AYRO, Inc. - Quarter Report: 2013 October (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended October 31, 2013

¨ 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: 001-34643

WPCS INTERNATIONAL INCORPORATED

(Exact name of registrant as specified in its charter)

	Delaware		98-0204758
	(State or other jurisdiction of incorporation or organization)		(IRS Employer Identification No.)

One East Uwchlan Avenue

Suite 301

Exton, Pennsylvania 19341

(Address of principal executive offices) (zip code)

(610) 903-0400

(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 x No ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x 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 definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer ¨	Accelerated filer ¨
Non-accelerated filer ¨	Smaller reporting company x
(Do not check if a smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x

As of December 11, 2013, there were 1,558,669 shares of registrant’s common stock outstanding.

WPCS INTERNATIONAL INCORPORATED AND SUBSIDIARIES

INDEX

PART I.	FINANCIAL INFORMATION

	ITEM 1.	Financial Statements

		Condensed consolidated balance sheets at October 31, 2013 (unaudited) and April 30, 2013	3-4

		Condensed consolidated statements of operations for the three and six months ended October 31, 2013 and 2012 (unaudited)	5

		Condensed consolidated statements of comprehensive (loss) income for the three and six months ended October 31, 2013 and 2012 (unaudited)	6

		Condensed consolidated statement of equity (deficit) for the six months ended October 31, 2013 (unaudited)	7

		Condensed consolidated statements of cash flows for the six months ended October 31, 2013 and 2012 (unaudited)	8-9

		Notes to unaudited condensed consolidated financial statements	10-27

	ITEM 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	28-46

	ITEM 3.	Quantitative and Qualitative Disclosures About Market Risk	47

	ITEM 4.	Controls and Procedures	48

PART II.	OTHER INFORMATION

	ITEM 1.	Legal Proceedings	49
	ITEM 1A.	Risk Factors	49
	ITEM 2.	Unregistered Sales of Equity Securities and Use of Proceeds	49
	ITEM 3.	Defaults Upon Senior Securities	49
	ITEM 4.	Mine Safety Disclosures	49
	ITEM 5.	Other Information	49
	ITEM 6.	Exhibits	49

	SIGNATURES		50

	2

WPCS INTERNATIONAL INCORPORATED AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

	October 31,		April 30,
ASSETS	2013		2013
	(unaudited)		(Note 1)
CURRENT ASSETS:

Cash and cash equivalents	$	1,498,206	$	915,752
Restricted cash		-		1,869,178
Accounts receivable, net of allowance of $999,643 and $1,107,593 at October 31, 2013 and April 30, 2013, respectively		9,099,911		7,085,969
Costs and estimated earnings in excess of billings on uncompleted contracts		1,149,409		1,079,367
Deferred contract costs		1,745,324		1,597,894
Prepaid expenses and other current assets		237,962		140,122
Prepaid income taxes		2,185		2,185
Current assets held for sale		1,843,353		1,905,449
Total current assets		15,576,350		14,595,916

PROPERTY AND EQUIPMENT, net		2,370,591		2,754,734

OTHER INTANGIBLE ASSETS, net		-		16,228

OTHER ASSETS		63,347		227,259

OTHER ASSETS HELD FOR SALE		405,542		550,829

Total assets	$	18,415,830	$	18,144,966

	3

WPCS INTERNATIONAL INCORPORATED AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS (CONTINUED)

	October 31,		April 30,
LIABILITIES AND EQUITY	2013		2013
	(unaudited)		(Note 1)
CURRENT LIABILITIES:

Current portion of loans payable	$	46,773	$	43,942
Senior secured convertible notes, net of debt discount of $3,400,000 and $2,888,889, October 31, 2013 and April 30, 2013, respectively		-		1,111,111
Derivative liability - senior secured convertible notes		-		3,088,756
Accounts payable and accrued expenses		4,316,412		4,102,050
Accrued severance expense		1,381,249		-
Billings in excess of costs and estimated earnings on uncompleted contracts		1,998,367		1,619,307
Deferred revenue		420,550		113,503
Other payable		1,533,757		1,743,986
Short-term bank loan		3,283,860		2,432,205
Income taxes payable		46,816		139,557
Current liabilities held for sale		700,430		685,631
Total current liabilities		13,728,214		15,080,048

Loans payable, net of current portion		147,222		133,838
Derivative liability - warrants		-		3,858,508
Total liabilities		13,875,436		19,072,394

COMMITMENTS AND CONTINGENCIES

EQUITY:

WPCS EQUITY (DEFICIT):
Preferred stock - $0.0001 par value, 5,000,000 shares authorized, none issued		-		-
Common stock - $0.0001 par value, 14,285,714 shares authorized, 1,308,669 and 994,187 shares issued and outstanding at October 31, 2013 and April 30, 2013, respectively		131		99
Additional paid-in capital		62,803,147		50,844,183
Accumulated deficit		(60,420,463)		(54,054,389)
Accumulated other comprehensive income on foreign currency translation		1,294,816		1,433,541

Total WPCS equity (deficit)		3,677,631		(1,776,566)

Noncontrolling interest		862,763		849,138
Total equity (deficit)		4,540,394		(927,428)

Total liabilities and equity	$	18,415,830	$	18,144,966

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

	4

WPCS INTERNATIONAL INCORPORATED AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

	Three Months Ended				Six Months Ended
	October 31,				October 31,
	2013		2012		2013		2012
			(Note 1)			(Note 1)	(Note 1)
REVENUE	$	7,355,744	$	7,958,243	$	15,187,127	$	19,246,260

COSTS AND EXPENSES:
Cost of revenue		5,602,337		5,013,329		11,346,996		13,968,212
Selling, general and administrative expenses		1,854,241		2,061,126		3,837,815		4,156,282
Severance expense		-		-		1,474,277		-
Depreciation and amortization		214,895		268,179		457,952		572,286

		7,671,473		7,342,634		17,117,040		18,696,780

OPERATING (LOSS) INCOME		(315,729)		615,609		(1,929,913)		549,480

OTHER EXPENSE (INCOME):
Interest expense		2,380,885		320,608		3,540,942		441,013
Change in fair value of derivative liabilities		(2,208,155)		-		833,750		-

(Loss) income from continuing operations before income tax provision		(488,459)		295,001		(6,304,605)		108,467
Income tax (benefit) provision		(5,863)		(199,705)		18,288		(65,176)

(LOSS) INCOME FROM CONTINUING OPERATIONS		(482,596)		494,706		(6,322,893)		173,643
Discontinued operations:

Loss from operations of discontinued operations, net of tax provision of $0, $215,700, $0, and $269,864, respectively		(8,718)		(473,728)		(39,747)		(1,484,142)

(Loss) gain from disposal		-		(485,212)		-		1,839,419

(Loss) income from discontinued operations, net of tax		(8,718)		(958,940)		(39,747)		355,277

CONSOLIDATED NET (LOSS) INCOME		(491,314)		(464,234)		(6,362,640)		528,920

Net (loss) income attributable to noncontrolling interest		(18,310)		29,152		3,434		28,605

NET (LOSS) INCOME ATTRIBUTABLE TO WPCS	$	(473,004)	$	(493,386)		(6,366,074)	$	500,315

Basic and diluted net (loss) income per common share attributable to WPCS:

(Loss) income from continuing operations attributable to WPCS	$	(0.36)	$	0.47	$	(5.57)	$	0.15
(Loss) income from discontinued operations attributable to WPCS	$	(0.01)	$	(0.97)	$	(0.03)	$	0.35
Basic and diluted net (loss) income per common share attributable to WPCS	$	(0.37)	$	(0.50)	$	(5.60)	$	0.50

Basic weighted average number of common shares outstanding		1,272,877		994,187		1,136,750		994,187

Diluted weighted average number of common shares outstanding		1,272,877		995,469		1,136,750		998,160

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

	5

WPCS INTERNATIONAL INCORPORATED AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE (LOSS) INCOME

(Unaudited)

	Three Months Ended				Six Months Ended
	October 31,				October 31,
	2013		2012		2013		2012
Consolidated net (loss) income	$	(491,314)	$	(464,234)	$	(6,362,640)	$	528,920
Other comprehensive income (loss) - foreign currency translation adjustments		97,267		(14,533)		(128,534)		9,156
Comprehensive (loss) income		(394,047)		(478,767)		(6,491,174)		538,076

Comprehensive (loss) income attributable to noncontrolling interest		(12,866)		50,881		13,625		36,000
Comprehensive (loss) income attributable to WPCS	$	(381,181)	$	(529,648)	$	(6,504,799)	$	502,076

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

	6

WPCS INTERNATIONAL INCORPORATED AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENT OF EQUITY (DEFICIT)

SIX MONTHS ENDED OCTOBER 31, 2013

(Unaudited)

							Additional				Accumulated				Non-
	Preferred Stock			Common Stock			Paid-In		Accumulated		Other Compre-		WPCS		Controlling		Total
	Shares	Amount		Shares	Amount		Capital		Deficit		hensive Income		Equity (Deficit)		Interest		Equity (Deficit)

BALANCE, May 1, 2013	-	$	-	994,187	$	99	$	50,844,183	$	(54,054,389)	$	1,433,541	$	(1,776,566)	$	849,138	$	(927,428)

Stock-based compensation	-		-	-		-		22,511		-		-		22,511		-		22,511

Issuance of common stock from Warrant amendment, waiver and exchange agreement	-		-	38,740		4		88,711		-		-		88,715		-		88,715

Conversion of Notes	-		-	275,742		28		593,895		-		-		593,923		-		593,923

Reclassification of derivative liability upon conversion of Notes	-		-	-		-		686,856		-		-		686,856		-		686,856

Reclassification of derivative liability from Notes and Warrant amendment	-		-	-		-		7,166,991		-		-		7,166,991		-		7,166,991

Unamortized debt discount from Notes amendment	-		-	-		-		3,400,000		-		-		3,400,000		-		3,400,000

Other comprehensive (loss) income	-		-	-		-		-		-		(138,725)		(138,725)		10,191		(128,534)

Net income attributable to noncontrolling interest	-		-	-		-		-		-		-		-		3,434		3,434

Net loss attributable to WPCS	-		-	-		-		-		(6,366,074)		-		(6,366,074)		-		(6,366,074)

BALANCE, October 31, 2013	-	$	-	1,308,669	$	131	$	62,803,147	$	(60,420,463)	$	1,294,816	$	3,677,631	$	862,763	$	4,540,394

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

	7

WPCS INTERNATIONAL INCORPORATED AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

	Six Months Ended
	October 31,
	2013		2012
OPERATING ACTIVITIES :
Consolidated net (loss) income	$	(6,362,640)	$	528,920

Adjustments to reconcile consolidated net (loss) income to net cash provided by (used in) operating activities:
Depreciation and amortization		457,952		783,530
Gain from disposition of operations		-		(1,838,419)
Amortization of notes discount		3,053,867		-
Change in the fair value of derivative liabilities		833,750		-
Stock-based compensation		22,511		103,951
Provision for doubtful accounts		29,784		32,923
Amortization of debt issuance costs		277,095		294,803
Loss (gain) on sale of fixed assets		13,509		(23,384)
Deferred income taxes		-		(153,822)
Changes in operating assets and liabilities:
Restricted cash		1,869,178		-
Accounts receivable		(2,014,625)		1,893,605
Costs and estimated earnings in excess of billings on uncompleted contracts		(70,042)		62,920
Deferred contract costs		(126,513)		-
Inventory		-		(18,431)
Prepaid expenses and other current assets		(97,330)		(156,031)
Income taxes payable		(94,919)		119,232
Prepaid taxes		-		39,931
Other assets		(11,001)		15,157
Assets held for sale		112,262		-
Accounts payable and accrued expenses		213,526		(1,753,067)
Accrued severance expense		1,381,249		-
Billings in excess of costs and estimated earnings on uncompleted contracts		379,060		(1,575,966)
Deferred revenue		303,804		658,485
NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES		170,477		(985,663)

	8

WPCS INTERNATIONAL INCORPORATED AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)

(Unaudited)

	Six Months Ended
	October 31,
	2013		2012

INVESTING ACTIVITIES:
Acquisition of property and equipment, net	$	(17,620)	$	(229,513)
Proceeds from sale of operations, net of transaction costs		-		4,554,009
NET CASH (USED IN) PROVIDED BY INVESTING ACTIVITIES		(17,620)		4,324,496

FINANCING ACTIVITIES:
Net proceeds from Section 16(b) settlement		-		222,413
Debt issuance costs		(102,182)		(56,514)
Repayments under lines of credit		-		(3,929,817)
Repayment to senior secured convertible notes		(9,507)		-
Repayments under loans payable, net		(23,534)		(53,619)
Repayments to joint venture partner, net		-		(2,516,123)
Repayments of capital lease obligations		-		(14,588)
Borrowings under short-term bank loan		816,100		2,367,645
Repayments under other payable		(210,229)		-
Borrowings under other payable		-		793,927
NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES		470,648		(3,186,676)

Effect of exchange rate changes on cash		(41,051)		(42,234)

NET INCREASE IN CASH AND CASH EQUIVALENTS		582,454		109,923
CASH AND CASH EQUIVALENTS, BEGINNING OF THE PERIOD		915,752		811,283
CASH AND CASH EQUIVALENTS, END OF THE PERIOD	$	1,498,206	$	921,206

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

	9

WPCS INTERNATIONAL INCORPORATED AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1 - LIQUIDITY AND BASIS OF PRESENTATION

Basis of Presentation

The accompanying unaudited condensed consolidated financial statements include the accounts of WPCS International Incorporated (WPCS) and its wholly- and majority-owned subsidiaries, as follows, collectively referred to as “we”, “us” or the "Company". United States-based subsidiaries include WPCS Incorporated, WPCS International – Suisun City, Inc. (Suisun City Operations), WPCS International – Lakewood, Inc. (Lakewood Operations), WPCS International – Hartford, Inc. (Hartford Operations), WPCS International – Trenton, Inc. (Trenton Operations), WPCS International – Seattle, Inc. (Seattle Operations), and WPCS International – Portland, Inc. (Portland Operations). International operations include WPCS Asia Limited, 60% of Taian AGS Pipeline Construction Co. Ltd. (China Operations), WPCS Australia Pty Ltd., WPCS International – Brendale, Pty Ltd., and The Pride Group (QLD) Pty Ltd. (Pride), (collectively, Australia Operations).

The accompanying unaudited condensed consolidated financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (SEC) for quarterly reports on Form 10-Q of Article 10 of Regulation S-X and do not include all of the information and note disclosures required by accounting principles generally accepted in the United States of America. Accordingly, the unaudited condensed consolidated financial statements should be read in conjunction with the Company’s audited consolidated financial statements and notes thereto for the fiscal year ended April 30, 2013 included in the Company’s Annual Report on Form 10-K. The accompanying unaudited condensed consolidated financial statements reflect all adjustments (consisting of normal recurring adjustments) which are, in the opinion of the management, considered necessary for a fair presentation of condensed consolidated financial position, results of operations and cash flows for the interim periods. Operating results for the three and six month periods ended October 31, 2013 are not necessarily indicative of the results that may be expected for the fiscal year ending April 30, 2014. The amounts for the April 30, 2013 balance sheet have been extracted from the audited consolidated financial statements included in Form 10-K for the year ended April 30, 2013.

The Company provides design-build engineering services that focus on the implementation requirements of communications infrastructure. The Company provides its engineering capabilities including wireless communication, specialty construction and electrical power to the public services, healthcare, energy and corporate enterprise markets worldwide.

Liquidity and Going Concern

The accompanying condensed consolidated financial statements have been prepared assuming the Company will continue as a going concern, which contemplates the realization of assets and satisfaction of liabilities in the normal course of business. The unaudited condensed consolidated financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts and the amount and classification of liabilities that might be necessary should the Company be unable to continue as a going concern.

At October 31, 2013, the Company has losses from operations, and has outstanding balances due to its former surety under a forbearance agreement of $1,533,757. These factors raise substantial doubt about the Company’s ability to continue as a going concern.

As further described in Note 4, “Senior Secured Convertible Notes”, on December 4, 2012, the Company entered into a Securities Purchase Agreement (the Purchase Agreement) with six accredited investors (the Buyers) pursuant to which, the Company sold an aggregate of (i) $4,000,000 principal amount of senior secured convertible notes (the Notes) and (ii) warrants (the Warrants) to purchase 2,274,796 shares of the Company's common stock (Common Stock), to the Buyers for aggregate gross proceeds of $4,000,000 (the Financing). The closing of the Financing was completed on December 5, 2012 (the Closing Date).

	10

WPCS INTERNATIONAL INCORPORATED AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

As more fully described in Note 12, “Commitments and Contingencies,” on July 12, 2012, the Company executed the Surety Financing and Confession of Judgment Agreement (the Financing Agreement) with Zurich American Insurance Company (Zurich). Under the terms of the Financing Agreement, Zurich advanced the Company $793,927 to assist in the completion of the project contract with the Camden County Improvement Authority for work at the Cooper Medical Center of Rowan University (the Owner or Cooper Project). The Company was in default under the terms of the Financing Agreement.

On April 17, 2013, the Company executed the Surety Forbearance and Confession of Judgment Agreement (the Forbearance Agreement) with Zurich, which supersedes the Financing Agreement. The Company is currently in default under the Forbearance Agreement due to its failure to pay the monthly Interim Liability Payment of $25,000 for the month of December 2013. In addition, the Company does not have the ability to discharge the Loss Amount of $1,533,757 due December 31, 2013 under the Forbearance Agreement. The Company is currently in discussions with Zurich for the settlement of the Loss Amount due under the Forbearance Agreement. There can be no assurance that the Company will be successful in settling with Zurich the Loss Amount due.

The Company has submitted a claim and request for equitable adjustment to the Owner in the amount of $2,421,425 (the Claim) for significant delays, disruptions and construction changes that were beyond its control related to the Cooper Project, which was completed in the fiscal year ended April 30, 2013. If the Company is successful in the settlement of this Claim, the Company expects to use the proceeds from the claim to repay Zurich the remaining amounts due under the Forbearance Agreement. There can be no assurance that the Company will be successful in settling with the Owner for all or a portion of the submitted claim.

The Company's continuation as a going concern beyond the next twelve months and its ability to discharge its liabilities and commitments in the normal course of business is ultimately dependent upon the execution of its future plans, which include the following: (1) its ability to generate future operating income, reduce operating expenses and produce cash from its operating activities, which will be affected by general economic, competitive, and other factors, many of which are beyond the Company's control; (2) the repayment of, or the modification of the terms under the Zurich Forbearance Agreement; (3) the settlement of the claim with the Owner; and (4) obtaining additional funds, either through financing or sale of assets. There can be no assurance that the Company’s plans to ensure continuation as a going concern will be successful.

NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

A summary of significant accounting policies consistently applied in the preparation of the accompanying unaudited condensed consolidated financial statements follows:

Principles of Consolidation

All significant intercompany transactions and balances have been eliminated in these condensed consolidated financial statements.

Cash and Cash Equivalents

Cash and cash equivalents include all cash and highly-liquid investments with a maturity at time of purchase of three months or less.

Restricted Cash

In connection with the terms of the Notes, all payments of accounts receivable of the Company (and its domestic subsidiaries) are deposited into an account (the Lockbox Account) controlled by Worldwide Stock Transfer, LLC (the Collateral Agent). The Company is permitted to receive from the Lockbox Account on a daily basis, such cash equal to (A) (i) the cash balance in the Lockbox Account plus (ii) 95% of the available qualified accounts receivable, less (iii) $250,000, minus (B) the amount of principal, accrued interest and costs and expenses owed pursuant to the Notes. At any given time, the Company considers the cash held in the Lockbox Account that it is not yet permitted to draw down based on the calculation above, to be restricted cash. Restricted cash is classified as a current asset, consistent with the classification of the Notes as a current liability. Based on the calculation above, the Company had the ability to draw down all of the cash held in the Lockbox Account, and as a result there was no restricted cash balance reported at October 31, 2013.

Accounts Receivable

Accounts receivable are due within contractual payment terms and are stated at amounts due from customers net of an allowance for doubtful accounts. Credit is extended based on evaluation of a customer's financial condition. Accounts outstanding longer than the contractual payment terms are considered past due. The Company determines an allowance by considering a number of factors, including the length of time trade accounts receivable are past due, our previous loss history, the customer's current ability to pay its obligation to the Company, and the condition of the general economy and the industry as a whole. The Company writes off accounts receivable when they become uncollectible, and payments subsequently received on such receivables are credited to the allowance for doubtful accounts.

	11

WPCS INTERNATIONAL INCORPORATED AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Derivative Instruments

The Company’s derivative liabilities are related to embedded conversion features of the Notes and the common stock Warrants issued in connection with the Purchase Agreement. For derivative instruments that are accounted for as liabilities, the derivative instrument is initially recorded at its fair value and is then re-valued at each reporting date, with changes in fair value recognized in earnings each reporting period. The Company uses the binomial lattice model to value the derivative instruments at inception and subsequent valuation dates and the value is re-assessed at the end of each reporting period, in accordance with Accounting Standards Codification (ASC) 815. Derivative instrument liabilities are classified in the consolidated balance sheets as current or non-current based on whether or not the net-cash settlement of the derivative instrument could be required within twelve months of the balance sheet date.

Fair Value of Financial Instruments

The Company’s material financial instruments at October 31, 2013 and for which disclosure of fair value is required by certain accounting standards consisted of cash and cash equivalents, accounts receivable, accounts payable, line of credit and loans payable. The fair values of cash and cash equivalents, accounts receivable, and accounts payable are equal to their carrying value because of their liquidity and short-term maturity. Management believes that the fair values of the line of credit and loans payable do not differ materially from their aggregate carrying values in that substantially all the obligations bear variable interest rates that are based on market rates or interest rates that are periodically adjustable to rates that are based on market rates.

Other Intangible Assets

Other intangible assets have finite useful lives and are comprised of customer lists. The Company reviews its other intangible assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. In performing a review for impairment, the Company compares the carrying value of the assets with their estimated future undiscounted cash flows from the use of the asset and eventual disposition. If the estimated undiscounted future cash flows are less than carrying value, an impairment loss is charged to operations based on the difference between the carrying amount and the fair value of the asset.

Other intangible assets consist of the following at October 31, 2013 and April 30, 2013:

	Estimated useful life	October 31,		April 30,
	(years)	2013		2013

Customer list	3-9	$	1,078,250	$	1,190,083
Less accumulated amortization			(1,078,250)		(1,173,855)
		$	-	$	16,228

Amortization expense of other intangible assets for the six months ended October 31, 2013 and 2012 was $16,228 and $32,502, respectively. There are no expected residual values related to these intangible assets.

Revenue Recognition

The Company generates its revenue by providing design-build engineering services for communications infrastructure. The Company’s design-build services report revenue pursuant to customer contracts that span varying periods of time. The Company reports revenue from contracts when persuasive evidence of an arrangement exists, fees are fixed or determinable, and collection is reasonably assured.

	12

WPCS INTERNATIONAL INCORPORATED AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

The Company records revenue and profit from long-term contracts on a percentage-of-completion basis, measured by the percentage of contract costs incurred to date to the estimated total costs for each contract. Contracts in process are valued at cost plus accrued profits less earned revenues and progress payments on uncompleted contracts. Contract costs include direct materials, direct labor, third party subcontractor services and those indirect costs related to contract performance. Contracts are generally considered substantially complete when engineering is completed and/or site construction is completed.

The Company has numerous contracts that are in various stages of completion. Such contracts require estimates to determine the appropriate cost and revenue recognition. Cost estimates are reviewed monthly on a contract-by-contract basis, and are revised periodically throughout the life of the contract such that adjustments to profit resulting from revisions are made cumulative to the date of the revision. Significant management judgments and estimates, including the estimated cost to complete projects, which determines the project’s percent complete, must be made and used in connection with the revenue recognized in the accounting period. Current estimates may be revised as additional information becomes available. If estimates of costs to complete long-term contracts indicate a loss, provision is made currently for the total loss anticipated. For the six months ended October 31, 2013 and 2012, the Company has provided aggregate loss provisions of approximately $12,000 and $99,000, respectively, related to anticipated losses on long-term contracts.

The length of the Company’s contracts varies but is typically between three months and two years. Assets and liabilities related to long-term contracts are included in current assets and current liabilities in the accompanying condensed consolidated balance sheets as they will be liquidated in the normal course of contract completion, although this may require more than one year.

The Company records revenue and profit from short-term contracts for the China Operations under the completed contract method, whereas income is recognized only when a contract is completed or substantially completed. Accordingly, during the period of performance, billings and deferred contract costs are accumulated on the consolidated balance sheets, but no revenue or income is recorded before completion or substantial completion of the work. The Company’s decision is based on the short-term nature of the work performed.

The Company also recognizes certain revenue from short-term contracts when equipment is delivered or the services have been provided to the customer. For maintenance contracts, revenue is recognized ratably over the service period.

Income Taxes

The Company accounts for income taxes pursuant to the asset and liability method which requires deferred income tax assets and liabilities to be computed annually for differences between the financial statement and tax bases of assets and liabilities that will result in taxable or deductible amounts in the future based on enacted tax laws and rates applicable to the periods in which the differences are expected to affect taxable income. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.

On a periodic basis, the Company evaluates its ability to realize its deferred tax assets net of its deferred tax liabilities and adjusts such amounts in light of changing facts and circumstances, including but not limited to the level of past and future taxable income, and the current and future expected utilization of tax benefit carryforwards. The Company considers all available evidence, both positive and negative, to determine whether, based on the weight of that evidence, a valuation allowance is required to reduce the net deferred tax assets to the amount that is more likely than not to be realized in future periods. The Company considers past performance, expected future taxable income and prudent and feasible tax planning strategies in assessing the amount of the valuation allowance. The Company’s forecast of expected future taxable income is based over such future periods that it believes can be reasonably estimated. Based on its analysis as of October 31, 2013, the Company continues to provide a full valuation allowance on its domestic and foreign deferred tax assets. The Company will continue to evaluate the realization of its deferred tax assets and liabilities on a periodic basis, and will adjust such amounts in light of changing facts and circumstances.

The Company performed a review for uncertainty in income tax positions in accordance with authoritative guidance. This review did not result in the recognition of any material unrecognized tax benefits as of October 31, 2013 and April 30, 2013. Management continually evaluates expiring statutes of limitations, audits, proposed settlements, changes in tax law and new authoritative rulings. The Company recognizes interest accrued related to unrecognized tax benefits in interest expense and penalties in selling, general and administrative expenses. For the six months ended October 31, 2013 and 2012, the Company recognized no interest or penalties. The statute of limitations for the Company's Federal, state and foreign income tax returns prior to fiscal years 2009 are closed.

	13

WPCS INTERNATIONAL INCORPORATED AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Net (Loss) Income Per Common Share

Basic and diluted net (loss) income per common share is computed as net (loss) income divided by the weighted average number of common shares outstanding for the period. Diluted net (loss) income per common share reflects the potential dilution that could occur from common stock issuable through exercise of stock options. The table below presents the computation of basic and diluted net (loss) income per common share from continuing operations for the three and six months ended October 31, 2013 and 2012, respectively:

Basic net (loss) income per share from continuing operations computation

	Three Months Ended				Six Months Ended
	October 31,				October 31,
	2013		2012		2013		2012
Numerator:

Net (loss) income attributable to WPCS	$	(464,286)	$	465,554	$	(6,326,327)	$	145,038

Denominator:

Basic weighted average shares outstanding		1,272,877		994,187		1,136,750		994,187

Basic net (loss) income per common share attributable to WPCS	$	(0.36)	$	0.47	$	(5.57)	$	0.15

Diluted net (loss) income per share from continuing operations computation

	Three Months Ended				Six Months Ended
	October 31,				October 31,
	2013		2012		2013		2012
Numerator:

Net (loss) income attributable to WPCS	$	(464,286)	$	465,554	$	(6,326,327)	$	145,038

Denominator:

Basic weighted average shares outstanding		1,272,877		994,187		1,136,750		994,187

Incremental shares from assumed conversion:
Conversion of stock options		-		1,282		-		3,973

Diluted weighted average shares		1,272,877		995,469		1,136,750		998,160

Diluted net (loss) income per common share attributable to WPCS	$	(0.36)	$	0.47	$	(5.57)	$	0.15

The following were excluded from the computation of diluted shares outstanding due to the losses from continuing operations for the three and six months ended October 31, 2013 as they would have had an anti-dilutive impact on the Company's net loss.

	Three Months Ended	Six Months Ended
	October 31	October 31
	2013	2013
Common stock equivalents:
Stock options	1,273	1,831
Conversion of senior secured convertible notes	678,808	790,044
Stock warrants	1,646,426	1,136,479

Totals	2,326,507	1,928,354

Noncontrolling Interest

Noncontrolling interest for the three and six months ended October 31, 2013 and 2012 consists of the following:

	Three Months Ended				Six Months Ended
	October 31,				October 31,
	2013		2012		2013		2012
Balance, beginning of period	$	875,629	$	1,102,440	$	849,138	$	1,117,322

Net (loss) income attributable to noncontrolling interest		(18,310)		29,152		3,434		28,605

Other comprehensive income attributable to noncontrolling interest		5,444		21,729		10,191		7,394

Balance, end of period	$	862,763	$	1,153,321	$	862,763	$	1,153,321

	14

WPCS INTERNATIONAL INCORPORATED AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Use of Estimates

In preparing financial statements in conformity with accounting principles generally accepted in the United States of America, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and revenue and expenses during the reporting period. The most significant estimates relate to the calculation of percentage-of-completion on uncompleted contracts, allowance for doubtful accounts, realization of deferred tax assets, and amortization method and lives of customer lists. Actual results could differ from those estimates.

Recently Issued Accounting Pronouncements

In December 2011, the FASB issued ASU No. 2011-11 (ASU 2011-11), Disclosures about Offsetting Assets and Liabilities where entities are required to disclose both gross information and net information about both instruments and transactions eligible for offset in the statement of financial position and instruments and transactions subject to an agreement similar to a master netting arrangement. This scope would include derivatives, sale and repurchase agreements, and reverse sale and repurchase agreements, and securities borrowing and securities lending arrangements. These disclosures assist users of financial statements in evaluating the effect or potential effect of netting arrangements on a company’s financial position. The adoption of ASU 2011-11 on May 1, 2013 did not have a material impact on the Company’s unaudited condensed consolidated financial statements.

	15

WPCS INTERNATIONAL INCORPORATED AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

NOTE 3 - COSTS AND ESTIMATED EARNINGS ON UNCOMPLETED CONTRACTS

The asset, “Costs and estimated earnings in excess of billings on uncompleted contracts”, represents revenue recognized in excess of amounts billed. The liability, “Billings in excess of costs and estimated earnings on uncompleted contracts”, represents billings in excess of revenue recognized.Costs and estimated earnings on uncompleted contracts consist of the following at October 31, 2013 and April 30, 2013:

	October 31, 2013		April 30, 2013

Costs incurred on uncompleted contracts	$	50,890,087	$	72,951,142
Provision for loss on uncompleted contracts		(11,972)		(23,376)
Estimated contract profit		1,928,749		2,391,027
		52,806,864		75,318,793
Less: Billings to date		53,655,822		75,858,733
Totals	$	(848,958)	$	(539,940)

Costs and estimated earnings in excess of billings on uncompleted contracts	$	1,149,409	$	1,079,367
Billings in excess of cost and estimated earnings on uncompleted contracts		1,998,367		1,619,307
Totals	$	(848,958)	$	(539,940)

Revisions in the estimated gross profits on contracts and contract amounts are made in the period in which circumstances requiring the revisions become known. During the three and six months ended October 31, 2013, the effect of such revisions in estimated contract profits resulted in an increase to gross profits of approximately $26,000 and $149,000, respectively, and during the three and six months ended October 31, 2012, the effect of such revisions resulted in an increase in gross profits of $1,047,000 and $1,563,000, respectively, from that which would have been reported had the revised estimates been used as the basis of recognition for contract profits in prior years.

Although management believes it has established adequate procedures for estimating costs to complete open contracts, additional costs could occur on contracts prior to completion.

NOTE 4 - SENIOR SECURED CONVERTIBLE NOTES

On December 4, 2012, the Company entered into the Purchase Agreement with the Buyers pursuant to which the Company sold an aggregate of (i) $4,000,000 principal amount of Notes and (ii) Warrants to purchase 2,274,796 shares of the Company's Common Stock to the Buyers for aggregate gross Financing proceeds of $4,000,000. In connection with the Financing, (i) the Company entered into a registration rights agreement with the Buyers (the Registration Rights Agreement), (ii) the Company and its subsidiaries entered into a security and pledge agreement in favor of the collateral agent for the Buyers (the Security Agreement), and (iii) subsidiaries of the Company entered into a guaranty in favor of the collateral agent for the Buyers (the Guaranty). The Closing Date of the Financing was December 5, 2012.

Pursuant to the terms of the Notes, the Company deposited the initial funds received from the Financing, minus $2,178,516, (the Initial Lending Amount) into the Lockbox Account controlled by the Collateral Agent, as collateral agent on behalf of the Buyers. The Company used the Initial Lending Amount to repay the existing loan of $2,000,000, plus $78,516 of interest accrued and fees and expenses to Sovereign Bank, N.A. (Sovereign), which credit agreement was terminated in connection with the Notes, and $100,000 for Buyer legal fees in connection with the Notes. In addition, all payments of accounts receivable of the Company (and its domestic subsidiaries) shall be deposited into the Lockbox Account. The Company is permitted to receive from the Lockbox Account, on a daily basis, such amount of cash equal to: (A) (i) cash balance in the Lockbox Account plus (ii) 95% of available qualified accounts receivable minus (iii) $250,000 minus (B) amount of principal, accrued interest, fees, costs and expenses owed pursuant to the Notes. The Notes contain certain customary representations and warranties, affirmative and negative covenants, and events of default. The principal covenant is that the Company shall maintain a current ratio of not less than 0.6 to 1.0 as of the last calendar day of each month. As of October 31, 2013, the Company is in compliance with the covenants.

The Notes were initially convertible into shares of Common Stock at a conversion price of $2.6376 per share (the Conversion Price). The Conversion Price was to be adjusted to 85% of the average of the closing bid prices for the five consecutive trading dates immediately prior to the following adjustment dates: (1) the earlier of the effective date of a registration statement or six months after closing (the First Adjustment); (2) the later of the date that is three months after the First Adjustment or one year after closing (the Second Adjustment); and (3) on the Stockholder Approval Date of February 28, 2013. On the Stockholder Approval Date, the Conversion Price was adjusted to $2.1539 per share. There was no adjustment to the Conversion Price on the First Adjustment date.

	16

WPCS INTERNATIONAL INCORPORATED AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

The Warrants are exercisable for a period of five years from the Closing Date at an initial exercise price of $3.2970 per share (the Exercise Price). The Exercise Price was subject to the same adjustments as provided in the Notes as described above and, as a result, the Exercise Price was adjusted to $2.1539 per share on the Stockholder Approval Date.

On October 25, 2013, the Company entered into an amendment, waiver and exchange agreement (the Amendment) with the Buyers that amended the conversion features of the Warrants and Notes. Pursuant to the Amendment, the Buyers exchanged 154,961 of their Warrants for 38,740 shares of common stock (the Shares) and warrants to purchase 154,961 shares of common stock (Exchange Warrants). Effectively, for every four Warrants surrendered, the Buyer received a unit of four Exchange Warrants and one Share. It was determined that the Black-Scholes value of one warrant being exchanged was equal to $1.83, resulting in four Warrants being equal to $7.32 and the parties valued the unit at a price of $7.52. As a result, the Shares issued were calculated at $0.20, and by the operation of the terms of the Notes, the conversion price of the Notes automatically adjusted to $0.20. The Exchange Warrants are exercisable for a period of five years from the date of issuance of the original Warrants at an initial exercise price of $2.1539 per share. The exercise price will only adjust in the event of any future stock splits or dividends.

Pursuant to the Amendment, the Buyers permanently waived, effective as of October 24, 2013, various provisions of the Warrants, including the anti-dilution protection from the issuance of securities at a price lower than the Exercise Price, the adjustment to market price on the first anniversary of the date of issuance of the Warrants and the Black-Scholes valuation upon the occurrence of a Fundamental Transaction (as defined in the Warrants). As a result of these waivers, the exercise price of the Warrants will only adjust in the event of any future stock splits or dividends. The Exercise Price of the Warrants remains at $2.1539 per share. After the Amendment, the Warrants and Exchange Warrants have the same terms, conditions and rights.

In addition, pursuant to the Amendment, the Buyers permanently waived various provisions of the Notes, including the adjustment to the conversion price under a Fundamental Transaction (as defined in the Notes), the anti-dilution protection from the issuance of securities at a price lower than the current exercise price and the adjustment to market price on the first anniversary of the date of issuance of the Notes. As a result of these waivers, the conversion price of the Notes will only adjust in the event of any future stock splits or dividends.

Further, the Buyers waived certain events of default that had occurred under the Notes as more fully described as follows. Pursuant to the terms of the Notes, an event of default occurs when the Company’s common stock is suspended or threatened with suspension from trading on The NASDAQ Capital Market (or an equivalent market). On October 7, 2013, the Company received a notice from the Staff of the Listing Qualifications Department of The NASDAQ Stock Market LLC (NASDAQ) indicating that the Company’s common stock would be subject to delisting from The NASDAQ Capital Market on October 16, 2013 due to the Company’s non-compliance with the applicable $2.5 million stockholders’ equity requirement, as set forth in Listing Rule 5550(b) (1). As a result of the notice from NASDAQ, an event of default occurred under the Notes, which was waived by the Buyers pursuant to the Amendment. The closing of the Amendment transaction occurred on October 30, 2013.

On November 5, 2013, the Company entered into an amendment agreement (the Note Amendment) with the Buyers. The closing of the Note Amendment transaction occurred on November 5, 2013, and the Note Amendment was deemed effective as of October 31, 2013. The Note Amendment eliminated certain features of the Notes which would otherwise result in substantial accounting charges to the Company.

Prior to the Note Amendment, if an event of default existed under the Notes, the Buyers would have been entitled to redeem $3,400,000 in aggregate principal and interest of the Notes for a redemption price equal to the greater of 125% of (x) the deemed value of the shares of common stock underlying the Note (the Intrinsic Value) and (y) the outstanding principal and unpaid interest under the Notes (the Base Value). The Note Amendment reduces and fixes the event of default redemption price by eliminating the Intrinsic Value calculation and modifying the Base Value calculation and interest rate to more accurately make-whole the holders of the Notes from the loss of interest from an early redemption of the Notes and the decreased value of the Notes without such Intrinsic Value rights. As revised, the event of default redemption amount equals the sum of the Conversion Amount (as defined in the Notes) to be redeemed, plus a make-whole amount equal to the amount of any interest that, but for any redemption of the Notes on such given date, would have accrued with respect to the Conversion Amount being redeemed under the Notes at the interest rate then in effect for the period from such given date through October 31, 2023, the amended maturity date of the Notes, discounted to the present value of such interest using a discount rate of 2.5% per annum. As a result, the fixed value of the event of default redemption price is approximately $10,900,000. In addition, the interest rate of the Notes was amended to 15% per annum, subject to increase to 25% per annum if an event of default occurs and is continuing.

The modifications to the Notes as a result of the Amendment and Note Amendment described above included a change in the conversion price of the Notes from $2.1539 to $0.20, and a change in the maturity date of the Note, from June 5, 2014 to October 31, 2023. As a result of the significant modifications of the Notes, the Company determined that the Notes were extinguished and New Notes were being issued. In connection with this modification, the Company compared the present value of the beneficial conversion features of the Notes to the New Notes. The Company determined that the present value of the New Notes exceeded the present value of the Notes, by more than 10%, primarily as a result of the change in the conversion price of the New Notes to $0.20 as compared to the $2.1539 under the Notes which resulted in the application of extinguishment accounting. The modification of the Note debt instrument for the six months ended October 31, 2013, resulted in the debt instruments being exchanged with substantially different terms and extinguishment accounting was applied resulting in a loss on extinguishment of debt for the unamortized discount related to the Notes of $1,299,304. In addition, the Company recorded a new debt discount based on the fixed conversion rate and exercise price of $0.20 per share of $3,400,000 related to the remaining proceeds of the New Notes.

A summary of the Notes and New Notes at October 31, 2013 is as follows:

	October 31, 2013
Senior secured convertible notes, interest at 4% per annum to maturity June 5, 2014 (Notes)	$	3,406,077
Debt discount - value attributable to derivatives attached to Notes		(1,299,304)
Total - current portion, Notes		2,106,773
Redemption of Notes		(6,077)
Loss on extinguishment of debt - Notes		1,299,304
Senior secured convertible notes, interest at 15% per annum to maturity October 31, 2023 (New Notes)		3,400,000
Debt discount - value attributable to beneficial conversion features, New Notes		(3,400,000)
Total - current portion, New Notes	$	-

	17

WPCS INTERNATIONAL INCORPORATED AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

As of October 31, 2013, $593,923 of Notes was converted into 275,742 shares of the Company’s Common Stock. In addition, $6,077 of Notes was redeemed for cash at the request of a Buyer.

The terms of the Notes and New Notes that follow remained the same after the extinguishment of debt described above. The Company has the right, at any time after one year from the Closing Date, to redeem all, but not less than all, of the outstanding Notes, upon not less than 20 trading days nor more than 30 trading days prior written notice. The redemption price shall equal 120% of the amount of principal and interest being redeemed.

The Buyers agreed to restrict their ability to convert the Notes and/or exercise the Warrants and receive shares of the Company’s Common Stock such that the number of shares of Common Stock held by the Buyer in the aggregate and its affiliates after such conversion or exercise does not exceed 9.99% of the then issued and outstanding shares of the Company’s Common Stock.

Pursuant to the Registration Rights Agreement, the Company agreed to file a registration statement with the SEC, within 30 days following receipt of a request from a Buyer (or 45 days with respect to an underwritten offering), covering such shares of common stock issuable upon conversion of the Notes or exercise of the Warrants, as requested by the Buyers, and have such registration statement declared effective by the SEC within 90 days thereafter. The Company also agreed to notify the Buyers if the Company at any time proposes to register any of its securities under the Securities Act of 1933, as amended, and of such Buyers’ right to participate in such registration. In connection with the conversion described above, no request has been received from a Buyer to register such shares.

If the Company fails to comply with the registration statement filing, effective date or maintenance date filing requirements, it is required to pay the Buyers a registration delay payment in cash equal to 2% of the Buyer’s original principal amount stated on such Investors’ Note as of the Closing Date on the date of each failure, and on every thirty (30) day anniversary of the respective failures (Registration Delay Payment). Notwithstanding the foregoing, in no event shall the aggregate amount of Registration Delay Payments exceed 10% of such Investor’s original principal amount stated on the Note on the Closing Date. The Company accounts for such Registration Delay Payments as contingent liabilities. Accordingly, the Company recognizes such damages when it becomes probable that they will be incurred and amounts are reasonably estimable.

Pursuant to the Guaranty, subsidiaries of the Company guaranteed to the collateral agent, for the benefit of the Buyers, the punctual payment, as and when due and payable, of all amounts owed by the Company in respect of the Purchase Agreement, the Notes and the other transaction documents executed in connection with the Purchase Agreement.

Pursuant to the Security Agreement, the Company and its subsidiaries granted, in favor of the collateral agent for the Buyers, a continuing security interest in all personal property and assets of the Company and its subsidiaries, as collateral security for the obligations of the Company and its subsidiaries under the Purchase Agreement, the Notes, the Guaranty and the other transaction documents.

NOTE 5 – OTHER DEBT

Short-Term Bank Loan

Effective August 1, 2013, the China Operations entered into a loan with the Bank of China (the Short-Term Bank Loan). The Short-Term Bank Loan provides for a loan in the amount of $3,283,860. The proceeds from the Short-Term Bank Loan were used to repay outstanding unsecured loans of $2,404,545 due to the Company’s joint venture partner, Taian Gas Group (TGG). The Short-Term Bank Loan has an interest rate of 7.38%, and interest is due on a quarterly basis. The Short-Term Bank Loan matures on August 1, 2014, and is guaranteed by TGG.

Loans Payable

The Company’s long-term debt also consists of notes issued by the Company or assumed in acquisitions related to working capital funding and the purchase of property and equipment in the ordinary course of business. At October 31, 2013, loans payable obligations totaled $193,995 with interest rates ranging from 4.24% to 8.99%.

	18

WPCS INTERNATIONAL INCORPORATED AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

NOTE 6 – DERIVATIVE LIABILITIES

Senior secured convertible notes- embedded conversion features

Immediately prior to entering into the Amendment and Note Amendment, the Notes met the definition of a hybrid instrument, as defined in ASC 815. The hybrid instrument was comprised of (i) a debt instrument, as the host contract and (ii) an option to convert the debentures into common stock of the Company, as an embedded derivative and recorded them as a discount to the Notes. The embedded derivatives derive their value based on the underlying fair value of the Company’s common stock. The embedded derivatives are not clearly and closely related to the underlying host debt instrument since the economic characteristics and risk associated with these derivatives are based on the common stock fair value. As a result, the Company determined the final fair value of the embedded derivatives and recognized a derivative liability of $4,000,437. The changes in the fair value of the embedded derivative were immediately recognized in earnings and classified as a gain or loss on the embedded derivative financial instrument in the accompanying condensed consolidated statements of operations. For the three and six months ended October 31, 2013, the Company recognized a loss of $61,408 and $1,598,537, respectively.

The Company estimated the fair value of the embedded derivatives using a binomial lattice model with the following assumptions: conversion price of $0.20 per share; risk free interest rate of 0.08%; expected life of 1.5 years; expected dividend of zero; a volatility factor of 134%; and a volume weighted average common stock price of $2.07 per share as of October 31, 2013. The expected lives of the instruments are equal to underlying term of the senior secured convertible notes. The expected volatility is based on the historical price volatility of the Company’s common stock. The risk-free interest rate represents the U.S. Treasury constant maturities rate for the expected life of the related conversion option. The dividend yield represents anticipated cash dividends to be paid over the expected life of the conversion option.

As a result of the Amendment and Note Amendment, the exercise price of the Notes were fixed at $0.20 per share, and will only adjust in the event of any future stock splits or dividends, and the redemption price of the Notes in the event of default was fixed at approximately $10,900,000. As a result, the Company determined that the modifications changed the instruments classification to an equity instrument which has resulted in bifurcation and liability accounting no longer being required. Accordingly, the Company reclassed the total former derivative liability related to the Notes of $4,000,437 to additional paid-in capital at October 31, 2013.

Common stock warrants

Immediately prior to entering into the Amendment, the Company determined that the fair value of the Warrants issued in connection with the issuance of the Notes under the Purchase Agreement was a derivative liability and recorded them as a discount to the Notes. The Company has recognized a final derivative liability of $3,093,722. The changes in the fair value of the embedded derivative were immediately recognized in earnings and classified as a gain or loss on the embedded derivative financial instrument in the accompanying condensed consolidated statements of operations. For the three and six months ended October 31, 2013, the Company recognized a gain of $2,269,563 and a loss of $764,786, respectively.

The Company estimated the fair value of the warrant derivative using a binomial lattice model with the following assumptions: conversion price of $2.1539 per share; risk free interest rate of 1.31%; expected life of 5 years; expected dividend of zero; a volatility factor of 81%; and a volume weighted average common stock price of $2.07 per share as of October 31, 2013. The expected lives of the instruments are equal to the contractual term of the Warrants. The expected volatility is based on the historical price volatility of the Company’s common stock. The risk-free interest rate represents the U.S. Treasury constant maturities rate for the expected life of the related warrants. The dividend yield represents anticipated cash dividends to be paid over the expected life of the conversion option.

In connection with the Amendment, the Company recorded $72,832 of additional non-cash interest expense for the fair value of the 154,961 Exchange Warrants issued. The Company estimated the fair value of the Exchange Warrants using the Black-Scholes-Merton pricing model with the following assumptions: conversion price of $2.1539; risk free interest rate of 1.070%; expected life of 5 years; expected dividend of zero; a volatility factor of 138.2%; and a common stock price of $2.17 as of October 23, 2013. In addition, the Company recorded the fair value of the 38,740 Shares issued with the Exchange Warrants at a fair value of $88,715 based on the closing market price on October 25, 2013 of $2.29 per share.

As a result of the Amendment and Note Amendment, the exercise price of the Warrants was fixed at $2.1539 per share, and will only adjust in the event of any future stock splits or dividends. As a result, the Company determined that the modifications changed the instruments classification to an equity instrument that has resulted in bifurcation and liability accounting no longer being required. Accordingly, the Company reclassed the total former derivative liability related to the Warrants of $3,093,722 to additional paid-in capital at October 31, 2013.

	19

WPCS INTERNATIONAL INCORPORATED AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

NOTE 7 - FAIR VALUE MEASUREMENTS

As defined by the ASC, fair value measurements and disclosures establish a hierarchy that prioritizes fair value measurements based on the type of inputs used for the various valuation techniques (market approach, income approach and cost approach). The levels of hierarchy are described below:

	·	Level 1: Observable inputs such as quoted market prices in active markets for identical assets or liabilities.

	·	Level 2: Inputs other than quoted market prices that are observable for the asset or liability, either directly or indirectly; these include quoted prices for similar assets or liabilities in active markets, such as interest rates and yield curves that are observable at commonly-quoted intervals.

	·	Level 3: Unobservable inputs that reflect the reporting entity’s own assumptions, as there is little, if any, related market activity.

The following table summarizes the financial liabilities measured at fair value on a recurring basis as of October 31, 2013, segregated by the level of the valuation inputs within the fair value hierarchy utilized to measure fair value:

		Quoted Prices in									Total Increase (Reduction)
		Active Markets for		Significant Other		Significant					in Fair Value
Balance Sheet		Identical Assets or		Observable Inputs		Unobservable		October 31, 2013	April 30, 2013		Recorded at
Location		Liabilities (Level 1)		(Level 2)		Inputs (Level 3)		Total	Total		October 31, 2013
Liabilities:

Derivative liability - secured convertible notes	$	-	$	-	$	-	$	-	3,088,756	$	1,598,536

Derivative liability - warrants	$	-	$	-	$	-	$	-	3,858,508	$	(764,786)

The table below sets forth a summary of changes in the fair value of the Company’s Level 3 derivative liabilities related to the senior secured convertible notes and warrants for the period ended October 31, 2013, prior to reclassification to an equity instrument as a result of the Amendment and Note Amendment.

October 31, 2013

	Notes		Warrants

Balance at beginning of year	$	3,088,756	$	3,858,508
Reduction in derivative instruments from note exercise		(686,856)		-
Change in fair value of derivative liabilities		1,598,537		(764,786)
		4,000,437		3,093,722
Reclassification of derivative liabilities to additional paid-in capital		(4,000,437)		(3,093,722)
Balance at end of period	$	-	$	-

	20

WPCS INTERNATIONAL INCORPORATED AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

NOTE 8 - RELATED PARTY TRANSACTIONS

In connection with the acquisition of Pride, the Company leases its Woombye, Queensland, Australia location from Pride Property Trust, of which the former shareholders of the Pride Group (QLD) Pty Ltd. are the members. For each of the six month periods ended October 31, 2013 and 2012, the rents paid for this lease were $50,169 and $58,915, respectively.

The China Operations revenue earned from TGG and subsidiaries was $0 for each of the six months ended October 31, 2013 and 2012. The China Operations accounts receivable due from TGG and subsidiaries was $0 and $221,474 as of October 31, 2013 and 2012, respectively. In addition, during the three months ended October 31, 2013, the Company received dividends from the China Operations of $367,981 that had been declared and accrued by TAGS in prior fiscal years.

As further described in Note 11, “Discontinued Operations”, the Company entered into a Securities Purchase Agreement to sell 100% of the shares of Pride for $1,400,000 to Turquino Equity LLC, whose managing member is Andrew Hidalgo, former Chairman and Chief Executive Officer of the Company.

NOTE 9 - SHAREHOLDERS’ EQUITY

Stock-Based Compensation Plans

In September 2006, the Company adopted the 2007 Incentive Stock Plan, under which officers, directors, key employees or consultants may be granted options. Under the 2007 Incentive Stock Plan, 57,142 shares of common stock were reserved for issuance upon the exercise of stock options, stock awards or restricted stock. These shares were registered under Form S-8. Under the terms of the 2007 Incentive Stock Plan, stock options are granted at exercise prices equal to the fair market value of the common stock at the date of grant, and become exercisable and expire in accordance with the terms of the stock option agreement between the optionee and the Company at the date of grant. These options generally vest based on between one to three years of continuous service and have five-year contractual terms. At October 31, 2013, options to purchase 48,563 shares were outstanding at exercise prices ranging from $2.52 to $21.98. At October 31, 2013, there were 6,794 options available for grant under the 2007 Incentive Stock Plan.

In September 2005, the Company adopted the 2006 Incentive Stock Plan, under which officers, directors, key employees or consultants may be granted options. Under the 2006 Incentive Stock Plan, 57,142 shares of common stock were reserved for issuance upon the exercise of stock options, stock awards or restricted stock. These shares were registered under Form S-8. Under the terms of the 2006 Incentive Stock Plan, stock options are granted at exercise prices equal to the fair market value of the common stock at the date of grant, and become exercisable and expire in accordance with the terms of the stock option agreement between the optionee and the Company at the date of grant. These options generally vest based on between one to three years of continuous service and have five-year contractual terms. At October 31, 2013, options to purchase 46,911 shares were outstanding at exercise prices ranging from $2.52 to $4.20. At October 31, 2013, there were 6 options available for grant under the 2006 Incentive Stock Plan.

In March 2003, the Company established a stock option plan pursuant to which options to acquire a maximum of 59,523 shares of the Company's common stock were reserved for grant (the "2002 Plan"). These shares were registered under Form S-8. Under the terms of the 2002 Plan, the options are exercisable at prices equal to the fair market value of the stock at the date of the grant and become exercisable in accordance with terms established at the time of the grant. These options generally vest based on between one to three years of continuous service and have five-year contractual terms. At October 31, 2013, options to purchase 14,636 shares were outstanding at exercise prices ranging from $4.20 to $24.71. There are no further shares available for grant under the 2002 Plan as the ten-year term of the 2002 Plan was reached in March 2013.

The Company estimates the fair value of stock options granted using the Black-Scholes-Merton option-pricing model. Compensation cost is then recognized on a straight-line basis over the vesting or service period and is net of estimated forfeitures. There were 1,760 stock options granted during the six months ended October 31, 2013. There were 87,857 stock options granted during the six months ended October 31, 2012.

The Company recorded stock-based compensation of $22,511 and $103,951 for the six months ended October 31, 2013 and 2012, respectively. At October 31, 2013, the total compensation cost related to unvested stock options granted to employees and directors under the Company’s stock option plans but not yet recognized was approximately $4,000 and is expected to be recognized over a weighted-average period of 7 months.

	21

WPCS INTERNATIONAL INCORPORATED AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

The Company has elected to adopt the shortcut method for determining the initial pool of excess tax benefits available to absorb tax deficiencies related to stock-based compensation. The shortcut method includes simplified procedures for establishing the beginning balance of the pool of excess tax benefits (the APIC Tax Pool) and for determining the subsequent effect on the APIC Tax Pool and the Company’s consolidated statements of cash flows of the tax effects of share-based compensation awards. Excess tax benefits related to share-based compensation are reflected as financing cash inflows.

Reverse Stock Split

Effective May 28, 2013, the Company amended its Certificate of Incorporation, as amended, pursuant to which the Company affected a one-for-seven reverse split of the Company’s issued and outstanding shares of common stock (the Reverse Stock Split) and reduced the number of authorized shares of common stock by the same ratio, from 100 million to 14,285,715. The total issued and outstanding common stock was decreased from 6,954,766 shares to 994,187 shares. All share-related and per share information have been adjusted to give effect to the Reserve Stock Split.

The purpose of the Reverse Stock Split was to raise the per share trading price of WPCS common stock to regain compliance with the $1.00 per share minimum bid price requirement for a continued listing on the NASDAQ Capital Market. In order to maintain the WPCS listing on the NASDAQ Capital Market, on or before June 24, 2013, the Company’s common stock was required to have a minimum closing bid price of $1.00 per share for a minimum of ten prior consecutive trading days, which was achieved.

Section 16(b) Settlement

On August 7, 2006, Maureen Huppe, a stockholder of the Company, filed suit in the United States District Court Southern District of New York, against defendants Special Situations Fund III QP, L.P. and Special Situations Private Equity Fund, L.P. (collectively SSF), former stockholders of the Company, alleging violations of Section 16(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78p (b) (Section 16(b)). SSF made sales of 20,445 shares of the Company’s common stock from December 15, 2005 to January 30, 2006, at prices ranging from $64.26 to $88.34 per share. On April 12, 2006, SSF purchased 95,209 shares of the Company’s common stock at $49.00 per share.

The complaint sought disgorgement from SSF for any "short-swing profits" obtained by them in violation of Section 16(b), as a result of the foregoing sales and purchases of the Company’s common stock within periods of less than nine months while SSF was a beneficial owner of more than 10% of the Company’s common stock. The complaint sought disgorgement to the Company of all profits earned by SSF on the transactions, attorneys’ fees and other expenses. While the suit named the Company as a nominal defendant, it contained no claims against nor sought relief from the Company.

On June 13, 2012, the parties executed a court approved settlement which resolved this Section 16(b) action. Pursuant to this settlement, SSF agreed to pay the Company $529,280 in disgorgement of short-swing profits, less the fees and expenses agreed upon by the plaintiffs of $272,539 in connection with the settlement, resulting in the remainder, or $254,361, paid to the Company. The Company recorded the net proceeds as additional paid-in capital.

NOTE 10 - SEGMENT REPORTING

The Company's reportable segments are determined and reviewed by management based upon the nature of the services, the external customers and customer industries and the sales and distribution methods used to market the products. The Company organizes its reportable segments to correspond with its primary service lines: wireless communications, specialty construction and electrical power. Management evaluates performance based upon income (loss) before income taxes. Corporate includes corporate salaries and external professional fees, such as accounting, legal and investor relations costs which are not allocated to the other segments. Corporate assets primarily include cash and cash equivalents and prepaid expenses.

As part of the divestiture transactions more fully described in Note 11, “Discontinued Operations”, the Company reclassified the reporting units within its reportable segments. As a result, wireless communications includes the Suisun City Operations, specialty construction includes the China Operations, and electrical power includes the Trenton, Seattle and Portland Operations, for each of the periods presented. The segment information presented below contains the operating results for the continuing operations only. The Lakewood, Hartford and Australia Operations are reported as discontinued operations, and were previously reported in the wireless communications segment. Segment results for the three and six months ended October 31, 2013 and 2012 are as follows:

	22

WPCS INTERNATIONAL INCORPORATED AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

	For the Three Months Ended October 31, 2013										For the Three Months Ended October 31, 2012

	Corporate		Wireless Communications		Specialty Construction		Electrical Power		Total		Corporate		Wireless Communications		Specialty Construction		Electrical Power		Total

Revenue	$	-	$	3,043,860	$	1,160,780	$	3,151,104	$	7,355,744	$	-	$	2,664,858	$	822,840	$	4,470,545	$	7,958,243

Depreciation and amortization	$	2,093	$	25,515	$	158,397	$	28,890	$	214,895	$	8,634	$	34,132	$	173,237	$	52,176	$	268,179

Income (loss) before income taxes from continuing operations	$	(623,318)	$	40,370	$	(51,638)	$	146,127	$	(488,459)	$	(930,257)	$	213,928	$	92,799	$	918,531	$	295,001

	As of and for the Six Months Ended October 31, 2013										As of and for the Six Months Ended October 31, 2012

	Corporate		Wireless Communications		Specialty Construction		Electrical Power		Total		Corporate		Wireless Communications		Specialty Construction		Electrical Power		Total

Revenue	$	-	$	6,098,599	$	2,033,505	$	7,055,023	$	15,187,127	$	-	$	5,123,269	$	1,853,639	$	12,269,352	$	19,246,260

Depreciation and amortization	$	6,167	$	51,150	$	321,479	$	79,156	$	457,952	$	19,627	$	71,328	$	347,928	$	133,403	$	572,286

Income (loss) before income taxes from continuing operations	$	(7,073,254)	$	130,562	$	26,873	$	611,214	$	(6,304,605)	$	(1,695,088)	$	443,112	$	111,629	$	1,248,814	$	108,467

Total assets	$	2,684,408	$	3,453,483	$	7,493,274	$	4,784,665	$	18,415,830	$	5,780,017	$	2,416,097	$	7,854,338	$	5,428,797	$	21,479,249

Additions of property and equipment	$	-	$	27,627	$	20,353	$	71,802	$	119,782	$	52,515	$	35,162	$	152,721	$	100,058	$	340,456

As of and for the six months ended October 31, 2013 and 2012, the specialty construction segment includes approximately $2,034,000 and $1,854,000, respectively, in revenue and $111,000 and $841,000, respectively, of net assets held in China related to the Company’s 60% interest in the China Operations.

NOTE 11 - DISCONTINUED OPERATIONS

Hartford and Lakewood Operations Asset Sales

On July 25, 2012, the Company and the Hartford and Lakewood Operations entered into an asset purchase agreement (the Asset Purchase Agreement), pursuant to which the Hartford and Lakewood Operations sold substantially all of their assets to two newly-created subsidiaries of Kavveri Telecom Products Limited (Kavveri) for a purchase price of $5.5 million in cash, subject to adjustment, and the assumption of their various liabilities. At closing, the Company received $4.9 million in cash, with the remaining $600,000 of the purchase price to be placed into escrow pursuant to the Asset Purchase Agreement. The Company used the proceeds from this sale to repay the full amount outstanding under the Credit Agreement of $4,022,320 as of July 25, 2012. The difference of $877,680 was deposited in its operating cash account.

Kavveri agreed to place $350,000 of the purchase price into escrow in the future pending assignment of certain contracts post-closing, with the Company receiving those funds upon successful assignment of the contracts. The remaining $250,000 is to be escrowed in the future for purposes of satisfying certain adjustments to the purchase price based on a final net asset valuation to be completed after closing as well as repurchase obligations of certain delinquent accounts receivable. No later than three days after the final determination of the net asset valuation, the purchasers are required to deposit the $600,000 into escrow.

To date, the Company has not reached agreement with Kavveri with regard to resolving the net asset valuation. On October 4, 2013, Kavveri submitted a revised aggregate claim for indemnification by the Company of approximately $1,013,000 with regard to (1) net asset valuation claim owed of approximately $421,000; (2) accounts receivable deemed uncollectible of $414,000 related to a project that was completed by the Company’s former Hartford Operations and accepted by the customer on or prior to the Closing Date; and (3) delinquent account receivables to be repurchased of approximately $178,000.

	23

WPCS INTERNATIONAL INCORPORATED AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

With regard to this revised claim, the Company continues to stand-by its previous position as described in its response to Kavveri on February 27, 2013. Among other things, the Company disputes the amount of the delinquent receivables, and believes that after consideration of reserves for uncollectible accounts and other offsets previously considered in its calculation of the net asset valuation, the total amount of accounts receivable deemed uncollectible for repurchase to be approximately $36,000. However, the Company contends that Kavveri missed the deadline to notify the Company regarding the repurchase of delinquent receivables pursuant to the terms of the Asset Purchase Agreement regarding timing for notification to the Company, which would eliminate any repurchase payment owed by the Company to Kavveri. The Company also believes that the $414,000 of accounts receivable claimed for indemnification by Kavveri is without merit. Finally, the Company also disputes the net asset valuation claim, and believes Kavveri owes the Company approximately $58,000, following its evaluation of the uncollectible accounts receivable. With regard to the net asset valuation claim, if the parties disagree, and if they are unable to come to an agreement, the matter will be submitted to one or more independent, nationally-recognized accounting firms for final determination. To date, no matters have been submitted to an independent accounting firm.

Australia Operations

On September 19, 2013, the Company entered into a Securities Purchase Agreement (the Agreement) with Turquino Equity LLC, a limited liability company (Turquino), whose managing member is Andrew Hidalgo, former Chairman and Chief Executive Officer of the Company. Pursuant to the Agreement, the Company agreed to sell 100% of the shares of Pride for $1,400,000 (Purchase Price). At the Closing Date, the Company will settle the Purchase Price with Turquino by applying the net after tax severance balance due Mr. Hidalgo under his separation agreement as further described in Note 13“Executive Management Changes”, as partial payment towards the Purchase Price, and Turquino will pay cash for the difference between the Purchase Price and the net severance balance due. The Agreement contains a number of conditions to closing, including but not limited to the following: (i) each of the Company and Turquino shall have performed and complied with all terms of the Agreement required to be performed or complied with by it at or prior to the Closing Date; (ii) no action or proceeding by or before any governmental authority shall have been instituted or threatened (and not subsequently dismissed, settled or otherwise terminated) which might restrain, prohibit or invalidate any of the transactions contemplated by the Agreement, other than an action or proceeding instituted or threatened by a party or any of its affiliates; (iii) the representations and warranties contained in made by each of the Company and Turquino to each other shall be true and correct in all material respects on the closing date as though made on and as of the closing date; (iv) the Company obtaining a fairness opinion that the Purchase Price is fair; and (v) the Company has obtained shareholder approval, if required. To date, the Company and Turquino have completed certain of the closing conditions, however the Company is in the process of obtaining shareholder approval, so it has not completed the closing. It is expected that the Agreement will be closed by January 31, 2014.

The Company has reported the financial activity of these three operations as discontinued operations for all periods presented. The disposal of two operations was concluded in fiscal year 2013, and the Company has reflected the gain from the disposal of the Hartford and Lakewood Operations in the three months ended July 31, 2012. A summary of the operating results for the discontinued operations is as follows:

	24

WPCS INTERNATIONAL INCORPORATED AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

	Three Months Ended				Six Months Ended
	October 31,				October 31,
	2013		2012		2013		2012

REVENUE	$	1,550,626	$	1,983,918	$	3,431,331	$	9,041,819

COSTS AND EXPENSES:
Cost of revenue		1,078,044		1,310,880		2,482,879		6,958,473
Selling, general and administrative expenses		435,920		875,813		897,157		3,082,787
Depreciation and amortization		46,994		51,887		95,426		211,244

		1,560,958		2,238,580		3,475,462		10,252,504

OPERATING LOSS FROM DISCONTINUED OPERATIONS		(10,332)		(254,662)		(44,131)		(1,210,685)

Interest expense		(1,614)		3,366		(4,384)		3,593

Loss from discontinued operations before income tax provision		(8,718)		(258,028)		(39,747)		(1,214,278)

Income tax provision		-		215,700		-		269,864

Loss from discontinued operations, net of tax		(8,718)		(473,728)		(39,747)		(1,484,142)

(Loss) gain from disposal		-		(485,212)		-		1,839,419

TOTAL (LOSS) INCOME FROM DISCONTINUED OPERATIONS	$	(8,718)	$	(958,940)	$	(39,747)	$	355,277

The Company incurred approximately $55,000 of expenses directly associated with the asset sales of the Hartford and Lakewood Operations.

There were no assets or liabilities included in the condensed consolidated balance sheet for the Hartford and Lakewood Operations at October 31, 2013 or April 30, 2013.

The following table summarizes the assets and liabilities held for sale:

ASSETS	October 31, 2013		April 30, 2013

CURRENT ASSETS:

Cash and cash equivalents	$	257,166	$	494,471
Accounts receivable, net of allowance		1,292,564		1,277,120
Costs and estimated earnings in excess of billings on uncompleted contracts		189,678		69,488
Prepaid expenses and other current assets		103,945		64,370
Total current assets held for sale		1,843,353		1,905,449

PROPERTY AND EQUIPMENT, net		205,970		298,721

OTHER INTANGIBLE ASSETS, net		183,411		234,404

OTHER ASSETS		16,161		17,704
Total other assets held for sale		405,542		550,829

Total assets held for sale	$	2,248,895	$	2,456,278

LIABILITIES
Accounts payable and accrued expenses	$	668,319	$	662,437
Billings in excess of costs and estimated earnings on uncompleted contracts		32,111		23,194
Total liabilities held for sale	$	700,430	$	685,631

	25

WPCS INTERNATIONAL INCORPORATED AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

NOTE 12 - COMMITMENTS AND CONTINGENCIES

Other payable to Zurich

On July 12, 2012, the Company executed the Financing Agreement with Zurich. Under the terms of the Zurich Agreement, Zurich advanced the Company $793,927 for the payment of labor and labor-related benefits to assist in completing the project contract with the Owner of Cooper Project. The Cooper Project is a $16.2 million project completed by the Company’s Trenton Operations. Zurich and its affiliate Fidelity and Deposit Company of Maryland (F&D), as surety, have issued certain performance and payment bonds on behalf of the Owner in regard to the Company’s work on this project. The Company was to repay Zurich the financial advances by September 2012; however the Company was in default under the Financing Agreement as it had not repaid Zurich the $793,927 and Zurich paid certain of the Company’s vendors pursuant to Zurich’s obligations under its payment bond on the Cooper Project. As a result, a letter of direction was sent to the Owner requesting that all current and future amounts to be paid on the contract be assigned and paid to Zurich directly.

In addition, the Company is contingently liable to Zurich and its affiliate F&D under a General Agreement of Indemnity (the Indemnity Agreement). Zurich and F&D, as surety, have issued certain performance and payment bonds on behalf of owners or customers regarding the Company’s work on various projects under the Indemnity Agreement. The Company agrees to indemnify the surety for any payments made by Zurich on contracts of suretyship, guaranty or indemnity.

On April 17, 2013, the Company executed the Forbearance Agreement with Zurich, which supersedes the Financing Agreement. As of April 16, 2013, the total Loss Amount due Zurich under the Forbearance Agreement less payments received by Zurich was $2,836,668. Under the Forbearance Agreement, among other things, the parties have agreed to the following payments which will be credited against the Loss Amount owed to Zurich by the Company: (1) the Company shall make monthly payments to Zurich of $25,000 due upon the fifth of each month, up to and including December 5, 2013 (the Interim Liability Payments); (2) Zurich is to receive any and all amounts due under the contracts for which Zurich has issued one or more bonds (the Customer Payments); and (3) the Claim, up to the Loss Amount as it exists at the time. As of October 31, 2013, the net Other Payable for the Loss Amount owed Zurich under the Forbearance Agreement was $1,533,757, which includes the initial Interim Liability Payments of $25,000 per month, and $1,090,604 of additional contract accounts receivable representing future Customer Payments and $22,922 of additional accounts payable assigned to Zurich which were reclassed from consolidated accounts receivable and accounts payable, respectively.

Each or any of the following shall constitute an event of default under the Forbearance Agreement: (a) failure by the Company to make any of the Interim Liability Payments; (b) failure by the Company to remit any Customer Payments received; (c) the failure by the Company or the Owner to remit the proceeds of the Claim to Zurich; and (d) any Loss Amount that still exists as of December 31, 2013. If an event of default occurs, Zurich is authorized to confess judgment against the Company, however the entry of any judgment by confession shall not constitute a waiver or release of any of Zurich’s rights under the Indemnity Agreement. The Company is currently in default under the Forbearance Agreement due to the failure to pay the monthly Interim Liability Payment of $25,000 for the month of December 2013. In addition, the Company does not have the ability to discharge the Loss Amount of $1,533,757 due December 31, 2013 under the Forbearance Agreement. The Company is currently in discussions with Zurich for the settlement of the Loss Amount due under the Forbearance Agreement. There can be no assurance that the Company will be successful in settling with Zurich the Loss Amount due.

The Company submitted the Claim to the Owner of $2,421,425 and is currently in negotiations with the Owner to settle the Claim. The next step in the resolution process as set forth in the contract with the Owner is mandatory non-binding mediation through the American Arbitration Association (the AAA). On April 15, 2013, the Company filed a Request for Mediation (the Mediation) with the AAA with regard to the Claim. The Company is awaiting a response from the Owner and, as such, no date has been established for the Mediation. If it is successful in the settlement of this Claim, the Company expects to use the proceeds from the Claim to repay Zurich the Loss Amount as it exists at the time. There can be no assurance that the Company will be successful in settling with the Owner for all or a portion of the submitted claim.

	26

WPCS INTERNATIONAL INCORPORATED AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

NOTE 13 - EXECUTIVE MANAGEMENT CHANGES

Andrew Hidalgo Separation

On July 24, 2013, the Company entered into a separation agreement (the Separation Agreement) with Andrew Hidalgo (Hidalgo), the Company’s former President, Chief Executive Officer and a member of the board of directors. Pursuant to the Separation Agreement, Hidalgo resigned effective at the close of business on July 30, 2013 (the Termination Date), as the President, Chief Executive Officer and a member of the board of directors of the Company and from all officer and director positions with all of the Company’s subsidiaries. As a result of the Separation Agreement, the Company recorded a one-time charge for severance expense of $1,474,277 for the six months ended October 31, 2013.

On September 19, 2013, the Company and Turquino, whose managing member is Hidalgo, entered into the Agreement to sell 100% of the shares of Pride to Turquino for $1,400,000 as more fully described in Note 11, “Discontinued Operations”. Until the date of closing of the Agreement the Company shall continue to pay Hidalgo his current base salary of $325,000 per year through the Company’s normal payroll process. At the closing date, the Company shall make the final Severance Payment, net of applicable taxes, and shall apply the net after tax Severance Payment as partial payment towards the purchase price for Pride. The cash difference between the after tax Severance Payment and the purchase price shall be paid to the Company at the closing date.

Sebastian Giordano Appointment

Effective August 1, 2013, Sebastian Giordano (Giordano), a member of the Company’s board of directors, was appointed as the Company’s Interim Chief Executive Officer.

Effective August 1, 2013, the Company entered into a letter agreement with Giordano (the Giordano Agreement) to serve as Interim Chief Executive Officer on a part-time basis until a permanent chief executive officer is appointed. The Giordano Agreement can be terminated by either party upon 30 days prior notice. Pursuant to the Giordano Agreement, Giordano shall receive a monthly consulting fee of $10,833. In addition, upon the Company approving a new stock incentive plan, Giordano shall receive a grant of 30,000 shares of the Company’s common stock and Giordano shall be entitled to receive a discretionary bonus upon successful achievement of a merger or acquisition of the Company by another entity. The Company will also reimburse Giordano for all reasonable expenses in connection with his services to the Company.

	27

WPCS INTERNATIONAL INCORPORATED AND SUBSIDIARIES

ITEM 2 – MANAGEMENT’S DISCUSSION AND ANALYSIS

OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

This Management's Discussion and Analysis of Financial Condition and Results of Operations includes a number of forward-looking statements that reflect Management's current views with respect to future events and financial performance. You can identify these statements by forward-looking words such as “may,” “will,” “expect,” “anticipate,” “believe,” “estimate” and “continue,” or similar words. Those statements include statements regarding the intent, belief or current expectations of us and members of our management team as well as the assumptions on which such statements are based. Prospective investors are cautioned that any such forward-looking statements are not guarantees of future performance and involve risk and uncertainties, and that actual results may differ materially from those contemplated by such forward-looking statements.

Readers are urged to carefully review and consider the various disclosures made by us in this report and in our other reports filed with the Securities and Exchange Commission. Important factors currently known to Management could cause actual results to differ materially from those in forward-looking statements. We undertake no obligation to update or revise forward-looking statements to reflect changed assumptions, the occurrence of unanticipated events or changes in the future operating results over time. We believe that management’s assumptions are based upon reasonable data derived from and known about our business and operations and the business and operations of the Company. No assurances are made that actual results of operations or the results of our future activities will not differ materially from management’s assumptions. Factors that could cause differences include, but are not limited to, expected market demand for the Company’s services, fluctuations in pricing for materials, and competition.

Overview

We are a global provider of design-build engineering services for communications infrastructure, with approximately 250 employees in five operations centers on three continents. We provide our engineering capabilities including wireless communication, specialty construction and electrical power to a diversified customer base in the public services, healthcare, energy and corporate enterprise markets worldwide.

Recent Developments

Note and Warrant Amendments

On October 25, 2013, we entered into an amendment, waiver and exchange agreement (the Amendment) with holders (Buyers) of outstanding secured convertible notes (Notes) and common stock purchase warrants (Warrants) that were sold pursuant to a securities purchase agreement dated December 4, 2012. Pursuant to the Amendment, the Buyers exchanged 154,961 of their Warrants for 38,740 shares of common stock (the Shares) and warrants to purchase 154,961 shares of common stock (the “Exchange Warrants”). Effectively, for every four Warrants surrendered, the Buyers received a unit of four Exchange Warrants and one Share. It was determined that the Black-Scholes value of one warrant being exchanged was equal to $1.83, resulting in four Warrants being equal to $7.32 and the parties valued the unit at a price of $7.52. As a result, the Shares issued were calculated at $0.20, and by the operation of the terms of the Notes, the conversion price of the Notes automatically adjusted to $0.20. The Exchange Warrants are exercisable for a period of five years from the date of issuance of the original Warrants at an initial exercise price of $2.1539 per share. The exercise price will only adjust in the event of any future stock splits or dividends.

	28

WPCS INTERNATIONAL INCORPORATED AND SUBSIDIARIES

ITEM 2 – MANAGEMENT’S DISCUSSION AND ANALYSIS

OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Further, the Buyers waived certain events of default that had occurred under the Notes as more fully described as follows. Pursuant to the terms of the Notes, an event of default occurs when the Company’s common stock is suspended or threatened with suspension from trading on The NASDAQ Capital Market (or an equivalent market). On October 7, 2013, the Company received from the Staff of the Listing Qualifications Department of The NASDAQ Stock Market LLC (NASDAQ) indicating that the Company’s common stock would be subject to delisting from The NASDAQ Capital Market on October 16, 2013 due to the Company’s non-compliance with the applicable $2.5 million stockholders’ equity requirement, as set forth in Listing Rule 5550(b) (1). As a result of the notice from NASDAQ, an event of default occurred under the Notes, which was waived by the Buyers pursuant to the Amendment. The closing of the Amendment transaction occurred on October 30, 2013.

On November 5, 2013, the Company entered into an amendment agreement (the Note Amendment) with the Buyers. The closing of the Note Amendment transaction occurred on November 5, 2013, and the Note Amendment was deemed effective as of October 31, 2013. The intent of the Note Amendment was to eliminate certain features of the Notes which would otherwise result in substantial accounting charges to the Company.

The modifications to the Notes as a result of the Amendment and Note Amendment described above included a change in the conversion price of the Notes from $2.1539 to $0.20, and a change in the maturity date of the Note, from June 5, 2014 to October 31, 2023. As a result of the significant modifications of the Notes, we determined that the Notes were extinguished and New Notes were being issued. In connection with this modification, we compared the present value of the beneficial conversion features of the Notes to the New Notes. We determined that the present value of the New Notes exceeded the present value of the Notes, by more than 10%, primarily as a result of the change in the conversion price of the New Notes to $0.20 as compared to the $2.1539 under the Notes which resulted in the application of extinguishment accounting. The modification of the Note debt instrument for the six months ended October 31, 2013, resulted in the debt instruments being exchanged with substantially different terms and extinguishment accounting was applied resulting in a loss on extinguishment of debt for the unamortized discount related to the Notes of $1,299,304. In addition, we recorded a new debt discount based on the fixed conversion rate and exercise price of $0.20 per share of $3,400,000 related to the remaining proceeds of the New Notes.

NASDAQ Compliance

On November 14, 2013, we received a letter from The NASDAQ Hearings Panel (the “Panel”) informing us that we had regained compliance with NASDAQ Listing Rule 5550(b) (1), the minimum stockholders’ equity rule. As a result the Panel determined that the Company is in compliance with all applicable listing standards required for listing on The NASDAQ Capital Market, and accordingly, the Panel has determined to continue the listing of the Company’s securities on The NASDAQ Stock Market.

As a result of the Amendment and Note Amendment effective as of October 31, 2013, the exercise price of the Notes were fixed at $0.20 per share, and will only adjust in the event of any future stock splits or dividends, and the redemption price of the Notes in the event of default was fixed at approximately $10,900,000. In addition, the exercise price of the Warrants were fixed at $2.1539 per share, and will only adjust in the event of any future stock splits or dividends As a result, we determined that the modifications changed the instruments classification to an equity instrument that resulted in bifurcation and derivative liability accounting no longer being required. Accordingly, we reclassified the total former derivative liability related to the Notes and Warrants of $7,094,000 to additional paid-in capital at October 31, 2013. As a result of these reclassifications, our stockholders’ equity is in excess of $4,500,000 as of October 31, 2013, allowing us to regain compliance with the minimum stockholder equity NASDAQ listing requirement.

Sale of Pride Operations

On September 19, 2013, we entered into the Agreement to sell 100% of the shares of Pride to Turquino, whose managing member is Andrew Hidalgo (Hidalgo), our former President, Chief Executive Officer and member of the board of directors, for $1,400,000. Until the date of closing of the Agreement, we shall continue to pay Hidalgo his current base salary of $325,000 per year through our normal payroll process, pursuant to the Separation Agreement previously entered into with Hidalgo. At the closing date, we shall make the final Severance Payment, net of applicable taxes, and shall apply the net after tax Severance Payment as partial payment towards the purchase price for Pride. The cash difference between the after tax Severance Payment and the purchase price shall be paid to the Company at the closing date.

	29

WPCS INTERNATIONAL INCORPORATED AND SUBSIDIARIES

ITEM 2 – MANAGEMENT’S DISCUSSION AND ANALYSIS

OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The Agreement contains a number of conditions to closing, including but not limited to the following: (i) each of the Company and Turquino shall have performed and complied with all terms of the Agreement required to be performed or complied with by it at or prior to the Closing Date; (ii) no action or proceeding by or before any governmental authority shall have been instituted or threatened (and not subsequently dismissed, settled or otherwise terminated) which might restrain, prohibit or invalidate any of the transactions contemplated by the Agreement, other than an action or proceeding instituted or threatened by a party or any of its affiliates; (iii) the representations and warranties contained in made by each of the Company and Turquino to each other shall be true and correct in all material respects on the closing date as though made on and as of the closing date; (iv) the Company obtaining a fairness opinion that the Purchase Price is fair; and (v) the Company has obtained shareholder approval, if required. To date, the Company and Turquino has completed certain of the closing conditions, however it is in the process of obtaining shareholder approval, so it has not yet completed the closing. It is expected that the Agreement will be closed by January 31, 2014.

Zurich Forbearance Agreement

On July 12, 2012, we executed the Financing Agreement with Zurich, to assist in the completion of the project contract with the Owner of Cooper Project. Under the terms of the Financing Agreement, Zurich advanced us $793,927 to assist in the completion of the Cooper Project, a $16.2 million project completed by our Trenton Operations. We were to repay Zurich the financial advances by September 2012, however we were in default under the terms of the Financing Agreement as we did not repay Zurich the $793,927, and Zurich paid certain of the our vendors pursuant to Zurich’s obligations under its payment bond on the Cooper Project. In addition, we are contingently liable to Zurich and its affiliate F&D under the Indemnity Agreement. Zurich and F&D, as surety, have issued certain performance and payment bonds on behalf of owners or customers regarding the Company’s work on various projects under the Indemnity Agreement. We also agree to indemnify the surety for any payments made by Zurich on contracts of suretyship, guaranty or indemnity.

As of October 31, 2013, the net Loss Amount owed Zurich under the Forbearance Agreement was approximately $1,534,000, and is classified as Other Payable in our condensed consolidated balance sheet.

Each or any of the following shall constitute an event of default under the Forbearance Agreement: (a) failure by us to make any of the Interim Liability Payments; (b) failure by us to remit any Customer Payments received; (c) the failure by us or the Owner to remit the proceeds of the Claim to Zurich; and (d) any Loss Amount that still exists as of December 31, 2013. We are currently in default under the Forbearance Agreement due to the failure to pay the monthly Interim Liability Payment of $25,000 for the month of December 2013. In addition, we do not have the ability to discharge the Loss Amount of $1,533,757 due December 31, 2013 under the Forbearance Agreement. We are currently in discussions with Zurich for the settlement of the Loss Amount due under the Forbearance Agreement. There can be no assurance that we will be successful in settling with Zurich the Loss Amount due.

We have submitted a Claim to the Owner of $2,421,425 and we are currently in negotiations with the Owner to settle the Claim. If we are successful in the settlement of this Claim, we expect to use the proceeds from the Claim to repay Zurich the Loss Amount as it exists at the time. There can be no assurance that we will be successful in settling with the Owner for all or a portion of the submitted claim.

Wireless Communication

Throughout the community or around the world, in remote and urban locations, wireless networks provide the connections that keep information flowing. The design and deployment of a wireless network solution requires an in-depth knowledge of radio frequency engineering so that wireless networks are free from interference with other signals and amplified sufficiently to carry data, voice or video with speed and accuracy. We have extensive experience and methodologies that are well suited to address these challenges for our customers. We are capable of designing wireless networks and providing the technology integration necessary to meet goals for enhanced communication, increased productivity and reduced costs. We have the engineering expertise to utilize all facets of wireless technology or combination of various technologies to develop a cost effective network for a customer's wireless communication requirements. This includes Wi-Fi networks, point-to-point systems, mesh networks, microwave systems, cellular networks, in-building systems and two-way communication systems.

With the divestiture of the Hartford and Lakewood Operations, we have performed less project work in the police, fire, and emergency dispatch markets. However, we will continue to provide wireless communications services through our remaining operations in markets such as utilities, education, military and transportation infrastructure, as part of the services we provide in our other operations.

	30

WPCS INTERNATIONAL INCORPORATED AND SUBSIDIARIES

ITEM 2 – MANAGEMENT’S DISCUSSION AND ANALYSIS

OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Specialty Construction

With the development of communities and industry, pipeline services are an integral part of the infrastructure process. We have expertise in the construction and maintenance of pipelines in our China Operations for natural gas and petroleum transmission. This includes experience in transmission infrastructure, horizontal directional drilling and rock trenching. In addition, we offer trenching services for power lines, telecommunications and water lines. Our services are performed with minimal ground disruption and environmental impact.

Electrical Power

Electrical power transmission and distribution networks built years ago often cannot fulfill the growing technological needs of today's end users. We provide complete electrical contracting services to help commercial and industrial facilities of all types and sizes to upgrade their power systems. Our capabilities include power transmission, switchgear, underground utilities, outside plant, instrumentation and controls. We provide an integrated approach to project coordination that creates cost-effective solutions. In addition, corporations, government entities, healthcare organizations and educational institutions depend on the reliability and accuracy of voice, data and video communications. However, the potential for this new technology cannot be realized without the right electrical infrastructure to support the convergence of technology. In this regard, we create integrated building systems, including the installation of advanced structured cabling systems and electrical networks. We support the integration of renewable energy, telecommunications, life safety, security and HVAC in an environmentally safe manner and design for future growth by building in additional capacity for expansion as new capabilities are added.

As part of prior divestiture transactions, we reclassified the reporting units within our reportable segments. As a result, wireless communications includes the Suisun City Operations, specialty construction includes the China Operations, and electrical power includes the Trenton, Seattle and Portland Operations, for each of the periods presented. For the six months ended October 31, 2013, wireless communication, specialty construction and electrical power represented approximately 40.2%, 13.4% and 46.4%, respectively, of our total revenue. For the six months ended October 31, 2012, wireless communication, specialty construction and electrical power represented approximately 26.6%, 9.6% and 63.8%, respectively, of our total revenue.

Industry Trends

We focus on markets such as public services, healthcare, energy and international which continue to show growth potential.

·	Public services. We provide communications infrastructure for public services which include utilities, education, military and transportation infrastructure. We believe there is an active market for communications infrastructure in the public service sector due to the need to create cost efficiencies through the implementation of new communications technology.

·	Healthcare. We provide communications infrastructure for hospitals and medical centers. In the healthcare market, the aging population is resulting in demands for upgraded and additional hospital infrastructure. New construction and renovations are occurring for hospitals domestically and internationally. In addition, there is a need to reduce the cost of delivering healthcare by implementing new communications technology. Our services include electrical power, structured cabling, security systems, life safety systems, environmental controls and communication systems.

·	Energy. We provide communications infrastructure for petrochemical, natural gas and electric utility companies as well as renewable energy systems for various entities. The need to deliver basic energy more efficiently and to create new energy sources is driving the growth in energy construction. This creates opportunities to upgrade and deploy new communications technology and design and build renewable energy solutions.

·	International. We provide communications infrastructure internationally for a variety of companies and government entities. China is spending on building its internal infrastructure. China has experienced positive GDP growth rates. The total international revenue was approximately 13.4% and 9.6% for the six months ended October 31, 2013 and 2012, respectively.

	31

WPCS INTERNATIONAL INCORPORATED AND SUBSIDIARIES

ITEM 2 – MANAGEMENT’S DISCUSSION AND ANALYSIS

OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Current Operating Trends and Financial Highlights

Management currently considers the following events, trends and uncertainties to be important in understanding our results of operations and financial condition during the current fiscal year:

In regards to our financial results for the three months ended October 31, 2013, we generated a net loss of approximately $473,000 or $0.37 per diluted common share, which includes non-cash charges of approximately $722,000 related to the amortization of Notes discount and expenses related to the issuance of the Exchange Warrants and Shares, approximately $1,299,000 related to the loss on extinguishment of the old Notes, offset by non-cash credits of approximately $2,208,000 related to the final change in fair value of the derivative liabilities associated with the Notes and Warrants, prior to the Amendment and Note Amendment which enabled us to reclassify the former derivative liabilities to stockholders’ equity. The non-cash charges and credits have no impact on our operating income or cash flows.

The net loss for the three months ended October 31, 2013 compares to a net loss of approximately $493,000, or $0.50 per diluted common share for the three months ended October 31, 2012, which includes a loss from discontinued operations for the Lakewood, Hartford, and Australia Operations of approximately $959,000, or $0.96 per diluted common share. In our continuing operations, for the three months ended October 31, 2012, we generated a net income of approximately $495,000, or $0.46 per diluted common share.

In regards to our financial results for the six months ended October 31, 2013, we generated a net loss of approximately $6,366,000, or $5.60 per diluted common share, which includes one-time charges of approximately $1,474,000 related to severance expense recorded per the Hidalgo Separation Agreement described above, approximately $1,754,000 related to the amortization of Notes discount and expenses related to the issuance of the Exchange Warrants and Shares, approximately $1,299,000 related to the loss on extinguishment of the old Notes, and approximately $834,000 related to the final change in fair value of the derivative liabilities associated with the Notes and Warrants, prior to the Amendment and Note Amendment which enabled us to reclassify the former derivative liabilities to stockholders’ equity. The non-cash charges have no impact on our operating income or cash flows.

The net loss for the six months ended October 31, 2013 compares to net income of approximately $500,000, or $0.50 per diluted common share for the six months ended October 31, 2012, which includes income from discontinued operations for the Lakewood, Hartford, and Australia Operations of approximately $355,000, or $0.35 per diluted common share. In our continuing operations, for the six months ended October 31, 2012, we generated a net income of approximately $174,000, or $0.15 per diluted common share.

The markets we serve in public services, healthcare, and energy continue to afford opportunities to grow our business. Two of our most important economic indicators for measuring our future revenue producing capability and demand for our services continue to be our backlog and bid list. For comparative purposes our backlog and bid list for prior periods only includes our continuing operations. Our backlog of unfilled orders was approximately $25.4 million at October 31, 2013, compared to backlog of $25.6 million at July 31, 2013, and $27.8 million at October 31, 2012.

Our bid list, which represents project bids under proposal for new and existing customers, was approximately $40.5 million at October 31, 2013, compared to approximately $38.7 million at July 31, 2013 and $37.9 million at October 31, 2012. Our goal is to continue converting more of these bids into contract awards and to increase our backlog in the quarters ahead.

We believe our design-build engineering focus for public services, healthcare, energy and corporate enterprise infrastructure will create additional opportunities both domestically and internationally. We believe that the ability to provide comprehensive communications infrastructure services including wireless communication, specialty construction and electrical power gives us a competitive advantage. In regards to strategic development, our focus is on organic growth opportunities and we feel optimistic about the markets we serve as evidenced by our new contract awards and customers continuing to seek bids from us, due to our experience in these markets.

While we continue to consider and develop organic growth opportunities, we are also seeking opportunities to improve our balance sheet. We have sought a number of opportunities for improvement, including: (i) the execution of an aggressive plan over the past several months to stabilize the operations, improve cash flows of the business through, amongst other things, reduction; operating cost. (ii) the divestiture of underperforming operations, as evidenced by the sale of the Pride Operations described above, and the wind-down of the unprofitable Trenton Operations; and (iii) the restructuring of the Notes and Warrants which has enabled the Company to eliminate the former derivative liabilities and rebuild our stockholders’ equity to regain compliance with the NASDAQ minimum stockholder equity requirements. As a result, we believe that all of these actions as well as continuing efforts to improve the Company's perfomance and financial position will contribute favorably to providing the Company with an opportunity to deliver improved shareholder value in the future.

	32

WPCS INTERNATIONAL INCORPORATED AND SUBSIDIARIES

ITEM 2 – MANAGEMENT’S DISCUSSION AND ANALYSIS

OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Results of Operations for the Three Months Ended October 31, 2013 Compared to the Three Months Ended October 31, 2012

Consolidated results for the three months ended October 31, 2013 and 2012 were as follows:

	Three Months Ended
	October 31,
	2013				2012

REVENUE	$	7,355,744	100.0	%	$	7,958,243	100.0	%

COSTS AND EXPENSES:
Cost of revenue		5,602,337	76.2	%		5,013,329	63.0	%
Selling, general and administrative expenses		1,854,241	25.2	%		2,061,126	25.9	%
Depreciation and amortization		214,895	2.9	%		268,179	3.4	%

Total costs and expenses		7,671,473	104.3	%		7,342,634	92.3	%

OPERATING (LOSS) INCOME		(315,729)	(4.3)	%		615,609	7.7	%

OTHER EXPENSE (INCOME):
Interest expense		2,380,885	32.3	%		320,608	4.0	%
Change in fair value of derivative liabilities		(2,208,155)	(30.0)	%		-	-

(Loss) income from continuing operations before income tax benefit		(488,459)	(6.6)	%		295,001	3.7	%

Income tax benefit		(5,863)	0.0	%		(199,705)	(2.5)	%

(LOSS) INCOME FROM CONTINUING OPERATIONS		(482,596)	(6.6)	%		494,706	6.2	%

Discontinued operations
Loss from operations of discontinued operations, net of tax		(8,718)	(0.1)	%		(473,728)	(5.9)	%
Loss from disposal		-	-			(485,212)	(6.1)	%

Loss from discontinued operations, net of tax		(8,718)	(0.1)	%		(958,940)	(12.0)	%

CONSOLIDATED NET LOSS		(491,314)	(6.7)	%		(464,234)	(5.8)	%

Net income (loss) attributable to noncontrolling interest		(18,310)	(0.3)	%		29,152	0.4	%

NET LOSS ATTRIBUTABLE TO WPCS	$	(473,004)	(6.4)	%	$	(493,386)	(6.2)	%

Revenue

Revenue for the three months ended October 31, 2013 was approximately $7,356,000, as compared to approximately $7,958,000 for the three months ended October 31, 2012. The decrease in revenue was due primarily to a reduction in revenue of the Trenton Operations as a result of a planned strategic change during fiscal 2013 to re-focus the Trenton Operation as a smaller revenue producing operation, while completing the Cooper Project. The prior period also included approximately $750,000 of change order revenue related to the Cooper Project. It is not expected that similar future projects will replace the Cooper Project or other larger projects that were completed in the prior period by the Trenton Operations. For the three months ended October 31, 2013, there were no customers who comprised more than 10% of consolidated total revenue. For the three months ended October 31, 2012, we had one customer, the Cooper Project, which comprised 15.6% of total revenue.

	33

WPCS INTERNATIONAL INCORPORATED AND SUBSIDIARIES

ITEM 2 – MANAGEMENT’S DISCUSSION AND ANALYSIS

OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Wireless communication segment revenue for the three months ended October 31, 2013 and 2012 was approximately $3,044,000, or 41.4%, and $2,665,000, or 33.5%, of total revenue, respectively. The increase in revenue was due to a net organic revenue growth rate in this segment of approximately 14.2%.

Specialty construction segment revenue for the three months ended October 31, 2013 and 2012 was approximately $1,161,000, or 15.8%, and $823,000, or 10.3%, of total revenue, respectively. The increase in revenue was primarily attributable to more projects completed in the three months ended October 31, 2013 as compared to the same period in the prior year for the China Operations. Revenue in the China Operations is recognized on a completed contract basis.

Electrical power segment revenue for the three months ended October 31, 2013 and 2012 was approximately $3,151,000, or 42.8%, and $4,470,000, or 56.2%, of total revenue, respectively. The decrease in revenue was due primarily to the planned strategic change during fiscal 2013 to re-focus the Trenton Operation as a smaller revenue producing operation, while completing the Cooper Project. It is not expected that similar future projects will replace the Cooper Project or other larger projects that were completed in the prior period by the Trenton Operations. Therefore, it is expected that our revenue in the electrical power segment will not substantially increase in the near future, as compared to current period levels.

Cost of Revenue

Cost of revenue consists of direct costs on contracts: materials, direct labor, third party subcontractor services, union benefits and other overhead costs. Our cost of revenue was approximately $5,602,000, or 76.2%, of revenue for the three months ended October 31, 2013, compared to $5,013,000, or 63.0%, for the same period of the prior year. The increase as a percentage of revenue is primarily due to the revenue blend of project work completed during the quarter. The prior period also included approximately $750,000 of change order revenue related to the Cooper Project, the costs of which were incurred in fiscal 2012.

Wireless communication segment cost of revenue and cost of revenue as a percentage of revenue for the three months ended October 31, 2013 and 2012 was approximately $2,443,000, and 80.3%, and $1,875,000, or 70.4%, respectively. The dollar increase in cost of revenue is due to the corresponding increase in revenue during the three months ended October 31, 2013. The increase as a percentage of revenue is due to the revenue blend of project work performed during the three months ended October 31, 2013.

Specialty construction segment cost of revenue and cost of revenue as a percentage of revenue for the three months ended October 31, 2013 and 2012 was approximately $884,000, and 76.2% and $414,000, and 50.4%, respectively. The dollar increase in cost of revenue is due to the corresponding increase in revenue during the three months ended October 31, 2013 plus increased costs from the revenue blend of project work completed on contracts this period as compared to the prior period. The increase as a percentage of revenue is due to the revenue blend of project work performed.

Electrical power segment cost of revenue and cost of revenue as a percentage of revenue for the three months ended October 31, 2013 and 2012 was approximately $2,275,000 and 72.2% and $2,724,000 and 60.9%, respectively. The dollar decrease in cost of revenue is due to the corresponding decrease in revenue during the three months ended October 31, 2013. The increase as a percentage of revenue is due to: (1) the prior period included approximately $750,000 of change order revenue related to the Cooper Project, the costs of which were incurred in fiscal 2012; and (2) the revenue blend of project work performed on contracts in this segment.

Selling, General and Administrative Expenses

For the three months ended October 31, 2013, total selling, general and administrative expenses were approximately $1,854,000, or 25.2%, of total revenue compared to $2,061,000, or 25.9%, of revenue for the prior period. Included in selling, general and administrative expenses for the three months ended October 31, 2013 were salaries, commissions, payroll taxes and other employee benefits incurred in the normal course of business of $821,000, which was a $285,000 decrease compared to the prior period due primarily to the lower salaries from cost reduction strategies. Professional fees were $186,000, which include on-going accounting, legal and investor relations fees. Insurance costs were $217,000 and rent for office facilities was $95,000. Automobile and other travel expenses were $217,000. Other selling, general and administrative expenses totaled $318,000. For the three months ended October 31, 2013, total selling, general and administrative expenses for the wireless communication, specialty construction and electrical power segments were approximately $533,000, $109,000 and $699,000, respectively, with the balance of approximately $513,000 pertaining to corporate expenses.

	34

WPCS INTERNATIONAL INCORPORATED AND SUBSIDIARIES

ITEM 2 – MANAGEMENT’S DISCUSSION AND ANALYSIS

OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

For the three months ended October 31, 2012, total selling, general and administrative expenses were approximately $2,061,000, or 25.9%, of total revenue. Included in selling, general and administrative expenses for the three months ended October 31, 2012 was $1,106,000 for salaries, commissions, payroll taxes and other employee benefits. Professional fees were $226,000, which include accounting, legal and investor relation fees. Insurance costs were $103,000 and rent for office facilities was $91,000. Automobile and other travel expenses were $236,000. Other selling, general and administrative expenses totaled $299,000. For the three months ended October 31, 2012, total selling, general and administrative expenses for the wireless communication, specialty construction and electrical power segments were approximately $542,000, $98,000 and $775,000, respectively, with the balance of approximately $646,000 pertaining to corporate expenses.

Depreciation and Amortization

For the three months ended October 31, 2013 and 2012, depreciation was approximately $215,000 and $252,000, respectively. The decrease in depreciation is due to the retirement of certain assets. The amortization of customer lists for the three months ended October 31, 2013 was $0 as compared to $16,000 for the same period of the prior year. The net decrease in amortization was due primarily to customer lists being fully amortized in the prior period compared to the current period. Customer lists are amortized over a period of three to nine years from the date of their acquisitions.

Interest Expense

For the three months ended October 31, 2013 and 2012, interest expense was approximately $2,381,000 and $321,000, respectively. The increase in interest expense is due primarily to the following: (1) noncash interest expense for the amortization of the debt discount for the Notes of $2,021,000 for the three months ended October 31, 2013; and (2) the amortization of debt issuance costs related to the Notes of approximately $237,000.

Change in Fair Value of Derivative Liabilities

We determine the fair value of the embedded conversion features of the Notes and the Warrants and record each of them as a discount to the Notes and each as a derivative liability. Accordingly, changes in the fair value of the derivatives are recognized and classified as an unrealized noncash gain or loss on the derivative financial instruments. For the three months ended October 31, 2013, the change on the fair value of the embedded conversion features of the Notes and Warrants resulted in a net gain of approximately $2,208,000, due primarily to the decrease in the market price of our common stock since July 31, 2013.

Income Taxes

The actual income tax rate from continuing operations for the three months ended October 31, 2013 was 1.2% compared to 67.7% for same period in the prior year. The difference was primarily due to no tax benefit being claimed for Federal and state losses during the three months ended October 31, 2013. We recorded income tax benefit of approximately $6,000 for our China Operations.

Loss from Discontinued Operations

As a result of the execution of the definitive purchase agreement for the divestiture of Pride on September 19, 2013, we have recorded the Australia Operations financial results as discontinued operations. As a result of the sale of the assets of the Hartford and Lakewood Operations on July 25, 2012, we recorded the financial results of these operations as discontinued operations. For the three months ended October 31, 2013 and 2012, we recorded losses from discontinued operations of approximately $9,000 and $959,000, respectively. Included in the loss from discontinued operations is a loss from disposal of approximately $485,000 and $55,000 of expenses directly related associated with the sale of the assets of the Hartford and Lakewood Operations.

	35

WPCS INTERNATIONAL INCORPORATED AND SUBSIDIARIES

ITEM 2 – MANAGEMENT’S DISCUSSION AND ANALYSIS

OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Net Loss Attributable to WPCS

The net loss attributable to WPCS was approximately $473,000 for the three months ended October 31, 2013. The net loss was net of Federal and state income tax benefit of approximately $6,000.

The net loss attributable to WPCS was approximately $493,000 for the three months ended October 31, 2012. The net loss was net of Federal and state income tax benefit of approximately $200,000.

Results of Operations for the Six Months Ended October 31, 2013 Compared to the Six Months Ended October 31, 2012

Consolidated results for the six months ended October 31, 2013 and 2012 were as follows:

	Six Months Ended
	October 31,
	2013				2012

REVENUE	$	15,187,127	100.0	%	$	19,246,260	100.0	%

COSTS AND EXPENSES:
Cost of revenue		11,346,996	74.7	%		13,968,212	72.6	%
Selling, general and administrative expenses		3,837,815	25.3	%		4,156,282	21.5	%
Severance expense		1,474,277	9.7	%		-	-
Depreciation and amortization		457,952	3.0	%		572,286	3.0	%

Total costs and expenses		17,117,040	112.7	%		18,696,780	97.1	%

OPERATING (LOSS) INCOME		(1,929,913)	(12.7)	%		549,480	2.9	%

OTHER EXPENSE:
Interest expense		3,540,942	23.3	%		441,013	2.3	%
Change in fair value of derivative liabilities		833,750	5.5	%		-	-

(Loss) income from continuing operations before income tax provision		(6,304,605)	(41.5)	%		108,467	0.6	%

Income tax provision (benefit)		18,288	0.1	%		(65,176)	(0.3)	%

(LOSS) INCOME FROM CONTINUING OPERATIONS		(6,322,893)	(41.6)	%		173,643	0.9	%

Discontinued operations
Loss from operations of discontinued operations, net of tax		(39,747)	(0.3)	%		(1,484,142)	(7.7)	%
Gain from disposal		-	-			1,839,419	9.6	%

(Loss) income from discontinued operations, net of tax		(39,747)	(0.3)	%		355,277	1.9	%

CONSOLIDATED NET (LOSS) INCOME		(6,362,640)	(41.9)	%		528,920	2.8	%

Net income attributable to noncontrolling interest		3,434	-			28,605	0.2	%

NET (LOSS) INCOME ATTRIBUTABLE TO WPCS	$	(6,366,074)	(41.9)	%	$	500,315	2.6	%

	36

WPCS INTERNATIONAL INCORPORATED AND SUBSIDIARIES

ITEM 2 – MANAGEMENT’S DISCUSSION AND ANALYSIS

OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Revenue

Revenue for the six months ended October 31, 2013 was approximately $15,187,000, as compared to approximately $19,246,000 for the six months ended October 31, 2012. The decrease in revenue was due primarily to a reduction in revenue of the Trenton Operations as a result of a planned strategic change during fiscal 2013 to re-focus the Trenton Operation as a smaller revenue producing operation, while completing the Cooper Project. The prior period also included approximately $1,486,000 of change order revenue related to the Cooper Project. It is not expected that similar future projects will replace the Cooper Project or other larger projects that were completed in the prior period by the Trenton Operations. For the six months ended October 31, 2013, there were no customers who comprised more than 10% of consolidated total revenue. For the six months ended October 31, 2012, we had one customer, the Cooper Project, which comprised 27.8% of total revenue.

Wireless communication segment revenue for the six months ended October 31, 2013 and 2012 was approximately $6,099,000, or 40.2%, and $5,123,000, or 26.6%, of total revenue, respectively. The increase in revenue was due to a net organic revenue growth rate in this segment of approximately 19.0%.

Specialty construction segment revenue for the six months ended October 31, 2013 and 2012 was approximately $2,033,000, or 13.4%, and $1,854,000, or 9.6%, of total revenue, respectively. The increase in revenue was primarily attributable to more projects completed in the six months ended October 31, 2013 as compared to the same period in the prior year for the China Operations. Revenue in the China Operations is recognized on a completed contract basis.

Electrical power segment revenue for the six months ended October 31, 2013 and 2012 was approximately $7,055,000, or 46.4%, and $12,269,000, or 63.8%, of total revenue, respectively. The decrease in revenue was due primarily to the planned strategic change during fiscal 2013 to re-focus the Trenton Operation as a smaller revenue producing operation, while completing the Cooper Project. It is not expected that similar future projects will replace the Cooper Project or other larger projects that were completed in the prior period by the Trenton Operations. Therefore, it is expected that our revenue in the electrical power segment will not substantially increase in the near future, as compared to current period levels.

Cost of Revenue

Cost of revenue consists of direct costs on contracts: materials, direct labor, third party subcontractor services, union benefits and other overhead costs. Our cost of revenue was approximately $11,347,000, or 74.7%, of revenue for the six months ended October 31, 2013, compared to $13,968,000, or 72.6%, for the same period of the prior year. The dollar decrease in our total cost of revenue is primarily due to the corresponding decrease in revenue during the six months ended October 31, 2013. The decrease as a percentage of revenue is primarily due to the revenue blend of project work completed during the six months. The prior period also included approximately $1,486,000 of change order revenue related to the Cooper Project, the costs of which were incurred in fiscal 2012.

Wireless communication segment cost of revenue and cost of revenue as a percentage of revenue for the six months ended October 31, 2013 and 2012 was approximately $4,878,000, and 80.0%, and $3,536,000, or 69.0%, respectively. The dollar increase in cost of revenue is due to the corresponding increase in revenue during the six months ended October 31, 2013, and increased costs as a result of the revenue blend of project work completed this period as compared to the same period last year. The increase as a percentage of revenue is due to the revenue blend of project work performed during the six months ended October 31, 2013.

Specialty construction segment cost of revenue and cost of revenue as a percentage of revenue for the six months ended October 31, 2013 and 2012 was approximately $1,404,000, and 69.0% and $1,147,000, and 61.9%, respectively. The dollar increase in cost of revenue is due to the corresponding increase in revenue during the six months ended October 31, 2013, and increased costs as a result of the revenue blend of project contracts completed this period as compared to the same period last year. The increase as a percentage of revenue is due to the revenue blend of project work performed.

Electrical power segment cost of revenue and cost of revenue as a percentage of revenue for the six months ended October 31, 2013 and 2012 was approximately $5,065,000 and 71.8% and $9,285,000 and 75.7%, respectively. The dollar decrease in cost of revenue is due to the corresponding decrease in revenue during the six months ended October 31, 2013. The increase as a percentage of revenue is due to: (1) the prior period included approximately $750,000 of change order revenue related to the Cooper Project, the costs of which were incurred in fiscal 2012, and (2) the revenue blend of project work performed on contracts in this segment.

	37

WPCS INTERNATIONAL INCORPORATED AND SUBSIDIARIES

ITEM 2 – MANAGEMENT’S DISCUSSION AND ANALYSIS

OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Selling, General and Administrative Expenses

For the six months ended October 31, 2013, total selling, general and administrative expenses were approximately $3,838,000, or 25.3%, of total revenue compared to $4,156,000, or 21.6%, of revenue for the prior year. Included in selling, general and administrative expenses for the six months ended October 31, 2013 were salaries, commissions, payroll taxes and other employee benefits incurred in the normal course of business of $1,772,000, which was a $574,000 decrease compared to the prior year due primarily to the lower salaries from cost reduction strategies. Professional fees were $541,000, which include on-going accounting, legal and investor relations fees. Insurance costs were $418,000 and rent for office facilities was $179,000. Automobile and other travel expenses were $435,000. Other selling, general and administrative expenses totaled $493,000. For the six months ended October 31, 2013, total selling, general and administrative expenses for the wireless communication, specialty construction and electrical power segments were approximately $1,038,000, $174,000 and $1,297,000, respectively, with the balance of approximately $1,329,000 pertaining to corporate expenses.

For the six months ended October 31, 2012, total selling, general and administrative expenses were approximately $4,156,000, or 21.6%, of total revenue. Included in selling, general and administrative expenses for the six months ended October 31, 2012 was $2,346,000 for salaries, commissions, payroll taxes and other employee benefits. Professional fees were $530,000, which include accounting, legal and investor relation fees. Insurance costs were $293,000 and rent for office facilities was $192,000. Automobile and other travel expenses were $511,000. Other selling, general and administrative expenses totaled $284,000. For the six months ended October 31, 2012, total selling, general and administrative expenses for the wireless communication, specialty construction and electrical power segments were approximately $1,072,000, $164,000 and $1,599,000, respectively, with the balance of approximately $1,321,000 pertaining to corporate expenses.

Severance Expense

On July 24, 2013, we entered into the Separation Agreement with Hidalgo, our former President, Chief Executive Officer and a member of the board of directors. Pursuant to the Separation Agreement, Hidalgo resigned, effective on the Termination Date, as the President, Chief Executive Officer and a member of the board of directors of the Company and from all officer and director positions with all of our subsidiaries. In connection with the Separation Agreement, we recorded a one-time charge of $1,474,277 related to the full severance obligation for the six months ended October 31, 2013.

Depreciation and Amortization

For the six months ended October 31, 2013 and 2012, depreciation was approximately $442,000 and $540,000, respectively. The decrease in depreciation is due to the retirement of certain assets. The amortization of customer lists for the six months ended October 31, 2013 was $16,000 as compared to $32,000 for the same period of the prior year. The net decrease in amortization was due primarily to certain customer lists being fully amortized in the prior period compared to the current period. Customer lists are amortized over a period of three to nine years from the date of their acquisitions.

Interest Expense

For the six months ended October 31, 2013 and 2012, interest expense was approximately $3,541,000 and $441,000, respectively. The increase in interest expense is due primarily to the following: (1) noncash interest expense for the amortization of the debt discount for the Notes of approximately $3,054,000 for the six months ended October 31, 2013; and (2) the amortization of debt issuance costs related to the Notes of approximately $277,000.

Change in Fair Value of Derivative Liabilities

We determine the fair value of the embedded conversion features of the Notes and the Warrants and record each of them as a discount to the Notes and each as a derivative liability. Accordingly, changes in the fair value of the derivatives are recognized and classified as an unrealized noncash gain or loss on the derivative financial instruments. For the six months ended October 31, 2013, the increase in the fair value of the embedded conversion features of the Notes and Warrants was approximately $834,000 due primarily to the increase in the market price of our common stock since April 30, 2013.

	38

WPCS INTERNATIONAL INCORPORATED AND SUBSIDIARIES

ITEM 2 – MANAGEMENT’S DISCUSSION AND ANALYSIS

OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Income Taxes

The actual income tax rate from continuing operations for the six months ended October 31, 2013 was 0.3% compared to 60.1% for same period in the prior year. The difference was primarily due to no tax benefit being claimed for Federal and state losses during the six months ended October 31, 2013. We recorded income tax provision of approximately $18,000 for our China Operations for the six months ended October 31, 2013.

(Loss) Income from Discontinued Operations

As a result of the execution of the definitive purchase agreement for the divestiture of Pride on September 19, 2013, we have recorded the Australia Operations financial results as discontinued operations. For the six months ended October 31, 2013, we recorded a loss from discontinued operations of approximately $40,000. As a result of the sale of the assets of the Hartford and Lakewood Operations on July 25, 2012, we recorded the financial results of these operations as discontinued operations. For the six months ended October 31, 2012, we recorded income from discontinued operations of approximately $355,000. Included in the income from discontinued operations is a gain from disposal of approximately $1,839,000 and $55,000 of expenses directly related associated with the sale of the assets of the Hartford and Lakewood Operations.

Net (Loss) Income Attributable to WPCS

The net loss attributable to WPCS was approximately $6,366,000 for the six months ended October 31, 2013. The net loss was net of Federal and state income tax provision of approximately $18,000.

The net income attributable to WPCS was approximately $500,000 for the six months ended October 31, 2012. The net income was net of Federal and state income tax benefit of approximately $65,000.

Liquidity and Capital Resources

At October 31, 2013, we had working capital of approximately $1,848,000, which consisted of current assets of approximately $15,576,000 and current liabilities of $13,728,000. The current liabilities as presented in the condensed consolidated balance sheet at October 31, 2013 include approximately $1,381,000 of severance liability related to the Hidalgo Separation Agreement and the $1,533,757 Loss Amount due under the Zurich Forbearance Agreement. This compares to a working capital deficiency of approximately $484,000 at April 30, 2013.

Our cash and cash equivalents balance at October 31, 2013 of $1,498,000. Our working capital needs are influenced by our level of operations, and generally increase with higher levels of revenue. Our sources of cash in the last several years have come from operating activities, credit facility borrowings and sales of convertible notes. Our future operating results may be affected by a number of factors including our success in bidding on future contracts and our continued ability to manage our controllable operating costs effectively. Our capital requirements depend on numerous factors, including the market for our services, the resources we devote to developing, marketing, selling and supporting our business, and the timing and extent of establishing additional markets and other factors.

Operating activities provided approximately $170,000 in cash for the six months ended October 31, 2013. The sources of cash from operating activities total approximately $8,948,000, comprised of approximately $4,689,000 of net noncash charges, a $1,869,000 decrease in restricted cash, a $112,000 decrease in net assets held for sale, a $214,000 increase in accounts payable and accrued expenses, a $1,381,000 increase in accrued severance expense for the Hidalgo Separation Agreement, a $379,000 increase in billings in excess of costs and estimated earnings on uncompleted contracts, and a $304,000 increase in deferred revenue. The uses of cash from operating activities total approximately $8,778,000, comprised of a net loss of approximately $6,363,000, a $2,015,000 increase in accounts receivable, a $70,000 increase in estimated earnings in excess of billings on uncompleted contracts, a $127,000 increase in deferred contract costs, a $97,000 increase in prepaid expenses and other current assets, a $95,000 increase in income taxes receivable and a $11,000 increase in other assets.

Our investing activities used cash of approximately $18,000 for acquiring property and equipment during the six months ended October 31, 2013.

	39

WPCS INTERNATIONAL INCORPORATED AND SUBSIDIARIES

ITEM 2 – MANAGEMENT’S DISCUSSION AND ANALYSIS

OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Our financing activities provided cash of approximately $471,000 for the six months ended October 31, 2013. Financing activities provided cash of approximately $816,000 from short-term loan borrowings offset by approximately $102,000 of debt issuance costs paid, a $9,000 repayment of convertible notes, $24,000 of repayments under loans payable, and $210,000 of repayments under other payables due Zurich.

Convertible Debenture Offering

On December 4, 2012, we entered into the Purchase Agreement with the Buyers pursuant to which, we sold an aggregate of (i) $4,000,000 principal amount of Notes and (ii) the Warrants to purchase 2,274,796 shares of our Common Stock, to the Buyers for aggregate Financing gross proceeds of $4,000,000. In connection with the Financing, (i) we entered into a Registration Rights Agreement, (ii) we and our subsidiaries entered into the Security Agreement, and (iii) our subsidiaries entered into the Guaranty in favor of the collateral agent for the Buyers. The Closing Date of the Financing was December 5, 2012.

Pursuant to the terms of the Notes, we deposited the initial funds received from the Financing, minus the Initial Lending Amount of $2,178,516 into the Lockbox Account controlled by the Collateral Agent, as collateral agent on behalf of the Buyers. We used the Initial Lending Amount to repay the existing loan of $2,000,000, plus $78,516 of interest accrued and fees and expenses to Sovereign, which credit agreement was terminated in connection with the Notes, and $100,000 for Buyer legal fees in connection with the Notes. In addition, all our payments of accounts receivable (and our domestic subsidiaries) shall be deposited into the Lockbox Account. We are permitted to receive from the Lockbox Account, on a daily basis, such amount of cash equal to: (A) (i) cash balance in the Lockbox Account plus (ii) 95% of available qualified accounts receivable minus (iii) $250,000 minus (B) amount of principal, accrued interest, fees, costs and expenses owed pursuant to the Notes. The Notes contain certain customary representations and warranties, affirmative and negative covenants, and events of default. The principal covenant is that we shall maintain a current ratio of not less than 0.6 to 1.0 as of the last calendar day of each month. As of October 31, 2013, we are in compliance with the covenants.

The Notes were initially convertible into shares of Common Stock at the Conversion Price of $2.6376 per share. The Conversion Price was to be adjusted to 85% of the average of the closing bid prices for the five consecutive trading dates immediately prior to the following adjustment dates: (1) the earlier of the effective date of a registration statement or six months after closing (the First Adjustment); (2) the later of the date that is three months after the First Adjustment or one year after closing (the Second Adjustment); and (3) on the Stockholder Approval Date of February 28, 2013. On the Stockholder Approval Date, the Conversion Price was adjusted to $2.1539 per share. There was no adjustment to the Conversion Price on the First Adjustment date.

On October 25, 2013, we entered into an amendment, waiver and exchange agreement (the Amendment) with holders (Buyers) of outstanding secured convertible notes (Notes) and common stock purchase warrants (Warrants) that were sold pursuant to a securities purchase agreement dated December 4, 2012. Pursuant to the Amendment, the Buyers exchanged 154,961 of their Warrants for 38,740 shares of common stock (the Shares) and warrants to purchase 154,961 shares of common stock (the Exchange Warrants). Effectively, for every four Warrants surrendered, the Buyers received a unit of four Exchange Warrants and one Share. It was determined that the Black-Scholes value of one warrant being exchanged was equal to $1.83, resulting in four Warrants being equal to $7.32 and the parties valued the unit at a price of $7.52. As a result, the Shares issued were calculated at $0.20, and by the operation of the terms of the Notes, the conversion price of the Notes automatically adjusted to $0.20.

The Exchange Warrants are exercisable for a period of five years from the date of issuance of the original Warrants at an initial exercise price of $2.1539 per share. The exercise price will only adjust in the event of any future stock splits or dividends.

	40

WPCS INTERNATIONAL INCORPORATED AND SUBSIDIARIES

ITEM 2 – MANAGEMENT’S DISCUSSION AND ANALYSIS

OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

On November 5, 2013, we entered into the Note Amendment with the Buyers. The closing of the Note Amendment transaction occurred on November 5, 2013, and the Note Amendment was deemed effective as of October 31, 2013. The Note Amendment eliminated certain features of the Notes which would otherwise have resulted in substantial accounting charges to the Company.

In addition, the interest rate of the Notes was amended to 15% per annum, subject to increase to 25% per annum if an event of default occurs and is continuing.

The modifications to the Notes as a result of the Amendment and Note Amendment described above included a change in the conversion price of the Notes from $2.1539 to $0.20, and a change in the maturity date of the Note, from June 5, 2014 to October 31, 2023. As a result of the significant modifications of the Notes, we determined that the Notes were extinguished and New Notes were being issued. In connection with this modification, we compared the present value of the beneficial conversion features of the Notes to the New Notes. We determined that the present value of the New Notes exceeded the present value of the Notes, by more than 10%, primarily as a result of the change in the conversion price of the New Notes to $0.20 as compared to the $2.1539 under the Notes which resulted in the application of extinguishment accounting. The modification of the Note debt instrument for the six months ended October 31, 2013, resulted in the debt instruments being exchanged with substantially different terms and extinguishment accounting was applied resulting in a loss on extinguishment of debt for the unamortized discount related to the Notes of $1,299,304. In addition, we recorded a new debt discount based on the fixed conversion rate and exercise price of $0.20 per share of $3,400,000 related to the remaining proceeds of the New Notes.

As of October 31, 2013, $593,923 of Notes was converted into 275,742 shares of our Common Stock. In addition, $6,077 of Notes was redeemed for cash at the request of a Buyer.

The terms of the Notes and New Notes that follow remained the same after the extinguishment of debt described above. We have the right, at any time after one year from the Closing Date, to redeem all, but not less than all, of the outstanding Notes, upon not less than 20 trading days nor more than 30 trading days prior written notice. The redemption price shall equal 120% of the amount of principal and interest being redeemed.

The Buyers agree to restrict their ability to convert the Notes and/or exercise the Warrants and receive shares of our Common Stock such that the number of shares of Common Stock held by the Buyer in the aggregate and its affiliates after such conversion or exercise does not exceed 9.99% of the then issued and outstanding shares of our Common Stock.

Pursuant to the Registration Rights Agreement, we agreed to file a registration statement with the SEC, within 30 days following receipt of a request from a Buyer (or 45 days with respect to an underwritten offering), covering such shares of common stock issuable upon conversion of the Notes or exercise of the Warrants, as requested by the Buyers, and have such registration statement declared effective by the SEC within 90 days thereafter. We also agreed to notify the Buyers if we at any time propose to register any of our securities under the Securities Act of 1933, as amended, and of such Buyers’ right to participate in such registration. In connection with the conversion described above, no request has been received from a Buyer to register such shares.

If we fail to comply with the registration statement filing, effective date or maintenance date filing requirements, we are required to pay the Buyers a registration delay payment in cash equal to 2% of the Buyer’s original principal amount stated on such Investors’ Note as of the Closing Date on the date of each failure, and on every thirty (30) day anniversary of the of the respective failures (Registration Delay Payment). Notwithstanding the foregoing, in no event shall the aggregate amount of Registration Delay Payments exceed 10% of such Investor’s original principal amount stated on the Note on the Closing Date. We account for such Registration Delay Payments as contingent liabilities as defined in ASC. Accordingly, we recognize such damages when it becomes probable that they will be incurred and amounts are reasonably estimable.

Pursuant to the Guaranty, our subsidiaries guaranteed to the collateral agent, for the benefit of the Buyers, the punctual payment, as and when due and payable, of all amounts owed by us in respect of the Purchase Agreement, the Notes and the other transaction documents executed in connection with the Purchase Agreement.

	41

WPCS INTERNATIONAL INCORPORATED AND SUBSIDIARIES

ITEM 2 – MANAGEMENT’S DISCUSSION AND ANALYSIS

OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Pursuant to the Security Agreement, we and our subsidiaries granted, in favor of the collateral agent for the Buyers, a continuing security interest in all our personal property and assets, as collateral security for our and the subsidiaries under the Purchase Agreement, the Notes, the Guaranty and the other transaction documents.

Hartford and Lakewood Operations Asset Sales

On July 25, 2012, the Company and the Hartford and Lakewood Operations entered into the Asset Purchase Agreement, pursuant to which the Hartford and Lakewood Operations sold substantially all of their assets to two newly-created subsidiaries of Kavveri for a purchase price of $5.5 million in cash, subject to adjustment, and the assumption of their various liabilities. At closing, we received $4.9 million in cash, and the remaining $600,000 of the purchase price is to be placed in escrow pursuant to the Asset Purchase Agreement. We used the proceeds from this sale to repay the full amount outstanding under the Credit Agreement of $4,022,320 as of July 25, 2012. The difference of $877,680 was deposited in our operating cash account.

The parties agreed to place $350,000 of the purchase price into escrow pending assignment of certain contracts post-closing, with us receiving those funds upon successful assignment of the contracts. The remaining $250,000 was to be escrowed for purposes of satisfying certain adjustments to the purchase price based on a final net asset valuation to be completed after closing as well as repurchase obligations of certain delinquent accounts receivable. No later than three days after the final determination of the net asset valuation, the purchasers are required to deposit the $600,000 into escrow.

To date, we have not reached agreement with Kavveri with regard to resolving the net asset valuation. On October 4, 2013, Kavveri submitted a revised aggregate claim for indemnification by us of approximately $1,013,000 with regard to (1) net asset valuation claim owed of approximately $421,000; (2) accounts receivable deemed uncollectible of $414,000 related to a project that was completed by our former Hartford Operations and accepted by the customer on or prior to the Closing Date; and (3) delinquent account receivables to be repurchased of approximately $178,000.

With regard to this revised claim, we continue to stand-by our previous position as described in its response to Kavveri on February 27, 2013. Among other things, we dispute the amount of the delinquent receivables, and believe that after consideration of reserves for uncollectible accounts and other offsets previously considered in its calculation of the net asset valuation, the total amount of accounts receivable deemed uncollectible for repurchase to be approximately $36,000. However, we contend that Kavveri missed the deadline to notify us regarding the repurchase of delinquent receivables pursuant to the terms of the Asset Purchase Agreement regarding timing for notification to us, which would eliminate any repurchase payment owed by us to Kavveri. We also believe that the $414,000 of accounts receivable claimed for indemnification by Kavveri is without merit. Finally, we also dispute the net asset valuation claim, and believe Kavveri owes us approximately $58,000, following our evaluation of the uncollectible accounts receivable. With regard to the net asset valuation claim, if the parties disagree, and if they are unable to come to an agreement, the matter will be submitted to one or more independent, nationally-recognized accounting firms for final determination. To date, no matters have been submitted to the independent accounting firm.

Short-Term Commitments with the China Operations

Effective August 1, 2013, the China Operations entered into a secured loan with the Bank of China (the Short-Term Bank Loan). The Short-Term Bank Loan provides for a loan in the amount of $3,283,860. The proceeds from the Short-Term Bank Loan were used to repay outstanding unsecured loans of $2,404,545 due to its joint venture partner, Taian Gas Group (TGG). The Short-Term Bank Loan has an interest rate of 7.38%, and interest is due on a quarterly basis.

Other Payable with Zurich

On July 12, 2012, we executed the Financing Agreement with Zurich, to assist in the completion of the project contract with the Owner of Cooper Project. Under the terms of the Financing Agreement, Zurich advanced us $793,927 to assist in the completion of the Cooper Project, a $16.2 million project completed by our Trenton Operations. We were to repay Zurich the financial advances by September 2012; however, we were in default under the terms of the Financing Agreement as we did not repay Zurich the $793,927, and Zurich paid certain of the our vendors pursuant to Zurich’s obligations under its payment bond on the Cooper Project. In addition, we are contingently liable to Zurich and its affiliate F&D under the Indemnity Agreement. Zurich and F&D, as surety, have issued certain performance and payment bonds on behalf of owners or customers regarding the Company’s work on various projects under the Indemnity Agreement. The Company agrees to indemnify the surety for any payments made by Zurich on contracts of suretyship, guaranty or indemnity.

	42

WPCS INTERNATIONAL INCORPORATED AND SUBSIDIARIES

ITEM 2 – MANAGEMENT’S DISCUSSION AND ANALYSIS

OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Furthermore regarding Zurich, F&D and the Indemnity Agreement, on April 17, 2013, we executed the Forbearance Agreement with Zurich, which supersedes the Financing Agreement. As of April 16, 2013, the total Loss Amount due Zurich under the Forbearance Agreement less payments received by Zurich was $2,836,668. Under the Forbearance Agreement, among other things, the parties have agreed to the following payments which will be credited against the Loss Amount owed to Zurich by us: (1) the Interim Liability Payments; (2) the Customer Payments; and (3) the Claim, up to the Loss Amount as it exists at the time. As of October 31, 2013, the net Other Payable for the Loss Amount owed Zurich under the Forbearance Agreement was $1,533,757, which includes the initial Interim Liability Payments of $25,000 per month, and $1,090,604 of additional contract accounts receivable representing future Customer Payments and $22,922 of additional accounts payable assigned to Zurich which were reclassed from consolidated accounts receivable and accounts payable, respectively.

We have submitted a Claim to the Owner of $2,421,425 for significant delays, disruptions and construction changes that were beyond its control and required us to perform additional work related to the Cooper Project, which was completed in the fiscal year ended April 30, 2013. We are currently in negotiations with the Owner to settle the Claim. The next step in the resolution process as set forth in the contract with the Owner is mandatory non-binding mediation through the AAA. On April 15, 2013, we filed a Mediation request with the AAA with regard to the Claim. We are awaiting a response from the Owner and, as such, no date has been established for the Mediation. If we are successful in the settlement of this Claim, we expect to use the proceeds from the Claim to repay Zurich the Loss Amount as it exists at the time. There can be no assurance that we will be successful in settling with the Owner for all or a portion of the submitted claim.

Going Concern

Our continuation as a going concern beyond the next twelve months and our ability to discharge our liabilities and commitments in the normal course of business is ultimately dependent upon the execution of its future plans, which include the following: (1) our ability to generate future operating income, reduce operating expenses and produce cash from our operating activities, which will be affected by general economic, competitive, and other factors, many of which are beyond our control (2) the repayment of, or the modification of the terms under the Zurich Forbearance Agreement; (3) the settlement of the claim with the Owner; and (4) obtaining additional funds through additional financing. There can be no assurance that our plans to ensure continuation as a going concern will be successful.

Backlog

As of October 31, 2013, we had a backlog of unfilled orders of approximately $25.4 million compared to approximately $25.9 million at April 30, 2013. We define backlog as the value of work-in-hand to be provided for customers as of a specific date where the following conditions are met (with the exception of engineering change orders): (i) the price of the work to be done is fixed; (ii) the scope of the work to be done is fixed, both in definition and amount; and (iii) there is a written contract, purchase order, agreement or other documentary evidence which represents a firm commitment by the customer to pay us for the work to be performed. These backlog amounts are based on contract values and purchase orders and may not result in actual receipt of revenue in the originally anticipated period or at all. We have experienced variances in the realization of our backlog because of project delays or cancellations resulting from external market factors and economic factors beyond our control and we may experience such delays or cancellations in the future. Backlog does not include new firm commitments that may be awarded to us by our customers from time to time in future periods. These new project awards could be started and completed in this same future period. Accordingly, our backlog does not necessarily represent the total revenue that could be earned by us in future periods.

Off-Balance Sheet Arrangements

We have no off-balance sheet arrangements.

	43

WPCS INTERNATIONAL INCORPORATED AND SUBSIDIARIES

ITEM 2 – MANAGEMENT’S DISCUSSION AND ANALYSIS

OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Critical Accounting Policies

Financial Reporting Release No. 60, published by the SEC, recommends that all companies include a discussion of critical accounting policies used in the preparation of their financial statements. While all these significant accounting policies impact our financial condition and results of operations, we view certain of these policies as critical. Policies determined to be critical are those policies that have the most significant impact on our consolidated financial statements and require management to use a greater degree of judgment and estimates. Actual results may differ from those estimates.

We believe that given current facts and circumstances, it is unlikely that applying any other reasonable judgments or estimate methodologies would cause a material effect on our condensed consolidated results of operations, financial position or liquidity for the periods presented in this report.

The accounting policies identified as critical are as follows:

Use of Estimates

In preparing financial statements in conformity with accounting principles generally accepted in the United States of America, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and revenue and expenses during the reporting period. The most significant estimates relate to the calculation of percentage-of-completion on uncompleted contracts, allowance for doubtful accounts, valuation of inventory, realization of deferred tax assets, amortization method and lives of customer lists, acquisition-related contingency consideration and estimates of the fair value of reporting units and discounted cash flows used in determining whether goodwill has been impaired. Actual results could differ from those estimates.

Accounts Receivable

Accounts receivable are due within contractual payment terms and are stated at amounts due from customers net of an allowance for doubtful accounts. Credit is extended based on evaluation of a customer's financial condition. Accounts outstanding longer than the contractual payment terms are considered past due. We determine our allowance by considering a number of factors, including the length of time trade accounts receivable are past due, our previous loss history, the customer's current ability to pay its obligation to the us, and the condition of the general economy and the industry as a whole. We write off accounts receivable when they become uncollectible, and payments subsequently received on such receivables are credited to the allowance for doubtful accounts.

Derivative Instruments

Derivative liabilities are related to embedded conversion features of the Notes and the common stock Warrants issued in connection with the Purchase Agreement. For derivative instruments that are accounted for as liabilities, the derivative instrument is initially recorded at its fair value and is then re-valued at each reporting date, with changes in fair value recognized in earnings each reporting period. We use the binomial lattice model to value the derivative instruments at inception and subsequent valuation dates and the value is re-assessed at the end of each reporting period, in accordance with ASC 815. Derivative instrument liabilities are classified in the balance sheet as current or non-current based on whether or not the net-cash settlement of the derivative instrument could be required within twelve months of the balance sheet date.

Fair Value of Financial Instruments

Our material financial instruments at October 31, 2013 and for which disclosure of estimated fair value is required by certain accounting standards consisted of cash and cash equivalents, accounts receivable, account payable, Notes, common stock Warrants and loans payable. The fair values of cash and cash equivalents, accounts receivable, and account payable are equal to their carrying value because of their liquidity and short-term maturity. The fair values of the Notes and common stock Warrants are accounted for in accordance with ASC 815. We believe that the fair values of the loans payable do not differ materially from their aggregate carrying values in that substantially all the obligations bear variable interest rates that are based on market rates or interest rates that are periodically adjustable to rates that are based on market rates.

	44

WPCS INTERNATIONAL INCORPORATED AND SUBSIDIARIES

ITEM 2 – MANAGEMENT’S DISCUSSION AND ANALYSIS

OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Other Long-lived Assets

We assess the impairment of long-lived assets whenever events or changes in circumstances indicate that their carrying value may not be recoverable from the estimated future cash flows expected to result from their use and eventual disposition. Our long-lived assets subject to this evaluation include property and equipment and amortizable intangible assets.

Deferred Income Taxes

We determine deferred tax liabilities and assets at the end of each period based on the future tax consequences that can be attributed to net operating loss carryovers and differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases, using the tax rate expected to be in effect when the taxes are actually paid or recovered. The recognition of deferred tax assets is reduced by a valuation allowance if it is more likely than not that the tax benefits will not be realized. The ultimate realization of deferred tax assets depends upon the generation of future taxable income during the periods in which those temporary differences become deductible.

At October 31, 2013, our net deferred tax assets are fully offset by a valuation allowance. We will continue to evaluate the realization of our deferred tax assets and liabilities on a periodic basis, and will adjust such amounts in light of changing facts and circumstances.

We consider past performance, expected future taxable income and prudent and feasible tax planning strategies in assessing the amount of the valuation allowance. Our forecast of expected future taxable income is based over such future periods that we believe can be reasonably estimated. Changes in market conditions that differ materially from our current expectations and changes in future tax laws in the U.S. may cause us to change our judgments of future taxable income. These changes, if any, may require us to adjust our existing tax valuation allowance higher or lower than the amount we have recorded.

Revenue Recognition

We generate our revenue by providing design-build engineering services for communications infrastructure. Our engineering services report revenue pursuant to customer contracts that span varying periods of time. We report revenue from contracts when persuasive evidence of an arrangement exists, fees are fixed or determinable, and collection is reasonably assured.

We record revenue and profit from long-term contracts on a percentage-of-completion basis, measured by the percentage of contract costs incurred to date to the estimated total costs for each contract. Contracts in process are valued at cost plus accrued profits less earned revenues and progress payments on uncompleted contracts. Contract costs include direct materials, direct labor, third party subcontractor services and those indirect costs related to contract performance. Contracts are generally considered substantially complete when engineering is completed and/or site construction is completed.

We have numerous contracts that are in various stages of completion. Such contracts require estimates to determine the appropriate cost and revenue recognition. Cost estimates are reviewed monthly on a contract-by-contract basis, and are revised periodically throughout the life of the contract such that adjustments to profit resulting from revisions are made cumulative to the date of the revision. Significant management judgments and estimates, including the estimated cost to complete projects, which determines the project’s percent complete, must be made and used in connection with the revenue recognized in the accounting period. Current estimates may be revised as additional information becomes available. If estimates of costs to complete long-term contracts indicate a loss, provision is made currently for the total loss anticipated.

The length of our contracts varies. Assets and liabilities related to long-term contracts are included in current assets and current liabilities as they will be liquidated in the normal course of contract completion, although this may require more than one year.

We record revenue and profit from short-term contracts for our China Operations under the completed contract method, whereas income is recognized only when a contract is completed or substantially completed. Accordingly, during the period of performance, billings and costs are accumulated on the balance sheet, but no revenue or income is recorded before completion or substantial completion of the work. Our decision is based on the short-term nature of the work performed.

We also recognize certain revenue from short-term contracts when equipment is delivered or the services have been provided to the customer. For maintenance contracts, revenue is recognized ratably over the service period.

	45

WPCS INTERNATIONAL INCORPORATED AND SUBSIDIARIES

ITEM 2 – MANAGEMENT’S DISCUSSION AND ANALYSIS

OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Recently Issued Accounting Pronouncements

In December 2011, the FASB issued ASU No. 2011-11 (ASU 2011-11), Disclosures about Offsetting Assets and Liabilities where entities are required to disclose both gross information and net information about both instruments and transactions eligible for offset in the statement of financial position and instruments and transactions subject to an agreement similar to a master netting arrangement. This scope would include derivatives, sale and repurchase agreements, and reverse sale and repurchase agreements, and securities borrowing and securities lending arrangements. These disclosures assist users of financial statements in evaluating the effect or potential effect of netting arrangements on a company’s financial position. The adoption of ASU 2011-11 on May 1, 2013 did not have a material impact on our unaudited condensed consolidated financial statements.

	46

WPCS INTERNATIONAL INCORPORATED AND SUBSIDIARIES

ITEM 3 – QUANTITATIVE AND QUALITATIVE

DISCLOSURES ABOUT MARKET RISK

Not required under Regulation S-K for “smaller reporting companies.”

	47

WPCS INTERNATIONAL INCORPORATED AND SUBSIDIARIES

ITEM 4 – CONTROLS AND PROCEDURES

(a) Evaluation of disclosure controls and procedures.

Our management, with the participation of our interim chief executive officer and chief financial officer, evaluated the effectiveness of our disclosure controls and procedures pursuant to Rule 13a-15 under the Securities Exchange Act of 1934 as of the end of the period covered by this Quarterly Report on Form 10-Q. In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. In addition, the design of disclosure controls and procedures must reflect the fact that there are resource constraints and that management is required to apply its judgment in evaluating the benefits of possible controls and procedures relative to their costs.

Based on our evaluation, our interim chief executive officer and chief financial officer concluded that, as of October 31, 2013, our disclosure controls and procedures are designed at a reasonable assurance level and are effective to provide reasonable assurance that information we are required to disclose in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms, and that such information is accumulated and communicated to our management, including our chief executive officer and chief financial officer, as appropriate, to allow timely decisions regarding required disclosure.

(b) Changes in internal control over financial reporting.

There were no changes in our internal control over financial reporting that occurred during the quarter ended October 31, 2013 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

	48

WPCS INTERNATIONAL INCORPORATED AND SUBSIDIARIES

PART II – OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

We are currently not a party to any material legal proceedings or claims.

ITEM 1A. RISK FACTORS

Not required under Regulation S-K for “smaller reporting companies.”

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

During the quarter ended October 31, 2013, the Company issued an aggregate of 38,740 shares of its common stock in connection with the exchange of 154,961 Warrants for 154,961 Exchange Warrants, and the 38,740 shares of the Company’s common stock. The shares were issued pursuant to the exemption from registration provided by Section 4(a)(2) of the Securities Act of 1933, as amended.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

None.

ITEM 4. MINE SAFETY DISCLOSURES

None.

ITEM 5. OTHER INFORMATION

None.

ITEM 6. EXHIBITS

31.01	Certification of Interim Chief Executive Officer pursuant to Exchange Act Rules 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

31.02	Certification of Chief Financial Officer pursuant to Exchange Act Rules 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

32.01	Certifications of Interim Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted 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

101.DEF	XBRL Taxonomy Extension Definition Linkbase Document

	49

WPCS INTERNATIONAL INCORPORATED AND SUBSIDIARIES

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.

	WPCS INTERNATIONAL INCORPORATED

Date: December 16, 2013		By:	/s/ JOSEPH HEATER
		Joseph Heater
		Chief Financial Officer

	50