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Table of Contents

 
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
     
þ   QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended July 31, 2011
For the quarterly period ended
JULY 31, 2011
OR
     
o   TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from                      to                     
Commission file number 0-5449
COMARCO, INC.
(Exact name of registrant as specified in its charter)
 
     
California
(State or other jurisdiction
of incorporation or organization)
  95-2088894
(I.R.S. Employer
Identification No.)
25541 Commercentre Drive, Lake Forest, California 92630
(Address of principal executive offices and zip code)
(949) 599-7400
(Registrant’s telephone number, including area code)
 
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
     Yes þ No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
     Yes þ No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
             
Large accelerated filer o   Accelerated filer o   Non-accelerated filer o   Smaller reporting company þ
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
     Yes þ Noo
The registrant had 7,383,869 shares of common stock outstanding as of September 12, 2011.
 
 

 


 

COMARCO, INC. AND SUBSIDIARY
QUARTERLY REPORT ON FORM 10-Q
FOR THE THREE AND SIX MONTHS ENDED JULY 31, 2011
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 EX-31.1
 EX-31.2
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 EX-101 INSTANCE DOCUMENT
 EX-101 SCHEMA DOCUMENT
 EX-101 CALCULATION LINKBASE DOCUMENT
 EX-101 LABELS LINKBASE DOCUMENT
 EX-101 PRESENTATION LINKBASE DOCUMENT

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PART I — FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
COMARCO, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
(In thousands, except share and par value amounts)
                 
    July 31,     January 31,  
    2011     2011(A)  
ASSETS
               
Current Assets:
               
Cash and cash equivalents
  $ 1,556     $ 6,381  
Accounts receivable due from customers, net of reserves of $64 and $53, respectively
    2,091       3,550  
Accounts receivable due from suppliers, net of reserves of $55 and $67, respectively
    764       724  
Inventory, net of reserves of $1,397 and $1,650, respectively
    1,737       1,521  
Other current assets
    360       165  
 
           
Total current assets
    6,508       12,341  
Property and equipment, net
    197       420  
 
           
Total assets
  $ 6,705     $ 12,761  
 
           
 
               
LIABILITIES AND STOCKHOLDERS’ EQUITY
               
Current Liabilities:
               
Accounts payable
  $ 3,682     $ 5,180  
Accrued liabilities
    2,264       2,762  
Line of credit
          1,000  
 
           
Total current liabilities
    5,946       8,942  
Deferred rent, net of current portion
    39        
 
           
Total liabilities
  $ 5,985     $ 8,942  
 
           
 
               
Commitments, Contingencies and Subsequent Events
               
 
               
Stockholders’ Equity:
               
Preferred stock, no par value, 10,000,000 shares authorized; no shares issued or outstanding at July 31, 2011 and January 31, 2011, respectively
           
Common stock, $0.10 par value, 50,625,000 shares authorized; 7,343,869 shares issued and outstanding at July 31, 2011 and January 31, 2011
    733       733  
Additional paid-in capital
    15,394       15,299  
Accumulated deficit
    (15,407 )     (12,213 )
 
           
Total stockholders’ equity
    720       3,819  
 
           
Total liabilities and stockholders’ equity
  $ 6,705     $ 12,761  
 
           
 
(A)   Derived from the audited consolidated financial statements as of January 31, 2011.
The accompanying notes are an integral part of these condensed consolidated financial statements.

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COMARCO, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(In thousands, except per share amounts)
                                 
    Three Months Ended     Six Months Ended  
    July 31,     July 31,  
    2011     2010     2011     2010  
Revenue
  $ 1,926     $ 12,783     $ 4,876     $ 20,297  
Cost of revenue
    2,232       10,645       5,006       16,557  
 
                       
Gross profit (loss)
    (306 )     2,138       (130 )     3,740  
 
                       
 
                               
Selling, general, and administrative expenses
    1,114       1,210       2,065       2,617  
Engineering and support expenses
    475       886       974       1,788  
 
                       
 
    1,589       2,096       3,039       4,405  
 
                       
 
                               
Operating income (loss)
    (1,895 )     42       (3,169 )     (665 )
Other loss, net
    (13 )     (23 )     (2 )     (42 )
 
                       
 
                               
Income (loss) from continuing operations before income taxes
    (1,908 )     19       (3,171 )     (707 )
Income tax expense
    2             2        
 
                       
 
                               
Net income (loss) from continuing operations
    (1,910 )     19       (3,173 )     (707 )
Loss from discontinued operations, net of income taxes
    (21 )     (594 )     (21 )     (601 )
 
                       
Net loss
  $ (1,931 )   $ (575 )   $ (3,194 )   $ (1,308 )
 
                       
 
                               
Basic and diluted loss per share:
                               
Net loss from continuing operations
  $ (0.26 )   $     $ (0.43 )   $ (0.10 )
Net loss from discontinued operations
          (0.08 )           (0.08 )
 
                       
 
  $ (0.26 )   $ (0.08 )   $ (0.43 )   $ (0.18 )
 
                       
 
                               
Weighted average common shares outstanding:
                               
Basic
    7,344       7,327       7,344       7,327  
 
                       
Diluted
    7,344       7,327       7,344       7,327  
 
                       
Common shares outstanding
    7,344       7,327       7,344       7,327  
 
                       
The accompanying notes are an integral part of these condensed consolidated financial statements.

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COMARCO, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(In thousands)
                 
    Six Months Ended  
    July 31,  
    2011     2010  
CASH FLOWS FROM OPERATING ACTIVITIES:
               
Net loss
  $ (3,194 )   $ (1,308 )
Loss from discontinued operations
  $ 21     $ 601  
Adjustments to reconcile net loss from continuing operations to net cash used in operating activities:
               
Depreciation
    271       380  
Loan origination fees
    53       56  
Stock-based compensation
    95       143  
Recovery from doubtful accounts receivable
          (104 )
Provision for obsolete inventory
    (185 )     (152 )
Changes in operating assets and liabilities:
               
Accounts receivable due from customers
    1,470       (3,357 )
Accounts receivable due from suppliers
    (51 )     (338 )
Inventory
    (31 )     (179 )
Other assets
    (195 )     (146 )
Accounts payable
    (1,498 )     3,276  
Accrued liabilities
    (498 )     (2,546 )
Deferred rent
    39       (63 )
 
           
Net cash used in continuing operating activities
    (3,703 )     (3,737 )
Net cash (used in) provided by discontinued operating activities
    (21 )     (601 )
 
           
Net cash used in operating activities
    (3,724 )     (4,338 )
 
           
 
               
CASH FLOWS FROM INVESTING ACTIVITIES:
               
Purchases of property and equipment
    (48 )     (240 )
 
           
Net cash used in investing activities
    (48 )     (240 )
 
           
 
               
CASH FLOWS FROM FINANCING ACTIVITIES:
               
Line of credit
    (1,000 )      
Loan origination fees
    (53 )     (56 )
 
           
Net cash used in financing activities
    (1,053 )     (56 )
 
           
 
               
Net decrease in cash and cash equivalents
    (4,825 )     (4,634 )
Cash and cash equivalents, beginning of period
    6,381       10,127  
 
           
Cash and cash equivalents, end of period
  $ 1,556     $ 5,493  
 
           
 
               
Supplemental disclosures of cash flow information:
               
Cash paid for interest
  $ 12     $ 28  
 
           
Cash paid for income taxes, net of refunds
  $ 2     $  
 
           
The accompanying notes are an integral part of these condensed consolidated financial statements.

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COMARCO, INC. AND SUBSIDIARY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. Organization
          Comarco, Inc., through its wholly-owned subsidiary Comarco Wireless Technologies, Inc. (collectively, “we,” “us,” “our,” “Comarco,” or the “Company”), is a leading developer and designer of mobile power adapters used to simultaneously power and charge notebook computers, mobile phones, BlackBerry® smartphones, iPods®, and many other portable, rechargeable handheld devices. Our operations consist solely of the operations of Comarco Wireless Technologies, Inc. (“CWT”), which was incorporated in the State of Delaware in September 1993. Comarco, Inc. was incorporated in California in 1960 and its common stock has been publicly traded since 1971 when it was spun-off from Genge Industries, Inc.
2. Summary of Significant Accounting Policies
          The summary of our significant accounting policies presented below is designed to assist the reader in understanding our condensed consolidated financial statements. Such financial statements and related notes are the representations of our management, who are responsible for their integrity and objectivity. In the opinion of management, these accounting policies conform to accounting principles generally accepted in the United States of America in all material respects, and have been consistently applied in preparing the accompanying condensed consolidated financial statements.
Future Operations, Change in Strategy, Liquidity and Capital Resources:
          The Company has experienced substantial pre-tax losses from continuing operations for the six months ended July 31, 2011 and 2010 totaling $3.2 million and $0.7 million, respectively. In addition, the Company experienced pre-tax losses from operations for fiscal 2011 totaling $5.4 million. The condensed consolidated financial statements have been prepared assuming that the Company will continue to operate as a going concern, which contemplates that the Company will realize its assets and satisfy its liabilities and commitments in the ordinary course of business. The Company’s condensed consolidated financial statements do not reflect any adjustments related to the outcome of this uncertainty. The Company’s future is highly dependent on its ability to sell its products at a profit, obtain liquidity, and its ultimate return to overall profitability. During the second quarter of fiscal 2012, the Company had two customers, Lenovo and Dell, both of which are original equipment manufacturers, or “OEM’s.”
          During the second quarter of fiscal 2012 the Company decided to change its sales strategy to sell its products directly to consumers. Although we plan to continue to sell select products in the OEM channel, we believe that we can increase sales and margins by also selling our products direct to consumers. To implement this strategy, during the latter part of the third quarter, we plan to launch our website to sell our newest generation of AC adapter. However, there can be no assurance that the Company will be able to successfully achieve its sales volume initiatives through the launch of its new website and the failure to achieve such initiatives could have a material adverse effect on the Company’s operations and financial condition.
          The Company had working capital totaling approximately $0.6 million at July 31, 2011. In order for us to conduct our business for the next twelve months and to continue operations thereafter and be able to discharge our liabilities and commitments in the normal course of business, we must increase sales, reduce operating expenses, and potentially raise additional funds, through either debt and/or equity financing to meet our working capital needs. On August 3, 2011, the Company received a letter from Silicon Valley Bank (“SVB”) indicating that an event of default had occurred under the Loan and Security Agreement entered into by and between the Company and SVB on February 11, 2009 (as amended, the “Loan Agreement”). The event of default relates to the Company’s failure to meet the minimum quick ratio financial covenant of “1.25 to 1.00” for each of the periods ending February 28, 2011, March 31, 2011, April 30, 2011, May 31, 2011 and June 30, 2011. The Company remains in default of the quick ratio financial covenant as of the date of this filing. The Company’s ability to borrow under the Loan Agreement may continue to be suspended based upon our failure to comply with the quick ratio covenant in the future. Although the Company is currently seeking other forms of financing, we cannot be certain we will be able to secure additional financing on terms acceptable to us, or at all.

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COMARCO, INC. AND SUBSIDIARY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Basis of Presentation:
          The interim condensed consolidated financial statements of Comarco included herein have been prepared without audit in accordance with accounting principles generally accepted in the United States of America for interim information and with the instructions for Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. The Company believes that the disclosures are adequate to make the information presented not misleading when read in conjunction with the audited consolidated financial statements included in the Company’s annual report on Form 10-K for the year ended January 31, 2011. The unaudited interim condensed consolidated financial information presented herein reflects all adjustments, consisting only of normal recurring accruals, which are, in the opinion of management, necessary for a fair presentation of the consolidated results for the interim periods presented. The consolidated results for the three and six months ended July 31, 2011 are not necessarily indicative of the results to be expected for the fiscal year ending January 31, 2012.
Cash and Cash Equivalents
          All highly liquid investments with remaining maturity dates of three months or less when acquired are classified as cash and cash equivalents. The fair value of cash and cash equivalents approximates the amounts shown in the unaudited interim condensed consolidated financial statements. Cash and cash equivalents are generally maintained in uninsured accounts, typically Eurodollar deposits with daily liquidity, which are subject to investment risk including possible loss of principal invested.
Principles of Consolidation
          The unaudited interim condensed consolidated financial statements of the Company include the accounts of Comarco, Inc. and CWT, its wholly owned subsidiary. All material intercompany balances, transactions, and profits and losses have been eliminated.
Accounts Receivable Due from Customers
          The Company offers unsecured credit terms to customers and performs ongoing credit evaluations of its customers. Accounts receivable balances result primarily from the timing of remittance payments by these customers to the Company. Accounts receivable are stated net of an allowance for doubtful accounts. Management develops its estimate of this reserve based upon specific identification of account balances that have indications of uncertainty of collection. Indications of uncertainty of collections may include the customer’s inability to pay, customer dissatisfaction, or other factors. Significant management judgments and estimates must be made and used in connection with establishing the allowance for doubtful accounts in any accounting period. Material differences may result in the amount and timing of our losses for any period if management made different judgments or utilized different estimates. Historically, such losses have been within management’s expectations and the reserves established.
Accounts Receivable Due from Suppliers
          Oftentimes the Company is able to source components locally that it later sells to its contract manufacturers, who build the finished goods, and other suppliers. This is especially the case when new products are initially introduced into production. Sales to the Company’s contract manufacturers and other suppliers are excluded from revenue and are recorded as a reduction to cost of revenue.
Use of Estimates
          The preparation of unaudited interim condensed 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 unaudited interim condensed consolidated financial statements and the reported amounts of revenue and expenses during the period reported. Actual results could materially differ from those estimates.

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COMARCO, INC. AND SUBSIDIARY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
          Certain accounting principles require subjective and complex judgments to be used in the preparation of financial statements. Accordingly, a different financial presentation could result depending on the judgments, estimates, or assumptions that are used. Such estimates and assumptions include, but are not specifically limited to, those required in the valuation of long-lived assets, allowance for doubtful accounts, reserves for inventory obsolescence, reserves for estimated warranty costs, including product recall costs, valuation allowances for deferred tax assets, and determination of stock based compensation.
          On April 30, 2010, the United States Consumer Product Safety Commission (“CPSC”) announced a product safety recall (the “Recall”) concerning approximately 500,000 units of our ChargeSource 90-watt universal AC power adapter sold to our distributer, Targus from June 2009 through March 2010. During the fourth quarter of fiscal 2010, the Company recorded an accrual of $4.6 million related to the Recall. The Company’s methodology for estimating the costs for the Recall involved estimating future costs to be incurred to replace the recalled adapters based on expected returns and the costs to conduct the Recall, particularly communication, replacement, and transportations costs. Another aspect of the estimate involves Comarco’s assessment of Targus’ and Comarco’s respective obligations regarding returned product. During the fourth quarter of fiscal 2011 and the first quarter of fiscal 2012, the Company recorded additional accruals of $0.3 million and $0.4 million, respectively, related to the Recall. During the third quarter of fiscal 2012, Targus and Comarco entered into a Release and Settlement Agreement (the “Settlement Agreement”) with respect to all matters concerning the Recall. In the third quarter, as part of the Settlement Agreement, Targus paid Comarco approximately $290,000 which represents a refund of previous amounts withheld from payment in the first quarter of fiscal 2012. The Company believes that it has accrued and paid for substantially all of its material financial obligations with respect to the Recall.
Reclassifications:
          Certain prior period balances have been reclassified to conform to the current period presentation. The reclassifications have no effect on previously reported results of operations or accumulated deficit.
Impairment or Disposal of Long-lived Assets:
          We review our long-lived assets for impairment whenever events or changes in circumstances indicate that their carrying amounts may not be recoverable. If the cost basis of a long-lived asset is greater than the projected future undiscounted net cash flows from such asset (excluding interest), an impairment loss is recognized. Impairment losses are calculated as the difference between the cost basis of an asset and its estimated fair value. We did not recognize any impairment charges during the three or six months ended July 31, 2011.
Fair Value of Financial Instruments:
          The Company’s financial instruments include cash and cash equivalents, accounts receivable due from customers and suppliers, accounts payable, accrued liabilities, and a line of credit. The carrying amount of cash and cash equivalents, accounts receivable due from customers and suppliers, accounts payable, and accrued liabilities are considered to be representative of their respective fair values because of the short-term nature of those instruments. The carrying amount of the Company’s line of credit approximates fair value since the interest rate approximates the market rate for debt securities with similar terms and risk characteristics.
3. Discontinued Operations
          The Company entered into an Asset Purchase Agreement on September 26, 2008 with Ascom Holding AG and its subsidiary Ascom Inc., (collectively, “Ascom”) to sell the Wireless Test Solutions (“WTS”) business and related assets. Comarco’s shareholders approved the transaction on November 26, 2008 which closed on January 6, 2009.

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COMARCO, INC. AND SUBSIDIARY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
          The aggregate purchase price paid to Comarco in connection with the transaction was $12,750,000 in cash, with $1,275,000 of the proceeds placed in escrow for one year from the closing date as security for general indemnification rights. The proceeds placed in escrow were released in January 2010.
          Operating results of the WTS discontinued operations are as follows (in thousands):
                                 
    Three Months Ended     Six Months Ended  
    July 31,     July 31,  
    2011     2010     2011     2010  
Revenues
  $     $     $     $  
 
                       
Income (loss) from discontinued operations:
                               
Gain on sale, net of taxes of $0
  $     $     $     $  
Loss from discontinued operations, before taxes
    (21 )     (594 )     (21 )     (601 )
Income tax expense
                       
 
                       
Total Loss from discontinued operations
  $ (21 )   $ (594 )   $ (21 )   $ (601 )
 
                       
          The fiscal 2012 year to date loss from WTS discontinued operations of $21,000 relates to a sales tax audit performed by the California State Board of Equalization during the second quarter of fiscal 2012. The expensed amount represents the portion of the assessment that is to be borne by Comarco for the sale of the WTS business to Ascom.
          The fiscal 2011 year to date loss from WTS discontinued operations of $601,000 relates to a settlement with a former officer and employee of the WTS business, whereby Comarco agreed to pay the former employee $508,000 which amount included reimbursement for attorney and professional fees. The remaining loss relates primarily to Comarco’s legal fees incurred relating to the matter.
4. Stock-Based Compensation
          The Company grants stock awards for a fixed number of shares to employees, consultants, and directors with an exercise price equal to the fair value of the shares at the date of grant.
          The Company accounts for stock-based compensation using the modified prospective method, which requires measurement of compensation cost for all stock awards at fair value on date of grant and recognition of compensation over the service period for awards expected to vest. The fair value of stock options is determined using a Lattice Binomial model for options with performance-based vesting tied to the Company’s stock price and the Black-Scholes valuation model for options with ratable term vesting. Both the Lattice Binomial and Black-Scholes valuation models require the input of subjective assumptions. These assumptions include estimating the length of time optionees will retain their vested stock options before exercising them (the “expected term”), the estimated volatility of our common stock price over the expected term, and the number of awards that will ultimately not complete their vesting requirements (“forfeitures”). Changes in these subjective assumptions can materially affect the estimate of fair value of stock-based compensation and, consequently, the related amount recognized as an expense on the consolidated statements of operations. As required under the accounting rules, the Company reviews its valuation assumptions at each grant date and, as a result, is likely to change its valuation assumptions used to value stock-based awards granted in future periods. The values derived from using either the Lattice Binomial or the Black-Scholes model are recognized as an expense over the vesting period, net of estimated forfeitures. The estimation of stock awards that will ultimately vest requires significant judgment. Actual results, and future changes in estimates, may differ from the Company’s current estimates.

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COMARCO, INC. AND SUBSIDIARY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
          The compensation expense recognized is summarized in the table below (in thousands except per share amounts):
                                 
    Three Months Ended     Six Months Ended  
    July 31,     July 31,  
    2011     2010     2011     2010  
Total stock-based compensation expense
  $ 24     $ 88     $ 95     $ 143  
 
                       
 
                               
Impact on basic and diluted earnings per share
  $ 0.00     $ 0.01     $ 0.01     $ 0.02  
          The total compensation cost related to nonvested awards not yet recognized is approximately $315,000, which will be expensed over a weighted average remaining life of 18 months.
          During the three and six months ended July 31, 2011, 220,000 and 295,000 restricted stock units were granted. During the three and six months ended July 31, 2011, no stock options were granted. During the three months ended July 31, 2010, 80,000 restricted stock units were granted and 10,000 stock options were granted. No restricted stock units or stock options were granted in the first quarter of fiscal 2010. The fair value of the restricted stock units granted during the three months ended July 31, 2010 was estimated using the stock price on the date of the grant of $2.35 and a forfeiture rate of 8.2 percent. The fair value of the 10,000 options granted under the Company’s stock option plans during the three months ended July 31, 2010 was estimated on the date of grant using the Black-Scholes option-pricing model utilizing the following weighted average assumptions:
         
Weighted average risk-free interest rate
    0.98 %
Expected life (in years)
    3.2  
Expected stock volatility
    62.2 %
Dividend yield
  None
Expected forfeitures
    10.6 %
          Comarco has stock-based compensation plans under which outside directors, consultants, and employees are eligible to receive stock options and other equity-based awards. The stock option plans and a director stock option plan provide that officers, key employees, directors and consultants may be granted options to purchase up to 3,312,500 shares of common stock of the Company at not less than 100 percent of the fair market value at the date of grant, unless the grantee is a 10 percent shareholder of the Company, in which case the price must not be less than 110 percent of the fair market value. Figures for these plans reflect a 3-for-2 stock split declared during the year ended January 31, 2001.
          The Company’s Director Stock Option Plan (the “Director Plan”) expired in December 2010, and the Company’s former employee stock option plan (the “Employee Plan”) expired during May 2005. These plans provided for 637,500 and 825,000 shares issuable, respectively. During December 2005, the Board of Directors approved and adopted the Company’s 2005 Equity Incentive Plan (the “2005 Plan”) covering 450,000 shares of common stock. The 2005 Plan was approved by the Company’s shareholders at its annual shareholders’ meeting in June 2006, and subsequently amended at its annual shareholders meeting in June 2008 to increase the number of shares issuable under the plan from 450,000 to 1,100,000 shares. In July 2011, the Company’s shareholders approved the 2011 Equity Incentive Plan (the “2011” Plan) covering 750,000 shares of common stock.
          Under both the 2011 and 2005 Plan, the Company may grant stock options, stock appreciation rights, restricted stock, restricted stock units, and performance based awards to employees, consultants and directors. Under all plans, awards vest or become exercisable in installments determined by the compensation committee of the

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COMARCO, INC. AND SUBSIDIARY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Company’s Board of Directors; however, under the 2005 Plan no option may be exercised prior to one year following the grant of the option. The options granted under the Director Plan and the Employee Plan expire as determined by the committee, but no later than ten years and one week after the date of grant (five years for 10 percent shareholders). The options granted under the 2011 and 2005 Plan expire as determined by the committee, but no later than ten years after the date of grant (five years for 10 percent shareholders).
          Transactions and other information related to stock options granted under these plans for the six months ended July 31, 2011 are summarized below:
                 
    Outstanding Options  
            Weighted-Average  
    Number of Shares     Exercise Price  
Balance, January 31, 2011
    1,022,500     $ 2.81  
Options granted
           
Options canceled or expired
    (407,500 )     1.85  
Options exercised
           
 
             
Balance, July 31, 2011
    615,000     $ 3.46  
 
             
Stock Options Exercisable at July 31, 2011
    322,050     $ 5.63  
 
             
          Transactions and other information related to restricted stock units (“RSU’s”) granted under these plans for the six months ended July 31, 2011 are summarized below:
                 
    Outstanding Restricted Stock Units  
            Weighted-Average  
            Stock Price  
    Number of Shares     On Grant Date  
Balance, January 31, 2011
    98,928     $ 2.56  
RSU’s granted
    295,000       0.30  
RSU’s canceled or expired
    (45,952 )     2.65  
Common Stock Issued
           
 
             
Balance, July 31, 2011
    347,976     $ 0.61  
 
             
          As of July 31, 2011 40,000 restricted stock units had vested. The shares were issued to the recipients in August 2011.
          As of July 31, 2011, the stock awards outstanding have an intrinsic value of $1,000, based on a closing market price of $0.27 per share on July 31, 2011. The following table summarizes information about the Company’s stock awards outstanding at July 31, 2011:
                     
    Awards Outstanding   Awards Exercisable
        Weighted-Avg.   Weighted-Avg.       Weighted-Avg.
Range of   Number   Remaining   Exercise/Grant   Number   Exercise/Grant
Exercise/Grant Prices   Outstanding   Contractual Life   Price   Exercisable   Price
$0.26 to 4.90
  781,476   4.03   $0.96   180,550   $1.69
6.29 to 9.89   121,500   2.82   7.89   121,500   7.89
10.43 to 11.60   60,000   3.77   10.72   60,000   10.72
                     
    962,976   3.86 years   2.45   362,050   5.27
                     
          At July 31, 2011, shares available for future grants were 995,224.

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COMARCO, INC. AND SUBSIDIARY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
5. Recent Accounting Pronouncements
          In February 2011, the FASB issued amended guidance on subsequent events. Under this amended guidance, SEC filers are no longer required to disclose the date through which subsequent events have been evaluated in originally issued and revised financial statements. This guidance was effective immediately and we adopted these new requirements upon issuance of this guidance.
6. Earnings (Loss) Per Share
          The Company calculates basic earnings (loss) per share by dividing net income (loss) by the weighted-average number of common shares outstanding during the reporting period. Diluted earnings (loss) per share reflects the effects of potentially dilutive securities. Since the Company incurred a net loss for the three and six months ended July 31, 2011 and 2010, basic and diluted loss per share were the same because the inclusion of potential common shares related to outstanding stock options in the calculation would have been antidilutive.
          Potential common shares of 10,275 and 4,288 have been excluded from diluted weighted average common shares for the three and six months ended July 31, 2011, as the effect would have been antidilutive. Similarly, potential common shares of 260,153 and 276,587 have been excluded from diluted weighted average common shares for the three and six months ended July 31, 2010, as the effect would have been antidilutive.
7. Customer and Supplier Concentrations
          A significant portion of the Company’s revenue is derived from a limited number of customers. The customers providing 10 percent or more of the Company’s revenue for the periods presented below are listed here:
                                 
    Three Months Ended July 31,  
    2011     2010  
            (In thousands)          
Total revenue
  $ 1,926       100 %   $ 12,783       100 %
 
                       
 
                               
Customer concentration:
                               
Dell Inc. and affiliates
  $ 314       16 %   $ 278       2 %
Targus Group International, Inc.
                10,016       78 %
Lenovo Information Products Co., Ltd.
    1,593       83 %     2,446       19 %
 
                       
 
  $ 1,907       99 %   $ 12,740       99 %
 
                       
                                 
    Three Months Ended July 31,  
    2011     2010  
            (In thousands)          
Total revenue
  $ 4,876       100 %   $ 20,297       100 %
 
                       
 
                               
Customer concentration:
                               
Dell Inc. and affiliates
  $ 685       14 %   $ 278       1 %
Targus Group International, Inc.
    1,174       24 %     15,654       77 %
Lenovo Information Products Co., Ltd.
    2,947       60 %     4,251       21 %
 
                       
 
  $ 4,806       98 %   $ 20,183       99 %
 
                       
          In March 2009, the Company entered into the Targus Agreement with Targus. The Company began shipments to Targus under the Targus Agreement during the second quarter of fiscal 2010. On January 25, 2011,

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COMARCO, INC. AND SUBSIDIARY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Targus provided the Company with written notification of non-renewal of the Targus Agreement. As such, there is no revenue from Targus in the second quarter of fiscal 2012 and there can be no assurance that any revenue will be generated from Targus in the future.
          The customers comprising 10 percent or more of the Company’s gross accounts receivable due from customers at either July 31, 2011 or January 31, 2011 are listed below (in thousands):
                                 
    July 31, 2011     January 31, 2011  
Total gross accounts receivable due from customers
  $ 2,155       100 %   $ 3,603       100 %
 
                       
 
                               
Customer concentration:
                               
Dell Inc and affiliates
    329       15 %     434       12 %
Targus Group International, Inc.
    119       6 %     471       13 %
Lenovo Information Products Co., Ltd.
    1,696       79 %     2,683       74 %
 
                       
 
  $ 2,144       100 %   $ 3,588       99 %
 
                       
          The suppliers comprising 10 percent or more of the Company’s gross accounts receivable due from suppliers at either July 31, 2011 or January 31, 2011 are listed below (in thousands).
                                 
    July 31, 2011     January 31, 2011  
Total gross accounts receivable due from suppliers
  $ 819       100 %   $ 791       100 %
 
                       
 
                               
Customer concentration:
                               
Edac Power Electronics Co.Ltd.
  $ 532       65 %   $ 532       67 %
Flextronics Electronics
    125       15 %     99       13 %
Zheng Ge Electrical Co., Ltd.
    122       15 %     122       15 %
 
                       
 
  $ 779       95 %   $ 753       95 %
 
                       
          A significant portion of our inventory purchases is derived from a limited number of contract manufacturers (“CM’s”) and other suppliers. The loss of one or more of our significant CM’s or suppliers could materially adversely affect our operations. For the three and six months ended July 31, 2011 two of our CM’s provided an aggregate of 50 and 88 percent, respectively, of total product costs. For the three months ended July 31, 2010 three of our CM’s provided an aggregate of 95 percent of total product costs. For the six months ended July 31, 2010 two of our CM’s provided an aggregate of 88 percent of total product costs.
          At July 31, 2011, approximately $3.5 million or 94 percent, of the Company’s accounts payable of $3.7 million was payable to three contract manufacturers, only one of which provided the majority of the product costs for the three and six months ended July 31, 2011. At July 31, 2011 and January 31, 2011, approximately $1.1 million or 30 percent and 21 percent, respectively, of the Company’s accounts payable was payable to Chicony Power Technology Co., Ltd., (“Chicony”) the manufacturer of the Bronx product which was subject to the Recall. At present we are in litigation with Chicony (see Note 11). At July 31, 2011 and January 31, 2011, approximately $2.0 million and $2.6 million or 53 percent and 51 percent, respectively, of the Company’s accounts payable was payable to Edac Power Electronics Co. Ltd., the manufacturer of the Manhattan product sold to Targus. At the present time we are in negotiations with this supplier to create a long-term payment plan.
          Additionally, at July 31, 2011, approximately $0.7 million or 70 percent of total uninvoiced materials and services of $1.0 million, included in accrued liabilities were payable to three of our contract manufacturers. At January 31, 2011 approximately $729,000, or 45 percent, of total uninvoiced materials and services of $1.6 million, included in accrued liabilities were payable to Flextronics Electronics and Zheng Ge Electrical Co., Ltd.

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COMARCO, INC. AND SUBSIDIARY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
8. Inventory
          Inventory, net of reserves, consists of the following (in thousands):
                 
    July 31,     January 31,  
    2011     2011  
Raw materials
  $ 1,145     $ 875  
Finished goods
    592       646  
 
           
 
  $ 1,737     $ 1,521  
 
           
          As of July 31, 2011, approximately $313,000 of total inventory was located at our corporate headquarters. The remaining balance is located at various contract manufacturer locations primarily in China.
9. Warranty Arrangements
          The Company records an accrual for estimated warranty costs as products are sold. Warranty costs are estimated based on periodic analysis of historical experience. These amounts are recorded in accrued liabilities in the unaudited interim condensed consolidated balance sheets. Changes in the estimated warranty accruals are recorded when the change in estimate is identified. During the fourth quarter of fiscal 2010, the Company recorded an accrual of $4.6 million related to the Recall announced on April 30, 2010. Approximately 500,000 Targus branded 90-watt universal AC power adapters for laptops are affected by the Recall. A summary of the warranty accrual activity is shown in the table below (in thousands):
                 
    As of And For the  
    Six Months Ended  
    July 31,  
    2011     2010  
Beginning balance
  $ 310     $ 4,759  
Accruals for warranties issued during the period
    399       203  
Utilization
    (679 )     (3,513 )
 
           
 
  $ 30     $ 1,449  
 
           
          The Company believes that the balance remaining as of July 31, 2011 is adequate to cover our standard warranty costs. As discussed in Note 2 (Summary of Significant Accounting Policies — Use of Estimates) and Note 12 (Subsequent Events), Targus and Comarco entered into a Release and Settlement Agreement (the “Settlement Agreement”) with respect to all matters concerning the Recall in August 2011. In the third quarter, as part of the Settlement Agreement, Targus paid Comarco approximately $290,000 which represents a refund of previous amounts withheld from payment in the first quarter of fiscal 2012 and charged to cost of revenue. During the third quarter Comarco will record the payment received from Targus and it will reduce previously recorded accruals for the Recall to the extent the refund represents amounts in excess of Recall warranty costs.
10. Line of Credit
          On February 11, 2009, the Company entered into a Loan and Security Agreement (the “Loan Agreement”) with Silicon Valley Bank (“SVB”). The Loan Agreement was renewed on February 8, 2010 and again on February 9, 2011 and matures, on February 9, 2012, at which time, any outstanding principal balance is payable in full.

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COMARCO, INC. AND SUBSIDIARY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
          On August 3, 2011 we received a letter from SVB indicating that the Company’s failure to meet the minimum quick ratio of 1.25 to 1.00 for each of the periods ended February 28, 2011, March 31, 2011, April 30, 201l, May 31, 2011 and June 30, 2011 constituted an event of default. As of the date of this filing, the Company remains in default of the quick ratio financial covenant.
          We currently have no borrowings outstanding under the Loan Agreement and the Company’s future ability to borrow under the Loan Agreement may continue to be suspended based upon our failure to comply with the quick ratio covenant in the future. The Company is currently seeking other forms of financing, however, we cannot be certain we will be able to secure additional financing on terms acceptable to us, or at all.
11. Commitments and Contingencies
Purchase Commitments with Suppliers
          The Company generally issues purchase orders to its suppliers with delivery dates from four to six weeks from the purchase order date. In addition, the Company regularly provides significant suppliers with rolling six-month forecasts of material and finished goods requirements for planning and long-lead time parts procurement purposes only. The Company is committed to accepting delivery of materials pursuant to its purchase orders subject to various contract provisions that allow it to delay receipt of such order or allow it to cancel orders beyond certain agreed lead times. Such cancellations may or may not include cancellation costs payable by the Company. In the past, the Company has been required to take delivery of materials from its suppliers that were in excess of its requirements and the Company has previously recognized charges and expenses related to such excess material. During the second quarter of fiscal 2012 we accrued a charge of $380,000 relating to such excess material relating to purchase commitments made to support the Targus business.
          If the Company is unable to adequately manage its suppliers and adjust such commitments for changes in demand, it may incur additional inventory expenses related to excess and obsolete inventory. Such expenses could have a material adverse effect on the Company’s business, results of operations, and financial position.
Executive Severance Commitments
          The Company has severance compensation agreements with certain key executives. These agreements require the Company to pay these executives, in the event of certain terminations of employment following a change of control of the Company, up to the amount of their then current annual base salary and the amount of any bonus amount the executive would have achieved for the year in which the termination occurs plus the acceleration of unvested options. The exact amount of this contingent obligation is not known and accordingly has not been recorded in the unaudited interim condensed consolidated financial statements.
Letter of Credit
          During the first quarter of fiscal 2010, the Company obtained a $77,000 letter of credit from SVB to allow for continuous and unlapsed compliance with a lease provision for the Company’s corporate offices. The letter of credit expires on October 26, 2011.
Legal Contingencies
          On April 26, 2011, Chicony, the contract manufacturer of the Bronx product that is the subject of the Recall, filed a complaint against the Company for breach of contract seeking payment of $1.2 million for the alleged non-payment by us of products manufactured by Chicony. The Company denies liability and filed a cross-complaint on May 13, 2011 seeking the recovery of damages of $4.9 million caused by Chicony’s failure to adhere to our technical specifications when manufacturing the Bronx product, which the Company believes resulted in the Recall of the product. The outcome of this matter is not determinable as of the date of the filing of this report.
          In addition to the pending matter described above, the Company is, from time to time, involved in various legal proceedings incidental to the conduct of its business. The Company believes that the outcome of all such legal

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COMARCO, INC. AND SUBSIDIARY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
proceedings will not, in the aggregate, have a material adverse effect on its consolidated results of operations and financial position.
12. Subsequent Events
          Management has evaluated events subsequent to July 31, 2011 through the date that the accompanying condensed consolidated financial statements were filed with the Securities and Exchange Commission for transactions and other events which may require adjustment of and/or disclosure in such financial statements.
          On August 5, 2011 Targus and Comarco entered into a Release and Settlement Agreement (the “Settlement Agreement”) with respect to all matters concerning the Recall. In the third quarter, as part of the Settlement Agreement, Targus paid Comarco $290,000 which represents a refund of amounts withheld from payment in the first quarter of fiscal 2012 and charged to cost of revenue. During the third quarter Comarco will record the payment recived from Targus and it will reduce previously recorded accruals for the Recall to the extent the refund represents amounts in excess of Recall warranty costs.
          On August 15, 2011, the Board of Directors terminated the employment of Fredrik Torstensson as interim President and Chief Executive Officer and simultaneously appointed Thomas W. Lanni as President and Chief Executive Officer. The Board of Directors also elected Mr. Lanni as a Director.
          On August 17, 2011, Comarco entered into a Settlement Agreement with a supplier to settle commitments made through Comarco purchase orders that had been placed for Manhattan product that was intended to be sold to Targus. Comarco accrued $380,000 to cost of revenue during the second quarter which represents the amount that was unpaid as of July 31, 2011.
          On September 9, 2011 the Company entered into a Settlement and Amended Cross-License Agreement (the “Agreement”) with iGo, Inc. (formerly Mobility Electronics, Inc.) (“iGo”). The Agreement fully settles previous litigation relating to various patent infringement causes of action that was dismissed without prejudice on May 26, 2009. Additionally the Agreement amends the Compromise Settlement Agreement and Release entered into by the parties on July 12, 2003.

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ITEM 2.   MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
          The following discussion and analysis should be read in conjunction with our unaudited interim condensed consolidated financial statements and the related notes and other financial information appearing elsewhere in this quarterly report on Form 10-Q.
Forward-Looking Statements
          This report, including the following discussion and analysis, contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Words such as “expects,” “anticipates,” “intends,” “plans,” “believes,” “seeks,” and “estimates,” and similar expressions or variations of such words are intended to identify forward-looking statements, but are not deemed to represent an all-inclusive means of identifying forward-looking statements included in this report. Additionally, statements concerning future matters are forward-looking statements.
          These forward-looking statements reflect current views about our plans, strategies, and prospects, but are only based on facts and factors known by us as of the date of this report. Consequently, forward-looking statements are inherently subject to risks and uncertainties, and actual results and outcomes may differ materially from the results and outcomes discussed in or anticipated by the forward-looking statements.
          Forward-looking statements in this report include those related to our objectives; our products and the availability of future products; our sales, revenues, and costs; the timing of fulfillment of purchase orders and completion of projects; demand for our products; and the sufficiency of our cash and cash equivalent balances. Many important factors may cause the Company’s actual results to differ materially from those discussed in any such forward-looking statements, including but not limited to the impact of general economic and retail uncertainty and perceived or actual weakening of economic conditions on customers’ and prospective customers’ spending on our products; quarterly and seasonal fluctuations in our revenue or other operating results; fluctuations in the demand for our products and the fact that a significant portion of our revenue is derived from a limited number of customers; unexpected difficulties and delays associated with our efforts to obtain cost reductions and achieve higher sales volumes for our ChargeSource® products; failure to accurately forecast customer demand and the risk that our customers may cancel their orders, change production quantities or delay production; the fact that our products are complex and have short life cycles and the average selling prices of our products will likely decrease over their sales cycles; disruptions in our relationships with our suppliers; failure to meet financial expectations of analysts and investors, including failure from significant reductions in demand from earlier anticipated levels; risks related to market acceptance of our products and our ability to meet contractual and technical commitments with our customers; activities by us and others regarding protection of intellectual property; competitors’ release of competitive products and other actions; and costs and potential adverse determinations arising out of adverse proceedings or litigation. Although we believe that the assumptions underlying the forward-looking statements are reasonable, any of the assumptions could prove inaccurate and, therefore, we cannot assure that the results contemplated in forward-looking statements will be realized in the timeframe anticipated or at all. In light of the significant uncertainties inherent in the forward-looking information included herein, the inclusion of such information should not be regarded as a representation by us or any other person that our objectives or plans will be achieved. Accordingly, investors are cautioned not to place undue reliance on our forward-looking statements. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law.
          In addition to the risks, uncertainties, and other factors discussed elsewhere in this quarterly report on Form 10-Q, the risks, uncertainties, and other factors that could cause or contribute to actual results differing materially from those expressed or implied in any forward-looking statements include, without limitation, those set forth under Part I, Item 1A “Risk Factors” in the Company’s Annual Report on Form 10-K for the fiscal year ended January 31, 2011 filed with the SEC, those contained in the Company’s other filings with the SEC, and those set forth above.

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Basis of Presentation
          The financial information presented in this report is not audited and is not necessarily indicative of our future consolidated financial position, results of operations, or cash flow. Our fiscal year ends on January 31 and our fiscal quarters end on April 30, July 31, and October 31. Unless otherwise stated, all dates refer to our fiscal year and fiscal periods.
Executive Summary
          Comarco, Inc., through its wholly-owned subsidiary Comarco Wireless Technologies, Inc. (collectively, “we,” “Comarco,” or the “Company”), is a leading developer and designer of mobile power adapters used to simultaneously power and charge notebook computers, cellular telephones, BlackBerry® smartphones, iPods®, and other portable, rechargeable handheld devices. Our operations consist solely of the operations of Comarco Wireless Technologies, Inc. (“CWT”).
          In addition to the risks, uncertainties and factors discussed elsewhere in this quarterly report on Form 10-Q and in the Company’s other filings with the SEC, management currently considers the following additional trends, events, and uncertainties to be important to understanding our results of operations for the quarter ended July 31, 2011:
    On August 5, 2011, the Company and Targus entered into a Release and Settlement Agreement (the “Settlement Agreement”) with respect to all matters concerning the previously announced Recall. In the third quarter, as part of the Settlement Agreement, Targus paid Comarco approximately $290,000 which represents a refund of previous amounts withheld from payment in the first quarter of fiscal 2012. The Company believes that it has accrued and paid for substantially all of its material financial obligations with respect to the Recall.
 
    On August 3, 2011, the Company received a letter from Silicon Valley Bank (“SVB”) indicating that an event of default had occurred under the Loan and Security Agreement entered into by and between the Company and SVB on February 11, 2009 (as amended, the “Loan Agreement”). The event of default relates to the Company’s failure to meet the minimum quick ratio financial covenant of “1.25 to 1.00” for each of the periods ending February 28, 2011, March 31, 2011, April 30, 2011, May 31, 2011 and June 30, 2011. The Company’s ability to borrow under the Loan Agreement may continue to be suspended based upon our failure to comply with the quick ratio covenant in the future. Although the Company is currently seeking other forms of financing, we cannot be certain we will be able to secure additional financing on terms acceptable to us, or at all.
 
    On January 25, 2011, the Company received written notification from Targus Group International, Inc. (“Targus”) of its non-renewal of the Strategic Product Development and Supply Agreement (the “Targus Agreement”). Although Targus confirmed its desire to continue a business relationship with Comarco in its written notification, the nature of our future business relationship remains unclear. At this time, future sales to Targus are uncertain. Sales to Targus accounted for approximately 79 percent of our revenue for the second quarter of fiscal 2011.
 
    Revenue for the second quarter of fiscal 2012 decreased to $1.9 million compared to $12.8 million for the second quarter of fiscal 2011. The decrease is primarily attributable to the loss of sales to Targus.
 
    On June 30, 2009, we announced that we were selected by Dell Inc. to provide an innovative 90 watt DC adapter for use in automobiles and airplanes. We began shipping this product in the latter part of May 2010 and revenue from sales to Dell totaled $0.4 million during the first quarter of fiscal 2012.
 
    We are focused on preserving our cash balances by monitoring expenses, identifying costs savings, and investing only in those development programs and products that we believe will most likely contribute to our profitability.

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Critical Accounting Policies
          Management’s Discussion and Analysis of Financial Condition and Results of Operations is based upon our unaudited interim condensed consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these unaudited interim condensed consolidated financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, and expenses, and related disclosure of contingent assets and liabilities. Management bases its estimates on historical experience and on various other assumptions that it believes to be reasonable under the circumstances. The results of these estimates form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ materially from our estimates.
          An accounting policy is deemed to be critical if it requires an accounting estimate to be made based on assumptions about matters that are highly uncertain at the time the estimate is made, and if different estimates that reasonably could have been used or changes in the accounting estimate that are reasonably likely to occur could materially change the financial statements. Management believes there have been no significant changes during the three and six months ended July 31, 2011 to the items that we disclosed as our critical accounting policies and estimates in Management’s Discussion and Analysis of Financial Condition and Results of Operations in our annual report on Form 10-K for the fiscal year ended January 31, 2011.
Results of Operations — Continuing Operations
Revenue
(in thousands except % change)
                                                 
    Three Months Ended     Six Months Ended     Year over Year  
    July 31,     July 31,     % Change  
    2011     2010     2011     2010     Three Months     Six Months  
Revenue
  $ 1,926     $ 12,783     $ 4,876     $ 20,297       (85 %)     (76 %)
 
                                       
Operating income (loss)
  $ (1,895 )   $ 42     $ (3,169 )   $ (665 )                
 
                                       
Net income (loss) from continuing operations
  $ (1,908 )   $ 19     $ (3,173 )   $ (707 )                
 
                                       
Revenue by Region
(in thousands except % change)
                                                 
    Three Months Ended     Six Months Ended     Year over Year  
    July 31,     July 31,     % Change  
    2011     2010     2011     2010     Three Months     Six Months  
Revenue:
                                               
North America
  $ 303     $ 10,331     $ 1,715     $ 15,929       (97 %)     (89 %)
Europe
    4       19       14       73       (79 %)     (81 %)
Asia
    1,619       2,433       3,147       4,295       (33 %)     (27 %)
 
                                   
 
  $ 1,926     $ 12,783     $ 4,876     $ 20,297                  
 
                                       

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Revenue by Customer
(in thousands except % change)
                                                                                 
    Three Months Ended     Six Months Ended     Year over Year  
    July 31,     July 31,     % Change  
    2011     2010     2011     2010     Three Months     Six Months  
            % of             % of             % of             % of                  
            Revenue             Revenue             Revenue             Revenue                  
Revenue:
                                                                               
Dell
    314       16 %     278       2 %     685       14 %     278       1 %     13 %     146 %
Lenovo
    1,593       83 %     2,446       19 %     2,947       61 %     4,251       21 %     (35 %)     (31 %)
Targus
                10,016       79 %     1,174       24 %     15,654       77 %     (100 %)     (93 %)
Other
    19       1 %     43             70       1 %     114       1 %     (56 %)     (38 %)
 
                                                           
 
  $ 1,926       100 %   $ 12,783       100 %   $ 4,876       100 %   $ 20,297       100 %     (85 %)     (76 %)
 
                                                           
          Revenue for the three and six months ended July 31, 2011 decreased by $10.9 million, or 85 percent, and $15.4 million, or 76 percent, respectively, compared to the corresponding periods of fiscal 2011. The decrease is attributable to the loss of Targus as a customer during fiscal 2012. As previously discussed, on January 25, 2011, we received written notification from Targus of its non-renewal of the Strategic Product Development and Supply Agreement. Additionally, revenue to Lenovo decreased during the three and six months ended July 31, 2011 compared to the corresponding periods of the prior fiscal year. The decrease was due, primarily, to a drop in Lenovo’s business customer demand. Finally, during the second quarter of fiscal 2011, we began shipments of a 90-watt auto-air DC adapter to Dell.

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Cost of Revenue and Gross Margin
(in thousands except
margin and % change)
                                                                                 
    Three Months Ended     Six Months Ended     Year over Year  
    July 31,     July 31,     % Change  
    2011     2010     2011     2010     Three Months     Six Months  
            % of             % of             % of             % of                  
            Total             Total             Total             Total                  
Cost of revenue:
                                                                               
Product cost
  $ 1,187       53 %   $ 9,001       85 %   $ 2,667       53 %   $ 14,003       85 %     (87 %)     (81 %)
Accrued product recall costs
                            350       7 %                        
Supplier Settlement
    383       17 %                 383       8 %                        
Fixed supply chain overhead
    608       27 %     943       9 %     1,031       21 %     1,739       10 %     (36 %)     (41 %)
Inventory reserve and scrap charges
    54       3 %     109       1 %     575       11 %     109       1 %     (50 %)     428 %
Freight, expedite, and other charges
                592       5 %                 706       4 %     (100 %)     (100 %)
 
                                                           
 
  $ 2,232       100 %   $ 10,645       100 %   $ 5,006       100 %   $ 16,557       100 %     (79 %)     (70 %)
 
                                                           
                                                 
    Three Months Ended   Six Months Ended   Year over Year
    July 31,   July 31,   ppt Change
    2011   2010   2011   2010   Three Months   Six Months
Gross margin (loss)
    (16 %)     17 %     (3 %)     18 %     (33 )     (21 )
          Cost of revenue for the three and six months ended July 31, 2011 decreased by $8.4 million, or 79 percent, and $11.6 million, or 70 percent, respectively, compared to the corresponding periods of fiscal 2011. These decreases are primarily attributable to the decreases in sales for the three and six months ended July 31, 2011 compared to the comparable prior year periods. During the six months ended July 31, 2011, we recorded an additional accrual of $350,000 for our product Recall. No similar costs were incurred in the comparable periods of the prior fiscal year. During the three and six months ended July 31, 2011, our fixed supply chain overhead costs decreased by $0.3 million and $0.7 million or 36 percent and 41 percent, respectively, when compared to the fixed supply chain overhead costs in the comparable prior year periods. These decreases are a result of measures taken late in the third quarter of fiscal 2011 to reduce personnel and other costs across all departments. Additionally, during the three months ended July 31, 2011 we accrued a charge of $380,000 relating to a settlement reached with a supplier relating to purchase commitments made to support the Targus business. There are no similar charges in the comparable prior year periods. During the first quarter of fiscal 2012 we incurred scrap charges of $0.5 million relating to Manhattan product components that we procured from a supplier during the first quarter of fiscal 2012. The Manhattan product was previously sold to Targus and we have reserved for those components that can only be used in that product. We did not incur any similar charges during the comparable periods of fiscal 2011. During the three and six months ended July 31, 2011 we incurred freight expedite and other charges of $0.6 million and $0.7 million, respectively. These costs were incurred to expedite delivery of Manhattan units to Targus. We had no similar costs in the corresponding periods of the current year.

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Operating Costs and Expenses
(in thousands except % change)
                                                                                 
    Three Months Ended     Six Months Ended        
    July 31,     July 31,     Year over Year % Change  
    2011     2010     2011     2010     Three Months     Six Months  
            % of             % of             % of             % of                  
            Revenue             Revenue             Revenue             Revenue                  
Operating expenses:
                                                                               
SG&A expenses, excluding corporate overhead
  $ 289       15 %   $ 258       2 %   $ 462       9 %   $ 662       3 %     12 %     (30 %)
Corporate overhead
    825       43 %     952       7 %     1,603       33 %     1,955       10 %     (13 %)     (18 %)
Engineering and support expenses
    475       25 %     886       7 %     974       20 %     1,788       9 %     (46 %)     (46 %)
 
                                                           
 
  $ 1,589       83 %   $ 2,096       16 %   $ 3,039       62 %   $ 4,405       22 %     (24 %)     (31 %)
 
                                                           
          Selling, general, and administrative expenses for the three months ended July 31, 2011 increased $30,000, or 12 percent compared to the corresponding periods of fiscal 2011. The sales and marketing department experienced a recovery of bad debt expense of $88,000 in the second quarter of fiscal 2011 and had no similar recovery in the second quarter of the current fiscal year. Selling, general, and administrative expenses for the six months ended July 31, 2011 decreased $0.2 million, primarily due to a reduction in personnel costs.
          Corporate overhead consists of salaries and other personnel-related expenses of our accounting and finance, human resources and benefits, and other administrative personnel, as well as professional fees, directors’ fees, and other costs and expenses attributable to being a public company. Corporate overhead decreased $0.1 million and $0.4 million for the three and six months ended July 31, 2011, respectively when compared to the corresponding periods of the prior fiscal year. The decreases in the current year relate primarily to a reduction in personnel costs. Offsetting these decreases is an accrual for approximately $0.2 million related to an employee termination matter.
          Engineering and support expenses generally consist of salaries, employer paid benefits, and other personnel related costs of our design engineers and testing and support personnel, as well as facility and IT costs, professional and consulting fees, lab costs, material usages, and travel and related costs incurred in the development and support of our products. Engineering and support expenses for the three and six months ended July 31, 2011 decreased $0.4 million, or 46 percent, and $0.8 million, or 46 percent, respectively. The decreases in the current year relate primarily to a reduction in personnel costs. Additionally we experienced decreased material usage, lab fees and testing and certification fees which varies with the timing of new product development for our retail and OEM accessories channels. Additionally, legal fees decreased $0.2 million for the six months ended July 31, 2011 compared to the same period of the prior fiscal year primarily due to fees incurred in the prior fiscal year in support of an employment dispute with a former employee that was resolved.
Other Income (loss), net
          Other income (loss), net, consists primarily of interest income earned on invested cash balances offset by interest expense related to our credit facility. For the three and six months ended July 31, 2011, interest income was negligible. Interest income earned on invested cash balances for the three and six months ended July 31, 2010 totaled $5,000 and $14,000, respectively. Interest expense and loan fee expenses related to our credit facility totaled $13,000 and $38,000 for the three and six months ended July 31, 2011. During the three and six months ended July 31, 2010 we incurred $28,000 and $56,000, respectively in interest expense and amortization of loan fees related to our credit facility. The current year decrease in interest income is due to decreased invested cash balances and decreased interest rates earned on invested cash balances.

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Income Tax Benefit
          Significant management judgment is required in determining our provision for income taxes, our deferred tax assets and liabilities, and any required valuation allowance. The Company continues to have a fully valued deferred tax asset. This valuation allowance was previously established based on management’s overall assessment of risks and uncertainties related to our future ability to realize, and hence, utilize certain deferred tax assets, primarily consisting of net operating losses and carry forward temporary differences. Due to the losses incurred during the first six months of fiscal 2012, the adjusted net deferred tax assets remain fully reserved as of July 31, 2011.
Discontinued Operations — Wireless Test Solutions (“WTS”)
Income (loss) from Discontinued Operations
(in thousands)
                                 
    Three Months Ended     Six Months Ended  
    July 31,     July 31,  
    2011     2010     2011     2010  
Gain on sale, net of income taxes of $0
  $     $     $     $  
Loss from discontinued operations, before taxes
    (21 )     (594 )     (21 )     (601 )
Income tax expense
                       
 
                       
Loss from discontinued operations
  $ (21 )   $ (594 )   $ (21 )   $ (601 )
 
                       
          The fiscal 2012 year to date loss from WTS discontinued operations of $21,000 relates to a sales tax audit performed by the California State Board of Equalization during the second quarter of fiscal 2012. The expensed amount represents the portion of the assessment that is to be borne by Comarco for the sale of the WTS business to Ascom.
          The fiscal 2011 year to date loss from WTS discontinued operations of $601,000 relates to a settlement with a former officer and employee of the WTS business, whereby Comarco agreed to pay the former employee $508,000 which amount included reimbursement for attorney and professional fees. The remaining loss relates primarily to Comarco’s legal fees incurred relating to the matter.
Liquidity and Capital Resources
          Cash and cash equivalents at July 31, 2011 decreased $4.8 million to $1.6 million as compared to $6.4 million at January 31, 2011. The following table is a summary of our Condensed Consolidated Statements of Cash Flows.
                 
    Six Months Ended July 31,  
    2011     2010  
    (in thousands)  
Cash used in:
               
Operating activities
  $ (3,724 )   $ (4,338 )
Investing activities
    (48 )     (240 )
Financing activities
    (1,053 )     (56 )

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Operating Activities
          Cash used in operating activities was $3.7 million for the six months ended July 31, 2011 and was driven by our net loss from continuing operations of $3.2 million. On a combined basis, our accounts payable and accrued liabilities decreased $2.0 million during the six months ended July 31, 2011. Offsetting these uses of cash, we collected a net $1.5 million in accounts receivable.
          Cash used in operating activities was $4.3 million for the six months ended July 31, 2010 and was driven by our net loss from continuing operations of $0.7 million offset by non-cash depreciation of $0.4 million. Additionally our accounts receivable and inventory balances increased by $3.7 million and $0.2 million, during the six months ended July 31, 2010, respectively, primarily as a result of increased sales volumes.
Investing Activities
          During the six months ended July 31, 2011, we purchased $48,000 of property and equipment, which was primarily tooling and equipment used for the manufacture of our ChargeSource® products.
          During the six months ended July 31, 2010, we purchased $0.2 million of property and equipment, primarily tooling and equipment used for the manufacture of our ChargeSource® products.
Financing Activities
          On February 11, 2009, the Company entered into a Loan and Security Agreement (the “Loan Agreement”) with Silicon Valley Bank (“SVB”). The Loan Agreement was renewed on February 8, 2010 and again on February 9, 2011 and matures, on February 9, 2012, at which time, any outstanding principal balance is payable in full.
          During the six months ended July 31, 2011 we repaid our line of credit of $1.0 million and we incurred $53,000 in loan origination fees relating to the renewal of the Loan Agreement with SVB.
          During the six months ended July 31, 2010 we incurred $56,000 in loan origination fees relating to the renewal of the Loan Agreement with SVB.
          On August 3, 2011 we received a letter from SVB indicating that the Company’s failure to meet the minimum quick ratio of 1.25 to 1.00 for each of the periods ended February 28, 2011, March 31, 2011, April 30, 201l, May 31, 2011 and June 30, 2011 constituted an event of default under the Loan Agreement.
          As of the date of this filing, we have no borrowings outstanding under the Loan Agreement and the Company’s ability to borrow under the Loan Agreement may continue to be limited or unavailable based upon our failure to comply with the quick ratio covenant in the future. The Company is currently seeking other forms of financing, however, we cannot be certain we will be able to secure additional financing on terms acceptable to us, or at all.
Future Operations and Liquidity Requirements for the Next 12 Months
          As of July 31, 2011 we had working capital of approximately $0.6 million. In order for us to conduct our business for the next twelve months and to continue operations thereafter and be able to discharge our liabilities and commitments in the normal course of business, we must increase sales, reduce operating expenses, and potentially raise additional funds, through either debt and/or equity financing to meet our working capital needs. Although the Company is currently seeking other forms of financing, we cannot be certain we will be able to secure additional financing on terms acceptable to us, or at all.
          These uncertainties raise substantial doubt about our ability to continue as a going concern. If we become unable to continue as a going concern, we may have to liquidate our assets, and might realize significantly less than the values at which they are carried on our financial statements, and stockholders may lose all or part of their investment in our common stock. The consolidated financial statements do not reflect any adjustments related to the outcome of this uncertainty.

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          As discussed above, there are several factors and events that could significantly affect our cash flows from operations, including, without limitation the following:
    The ability of our contract manufacturers of our ChargeSource® products to manufacture our products at the level currently anticipated, and the ability of our ChargeSource® products to meet any required specifications.
 
    The timing of the development, delivery or release of our ChargeSource® products.
 
    Our ability to execute our current strategy of direct sales of our products to consumers.
 
    Our ability to raise additional funds, through either debt and/or equity financing.
          We are currently focused on preserving our cash balances by monitoring expenses, identifying cost savings, and investing only in those development programs and products that we believe will most likely contribute to our potential future profitability. As we execute on our current strategy, however, we may require further debt and/or equity capital to fund our working capital needs. In particular, we have experienced, and anticipate that we may experience a negative operating cash flow in the future. We may attempt to raise additional funds through public or private debt or equity financings if such financings become available on acceptable terms. We cannot be certain that any additional financing we may need will be available on terms acceptable to us, or at all. If adequate funds are not available or are not available on acceptable terms, we may not be able to take advantage of opportunities, develop new products or otherwise respond to competitive pressures, and our operating results and financial condition could be adversely affected.

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ITEM 3.   QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are not required to provide disclosure in response to Part 1: Item 3 of Form 10-Q because we are considered to be a “smaller reporting company.”
ITEM 4.   CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
          “Disclosure controls and procedures” are the controls and other procedures of an issuer that are designed to ensure that information required to be disclosed by the issuer in the reports filed or submitted by it under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), is recorded, processed, summarized, and reported within the time periods specified in the rules and forms of the SEC. “Disclosure controls and procedures” include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in its Exchange Act reports is accumulated and communicated to the issuer’s management, including its principal executive and financial officers, as appropriate, to allow timely decisions regarding required disclosure.
          Under the direction and participation of our management, including our Principal Executive Officer and Principal Financial Officer, we evaluated the effectiveness of our disclosure controls and procedures as of July 31, 2011, the end of the period covered by this quarterly report on Form 10-Q. Based upon that evaluation, our Principal Executive Officer and Principal Financial Officer concluded that our disclosure controls and procedures were not effective as of the end of the period covered by this quarterly report on Form 10-Q due to changes in internal control identified below. Notwithstanding the foregoing, a control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that it will detect or uncover failures within the Company to disclose material information otherwise required to be set forth in the Company’s periodic reports.
Changes in Internal Control Over Financial Reporting
          “Internal control over financial reporting” is a process designed by, or under the supervision of, the issuer’s principal executive and financial officers, and effected by the issuer’s board of directors, management, and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles and includes those policies and procedures that:
  (1)   pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the issuer;
 
  (2)   provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the issuer are being made only in accordance with authorizations of management and directors of the issuer; and
 
  (3)   provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the issuer’s assets that could have a material effect on the financial statements.
          Our management has concluded that, as of July 31, 2011, our internal control over financial reporting is not effective in providing reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with United States generally accepted accounting principles. Our management’s finding of ineffective internal control over financial reporting results primarily from the fact that during the second quarter and thereafter the Company’s finance department has too few employees to have adequate segregation of duties necessary for an appropriate system of internal controls.

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     While the lack of effective internal control over financial reporting during the fiscal quarter ended July 31, 2011 did not result in any particular deficiency in our financial reporting for the fiscal quarter ended July 31, 2011, management believes that the lack of effectiveness of our internal control over financial reporting could result in a failure to provide reliable financial reporting in the future. In order to remedy our existing internal control deficiency, we will need to either (1) raise additional capital or improve our working capital position to allow us to hire additional accounting staff, or (2) successfully train our existing staff to take on additional responsibilities that will assist us in creating an effective system of internal controls over financial reporting.
PART II — OTHER INFORMATION
ITEM 1.   LEGAL PROCEEDINGS
Chicony Power Technology Co. Ltd. (“Chicony”) vs. Comarco, Inc., Case No. 30-2011 Superior Court of California. On April 26, 2011, Chicony, the contract manufacturer of the Bronx product that is the subject of the Recall, filed a complaint against the Company for breach of contract seeking payment of $1.2 million for the alleged non-payment by us of products manufactured by Chicony. The Company denies liability and filed a cross-complaint on May 13, 2011 seeking the recovery of damages of $4.9 million caused by Chicony’s failure to adhere to our technical specifications when manufacturing the Bronx product, which the Company believes resulted in the Recall of the product. The outcome of this matter is not determinable nor estimable as of the date of the filing of this report on Form 10-Q.
     In addition to the matter described above, 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 such pending legal proceedings will not in the aggregate have a material adverse effect on our consolidated results of operations or financial condition.
ITEM 1A.   RISK FACTORS
     Our business, financial condition and operations are subject to a number of factors, risks and uncertainties, including those previously disclosed under Part I. Item 1A “Risk Factors” of our annual report on Form 10-K for the fiscal year ended January 31, 2011 as well as any amendments thereto or additions and changes thereto contained in this quarterly report on Form 10-Q and any subsequent filings of quarterly reports on Form 10-Q. The disclosures in our annual report on Form 10-K, this quarterly report on Form 10-Q and our subsequent reports and filings are not necessarily a definitive list of all factors that may affect our business, financial condition and future results of operations. There have been no material changes to the risk factors as disclosed in our annual report on Form 10-K for the fiscal year ended January 31, 2011.
ITEM 6. EXHIBITS
     
31.1
  Certification of Principal Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
 
   
31.2
  Certification of Principal Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
 
   
32.1
  Certification of Principal Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
 
   
32.2
  Certification of Principal Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
 
   
101.INS**
  XBRL Instance Document
 
   
101.SCH**
  XBRL Taxonomy Extension Schema Document
 
   
101.CAL**
  XBRL Taxonomy Extension Calculation Linkbase Document
 
   
101.LAB**
  XBRL Taxonomy Extension Label Linkbase Document
 
   
101.PRE**
  XBRL Taxonomy Extension Presentation Linkbase Document
 
     
** XBRL (Extensible Business Reporting Language) information is furnished and filed or a part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, is deemed not filed for purposes of Section 18 of the Securities Exchange Act of 1934, and otherwise is not subject to liability under these sections.

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SIGNATURES
     Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.
         
  COMARCO, INC.
 
 
Date: September 14, 2011  /s/ THOMAS W. LANNI    
  Thomas W. Lanni   
  President and Chief Executive Officer
(Principal Executive Officer) 
 
 
     
Date: September 14, 2011  /s/ ALISHA K. CHARLTON    
  Alisha K. Charlton   
  Vice President and Chief Accounting Officer (Principal Financial and Accounting Officer)   

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EXHIBIT INDEX
Exhibit Description
     
31.1
  Certification of Principal Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
 
   
31.2
  Certification of Principal Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
 
   
32.1
  Certification of Principal Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
 
   
32.2
  Certification of Principal Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
 
   
101.INS**
  XBRL Instance Document
 
   
101.SCH**
  XBRL Taxonomy Extension Schema Document
 
   
101.CAL**
  XBRL Taxonomy Extension Calculation Linkbase Document
 
   
101.LAB**
  XBRL Taxonomy Extension Label Linkbase Document
 
   
101.PRE**
  XBRL Taxonomy Extension Presentation Linkbase Document
 
     
** XBRL (Extensible Business Reporting Language) information is furnished and filed or a part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, is deemed not filed for purposes of Section 18 of the Securities Exchange Act of 1934, and otherwise is not subject to liability under these sections.

29