| COMARCO INC ITEM 1A RISK FACTORS A significant portion of our revenue is derived from the sale of our WTS products to customers in the wireless communications industry, which has experienced a significant downturn during the past several years |
| If the wireless communications industry does not continue to improve, our operating results and financial condition could suffer |
| Revenue from the sale of our WTS products accounted for 52 percent of our total revenue in fiscal 2006 |
| Wireless carriers are the primary customers for our WTS products |
| These customers operate in an environment driven by new technology, increased competition, and regulatory change |
| To compete effectively, the wireless carriers must offer their subscribers lower prices, improved quality of service, and innovative new services |
| Increasing minutes of use, global subscribers, and data-intensive applications are driving higher capacity utilization of existing networks, requiring wireless carriers around the globe to place a greater emphasis on capital expenditures devoted to their wireless networks |
| We continue to believe that wireless carriers are allocating increasing levels of capital resources to meet consumer demands |
| If wireless carriers reduce their capital investments in wireless infrastructure and related test tools offered by our WTS business, our operating results and financial condition may be adversely affected |
| A significant portion of our revenue is derived from the sale and maintenance of emergency call box systems to governmental customers that have experienced severe budgetary constraints in the recent past |
| If current and planned projects to install or upgrade call box systems are delayed, our operating results and financial condition could suffer |
| Revenue from the sale and maintenance of our emergency call box systems and upgrades accounted for 21 percent of our revenues in fiscal 2006 |
| Approximately 76prca of our call box revenue is derived from state and local governmental agencies in California, which prior to fiscal 2005, were experiencing severe budgetary constraints |
| If these adverse budgetary conditions recur, we expect significant reductions in spending by our governmental customers, which would likely adversely affect our operating results and financial condition |
| Failure to adjust our operations due to changing market conditions or failure to accurately estimate demand for our products could adversely affect our operating results |
| During the past several years, the spending patterns of many of our WTS customers have been volatile and unpredictable |
| In addition, consumer demand for our ChargeSource mobile power products has been subject to 7 ______________________________________________________________________ [33]Table of Contents fluctuations as a result of our choices of distribution partners, market acceptance of our recently released products, the timing and size of customer orders, and consumer demand for rechargeable mobile electronic devices |
| Accordingly, it has been difficult for us to forecast the demand for these products |
| We also are limited in our ability to quickly adapt our manufacturing and related cost structures because a significant portion of our sales and marketing, design and other engineering, and manufacturing costs are fixed |
| If customer demand for our WTS and call box products declines or if we otherwise fail to accurately forecast reduced customer demand, we will likely experience excess capacity, which could adversely affect our operating results |
| Conversely, if market conditions improve, our manufacturing capacity may not be adequate to fill increased customer demand |
| As a result, we might not be able to fulfill customer orders in a timely manner, which could adversely affect our customer relationships and operating results |
| The WTS and ChargeSource products we make are complex and have short life cycles |
| If we are unable to rapidly and successfully develop and introduce new products, some of our products may become obsolete and our operating results could suffer |
| The wireless communications and consumer electronics industries are characterized by rapid technological changes, frequent new product introductions and evolving industry standards |
| Additionally, our ChargeSource mobile power products have short life cycles, and may become obsolete over relatively short periods of time |
| Our future success depends on our ability to develop, introduce, and deliver on a timely basis and in sufficient quantity new products, components, and enhancements |
| The success of any new product offering will depend on several factors, including our ability to: • Properly identify customer needs and technological trends; • Timely develop new technologies and applications; • Price our products and services competitively; • Timely manufacture and deliver our products in sufficient volume, and • Differentiate our products from those of our competitors |
| Development of new products requires high levels of innovation from both our engineers and our component suppliers |
| Development of a new product often requires a substantial investment before we can determine the commercial viability of the product |
| If we dedicate a significant amount of resources to the development of products that do not achieve broad market acceptance, our operating results may suffer |
| Our operating results may also be adversely affected due to the timing of product introductions by competitors, especially when a competitor introduces a new product before our own comparable product is ready to be introduced |
| The wireless communications and consumer electronics industries are highly competitive, and our profitability will be adversely affected if we are not able to compete effectively |
| The wireless communications and consumer electronics industries in which we sell our products are highly competitive in many areas, including the timing of development and introduction of new products, technology, price, quality, and customer service and support |
| Our competitors range from some of the respective industries’ largest corporations to many relatively small and highly specialized firms |
| Many of our competitors possess advantages over us, including greater financial and marketing resources, greater name recognition and larger and more established customer and supplier relationships |
| Our competitors also may be able to respond more quickly to new or emerging technologies and changes in customer needs |
| If we do not have the resources or expertise or otherwise fail to develop successful strategies to address these competitive disadvantages, we could lose customers causing our revenue to decline |
| 8 ______________________________________________________________________ [34]Table of Contents The average selling prices of our products may decrease over their sales cycles, especially upon the introduction of new products, which may negatively affect our revenue and operating results |
| Our products may experience a reduction in the average selling prices over their respective sales cycles |
| Further, as we introduce new or next-generation products, sales prices of legacy products may decline substantially |
| In order to sell products that have a falling average selling price and maintain margins at the same time, we need to continually reduce product and manufacturing costs |
| There can be no assurances we will be successful in our efforts to reduce these costs |
| In order to do so, we must carefully manage the price paid for components used in our products, as well as manage our inventory costs to reduce overall product costs |
| If we are unable to reduce the cost of legacy products as new products are introduced, our average gross margins may decline and adversely affect our operating results |
| A significant portion of our revenue is dependent in part upon our relationships with our strategic distribution partners and their performance |
| If we are unable to successfully manage our relationships with the distributors of our mobile power products, our revenue and operating results could suffer |
| Our ChargeSource mobile power products are distributed by Kensington, a tier-one distributor of consumer electronics |
| Due to the terms of our agreement with Kensington, our direct access to certain significant distribution channels may be limited |
| Accordingly, our success will depend in part upon Kensington’s ability and willingness to effectively and widely distribute our ChargeSource products |
| If Kensington does not purchase the volume of products that we anticipate, our revenue and results of operations will suffer |
| During January 2006, we sold our 18 percent ownership interest in SwissQual to Spirent |
| See section entitled “Wireless Test Solutions” of Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations |
| ” We currently expect SwissQual to continue as our exclusive reseller in our European region until January 2007 |
| We are currently establishing a direct sales and support organization for the European region to replace SwissQual once the current reseller agreement expires |
| Additionally, we are exploring other potential strategic alliances that could enhance our technologies, positioning, and global footprint for sales and support |
| However, we are unsure as to what long term effect, if any, the sale of SwissQual to Spirent will have on SwissQual’s future sales of our products |
| Our success will depend in part upon our ability to replace SwissQual as the provider of sales and support services and upon our ability to compete with Spirent |
| A significant portion of our revenue is derived from a limited number of customers, and any loss of, cancellation or delay in purchases by these customers could cause a significant decrease in our revenue |
| We have historically derived a significant portion of our revenue from a limited number of customers |
| Our three key customers for fiscal 2006 accounted for dlra32dtta5 million or 69 percent of total revenue |
| SwissQual accounted for dlra8dtta8 million or 19 percent of total revenue |
| See section entitled “Wireless Test Solutions” of Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations |
| ” We currently expect SwissQual to continue as our exclusive reseller in our European region until January 2007 |
| However, we are unsure as to what long term effect, if any, the sale of SwissQual will have on SwissQual’s future sales of our products |
| Kensington, the distributor of our mobile power products, accounted for dlra11dtta8 million or 25 percent of total revenue |
| Our current distribution agreement with Kensington requires them to purchase minimum quantities from us during the term of the agreement; however, it is not assured that Kensington will be able to meet its purchase commitments, or meet or exceed our historical level of unit sales |
| If SwissQual, Kensington, or any of our other key customers reduces, cancels, or delays orders from us, and we are not able to develop other customers who purchase products at comparable levels, our revenue could decrease significantly |
| In addition any difficulty in collecting amounts due from one or more of our key customers would negatively impact our results of operations and financial condition |
| We expect that a limited number of customers will continue to represent a large percentage of our revenue |
| 9 ______________________________________________________________________ [35]Table of Contents We may experience quality or safety defects in our products that could cause us to institute product recalls, require us to provide replacement products and harm our reputation |
| Often product defects are identified during our design, development, and manufacturing processes, which we are able to correct timely |
| Sometimes, defects are identified after introduction and shipment of products |
| If we are unable to timely fix defects or adequately address quality control issues, our relationships with our customers may be impaired, our reputation may suffer and we may lose customers |
| Any of the foregoing could adversely affect our business and results of operations |
| Economic, political and other risks associated with our international sales and operations could adversely affect our results of operations |
| We currently maintain sales and support operations in the United States, China, Europe, and Latin America |
| Accordingly, our business is subject to worldwide economic and market conditions and risks generally associated with doing business abroad, such as fluctuating foreign currency exchange rates, weaknesses in the economic conditions in particular countries or regions, the stability of international monetary conditions, tariff and trade policies, domestic and foreign tax policies, foreign governmental regulations, political unrest and disruptions and delays in shipments |
| Specifically, our ChargeSource contract manufacturer and a majority of our component suppliers are located in Asia |
| We do business with our foreign supply base in US dollars |
| Our costs increase in countries with currencies that are increasing in value against the US dollar |
| Also, we cannot be sure that our international supply base will continue to accept orders denominated in US dollars |
| If they do not, our costs will become more directly subject to foreign exchange fluctuations |
| These factors, among others, could adversely affect our sales of products and services in international markets |
| Additionally, we have limited experience selling our products and services in markets outside our regions in the Americas and Europe |
| However, it is currently our intention to expand our international operations and establish additional sales and support offices in primary international markets |
| If our international sales efforts are not successful, our results of operations and financial condition could be negatively affected |
| Our failure to address laws and regulations governing our government contracts, could adversely affect our business and operating results |
| We depend on contracts with state and local governmental agencies for a significant portion of our revenue, and are subject to various laws and regulations that only apply to companies doing business with the government |
| For example, we supply call box products and provide system installation and long-term maintenance services to regional and municipal transit authorities and other governmental agencies |
| In fiscal 2006, we derived 18 percent of our revenue from contracts with these governmental customers |
| From time to time we are also subject to investigation for compliance with regulations governing our government contracts |
| Our failure to comply with any of these laws or regulations could result in suspension of these contracts, or subject us to administrative claims |
| Disruptions in our relationships with our suppliers or in our suppliers’ operations could result in shortages of necessary components and adversely affect our operations |
| We currently procure, and expect to continue to procure, certain components from single source manufacturers who provide unique component designs or who meet certain quality and performance requirements |
| In addition, we sometimes purchase customized components from single sources in order to take advantage of volume pricing discounts |
| In fiscal 2006, only the contract manufacturer of our ChargeSource products, which provided dlra4dtta5 million or 19 percent of all inventory purchases, provided more than 10 percent of total inventory purchases |
| 10 ______________________________________________________________________ [36]Table of Contents The performance of these suppliers is largely outside our control |
| In the past, we have experienced, and may continue to experience, shortages of important single source components |
| Our suppliers may fail to timely deliver components or provide components of sufficient quality |
| If this occurs, we may need to adjust both product designs and production schedules, which could result in delays in the production and delivery of products to our customers |
| These delays or defects could harm our reputation and impair our customer relationships |
| Third parties may claim that we are infringing their intellectual property, and we could suffer significant litigation, settlement or licensing costs and expenses or be prevented from selling certain products |
| Third parties have claimed, and may in the future claim, that we are infringing their intellectual property rights |
| These intellectual property infringement claims, whether we ultimately are found to be infringing any third party’s intellectual property rights or not, are time-consuming, costly to defend, and divert resources and management attention away from our operations |
| Infringement claims by third parties also could subject us to significant damage awards or fines or require us to pay large amounts to settle such claims |
| Additionally, claims of intellectual property infringement might require us to enter into royalty or license agreements |
| If we cannot or do not license the infringed technology on acceptable terms or substitute similar technology from other sources, we could be prevented from or restricted in selling our products containing, or manufactured with, the infringed technology |
| Third parties may infringe our intellectual property rights, and we may be required to spend significant resources enforcing these rights or otherwise suffer competitive injury |
| Our success depends in large part on our proprietary technology |
| We generally rely upon patent, copyright, trademark, and trade secret laws in the United States and in certain other countries, and rely on confidentiality agreements with our employees, customers, and partners to establish and maintain our intellectual proprietary rights in our proprietary technology |
| We are required to spend significant resources to monitor and enforce our intellectual property rights; however these rights might not necessarily provide us with a sufficient competitive advantage |
| Our intellectual proprietary rights could be challenged, invalidated, or circumvented by competitors or others |
| Our employees, customers or partners could breach our confidentiality agreements, for which we may not have an adequate remedy available |
| We also may not be able to timely detect the infringement of our intellectual property rights, which could harm our competitive position |
| Finally, the rapid pace of technological change in the wireless communications and consumer electronics industries could make certain of our key proprietary technology obsolete or provide us with less of a competitive advantage |
| If we suffer the loss of our manufacturing facility due to catastrophe, our operations would be adversely affected |
| We have one manufacturing facility, which is located in Irvine, California |
| Although we carry insurance for property damage, we do not carry insurance or financial reserves for all possible catastrophes, including interruptions or potential losses arising from earthquakes or terrorism |
| Any significant disruption in our manufacturing operation at the facility, whether due to fire, natural disaster, or otherwise, would have a material adverse effect on our financial condition and operating results |
| Additionally, as previously discussed, during fiscal 2005 we transitioned the manufacturing of our ChargeSource products to a contract manufacturer located in China |
| If any significant disruption occurs in the facility in China, it would have a material adverse effect on our financial condition and operating results |
| We depend upon the services of key personnel, and may not be able to attract and retain additional key personnel |
| Our success depends to a significant extent on the continued services and experience of our key research, engineering, sales, marketing and executive personnel |
| If for any reason our key personnel left our employ and 11 ______________________________________________________________________ [37]Table of Contents we failed to replace a sufficient number of these personnel, we might not be able to maintain or expand our business |
| Competition for such highly skilled personnel in our wireless communications and consumer electronics industries is intense, and we cannot be certain that we will be able to hire or re-hire sufficiently qualified personnel in adequate numbers to meet the demand for our products and services |
| If we are unable to identify, hire and integrate these skilled personnel in a timely or cost-efficient manner, our operating results could suffer |
| We may not be able to successfully integrate future acquisitions, which could adversely affect our business, financial condition and results of operations |
| We have acquired, and are likely to acquire in the future, businesses, products, and technologies that complement or expand our current operations |
| Acquisitions could require significant capital investments and require us to integrate with companies that have different cultures, management teams and business infrastructure |
| Depending on the size and complexity of an acquisition, our successful integration of the acquisition could depend on several factors, including: • Difficulties in assimilating and integrating the operations, products and workforces of an acquired business; • The retention of key employees; • Management of facilities and employees in separate geographic areas; • The integration or coordination of different research and development and product manufacturing facilities; • Successfully converting information and accounting systems, and • Diversion of resources and management attention from our other operations |
| If market conditions or other factors require us to change our strategic direction, we may fail to realize the expected value from one or more of our acquisitions |
| Our failure to successfully integrate our acquisitions or realize the expected value from past or future acquisitions could harm our business, financial condition and results of operations |
| We may need additional capital in the future to fund the growth of our businesses, which we may not be able to obtain or obtain on acceptable terms |
| We currently anticipate that our available capital resources and operating income will be sufficient to meet our expected working capital and capital expenditure requirements for at least the next 12 months |
| However, it is not assured that such resources will be sufficient to fund the long-term growth of our business |
| We may raise additional funds through public or private debt or equity financings if such financings become available on favorable terms |
| Or we may seek working capital financing under a revolving line of credit |
| We cannot assure that any additional financing we may need will be available on terms favorable 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 unanticipated opportunities, develop new products or otherwise respond to competitive pressures |
| In any such case, our operating results and financial condition could be adversely affected |
| Our quarterly operating results are subject to significant fluctuations and, if our operating results decline or are worse than expected, our stock price could fall |
| We have experienced, and expect to continue to experience, significant quarterly fluctuations in revenue and operating results for our three businesses |
| Our quarterly operating results may fluctuate for many reasons, including: • The size and timing of customer orders and shipments; 12 ______________________________________________________________________ [38]Table of Contents • The degree and rate of growth in the markets in which we compete and the accompanying demand for our products; • Limitations in our ability to forecast our manufacturing needs; • Our ability to introduce, and the timing of our introductions of, new or enhanced products; • Product failures and recalls, product quality control problems and associated in-field service support costs; • Warranty expenses; • Availability and cost of components, and • Changes in average sales prices |
| Due to these and other factors, our past results are not reliable indicators of our future performance |
| In addition, a significant portion of our operating expenses is relatively fixed due to sales, engineering and manufacturing overhead |
| If we experience a decline in revenue, we may be unable to reduce our fixed costs quickly enough to compensate for the decline, which would magnify the adverse impact of such revenue shortfall on our results of operations |
| If our operating results decline or are below expectations of securities analysts or investors, the market price of our stock may decline significantly |
| Our stock price has been and will likely remain highly volatile |
| The stock market in general, and the stock prices of technology and wireless communications companies in particular, have experienced fluctuations that have often been unrelated or disproportionate to the operating performance of these companies |
| Broad market and industry stock price fluctuations may adversely affect the market price of shares of our common stock |
| The market price of our stock has exhibited significant price fluctuations, which makes our stock unsuitable for many investors |
| Our stock price may also be affected by the following factors: • Our quarterly operating results; • Changes in the wireless communications and consumer electronics industries; • Changes in the economic outlook of the particular markets in which we sell our products and services; • The gain or loss of significant customers; • Reductions in demand or expectations of future demand by our customers; • Changes in stock market analyst recommendations regarding us, our competitors, or our customers; • The timing and announcements of technological innovations or new products by our competitors or by us, and • Other events affecting other companies that investors deem comparable to us |
| Our articles of incorporation and shareholder rights plan could make a potential acquisition that is not approved by our board of directors more difficult |
| Provisions of our articles of incorporation and our shareholder rights plan could make it more difficult for a third party to acquire control of us |
| Our articles of incorporation prohibit the consummation of a merger, reorganization or recapitalization, sale or lease of a substantial amount of assets with, or issuance of equity securities valued at dlra2dtta0 million or more to a stockholder that owns 10 percent or more of our common stock, unless certain requirements relating to board or shareholder approval are met |
| Our articles also prohibit shareholder action by written consent, which could make certain changes of control more difficult by requiring the holding of a special meeting of shareholders for purposes of taking shareholder action |
| 13 ______________________________________________________________________ [39]Table of Contents In addition, in February 2003 we adopted a shareholder rights plan whereby, for each outstanding share of common stock, we distributed a preferred stock purchase right entitling the holder to purchase one one-hundredth of a share of preferred stock at an exercise price of dlra75 |
| If any person or group acquires or makes an offer to acquire 15 percent or more of our common stock, the preferred stock purchase right will become exercisable by persons other than the 15 percent or more person or group, unless our board of directors timely redeems the preferred stock purchase right or has approved the offer |
| As a result, the preferred stock purchase rights may cause substantial dilution to the ownership of a person or group that attempts to acquire us on terms not approved by our board of directors |
| In February 2006, our Board of Directors terminated our shareholder rights plan effective January 31, 2007 and adopted a policy that, with certain exceptions, requires the board to obtain stockholder approval before adopting any shareholder rights plan in the future |
| These provisions in our articles of incorporation and our existing shareholder rights plan could discourage takeover attempts which some shareholders might deem to be in their best interests or in which shareholders would receive a premium for their shares over the then existing market price of our common stock |
| The trading volume of our common stock often has been limited and may depress the price for our common stock |
| The trading volume of our common stock has been and may continue to be limited |
| Limited trading volume could depress the price for our common stock because fewer analysts may provide coverage for our stock and because investors might be unwilling to pay a higher market price for a stock that is less liquid |
| In addition, limited trading volume, along with market and industry stock price fluctuations and other factors affecting our operations, could result in greater volatility in the price of our common stock |
| A significant decline in our stock price, even if temporary, could result in substantial losses for individual shareholders and could subject us to costly and disruptive securities litigation |