majority of which are serviced and maintained under long-term agreements, which expire at
various dates through February 2011.



Approximately 75 percent
of our call box revenue is derived from agencies of Californias state and local governments. The State of California is currently experiencing financial and political challenges. We believe these challenges have created uncertainty with
respect to the spending patterns of our California based customers. As a result, projects and the related contracts to upgrade and expand certain call box systems have been delayed. While we currently believe that these projects will move ahead, we
are unable to forecast the timing of such events in the near-term.



The wireless applications business also includes the ChargeSource family of mobile power products. During the second quarter of fiscal 2004, our offering of ChargeSource products was expanded with the release of the 120-watt universal AC/DC
adapter and the 120-watt universal DC adapter. By simply changing the compact SmartTips connected to the end of the charging cable, these products are capable of charging and powering multiple target devices, including most notebook computers,
cellular telephones, PDAs, and other handheld devices.



Until
recently, most current notebook computers required no more than 70 watts of power to operate. However, the personal computer industry is currently transitioning to notebook computers with increasing power requirements. As the power requirement
increases, so does the size of the original equipment of the manufacturer (OEM) AC charger sold with the notebook computer. To address this industry wide trend, we have developed a family of ChargeSource products that are compatible with
legacy and current notebook computers, as well as those notebook computers expected to be available during the next 18 months. These





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##### Table of Contents

new ChargeSource products are able to deliver up to 120 watts of power in a very small form factor. The new ChargeSource
family of products consists of the following:



| |  |  | 120-Watt Universal AC/DC Adapter  A universal adapter capable of charging most notebook computers requiring up to 120 watts of power, as well as cell phones, PDAs, and
other handheld devices. This adapter is used in the office, home, hotel, as well as the automobile and airplane. This product began shipping at the end of the second quarter of the current fiscal year.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | 120-Watt Universal DC Adapter  A universal adapter capable of charging most notebook computers requiring up to 120 watts of power, as well as cell phones, PDAs, and
other handheld devices. This adapter is used in the automobile and airplane. This product began shipping at the end of the second quarter of the current fiscal year.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | 60-Watt Hour Universal Battery  This universal battery is used to charge and power all notebook computers, cell phones, PDAs, and other handheld devices. This product
is expected to be shipped during the fourth quarter of the current fiscal year.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Our new 120-watt ChargeSource products, as well as the universal battery are compatible with existing Smart Tips and are backwards compatible with the 70-Watt adapters, which we continue to manufacture and sell based
on the requirements of the retailers. Targus Group International (Targus) currently distributes our available products.



In cooperation with the Consumer Products Safety Commission, on March 20, 2003, Comarco voluntarily initiated a product safety recall of its legacy
ChargeSource 70-watt AC power adapters. This product safety recall impacts approximately 125,000 units that were sold in fiscal 2003. Comarco and Targus entered into an agreement to address the impact of the recall action. Under the terms of the
agreement Comarco issued a $3.2 million credit to Targus in fiscal 2003 in consideration of a full release. Of the $3.2 million credit issued to Targus in the fourth quarter of fiscal 2003, returns totaling $1.9 million have been received from
Targus through July 31, 2003. Additionally, the Company accrued $554,000 in costs related to the recall action in cost of revenue. The Company believes that the balance remaining as of July 31, 2003 of $305,000, is adequate to cover additional
product recall costs expected to be paid.



The following table
sets forth certain items as a percentage of revenue from our condensed consolidated statements of operations for the three and six months ended July 31, 2003 and 2002. The table and discussion that follows provides information which management
believes is relevant to an assessment and understanding of our condensed consolidated results of operations and financial condition. The discussion should be read in conjunction with the condensed consolidated financial statements and accompanying
notes thereto included elsewhere herein.



|                |  | Three MonthsEnded July 31, |   |  | Six MonthsEnded July 31, |  
|--------------- |  | -------------------------- | - |  | ------------------------ | -
|                |  | 2003                       |   |  | 2002                     |  
|Revenue         |  | 100                        | % |  | 100                      | %
|Cost of revenue |  | 78.0                       |   |  | 72.1                     |  
|                |  |                            |   |  |                          |  
|Gross margin    |  | 22.0                       |   |  | 27.9                     |  



(continued)



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##### Table of Contents

|                                                                    |  | Three Months Ended July 31, |    |  | Six Months Ended July 31, |   
|------------------------------------------------------------------- |  | --------------------------- | -- |  | ------------------------- | --
|                                                                    |  | 2003                        |    |  | 2002                      |   
|Selling, general and administrative costs                           |  | 62.2                        |    |  | 23.9                      |   
|Asset impairment charge                                             |  |                            |    |  | 84.0                      |   
|Engineering and support costs                                       |  | 25.9                        |    |  | 13.0                      |   
|                                                                    |  |                             |    |  |                           |   
|Operating loss                                                      |  | (66.1                       | )  |  | (93.0                     | ) 
|Other income, net                                                   |  | 1.1                         |    |  | 0.9                       |   
|Minority interest                                                   |  | 0.5                         |    |  | 0.7                       |   
|                                                                    |  |                             |    |  |                           |   
|Loss before income taxes                                            |  | (64.5                       | )  |  | (91.4                     | ) 
|Income tax benefit                                                  |  | (23.7                       | )  |  | (24.2                     | ) 
|                                                                    |  |                             |    |  |                           |   
|Net loss before cumulative effect of change in accounting principle |  | (40.8                       | )% |  | (67.2                     | )%
|                                                                    |  |                             |    |  |                           |   



Comparison of the three months
ended July 31, 2003 to the three months ended July 31, 2002



Consolidated



Revenue



Total revenue for the second quarter of fiscal 2004, which ended July 31,
2003, was $5.5 million compared to $10.0 million for the second quarter of fiscal 2003, a decrease of $4.5 million or 44.8 percent. As discussed below, the decrease is attributable to decreased sales of our wireless applications products, as well as
our exit from our engineering services business during the second quarter of fiscal 2003.



We track the geographic location of our sales based upon the location of our customers to which our products are shipped. Certain of our customers purchase products from us at central locations and then reship the
product to locations throughout the world. Accordingly, we are unable to track the ultimate geographic location of our products. Sales to customers in North America and Europe accounted for approximately 67 percent and 21 percent of revenue, or $3.7
million and $1.2 million, respectively, for the second quarter ended July 31, 2003. For the comparable period of the prior fiscal year, sales to customers in North America and Europe accounted for approximately 83 percent and 9 percent of revenue,
or $8.3 million and $0.9 million, respectively.



Cost of Revenue and Gross
Margin



Total cost of revenue for the second quarter of
fiscal 2004 was $4.3 million compared to $7.2 million for the second quarter of fiscal 2003, a decrease of approximately $2.9 million or 40.3 percent. As a percentage of revenue, gross margin decreased to 22.0 percent from 27.9 percent for the
second quarter of the prior fiscal year. The decrease in gross margin reflects the costs of ramping-up production of our newly released 120-watt universal power adapters.



Legal, Settlement, and Related Costs



During the second quarter of fiscal 2004, we settled each of the matters more fully discussed in the section Legal Proceedings in Part II,
Item 1 of this report on Form 10-Q. These matters related to our wireless applications business, and for the second quarter of fiscal 2004, we incurred approximately $1.9 million in legal, settlement, and related costs. Approximately $1.7 million of
these costs are included in selling, general and administrative costs for the second quarter, with the balance recorded in cost of revenue. No additional costs related to these matters are expected to be incurred.



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Selling, General and Administrative Costs



Selling, general, and administrative costs for the second quarter of fiscal 2004 were $3.4 million, compared to $2.4 million
for the second quarter of fiscal 2003, an increase of $1.0 million or 43.6 percent. As discussed above, we incurred approximately $1.7 million in legal, settlement, and related costs during the second quarter of fiscal 2004. These costs were in
excess of comparable costs incurred in the second quarter of the prior fiscal year. For the balance of fiscal 2004, quarterly selling, general, and administrative costs are expected to range between $2.0 million and $2.3 million, consistent with
both the second quarter of fiscal 2003 and the first quarter of fiscal 2004. As a percentage of revenue, selling, general, and administrative costs were 62.2 percent and 23.9 percent for the quarters ended July 31, 2003 and 2002, respectively.



Engineering and Support Costs



The Company capitalizes costs incurred for the development of software
embedded in our wireless test solutions products that will be sold when technological feasibility has been established. These capitalized costs are subject to an ongoing assessment of recoverability based on anticipated future revenue and changes in
hardware and software technologies. Costs that are capitalized include direct labor and related overhead. Engineering and support costs for the second quarter of fiscal 2004 and 2003 are as follows (in thousands):



|                                             |  | Three Months Ended July 31, |      
|-------------------------------------------- |  | --------------------------- | -----
|                                             |  | 2003                        |      
|Engineering                                  |  | $                           | 2,041
|Less: Capitalized software development costs |  |                             | (944 
|Support Costs                                |  |                             | 334  
|                                             |  |                             |      
|                                             |  | $                           | 1,431
|                                             |  |                             |      



Engineering and
support costs, net of capitalized software development costs, for the second quarter of fiscal 2004 were $1.4 million compared to $1.3 million for the prior fiscal quarter, an increase of approximately $0.1 million. Gross engineering and support
costs, before reduction for capitalized software development costs, increased $0.2 million in comparison to the second quarter of fiscal 2003. This increase is primarily due to increased product development costs offset by reduced staffing of our
product support function. Capitalized software development costs remained constant at $0.9 million for the second quarter of fiscal 2004 in comparison to the prior fiscal quarter. The increase in engineering costs during the second quarter of fiscal
2004 is attributable to the development and release of Seven.Five products, including the Seven.Five Solo and Seven.Five Duo, during the second quarter of fiscal 2004.



Other Income



Other income consists primarily of interest income.



Income Tax Benefit



The effective tax rates for the quarters ended July 31, 2003 and 2002, were 36.8 percent primarily and 26.5 percent, respectively. The lower prior year
effective tax rate used to compute the tax benefit of $2.4 million was caused primarily by non-deductible asset impairment charges recorded during the second quarter of fiscal 2003. No such non-deductible expenses were recorded in fiscal 2004.



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Wireless Test Solutions



|                    |  | Three Months EndedJuly 31, |      
|------------------- |  | -------------------------- | -----
|                    |  | 2003                       |      
|                    |  | (In thousands)             |      
|Revenue             |  | $                          | 2,480
|Cost of revenue     |  |                            | 1,191
|                    |  |                            |      
|Gross profit (loss) |  | $                          | 1,289
|                    |  |                            |      
|Gross margin        |  |                            | 52.0 
|                    |  |                            |      



Revenue



Wireless test solutions revenue for the second quarter of fiscal 2004 was
$2.5 million compared to $3.4 million for the second quarter of fiscal 2003, a decrease of $0.9 million or 26.5 percent. This decrease reflects the shifting of sales from our legacy 2G wireless test solutions products to our newly released
Seven.Five platform, as well as reductions in engineering services, which we ceased providing during the second quarter of fiscal 2003. Revenue from engineering services for the second quarter of fiscal 2003 totaled approximately $450,000.



Cost of Revenue and Gross Margin



Cost of revenue from our wireless test solutions business for the second
quarter of fiscal 2004 was $1.2 million compared to $3.4 million for the second quarter of fiscal 2003, a decrease of approximately $2.2 million or 65.4 percent. Gross margin for the second quarter of fiscal 2004 increased to 52.0 percent
from (2.0) percent for the corresponding period of the prior fiscal year. The increase in gross margin was due to a change in the relative mix of business for the second quarter (product sales vs. maintenance revenue). Also contributing to the
increase in gross margin is a non-cash inventory impairment charge totaling $1.4 million that was recorded in the second quarter of fiscal 2003. No comparable costs were incurred during fiscal 2004.



Wireless Applications



|                    |  | Three Months EndedJuly 31, |      
|------------------- |  | -------------------------- | -----
|                    |  | 2003                       |      
|                    |  | (In thousands)             |      
|Revenue             |  | $                          | 3,045
|Cost of revenue     |  |                            | 3,117
|                    |  |                            |      
|Gross profit (loss) |  | $                          | (72  
|                    |  |                            |      
|Gross margin        |  |                            | (2.4 
|                    |  |                            |      



Revenue



Wireless applications revenue for the second quarter of 2004 was $3.0
million compared to $6.6 million for the second quarter of 2003, a decrease of approximately $3.6 million or 54.1 percent. This decrease was due to a $2.3 million decrease in sales of our ChargeSource products and a $1.3 million decrease in sales of
our call box products.



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The decrease in sales of our ChargeSource products is due to the phase-out of our 70-watt products as our
primary market offering and the transition to newly developed 120-watt products. We began shipping both the 120-watt universal AC/DC and 120-watt universal DC power adapters at the end of the second quarter of fiscal 2004. For the remainder of
fiscal 2004, we expect that our ChargeSource revenue will be approximately $5.5 million per quarter.



The decrease in sales of our call box products relates to delays in receiving contracts to upgrade and expand several call systems based in California. As
previously discussed, California is currently experiencing financial and political challenges. We believe these challenges have created uncertainty with respect to the spending patterns of our California based customers. As a result, projects and
the related contracts to upgrade and expand certain call box systems have been delayed. Sales of call box products tend to fluctuate from quarter to quarter while revenue from the long-term maintenance contracts are relatively comparable quarter to
quarter.



Cost of Revenue and Gross Margin



Wireless applications cost of revenue for the second quarter of fiscal 2004
was $3.1 million compared to $3.7 million for the second quarter of fiscal 2003. As a percentage of revenue, gross margin was (2.4) percent versus 43.1 percent for the corresponding period of the prior fiscal year. The decrease in gross margin
reflects the costs of ramping-up production of our newly released 120-watt universal power adapters, while dramatically reducing production quantities of legacy products. The new 120-watt products began shipping at the end of the second quarter of
fiscal 2004.



Comparison of the Six Months Ended July 31, 2003 to the Six
Months Ended July 31, 2002



Consolidated



Revenue



Total revenue for the six months ended July 31, 2003, was $12.0 million compared to $17.8 million for the six months ended
July 31, 2002, a decrease of approximately $5.8 million or 32.6 percent. As discussed below, the decrease is attributable to a $3.6 million decrease in sales of our wireless applications products and a $2.1 million decrease in sales of our wireless
test solutions products.



Sales to customers in North America
and Europe accounted for approximately 79 percent and 15 percent of revenue, or $9.5 million and $1.8 million, respectively, for the six months ended July 31, 2003. For the comparable period of the prior fiscal year, sales to customers in North
America and Europe accounted for approximately 87 percent and 7 percent of revenue, or $15.4 million and $1.3 million, respectively.



Cost of Revenue and Gross Margin



Total cost of revenue for the six months ended July 31, 2003, was $8.3 million compared to $12.2 million for the corresponding period of fiscal 2003, a
decrease of approximately $3.9 million or 32.3 percent. As a percentage of revenue, gross margin was 31.0 percent as compared to 31.4 percent for the six months ended July 31, 2003 and 2002, respectively. As discussed previously, during the three
months ended July 31, 2002, we recorded a non-cash inventory impairment charge totaling $1.4 million related to our wireless test solutions legacy 2G products. As discussed below, the decrease in gross margin is primarily attributable to the costs
of ramping up production of our newly released 120-watt universal power adapters.



Selling, General and Administrative Costs



Selling, general and administrative costs for the six months ended July 31, 2003 were $5.7 million compared to $4.7 million for the corresponding period of the prior fiscal year, an increase of $1.0 million or 21.7 percent. The increase in
selling, general and administrative expenses is attributable to the legal settlements and



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related fees incurred during the second quarter of fiscal 2004. As a percentage of revenue, selling, general and
administrative costs were 48.0 percent and 26.6 percent for the six months ended July 31, 2003 and 2002, respectively.



Engineering and Support Costs



The Company capitalizes costs incurred for the development of software embedded in our wireless test solutions products that will be sold when
technological feasibility has been established. These capitalized costs are subject to an ongoing assessment of recoverability based on anticipated future revenue and changes in hardware and software technologies. Costs that are capitalized include
direct labor and related overhead. Engineering and support costs for the six months ended July 31, 2003 and 2002, are as follows (in thousands):



|                                             |  | Six Months EndedJuly 31, |       
|-------------------------------------------- |  | ------------------------ | ------
|                                             |  | 2003                     |       
|Engineering                                  |  | $                        | 3,925 
|Less: Capitalized software development costs |  |                          | (1,726
|Support Costs                                |  |                          | 776   
|                                             |  |                          |       
|                                             |  | $                        | 2,975 
|                                             |  |                          |       



Engineering and
support costs, net of capitalized software development costs, for the six months ended July 31, 2003 were $3.0 million compared to $2.7 million for the corresponding period of the prior fiscal year, an increase of approximately $0.3 million. Gross
engineering and support costs, before reduction for capitalized software development costs, remained flat at $4.7 million in comparison to the second half of fiscal 2003. This is primarily due to increased product development costs offset by reduced
staffing of our product support function. Capitalized software development costs decreased $0.3 million for the second half of fiscal 2004 in comparison to the comparable period of the prior fiscal year. The increase in engineering costs during the
second half of fiscal 2004 is attributable to the development and release of Seven.Five products, including the Seven.Five Solo and Seven.Five Duo, during the second quarter of fiscal 2004.



Other Income



Other income consists primarily of interest income.



Income Tax Benefit



The effective tax rate for the six months ended July 31, 2003 and 2002, was 36.0 percent and 27.4 percent, respectively. The lower prior year effective
tax rate used to compute the tax benefit of $2.7 million was caused primarily by non-deductible asset impairment charges recorded during the second quarter of fiscal 2003. No such non-deductible expenses were recorded in fiscal 2004.



Cumulative Effect of Accounting Change



The Company adopted SFAS No. 142 Goodwill and Other Intangible
Assets effective February 1, 2002. During the second quarter of fiscal 2003, we completed the required transitional impairment test under the new rules and recorded a non-cash charge of $2.9 million to write down fully the carrying value of
the goodwill related to our EDX software reporting unit. This reporting unit is included in our wireless test solutions segment for financial reporting purposes, and the related goodwill was generated through our acquisition of EDX Engineering, Inc.
during December 2000. Such charge is reflected as a cumulative effect of change in accounting principle. In calculating the impairment charge, the fair value of the impaired reporting unit underlying the wireless infrastructure segment was estimated
using a discounted cash flow methodology. This charge writes off the entire carrying value of the recorded goodwill for that reporting unit. No comparable charges were recorded during the six months ended July 31, 2003.



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Wireless Test Solutions



|                |  | Six Months Ended July 31, |      
|--------------- |  | ------------------------- | -----
|                |  | 2003                      |      
|                |  | (Dollars in thousands)    |      
|Revenue         |  | $                         | 4,334
|Cost of revenue |  |                           | 2,379
|                |  |                           |      
|Gross profit    |  | $                         | 1,955
|                |  |                           |      
|Gross margin    |  |                           | 45.1 
|                |  |                           |      



Revenue



Revenue from our wireless test solutions segment for the six months ended
July 31, 2003, was $4.3 million compared to $6.5 million for the six months ended July 31, 2002, a decrease of 33.1 percent. Of the total decrease of $2.2 million, $0.9 million relates to the exiting of the engineering services business which we
ceased providing in the second quarter of fiscal 2003. The remaining decrease of $1.3 million represents the shifting of sales from our legacy 2G wireless test solutions products to our newly released Seven.Five products.



Cost of Revenue and Gross Margin



Cost of revenue from our wireless infrastructure segment in the six months
ended July 31, 2003, was $2.4 million compared to $5.6 million for the six months ended July 31, 2002, a decrease of approximately $3.2 million or 57.7 percent. Gross margin for the six months ended July 31, 2003 increased to 45.1 percent from
13.3 percent for the corresponding period of the prior fiscal year. The increase in gross margin was due to a change in the relative mix of business for the six months ended July 31, 2003 (product sales vs. maintenance revenue). Also
contributing to the increase in gross margin is a non-cash inventory impairment charge totaling $1.4 million that was recorded in the second quarter of fiscal 2003. No comparable costs were incurred during fiscal 2004.



Wireless Applications



|                |  | Six Months Ended July31, |      
|--------------- |  | ------------------------ | -----
|                |  | 2003                     |      
|                |  | (Dollars in thousands)   |      
|Revenue         |  | $                        | 7,647
|Cost of revenue |  |                          | 5,883
|                |  |                          |      
|Gross profit    |  | $                        | 1,764
|                |  |                          |      
|Gross margin    |  |                          | 23.1 
|                |  |                          |      



Revenue



Revenue from our wireless applications segment for the six months ended July
31, 2003 was $7.6 million compared to $11.3 million for the six months ended July 31, 2002, a decrease of approximately $3.6 million or 32.3 percent. This decrease was due to a $2.6 million decrease in sales of our ChargeSource products and a $1.0
million decrease in sales of our call box products.



The
decrease in sales of our ChargeSource products is due to the phase-out of our 70-watt products as our primary market offering and the transition to newly developed 120-watt products. We began shipping both the 120-watt universal AC/DC and 120-watt
universal DC power adapters at the end of the second quarter of fiscal 2004. For the remainder of fiscal 2004, we expect that our ChargeSource revenue will be approximately $5.5 million per quarter.



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The decrease in sales of our call box products relates to delays in receiving contracts to upgrade and
expand several call systems based in California. As previously discussed, California is currently experiencing financial and political challenges. We believe these challenges have created uncertainty with respect to the spending patterns of our
California based customers. As a result, projects and the related contracts to upgrade and expand certain call box systems have been delayed. Sales of call box products tend to fluctuate from quarter to quarter while revenue from the long-term
maintenance contracts are relatively comparable quarter to quarter.



Cost of
Revenue and Gross Margin



Cost of revenue from our
wireless applications segment for the six months ended July 31, 2003 was $5.9 million compared to $6.6 million for the six months ended July 31, 2002, a decrease of $0.7 million or 10.5 percent. As a percentage of revenue, gross margin decreased to
23.1 percent from 41.8 percent for the six months ended July 31, 2002. The decrease in gross margin is attributable to startup production costs associated with the new 120-watt products, while dramatically reducing production quantities of legacy
products. The new 120-watt products began shipping at the end of the second quarter of fiscal 2004.



Liquidity and Capital Resources



Our financial position remains strong, with cash and cash equivalents of $18.9 million at July 31, 2003.



The following table summarizes Comarcos cash flows for the six months ended July 31, 2003 and 2002:



|                                                                             |  | Six Months Ended July 31, |       
|---------------------------------------------------------------------------- |  | ------------------------- | ------
|                                                                             |  | 2003                      |       
|                                                                             |  | (In thousands)            |       
|Net cash provided by (used in):                                              |  |                           |       
|Operating activities                                                         |  | $                         | (3,382
|Investing activities                                                         |  |                           | (2,991
|Financing activities                                                         |  | $                         | (106  
|                                                                             |  |                           |       
|Net increase (decrease) in cash and cash equivalents  continuing operations |  | $                         | (6,479
|                                                                             |  |                           |       



Cash Flows from Operating
Activities



Cash used in operations was $3.4 million for
the first half of fiscal 2004 compared to $5.2 million of cash generated from operations for the corresponding period of the prior fiscal year. The net loss from continuing operations before non-cash charges of depreciation and amortization was
approximately $0.8 million. Additionally, the Companys deferred revenue decreased by $1.1 million and our deferred income taxes increased by $1.4 million. The decrease in deferred revenue reflects a non-cash increase in revenue for the period
as we ratably recognize the revenue of previously deferred sales over the term of the service period. Similarly, the increase in deferred income taxes reflects the non-cash portion of our recorded income tax benefit.



The $5.2 million in cash provided by operations for the six months ended July
31, 2002 is primarily related to net income from operations before non-cash charges of depreciation and amortization, asset impairment charges, and cumulative effect of change in accounting principle of $5.8 million. Cash generated is further
increased by a reduction in accounts receivable of $3.6 million and is offset primarily by a decrease in accrued liabilities of $1.9 million and the $2.7 million increase in the deferred tax benefit.



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Cash Flows from Investing Activities



Net cash used in investing activities was $3.0 million for the first half of fiscal 2004 compared to $2.8 million for the
first half of fiscal 2003. In both periods, capital expenditures for property and equipment and software development constituted substantially all of our cash used in investing activities.



Cash Flows from Financing Activities



Net cash used in financing activities for the first six months of fiscal
2004 consisted of $195,000 that was used to repurchase 25,640 shares of the Companys common stock in the open market for an average purchase price of $7.61. From program inception in 1992 through July 31, 2003, the Company has repurchased
approximately 2.6 million shares for an average price of $8.22 per share. The cash used was offset by $89,000 from the sale of common stock issued through the Companys subsidiary option plan. Net cash used in financing activities for the six
months ended July 31, 2002 consisted of $353,000 that was used to repurchase 35,905 shares of the Companys common stock in the open market for an average price of $9.84 per share under our share repurchase program. The cash used was offset by
proceeds of $78,000 received from the sales of common stock issued through the Companys subsidiary stock option plan and proceeds from the sale of common stock issued through employee and director stock option plans of $121,000.



We believe that our existing cash and cash equivalent balances and cash from
operations will provide us sufficient funds to satisfy our cash requirements for at least the next twelve months.



Critical Accounting Policies



We have identified the following critical accounting policies as the most significant for purposes of fully understanding and evaluating our reported
financial results: revenue recognition, capitalized software development costs, accounts receivable, inventory, income taxes, valuation of goodwill, and valuation of long-lived assets. These critical accounting policies have been applied during the
first and second quarters of fiscal 2004 consistent with the prior periods and the year ended January 31, 2003.



For further information, refer to the discussion of critical accounting policies included in Managements Discussion and Analysis in the
Companys annual report on Form 10-K for the year ended January 31, 2003.



ITEM 3.    QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK



Currency Risk



The Company is exposed to the risk of changes in currency exchange rates. As of July 31, 2003, we had no material accounts receivable denominated in
foreign currencies. Our standard terms require customers to pay for our products and services in U.S. dollars. For those orders denominated in foreign currencies, we may limit our exposure to losses from foreign currency transactions through forward
foreign exchange contracts. To date, sales denominated in foreign currencies have not been significant and we have not entered into any foreign exchange contracts.



Interest Rate Sensitivity



The primary objective of our investment activities is to preserve principal while at the same time maximizing the income we receive from our investments
without significantly increasing risk. Some of the securities that we have invested in may be subject to market risk. This means that a change in prevailing interest rates may cause the principal amount of the investment to fluctuate. For example,
if we hold a security that was issued with a fixed interest rate at the then-prevailing rate and the prevailing interest rate later rises, the principal amount of our investment will probably decline in value. To minimize this risk, we maintain a
significant portion of our cash balances in money market funds. In general, money market funds are not subject to interest rate risk because the interest paid on such funds fluctuates with the prevailing interest rate.



We do not hold any derivative financial instruments.



Our cash and cash equivalents have maturities dates of three months or less
and the fair value approximates the carrying value in our financial statements.



Equity Price Risk



Our short-term investments
consist primarily of balances maintained in a non-qualified deferred compensation plan funded by our executives and directors. We value these investments using the closing market value for the last day of each month. These investments are subject to
market price volatility. We reflect these investments on our balance sheet at their market value, with the unrealized gains and losses excluded from reported operations. We have also invested in equity instruments of SwissQual, a privately held
company. We evaluate whether any decline in value of certain public and non-public equity investments is other than temporary.



Due to the inherent risk associated with some of our investments, and in light of current stock market conditions, we may incur future losses on the
sales, write-downs, or write-offs of our investments. We do not currently hedge against equity price changes.



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ITEM 4.    CONTROLS AND PROCEDURES



|(a) |  | Evaluation of disclosure controls and procedures
|--- |  | ------------------------------------------------



As of the end of the period covered by this report, an evaluation was performed, under the supervision and with the participation of our
management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to the Securities Exchange Act of 1934, as amended, Rule 13a-14c.
Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective. There have been no significant changes in our internal controls or in other factors that could
significantly affect internal controls subsequent to the date the evaluation was performed.



|(b) |  | Changes in internal controls
|--- |  | ----------------------------



There have been no significant changes in internal controls or in other factors that could significantly affect these internal controls
subsequent to the date of our most recent evaluation.



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PART II  OTHER INFORMATION



ITEM 1.    LEGAL PROCEEDINGS



|1. |  | Mobility Electronics, Inc. v. Comarco, Inc. and Comarco Wireless Technologies, Inc.,
|-- |  | ------------------------------------------------------------------------------------

Case No. CIV-01-1489-PHX-MHM, U.S. District Court for the District of Arizona (Mobility Arizona Action);

Comarco Wireless Technologies, Inc. vs. Xtend Micro Products, Inc. and iGo Corporation,

Case No. SACV 02-640 AHS (ANx), U.S. District Court for the Central District of California, Southern Division (Comarco California Action);

Comarco Wireless Technologies, Inc. v. Mobility Electronics, Inc., Hipro Electronics Company, Ltd., and iGo Direct
Corporation,

Case No. CIV-03-0202 PHX-MHM, U.S. District Court for the District of Arizona (Comarco Arizona Action):



In August 2001, Mobility Electronics, Inc.
(Mobility) initiated the Mobility Arizona Action against the Company and Comarco Wireless Technologies, Inc. (CWT) alleging that CWTs ChargeSource power supply products infringed U.S. Patent No. 5,347,211 (the
211 Patent). In addition, Mobility sought a declaratory judgment that three of CWTs power supply related patents are either invalid or not infringed by power supplies produced or to be produced by Mobility. The three CWT patents
are U.S. Patent Nos. 6,091,611 (the 611 Patent), 6,172,884 (the 884 patent), and 5,838,554 (the 554 patent). Comarcos customer, Targus Group International, Inc. (Targus) was
later added as a defendant.



In June 2002, CWT initiated the
Comarco California Action against Xtend Micro Products, Inc. (Xtend) and its parent entity, iGo Corporation (iGo), alleging that its 611 and 884 patents are infringed by Xtends PowerXtender and AC Adapter power supply products as well as other
power supply and power adapter products and related accessories. iGo acquired Xtend, and then iGo merged into a newly formed subsidiary of Mobility named iGo Direct Corporation (iGo Direct). The Comarco California Action was transferred
to and consolidated with the Mobility Arizona Action.



In
January 2003, CWT initiated the Comarco Arizona Action against Mobility, iGo Direct, and Hipro Electronics Company, Ltd. (Hipro), alleging that the Juice power supply products and related accessories made by Hipro for Mobility and sold through iGo Direct, infringed
Comarcos 611 and 884 patents. The Comarco Arizona Action was consolidated with the Mobility Arizona Action and the Comarco California Action.



Effective July 12, 2003, all the parties to all three actions entered into a Settlement Agreement. All three actions are being dismissed. Under the
terms of the Settlement Agreement, neither the Company nor CWT was required to make any payment. Mobility and CWT cross-licensed certain patent rights related to powering electronic devices, including certain patent rights relating to automatic
programmability and combination AC/DC capability.



|2. |  | Los Angeles County Service Authority for Freeway Emergencies v. Comarco Wireless Technologies, Inc.,
|-- |  | ----------------------------------------------------------------------------------------------------

Case No. SACV 02-567 AHS (ANx), U.S. District Court for the Central District of California, Southern Division:



Los Angeles County Service Authority for Freeway Emergencies
(LASAFE) filed this action against CWT on June 10, 2002, relating to two contracts between LASAFE and CWT concerning call box systems manufactured by CWT, upgraded by CWT to comply with the Americans with Disabilities Act
(ADA) and maintained by CWT until its contractual obligations to provide maintenance expired. On August 2, 2002, LASAFE filed a first amended complaint (hereafter, the complaint). The complaint includes eight counts. In the
first five counts LASAFE alleges CWT breached its contractual obligations and implied warranties by failing to properly maintain and repair the call box system and failing to provide certain deliverables to LASAFE. In the last three counts LASAFE
alleges that U.S. Patent No. 6,035,187 owned by CWT and entitled Apparatus and Method for



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Improved Emergency Call Box (the 187 Patent) should be assigned to LASAFE, and CWT should
compensate LASAFE, because an LASAFE employee is the true inventor of the invention claimed in the 187 Patent. The complaint seeks an unspecified amount of actual and punitive damages, ownership of the 187 patent, an order that CWT
specifically perform its obligations under the contracts, recovery of attorneys fees, and an audit to determine the number of allegedly infringing call boxes.



In October 2002, the Court dismissed the first five counts of LASAFEs complain without prejudice finding that the claims properly belonged in
state court, not federal court.



On November 7, 2002, LASAFE
filed an action in California Superior Court for the County of Los Angeles, Case No. BC 248897 styled Los Angeles County Service Authority for Freeway Emergencies v. Comarco Wireless Technologies Inc., alleging the same facts and legal
theories set forth in its first five counts of the federal case that were discussed. On January 9, 2003, CWT filed an answer and cross-complaint seeking payment for its services under one of the contracts.



On June 3, 2003, the parties mediated the disputes involved in the federal
and the state actions and reached a tentative settlement agreement. The LASAFE board has since approved such a settlement, and the parties are currently working on drafting the formal settlement agreement. The federal and state cases have been
stayed.



|3. |  | Stephen C. Dixon et al. v. Circuit City Stores, Inc. et al., Case No. 1:03CV173, U.S.D.C. E.D.Va.:
|-- |  | --------------------------------------------------------------------------------------------------



In February 2003, Plaintiffs filed suit against Circuit City Stores, Inc.;
Belkin Corporation; Targus, Inc.; and Tecnozone Enterprises, LLC. The complaint alleged that power supply products supplied to Circuit City for resale by Belkin, Targus, and Tecnozone infringed United States Patent No. 6,064,177 (the 177
patent). ChargeSource power supply products supplied to Targus by CWT were among the products at issue. In June 2003, the entire case as it related to CWTs products was dismissed with prejudice.



We are from time to time involved in various legal proceedings incidental to
the conduct of our business. We believe that the outcome of all other such pending legal proceedings will not in the aggregate have a material adverse effect on our financial condition and operating results.



|ITEM 2. |  | CHANGES IN SECURITIES AND USE OF PROCEEDS
|------- |  | -----------------------------------------



| |  | None.
| |  | -----



|ITEM 3. |  | DEFAULTS UPON SENIOR SECURITIES
|------- |  | -------------------------------



| |  | None.
| |  | -----



|ITEM 4. |  | SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
|------- |  | ---------------------------------------------------



The Annual Meeting of Shareholders of Comarco was held on June 24, 2003. The holders of Comarcos stock were entitled to elect five directors to
serve until 2004.



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##### Table of Contents

The following table sets forth the names of the five persons elected at the Annual Meeting to serve as
directors until 2004 and the number of votes cast for or against with respect to each person.



|                   |  | For       |  | Withheld 
|------------------ |  | --------- |  | ---------
|Don M. Bailey      |  | 5,507,785 |  | 1,163,387
|Thomas A. Franza   |  | 5,587,983 |  | 1,083,189
|Gerald D. Griffin  |  | 5,776,342 |  | 894,830  
|Jeffrey R. Hultman |  | 6,136,171 |  | 535,001  
|Erik van der Kaay  |  | 6,136,146 |  | 535,026  



|ITEM 5. |  | OTHER INFORMATION
|------- |  | -----------------



| |  | None.
| |  | -----



ITEM 6.     EXHIBITS AND REPORTS ON FORM 8-K



|(a) |  | Exhibits:
|--- |  | ---------



11

Schedule of Computation of Net Loss Per Share31.1

Certification of Chief Executive Officer Pursuant to Section 302 of the SarbanesOxley Act of 200231.2

Certification of Chief Financial Officer Pursuant to Section 302 of the SarbanesOxley Act of 200232.1

Certification of Chief Executive Officer and Chief Financial Officer Pursuant to Section 906 of the SarbanesOxley Act of 2002




|(b) |  | Reports on Form 8-K:
|--- |  | --------------------



| |  | The Registrant furnished a Current Report to the SEC on Form 8-K on May 30, 2003 under Item 12, Results of Operations and Financial Condition, the announcement of financial results
for the fiscal quarter ended April 30, 2003.
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | The Registrant furnished a Current Report to the SEC on Form 8-K on June 2, 2003, under Item 12, Results of Operations and Financial Condition, to provide a transcript of a
conference call and simultaneous web-cast presentation on May 28, 2003, relating to the Companys financial results for the first quarter ended April 30, 2003.
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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##### Table of Contents

SIGNATURES



Pursuant to the
requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.



|                          |  |  |  | COMARCO, INC.                             
|------------------------- |  |  |  | ------------------------------------------
|                          |  | 
|Date:  September 12, 2003 |  |  |  | /s/    Thomas A. Franza                   
|                          |  |  |  | Thomas A. Franza                          
|                          |  |  |  | President and Chief Executive Officer     
|                          |  | 
|Date:  September 12, 2003 |  |  |  | /s/    Daniel R. Lutz                     
|                          |  |  |  | Daniel R. Lutz                            
|                          |  |  |  | Vice President and Chief Financial Officer



31