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, 2008

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934

For the transition period from _________ to __________

Commission file number: 0-26277

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  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 o
 Accelerated filer o 
 Non-accelerated filer o 
 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  o  No  x

As of December 10, 2008, there were 7,052,943 shares of registrant’s common stock outstanding.


 
1

 

WPCS INTERNATIONAL INCORPORATED AND SUBSIDIARIES



INDEX
       
PART I.
FINANCIAL INFORMATION
 
       
 
ITEM 1.
Condensed consolidated balance sheets at October 31, 2008 (unaudited) and April 30, 2008
3-4
       
   
Condensed consolidated statements of income for the three and six months ended October 31, 2008 and 2007 (unaudited)
5
       
   
Condensed consolidated statement of shareholders’ equity for the six months ended October 31, 2008 (unaudited)
6
       
   
Condensed consolidated statements of cash flows for the six months ended October 31, 2008 and 2007 (unaudited)
7-8
       
   
Notes to unaudited condensed consolidated financial statements
9-23
       
 
ITEM 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
24-35
       
 
ITEM 3.
Controls and Procedures
36
       
PART II.
OTHER INFORMATION
 
       
 
ITEM 1
Legal proceedings
37
 
ITEM 2
Unregistered sales of equity securities and use of proceeds
37
 
ITEM 3
Defaults upon senior securities
37
 
ITEM 4
Submission of matters to a vote of security holders
37
 
ITEM 5
Other information
37
 
ITEM 6
Exhibits
37
       
 
SIGNATURES
38



 
2

 
 
 

 
WPCS INTERNATIONAL INCORPORATED AND SUBSIDIARIES
 
CONDENSED CONSOLIDATED BALANCE SHEETS



   
October 31,
   
April 30,
 
ASSETS
 
2008
   
2008
 
   
(Unaudited)
   
(Note 1)
 
CURRENT ASSETS:
           
             
Cash and cash equivalents
  $ 13,235,880     $ 7,449,530  
 
Accounts receivable, net of allowance of $133,803 and $98,786 at October 31, 2008 and April 30, 2008, respectively
    26,542,341       29,092,488  
                 
Costs and estimated earnings in excess of billings on uncompleted contracts
    4,819,434       3,887,152  
Inventory
    3,186,090       2,791,782  
Prepaid expenses and other current assets
    1,826,629       1,002,993  
Prepaid income tax
    -       122,342  
Deferred tax assets
    166,329       35,939  
Total current assets
    49,776,703       44,382,226  
                 
PROPERTY AND EQUIPMENT, net
    6,858,020       6,828,162  
                 
OTHER INTANGIBLE ASSETS, net
    2,236,574       2,929,937  
                 
GOODWILL
    32,081,048       28,987,501  
                 
OTHER ASSETS
    154,765       820,315  
                 
Total assets
  $ 91,107,110     $ 83,948,141  

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

 
3

 
 
 

 
WPCS INTERNATIONAL INCORPORATED AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS (continued)
 
 
 

LIABILITIES AND SHAREHOLDERS' EQUITY
 
October 31,
   
April 30,
 
   
2008
   
2008
 
   
(Unaudited)
   
(Note 1)
 
CURRENT LIABILITIES:
           
             
Current portion of loans payable
  $ 107,475     $ 1,272,112  
Borrowings under line of credit
    -       750,000  
Current portion of capital lease obligations
    105,908       91,491  
Accounts payable and accrued expenses
    10,715,483       9,305,791  
Billings in excess of costs and estimated earnings on uncompleted contracts
    6,144,343       3,602,422  
Deferred revenue
    808,251       602,560  
Due to shareholders
    3,194,611       2,300,083  
Income taxes payable
    170,816       -  
Total current liabilities
    21,246,887       17,924,459  
                 
Borrowings under line of credit
    7,626,056       4,376,056  
Loans payable, net of current portion
    104,420       156,978  
Capital lease obligations, net of current portion
    203,766       215,780  
Deferred tax liabilities
    1,174,380       1,173,786  
Total liabilities
    30,355,509       23,847,059  
                 
Minority interest in subsidiary
    1,393,046       1,331,850  
                 
COMMITMENTS AND CONTINGENCIES
               
                 
SHAREHOLDERS' EQUITY:
               
Preferred stock - $0.0001 par value, 5,000,000 shares authorized, none issued
    -       -  
Common stock - $0.0001 par value, 75,000,000 shares authorized, 7,251,083 shares issued and outstanding at October 31, 2008 and April 30, 2008
    725       725  
Additional paid-in capital
    50,827,277       50,775,938  
Retained earnings
    8,909,683       7,709,562  
Accumulated other comprehensive (loss) income on foreign currency translation
    (379,130 )     283,007  
                 
Total shareholders' equity
    59,358,555       58,769,232  
                 
Total liabilities and shareholders' equity
  $ 91,107,110     $ 83,948,141  

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


 
4

 
 
 

 
WPCS INTERNATIONAL INCORPORATED AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)

   
Three Months Ended
   
Six Months Ended
 
   
October 31,
   
October 31,
 
   
2008
   
2007
   
2008
   
2007
 
                         
                         
REVENUE
  $ 28,767,681     $ 28,105,044     $ 57,035,212     $ 49,921,050  
                                 
COSTS AND EXPENSES:
                               
Cost of revenue
    21,421,304       20,646,816       41,606,178       35,834,568  
Selling, general and administrative expenses
    5,945,671       4,518,881       11,883,160       8,578,137  
Depreciation and amortization
    651,039       468,615       1,340,181       998,202  
                                 
Total costs and expenses
    28,018,014       25,634,312       54,829,519       45,410,907  
                                 
OPERATING INCOME
    749,667       2,470,732       2,205,693       4,510,143  
                                 
OTHER EXPENSE (INCOME):
                               
Interest expense
    136,681       185,636       248,284       308,218  
Interest income
    (22,073 )     (140,663 )     (48,112 )     (355,175 )
Minority interest
    19,950       57,140       61,196       60,788  
                                 
INCOME BEFORE INCOME TAX PROVISION
    615,109       2,368,619       1,944,325       4,496,312  
                                 
Income tax provision
    253,299       867,106       744,204       1,722,184  
                                 
NET INCOME
  $ 361,810     $ 1,501,513     $ 1,200,121     $ 2,774,128  
                                 
Basic net income per common share
  $ 0.05     $ 0.21     $ 0.17     $ 0.39  
                                 
Diluted net income per common share
  $ 0.05     $ 0.19     $ 0.17     $ 0.35  
                                 
Basic weighted average number of common shares outstanding
    7,251,083       7,079,977       7,251,083       7,026,818  
                                 
Diluted weighted average number of common shares outstanding
    7,262,419       7,958,535       7,259,353       8,013,332  

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

 
5

 
 
 
 
WPCS INTERNATIONAL INCORPORATED AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY
 SIX MONTHS ENDED OCTOBER 31, 2008
(Unaudited)

                                       
Accumulated
       
                           
Additional Paid-In Capital
         
Other Compre-
   
Total Shareholders' Equity
 
   
Preferred Stock
   
Common Stock
   
Retained
   
hensive
 
   
Shares
   
Amount
   
Shares
   
Amount
   
Earnings
   
Income(loss)
 
                                                 
BALANCE, MAY 1, 2008
    -     $ -       7,251,083     $ 725     $ 50,775,938     $ 7,709,562     $ 283,007     $ 58,769,232  
                                                                 
Fair value of stock options granted to employees
    -       -       -       -       56,339       -       -       56,339  
                                                                 
Equity issuance cost
    -       -       -       -       (5,000 )     -       -       (5,000 )
                                                                 
Accumulated other comprehensive loss
    -       -       -       -       -       -       (662,137 )     (662,137 )
                                                                 
Net income
    -       -       -       -       -       1,200,121       -       1,200,121  
                                                                 
BALANCE, OCTOBER 31, 2008
    -     $ -       7,251,083     $ 725     $ 50,827,277     $ 8,909,683     $ (379,130 )   $ 59,358,555  


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

 
6

 
 
 
 
WPCS INTERNATIONAL INCORPORATED AND SUBSIDIARIES
 
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)

   
Six Months Ended
 
   
October 31,
 
   
2008
   
2007
 
             
OPERATING ACTIVITIES :
           
Net income
  $ 1,200,121     $ 2,774,128  
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
               
Depreciation and amortization
    1,340,181       998,202  
Fair value of stock options granted to employees
    56,339       24,435  
Provision for doubtful accounts
    52,932       -  
Amortization of debt issuance costs
    5,161       -  
Excess tax benefit from exercise of stock options
    -       (12,000 )
Minority interest
    61,196       60,788  
(Gain) loss on sale of fixed assets
    (3,822 )     4,875  
Deferred income taxes
    (87,146 )     68,000  
Changes in operating assets and liabilities, net of effects of acquisitions:
               
Accounts receivable
    2,299,194       (2,804,552 )
Costs and estimated earnings in excess of billings on uncompleted contracts
    (1,004,154 )     (862,180 )
Inventory
    (475,630 )     (947,733 )
Prepaid expenses and other current assets
    (454,208 )     (429,078 )
Other assets
    471,681       139,883  
Accounts payable and accrued expenses
    1,511,588       1,619,596  
Billings in excess of costs and estimated earnings on uncompleted contracts
    2,488,644       (913,039 )
Deferred revenue
    205,653       151,597  
Income taxes payable
    350,351       (53,918 )
NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES
    8,018,081       (180,996 )

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 (continued)
(Unaudited)


INVESTING ACTIVITIES:
           
Acquisition of property and equipment, net
    (714,151 )     (370,230 )
Acquisition of NECS, net of cash received
    -       (3,534 )
Acquisition of SECS, net of cash received
    -       57,451  
Acquisition of Voacolo, net of cash received
    (2,500,000 )     (66,000 )
Acquisition of Lincoln Wind, net of cash received
    (420,464 )     -  
Acquisition of Major, net of cash received
    -       (3,091,777 )
Acquisition of Max, net of cash received
    (287,181 )     (523,045 )
Acquisition of Empire, net of cash received
    (7,521 )     -  
Acquisition of James, net of cash received
    (287,735 )     -  
Acquisition of Energize, net of cash received
    (24,516 )     -  
NET CASH USED IN INVESTING ACTIVITIES
    (4,241,568 )     (3,997,135 )
                 
FINANCING ACTIVITIES:
               
Net proceeds from exercise of stock options
    -       55,042  
Excess tax benefit from exercise of stock options
    -       12,000  
Equity issuance costs
    (5,000 )     (4,959 )
Borrowings/(repayments) under lines of credit, net
    2,500,000       (6,540,991 )
(Repayments)/borrowings under loans payable, net
    (1,217,195 )     399,797  
Borrowings/(repayments) of amounts due to shareholders
    827,678       (238,420 )
Payments of capital lease obligations
    (25,887 )     (45,009 )
NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES
    2,079,596       (6,362,540 )
                 
Effect of exchange rate changes on cash
    (69,759 )     6,036  
                 
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
    5,786,350       (10,534,635 )
CASH AND CASH EQUIVALENTS, BEGINNING OF THE PERIOD
    7,449,530       21,558,739  
CASH AND CASH EQUIVALENTS, END OF THE PERIOD
  $ 13,235,880     $ 11,024,104  


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

 
8

 
 
 
WPCS INTERNATIONAL INCORPORATED AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1 - BASIS OF PRESENTATION

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, 2008 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, 2008 are not necessarily indicative of the results that may be expected for the fiscal year ending April 30, 2009. The amounts for the April 30, 2008 balance sheet have been extracted from the audited consolidated financial statements included in Form 10-K for the year ended April 30, 2008.

The accompanying condensed consolidated financial statements include the accounts of WPCS International Incorporated (WPCS) and its wholly and majority-owned subsidiaries, WPCS Incorporated, Invisinet, Inc. (Invisinet), Walker Comm, Inc. (Walker), Clayborn Contracting Group, Inc. (Clayborn), Heinz Corporation (Heinz), Quality Communications & Alarm Company, Inc. (Quality), New England Communications Systems, Inc. (NECS), Southeastern Communication Services, Inc. (SECS), Voacolo Electric Incorporated (Voacolo), Taian AGS Pipeline Construction Co. Ltd (TAGS), Major Electric, Inc. (Major) from August 1, 2007 (date of acquisition), Max Engineering LLC (Max) from August 2, 2007 (date of acquisition), Gomes and Gomes, Inc. dba Empire Electric (Empire) from November 1, 2007 (date of acquisition), WPCS Australia Pty Ltd  from November 12, 2007 (date of formation), James Design Pty Ltd (James) from November 30, 2007 (date of acquisition), WPCS Asia Limited from January 24, 2008 (date of formation), RL & CA MacKay Pty Ltd. dba Energize Electrical (Energize) from April 4, 2008 (date of acquisition), and Lincoln Wind LLC (Lincoln Wind) from June 26, 2008 (date of acquisition), collectively the “Company”.

The Company provides design-build engineering services that focus on the implementation requirements of wireless technology.  The Company serves the specialty communication systems and wireless infrastructure sectors.  The Company provides services that include site design, technology integration, electrical contracting, construction, and project management for corporations, government entities and educational institutions worldwide.

NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

A summary of significant accounting policies consistently applied in the preparation of the accompanying 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 an original maturity at time of purchase of three months or less.

Goodwill and Other Intangible Assets

In accordance with Statement of Financial Accounting Standards (SFAS No. 142), “Goodwill and Other Intangible Assets,” goodwill and indefinite-lived intangible assets are no longer amortized but are assessed for impairment on at least an annual basis. SFAS No. 142 also requires that intangible assets with definite useful lives be amortized over their respective estimated useful lives to their estimated residual values, and reviewed for impairment.
 
SFAS No. 142 requires that goodwill be tested at least annually, utilizing a two-step methodology. The initial step requires the Company to determine the fair value of the business acquired (reporting unit) and compare it to the carrying value, including goodwill, of such business (reporting unit). If the fair value exceeds the carrying value, no impairment loss is recognized. However, if the carrying value of the reporting unit exceeds its fair value, the goodwill of the unit may be impaired. The amount, if any, of the impairment is then measured in the second step, based on the excess, if any, of the reporting unit’s carrying value of goodwill over its implied value.
 
9

 
 
WPCS INTERNATIONAL INCORPORATED AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 
The Company determines the fair value of the businesses acquired (reporting units) for purposes of this test primarily by using a discounted cash flow valuation technique. Significant estimates used in the valuation include estimates of future cash flows, both future short-term and long-term growth rates, and estimated cost of capital for purposes of arriving at a discount factor. The Company expects to perform its annual impairment test at April 30 absent any interim impairment indicators. Adverse changes in general economic conditions could impact the Company's valuation of its reporting units.  However, the Company considered current economic conditions, and concluded that indicators did not suggest testing goodwill or intangible assets for impairment on an interim basis in advance of the tests it performs annually at the end of the fourth quarter of each year.

Changes in goodwill consist of the following during the six months ended October 31, 2008:

   
Wireless
   
Specialty
   
Total
 
   
Infrastructure
   
Communication
       
                   
Beginning balance, May 1, 2008
  $ 4,583,701     $ 24,403,800     $ 28,987,501  
                         
Voacolo acquisition - additional earnout payment
    -       2,500,000       2,500,000  
Major acquisition - NTAV and purchase price adjustment
    -       6,353       6,353  
Max acquisition - additional earnout payment
    287,181       -       287,181  
Lincoln Wind acquisition
    -       280,494       280,494  
Empire acquisition - purchase price adjustment
    -       81,366       81,366  
James acquisition - purchase price adjustment
    -       408,727       408,727  
Energize acquisition - purchase price adjustment
    -       62,460       62,460  
Foreign currency translation adjustments
    -       (533,034 )     (533,034 )
Ending balance, October 31, 2008
  $ 4,870,882     $ 27,210,166     $ 32,081,048  

Other intangible assets consist of the following at October 31, 2008 and April 30, 2008:

   
Estimated useful life (years)
   
October 31,
2008
   
April 30,
2008
 
                   
Customer lists
   
5 - 9
    $ 3,886,113     $ 4,119,269  
Contract backlog
   
1 - 3
      885,127       919,722  
              4,771,240       5,038,991  
 
Less accumulated amortization expense
            2,534,666       2,109,054  
            $ 2,236,574     $ 2,929,937  

Amortization expense for other intangible assets for the six months ended October 31, 2008 and 2007 was $468,081 and $323,066, 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 specialty communication systems and wireless infrastructure services. The Company provides services that include site design, technology integration, electrical contracting, construction, and project management. The Company’s engineering and deployment 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.

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.

 
10

 
 
 
WPCS INTERNATIONAL INCORPORATED AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 

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.

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

Income taxes are accounted for in accordance with SFAS No. 109, "Accounting of Income Taxes." Under SFAS No. 109, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Under SFAS No. 109, 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. 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.

In June 2006, the Financial Accounting Standards Board (FASB) issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes – an interpretation of FAS No. 109 (“FIN 48”), which clarifies the accounting for uncertainty in income taxes is subject to significant and varied interpretations that have resulted in diverse and inconsistent accounting practices and measurements. Addressing such diversity, FIN 48 prescribes a consistent recognition threshold and measurement attribute, as well as clear criteria for subsequently recognizing, derecognizing and measuring changes in such tax positions for financial statement purposes. FIN 48 also requires expanded disclosure with respect to the uncertainty in income taxes. FIN 48 is effective for fiscal years beginning after December 15, 2006. The adoption of FIN 48 on May 1, 2007 had no impact on the Company’s condensed consolidated financial position, results of operations, cash flows or financial statement disclosures.
 
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, 2008, and 2007, the Company recognized no interest or penalties, respectively.

Earning Per Common Share

Earning per common share is computed pursuant to SFAS No. 128, "Earnings Per Share" (EPS). Basic net income per common share is computed as net income divided by the weighted average number of common shares outstanding for the period. Diluted net income per common share reflects the potential dilution that could occur from common stock issuable through stock options and warrants.  The table below presents the computation of basic and diluted net income per common share for the three and six months ended October 31, 2008 and 2007, respectively:
 
Basic earnings per share computation
 
Three Months Ended
   
Six Months Ended
 
   
October 31,
   
October 31,
 
Numerator:
 
2008
   
2007
   
2008
   
2007
 
                         
     Net income
  $ 361,810     $ 1,501,513     $ 1,200,121     $ 2,774,128  
                                 
Denominator:
                               
                                 
     Basic weighted average shares outstanding
    7,251,083       7,079,977       7,251,083       7,026,818  
                                 
Basic net income per common share
  $ 0.05     $ 0.21     $ 0.17     $ 0.39  
                                 
                                 
                                 
Diluted earnings per share computation
 
Three Months Ended
   
Six Months Ended
 
   
October 31,
   
October 31,
 
Numerator:
 
2008
   
2007
   
2008
   
2007
 
                                 
     Net income
  $ 361,810     $ 1,501,513     $ 1,200,121     $ 2,774,128  
                                 
Denominator:
                               
                                 
     Basic weighted average shares outstanding
    7,251,083       7,079,977       7,251,083       7,026,818  
                                 
     Incremental shares from assumed conversion:
                               
                                 
          Conversion of stock options
    11,336       200,598       8,270       221,472  
                                 
          Conversion of common stock warrants
    -       677,960       -       765,042  
                                 
     Diluted weighted average shares
    7,262,419       7,958,535       7,259,353       8,013,332  
                                 
Diluted net income per common share
  $ 0.05     $ 0.19     $ 0.17     $ 0.35  

At October 31, 2008 and 2007, the Company had 691,475 and 561,468 stock options and 1,883,796 warrants outstanding, respectively, which are potentially dilutive securities.  For the three months ended October 31, 2008 and 2007, 667,759 and 75,219 stock options were not included in the computation of the diluted earnings per share, respectively.  For the three and six months ended October 31, 2008, 1,883,796 warrants were not included in the computation of the diluted earnings per share.  For the six months ended October 31, 2008 and 2007, 642,400 and 63,434 stock options were excluded from the computation of the diluted earnings per share, respectively. These potentially dilutive securities were excluded because the stock option exercise prices exceeded the average market price of the common stock and, therefore, the effects would be antidilutive.
 
 
11

 
 
 
 
WPCS INTERNATIONAL INCORPORATED AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

Comprehensive Income (Loss)

Comprehensive income (loss) for the three and six months ended October 31, 2008 and 2007 consists of the following:
 
   
Three months ended
   
Six months ended
 
   
October 31,
   
October 31,
 
   
2008
   
2007
   
2008
   
2007
 
Net income
  $ 361,810     $ 1,501,513     $ 1,200,121     $ 2,774,128  
Other comprehensive (loss) income –
 foreign currency translation adjustments, net
    (735,869 )     46,200       (662,137 )     109,965  
Comprehensive (loss) income
  $ (374,059 )   $ 1,547,713     $ 537,984     $ 2,884,093  

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, amortization method and lives of customer lists, 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.

Recently Issued Accounting Pronouncements

On September 15, 2006, the FASB issued Statement of Financial Accounting Standards No. 157, “Fair Value Measurements” (SFAS 157), which is effective for fiscal years beginning after November 15, 2007 and for interim periods within those years. SFAS 157 defines fair value, establishes a framework for measuring fair value and expands the related disclosure requirements. On February 12, 2008, the FASB issued staff position No. SFAS 157-2, “effective date of FASB No. 157 Fair Value Measurements”, which delays the effective date of SFAS 157 for non-financial assets and liabilities to fiscal years beginning after November 15, 2008. The adoption of SFAS 157 had no impact on the Company’s condensed consolidated financial position, results of operations, cash flows or financial statement disclosures.

In February, 2007, the FASB issued FASB Statement of Financial Accounting Standards No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities (SFAS 159), which permits entities to choose to measure many financial assets and financial liabilities at fair value. Unrealized gains and losses on items for which the fair value option has been elected are reported in earnings. SFAS 159 is effective for fiscal years beginning after November 15, 2007.  The adoption of SFAS 159 had no impact on the Company’s consolidated financial position, results of operations, cash flows or financial statement disclosures.

On December 4, 2007, the FASB issued SFAS No. 141(R) “Business Combinations” (SFAS 141(R)), and SFAS No. 160 “Noncontrolling Interests in Consolidated Financial Statements, an amendment of ARB No. 51” (SFAS 160).  These new standards will significantly change the accounting for and reporting for business combination transactions and noncontrolling (minority) interests in consolidated financial statements. SFAS 141(R) and SFAS 160 are required to be adopted simultaneously and are effective for the first annual reporting period beginning on or after December 15, 2008. Earlier adoption is prohibited. The Company will evaluate the impact of adopting SFAS 141(R) and SFAS 160 on its condensed consolidated financial position, results of operations, cash flows or financial statement disclosures.

On March 19, 2008, the FASB Issued SFAS No. 161, “Disclosures About Derivative Instruments and Hedging Activities”(SFAS 161). This statement is intended to improve financial reporting about derivative instruments and hedging activities by requiring enhanced disclosures. This statement is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008, with early application encouraged. The Company is currently evaluating the impact that SFAS 161 will have on its condensed consolidated financial position, results of operations, cash flows or financial statement disclosures.

In June 2008, the FASB ratified EITF Issue 07-5, “Determining Whether an Instrument (or Embedded Feature) Is Indexed to an Entity’s Own Stock” (EITF 07-5). The primary objective of EITF 07-5 is to provide guidance for determining whether an equity-linked financial instrument or embedded feature within a contract is indexed to an entity’s own stock, which is a key criterion of the scope exception to paragraph 11(a) of SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities.” An equity-linked financial instrument or embedded feature within a contract that is not considered indexed to an entity’s own stock could be required to be classified as an asset or liability and marked-to-market through earnings. EITF 07-5 specifies a two-step approach in evaluating whether an equity-linked financial instrument or embedded feature within a contract is indexed to its own stock. The first step involves evaluating the instrument’s contingent exercise provisions, if any, and the second step involves evaluating the instrument’s settlement provisions. EITF 07-5 is effective for financial statements issued for fiscal years beginning after December 15, 2008, and must be applied to all instruments outstanding as of the effective date. Accordingly, the Company will adopt EITF 07-5 on May 1, 2009, but has not yet determined the impact, if any, on its consolidated financial position, results of operations and cash flows.

 
12

 
 
 
 
WPCS INTERNATIONAL INCORPORATED AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

No other recently issued accounting pronouncement issued or effective after the end of the fiscal year is expected to have a material impact on the Company’s condensed consolidated financial statements.

NOTE 3 - ACQUISITIONS

In accordance with SFAS No. 141, “Business Combinations,” acquisitions are accounted for under the purchase method of accounting.  Under the purchase method of accounting, assets acquired and liabilities assumed are recorded at their estimated fair values.  Goodwill is recorded to the extent the purchase price consideration, including certain acquisition and closing costs, exceeds the fair value of the net identifiable assets acquired at the date of the acquisition.

Voacolo

On March 30, 2007, the Company acquired Voacolo. The aggregate consideration paid by the Company, including acquisition transaction costs of $31,389, was $5,063,863 of which $3,781,389 was paid in cash, and the Company issued 116,497 shares of common stock valued at $1,282,473. In June 2008, the Company settled and paid aggregate additional cash consideration of $2,500,000 to the former Voacolo shareholders for the earnout settlement for the twelve months ended March 31, 2008. Voacolo was acquired pursuant to a Stock Purchase Agreement among the Company, and the former Voacolo shareholders, dated and effective as of March 30, 2007. In connection with the acquisition, Voacolo entered into employment agreements with the former Voacolo shareholders, each for a period of two years.  The acquisition of Voacolo expands the Company’s geographic presence in the Mid-Atlantic region and provides additional  electrical contracting services  in both high and low voltage applications, structured cabling and voice/data/video solutions, as well as the expansion of its operations into wireless video surveillance.

A valuation of certain assets was completed, including property and equipment, list of major customers and backlog, and the Company internally determined the fair value of other assets and liabilities. In determining the fair value of acquired assets, standard valuation techniques were used including the market and income approach.

The purchase price allocation has been determined as follows:
 
Assets purchased:
     
Cash
  $ 584,094  
Accounts receivable
    2,095,564  
Inventory
    217,500  
Prepaid expenses
    46,858  
Costs and estimated earnings in excess of billings
    215,143  
Fixed assets
    346,569  
Backlog
    200,200  
Customer lists
    132,000  
Goodwill
    3,988,732  
      7,826,660  
Liabilities assumed:
       
Accounts payable
    (732,252 )
Accrued expenses
    (102,832 )
Payroll and other payables
    (79,943 )
Billings in excess of costs and estimated earnings
    (935,179 )
Deferred income tax payable
    (181,000 )
Income tax payable
    (28,171 )
Loan payable
    (602,984 )
Notes payable
    (100,436 )
      (2,762,797 )
Purchase price
  $ 5,063,863  

 
13

 
 
 
 
 
WPCS INTERNATIONAL INCORPORATED AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Major

On August 1, 2007, the Company acquired Major. The aggregate consideration paid by the Company, including acquisition transaction costs of $44,226, was $6,292,151 of which $3,844,135 was paid in cash and the Company issued 242,776 shares of common stock valued at $2,448,016.  The Company determined not to proceed with the Internal Revenue Code Section 338(h)(10) election, which resulted in recording additional deferred tax liabilities of $304,000 related to the purchase price allocation and a corresponding increase in goodwill.  In connection with the additional purchase price adjustments to settle earnout and working capital adjustments, the Company has recorded a receivable from the former Major shareholders of $371,566, resulting in a corresponding decrease in goodwill. This receivable will be repaid within the next 12 months in three equal installments.  Through October 31, 2008, the Company has received payments of $121,474 related to this receivable.

Major was acquired pursuant to a Stock Purchase Agreement among the Company and the former Major shareholders, dated and effective as of August 1, 2007. In connection with the acquisition, Major entered into employment agreements with the former president and vice president, for a period of one and two years, respectively. The acquisition of Major expands the Company’s geographic presence in the Pacific Northwest region and provides additional wireless and electrical contracting services  in direct digital controls, security, wireless SCADA applications and wireless infrastructure.

A valuation of certain assets was completed, including property and equipment, list of major customers and backlog, and the Company internally determined the fair value of other assets and liabilities. In determining the fair value of acquired assets, standard valuation techniques were used including the market and income approach.

The purchase price allocation has been determined as follows:

Assets purchased:
     
Accounts receivable
  $ 3,830,626  
Inventory
    162,647  
Prepaid expenses
    117,349  
Costs and estimated earnings in excess of billings
    1,445,749  
Fixed assets
    682,637  
Other assets
    8,855  
Backlog
    130,000  
Customer lists
    390,000  
Goodwill
    4,511,915  
      11,279,778  
Liabilities assumed:
       
Cash overdraft
    (52,618 )
Accounts payable
    (424,513 )
Accrued expenses
    (12,788 )
Payroll and other payable
    (605,456 )
Billings in excess of costs and estimated earnings
    (1,059,123 )
Deferred tax liabilities
    (304,000 )
Line of credit
    (2,086,774 )
Loan payable
    (24,638 )
Capital lease obligation
    (242,297 )
Shareholder loan
    (175,420 )
      (4,987,627 )
Purchase price
  $ 6,292,151  

 
14

 
 
 
 
WPCS INTERNATIONAL INCORPORATED AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 Max

On August 2, 2007, the Company acquired Max. The aggregate consideration paid by the Company, including acquisition transaction costs of $30,498, was $1,117,679 of which $917,679 was paid in cash and the Company issued 17,007 shares of common stock valued at $200,000. In October 2008, the Company settled and paid additional cash consideration of $287,181 to the former Max members for the earnout settlement for the twelve months ended August 1, 2008. In addition, the Company shall pay an additional $375,000 in cash or Company common stock if Max’s earnings before interest and taxes for the twelve months ending August 1, 2009 shall equal or exceed $375,000. Max was acquired pursuant to a Membership Interest Purchase Agreement among the Company and the former Max members, dated and effective as of August 2, 2007. In connection with the acquisition, Max entered into employment agreements with the former members, each for a period of two years. The acquisition of Max expands the Company’s geographic expansion into Texas and provides additional engineering services that specialize in the design of specialty communication systems and wireless infrastructure for the telecommunications, oil, gas and wind energy markets.

A valuation of certain assets was completed, including property and equipment and list of major customers, and the Company internally determined the fair value of other assets and liabilities. In determining the fair value of acquired assets, standard valuation techniques were used including the market and income approach.

The purchase price allocation has been determined as follows:
 
Assets purchased:
     
Cash
  $ 105,926  
Accounts receivable
    256,829  
Costs and estimated earnings in excess of billings
    4,500  
Fixed assets
    21,890  
Other assets
    1,950  
Customer lists
    216,000  
Goodwill
    591,588  
      1,198,683  
Liabilities assumed:
       
Accrued expenses
    (59,186 )
Payroll and other payable
    (19,318 )
Accrued tax payable
    (2,500 )
      (81,004 )
Purchase price
  $ 1,117,679  
 
Empire

On November 1, 2007, the Company acquired Empire. The aggregate consideration paid by the Company, including acquisition transaction costs of $47,674, was $2,518,675 in cash. Empire was acquired pursuant to a Stock Purchase Agreement among the Company and the former shareholders of Empire, dated as of November 1, 2007.  In connection with the acquisition, Empire entered into employment agreements with the former shareholders for a period of two years. The acquisition of Empire expands the Company’s geographic presence in California and provides additional electrical contractor services that specialize in low voltage applications for healthcare, state government and military customers.

A valuation of certain assets was completed, including property and equipment, list of major customers and backlog, and the Company internally determined the fair value of other assets and liabilities. In determining the fair value of acquired assets, standard valuation techniques were used including the market and income approach.

 
15

 

 
 
WPCS INTERNATIONAL INCORPORATED AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 
The purchase price allocation has been determined as follows:
 
Assets purchased:
     
Cash
  $ 83,155  
Accounts receivable
    2,313,633  
Inventory
    124,983  
Prepaid expenses
    6,569  
Prepaid income tax
    76,426  
Costs and estimated earnings in excess of billings
    72,518  
Fixed assets
    284,451  
Backlog
    344,900  
Customer lists
    100,000  
Goodwill
    1,878,075  
      5,284,710  
Liabilities assumed:
       
         
Accounts payable
    (1,113,789 )
Accrued expenses
    (53,871 )
Payroll and other payable
    (327,112 )
Billings in excess of costs and estimated earnings
    (420,874 )
Line of credit
    (400,000 )
Deferred tax liability
    (235,000 )
Notes payable
    (47,024 )
Shareholder loan
    (168,365 )
      (2,766,035 )
Purchase price
  $ 2,518,675  

James

On November 30, 2007, the Company acquired James. The aggregate consideration paid by the Company, including acquisition transaction costs of $81,153, was $1,562,879 in cash.  In May 2008, the Company settled and paid aggregate additional cash consideration of $281,725 and released the escrow amount of $120,000 to the former James shareholders for final settlement of the net tangible asset adjustment.   James was acquired pursuant to a Share Purchase Agreement among the Company and the former shareholders of James, dated as of November 30, 2007. In connection with the acquisition, the Company entered into an employment agreement with the former president for a period of two years. James is a design engineering services company specializing in building automation including mechanical, electrical, hydraulic, fire protection, lift, security access and wireless systems. The acquisition of James provides the Company international expansion into Australia consistent with our emphasis on Australia, China and surrounding Pacific Rim countries.

A valuation of certain assets was completed, including property and equipment, list of major customers and backlog, and the Company internally determined the fair value of other assets and liabilities. In determining the fair value of acquired assets, standard valuation techniques were used including the market and income approach.

The purchase price allocation has been determined as follows:

Assets purchased:
     
Cash
  $ 231,386  
Accounts receivable
    312,135  
Prepaid expenses
    6,450  
Deferred tax assets
    17,431  
Costs and estimated earnings in excess of billings
    26,272  
Fixed assets
    115,343  
Other assets
    830  
Customer lists
    270,748  
Backlog
    112,369  
Goodwill
    843,563  
      1,936,527  
Liabilities assumed:
       
         
Accounts payable
    (26,288 )
Accrued expenses
    (74,510 )
Payroll and other payable
    (9,409 )
Loan payable
    (6,099 )
Sales and use tax payable
    (40,516 )
Income tax payable
    (216,826 )
      (373,648 )
Purchase price
  $ 1,562,879  

 
16

 
 
 
 
WPCS INTERNATIONAL INCORPORATED AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Energize

On April 4, 2008, the Company acquired Energize. The aggregate consideration paid by the Company, including acquisition transaction costs of $114,112 was $1,689,756 in cash, subject to adjustment. In July 2008, the Company settled and paid aggregate additional cash consideration of $32,522 to the former Energize shareholders for final settlement of the net tangible asset adjustment. Energize was acquired pursuant to a Share Purchase Agreement among the Company and the former shareholders of Energize, dated as of April 4, 2008. In connection with the acquisition, the Company entered into an employment agreement with the former president for a period of two years.   Energize is an electrical contractor specializing in underground utilities, maintenance and low voltage applications including voice, data and video for commercial and building infrastructure companies, and is expanding its wireless deployment capabilities.  The acquisition of Energize provides further international expansion into Australia.

A valuation of certain assets was completed, including property and equipment and list of major customers, and the Company internally determined the fair value of other assets and liabilities. In determining the fair value of acquired assets, standard valuation techniques were used including the market and income approach.

The purchase price allocation has been determined as follows:

Assets purchased:
     
Cash
  $ 21,429  
Accounts receivable
    189,197  
Inventory
    55,084  
Costs and estimated earnings in excess of billings
    415  
Fixed assets
    106,165  
Deferred tax assets
    2,108  
Customer lists
    509,740  
Goodwill
    1,023,660  
      1,907,798  
Liabilities assumed:
       
         
Accounts payable
    (69,562 )
Accrued expenses
    (7,444 )
Payroll and other payable
    (37,175 )
Sales and use tax payable
    (12,449 )
Income tax payable
    (91,412 )
      (218,042 )
Purchase price
  $ 1,689,756  


 
17

 
 
 

 
WPCS INTERNATIONAL INCORPORATED AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Lincoln Wind

On June 26, 2008, the Company acquired all the assets of Lincoln Wind for aggregate consideration of $420,464 in cash, including acquisition transaction costs of $20,464. The assets of Lincoln Wind were acquired pursuant to an Asset Purchase Agreement among Max, the Company, Lincoln Wind and the former member. In connection with the acquisition, Max also entered into an employment agreement with the former member for two years. Lincoln Wind is an engineering company focused on the implementation of meteorological towers that measure the wind capacity of geographic areas prior to the construction of a wind farm.  The acquisition of Lincoln Wind provides additional engineering services that specialize in the design of specialty communication systems for the wind energy market.

The preliminary purchase price allocation has been made resulting in goodwill and other intangible assets of approximately $280,000.  Upon completion of a final purchase price allocation, there may be an increase or decrease in the amount of goodwill and a corresponding increase or decrease in other intangible assets.

The preliminary purchase price allocation has been determined as follows:

Assets purchased:
     
       
Fixed assets
  $ 139,970  
Goodwill and other intangible assets
    280,494  
Purchase price
  $ 420,464  

Pro forma Information

The following unaudited consolidated pro forma financial information presents the combined results of operations of the Company, Major, Max, Empire, James, Energize and Lincoln Wind for the three and six months ended October 31, 2008 and 2007 as if the acquisitions had occurred at May 1, 2007, including the issuance of the Company’s common stock as consideration for the acquisition of Major. The consolidated pro forma financial information does not necessarily reflect the results of operations that would have occurred had the Company, Major, Max, Empire, James, Energize and Lincoln Wind been a single entity during these periods.

   
Consolidated Pro Forma
 
                   
   
Three months
   
Six months
   
Six months
 
   
ended
   
ended
   
ended
 
   
October 31, 2007
   
October 31, 2008
   
October 31, 2007
 
                   
Revenues
  $ 32,299,992     $ 57,164,133     $ 61,258,226  
                         
Net income
    1,415,218       1,128,320       3,444,281  
                         
Basic weighted shares
    7,249,564       7,251,083       7,248,866  
Diluted weighted shares
    8,128,122       7,259,353       8,235,380  
                         
Basic net income per share
  $ 0.20     $ 0.16     $ 0.48  
Diluted net income per share
  $ 0.17     $ 0.16     $ 0.42  

 
18

 
 
 
WPCS INTERNATIONAL INCORPORATED AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

NOTE 4 - 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, 2008 and April 30, 2008:

   
October 31, 2008
   
April 30, 2008
 
Costs incurred on uncompleted contracts
  $ 72,533,571     $ 66,331,553  
Estimated contract profit
    21,595,383       20,900,509  
      94,128,954       87,232,062  
Less: billings to date
    95,453,863       86,947,332  
                           Net excess of (billings)costs
  $ (1,324,909 )   $ 284,730  
                 
Costs and estimated earnings in excess of billings
  on uncompleted contracts
  $ 4,819,434     $ 3,887,152  
Billings in excess of costs and estimated earnings
               
  on uncompleted contracts
    (6,144,343 )     (3,602,422 )
                           Net excess of (billings)costs
  $ (1,324,909 )   $ 284,730  

NOTE 5 – DEBT

Lines of Credit

On April 10, 2007, the Company entered into a loan agreement (Loan Agreement) with Bank of America, N.A. (BOA), which  provided for a revolving line of credit in an amount not to exceed $12,000,000, together with a letter of credit facility not to exceed $2,000,000. On August 7, 2008, the Loan Agreement  was amended to increase the revolving line of credit in an amount not to exceed $15,000,000. The Company and its subsidiaries also entered into security agreements with BOA, pursuant to which the Company granted a security interest to BOA in all of our assets.   The Loan Agreement contains customary covenants, including but not limited to (i) funded debt to tangible net worth, and (ii) minimum interest coverage ratio. As of October 31, the Company was in compliance with the Loan Agreement covenants. The loan commitment shall expire on April 10, 2010, and the Company may repay the loan at any time.

Loans under the Loan Agreement bear interest at a rate equal to BOA’s prime rate, minus one percentage point, or the Company has the option to elect to use the optional interest rate of LIBOR plus one hundred seventy-five basis points.  As of October 31, 2008, interest rates ranged from 4.00% to 4.82% on outstanding borrowings of $7,626,056 under the Loan Agreement.

In connection with the acquisition of Empire, the Company assumed a revolving line of credit facility with a commercial bank with a balance of $400,000 at the closing date.  The outstanding balance of $750,000 was repaid by the Company in July 2008.

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, 2008, loans payable and capital lease obligations totaled $521,569 with interest rates ranging from 0% to 12.67%.

Due to Shareholders

As of October 31, 2008, TAGS had outstanding loans due to a related party, Taian Gas Group (TGG), totaling $3,194,611, of which $1,461,820 matures on June 3, 2009, and bears interest at 8.217% and $1,608,002 which matures on September 9, 2009 and bears interest at 8.217%.

NOTE 6 - RELATED PARTY TRANSACTIONS

In connection with the acquisition of Walker, the Company assumed a ten-year lease with a trust, of which, a certain officer of the Company is the trustee, for a building and land located in Fairfield, California, which is occupied by its Walker subsidiary.  For the six months ended October 31, 2008 and 2007, the rent paid for this lease was $46,830 and $45,023, respectively.

In connection with the acquisition of SECS, the Company leases its Sarasota, Florida location from a trust, of which one of the former shareholders of SECS is the trustee. For the six months ended October 31, 2008 and 2007, the rent paid for this lease was $26,847 and $26,065, respectively.

 
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WPCS INTERNATIONAL INCORPORATED AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


In connection with the acquisition of Voacolo, the Company leases its Trenton, New Jersey location from Voacolo Properties LLC, of which the former shareholders of Voacolo are the members. For the six months ended October 31, 2008 and 2007, the rent paid for this lease was $30,000 and $27,000, respectively.

In connection with the acquisition of TAGS in fiscal 2007, the Company’s joint venture partner provided the office building for TAGS rent free during fiscal year 2008. The Company expects to enter into a lease with the joint venture partner in fiscal 2009.

NOTE 7 - STOCK OPTION PLANS AND COMMON STOCK PURCHASE WARRANTS

Stock Option 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, 400,000 shares of common stock were reserved for issuance upon the exercise of stock options, stock awards or restricted stock.  At October 31, 2008, options to purchase 175,000 shares were outstanding at exercise prices ranging from $2.37 to $6.33. At October 31, 2008, there were 225,000 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, 400,000 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, 2008, options to purchase 327,059 shares were outstanding at exercise prices ranging from $6.14 to $12.10. At October 31, 2008, there were 1,365 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 416,667 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, 2008, options to purchase 189,416 shares were outstanding at exercise prices ranging from $2.37 to $12.10. At October 31, 2008, there were 84,734 shares available for grant under the 2002 Plan.

The following table summarizes stock option activity for the six months ended October 31, 2008, during which there were no options exercised under the Company’s stock option plans:

   
2002 Plan
 
   
Number of Shares
   
Weighted-average Exercise Price
   
Weighted- average Remaining Contractual Term
   
Aggregate 
Intrinsic Value
 
 
 
 
 
                         
Outstanding, May 1, 2008
    238,092     $ 8.21              
                             
Granted
    25,900     $ 4.56              
Exercised
    -       -              
Forfeited/Expired
    (74,576 )   $ 10.97              
                             
Outstanding, October 31, 2008
    189,416     $ 6.62       1.9     $ 5,607  
                                 
Vested and expected to vested, October 31, 2008
    182,835     $ 6.65       1.8     $ 4,954  
                                 
Exercisable, October 31, 2008
    146,083     $ 6.83       1.1     $ 0  

 
20

 
WPCS INTERNATIONAL INCORPORATED AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS



   
2006 Plan
 
   
Number of Shares
   
Weighted-average Exercise Price
   
Weighted-average Remaining Contractual Term
   
Aggregate Intrinsic Value
 
 
 
 
 
                         
Outstanding, May 1, 2008
    327,726     $ 6.32              
                             
Granted
    -       -              
Exercised
    -       -              
Forfeited/Expired
    (667 )   $ 7.27              
                             
Outstanding, October 31, 2008
    327,059     $ 6.32       2.0     $ 0  
                                 
Vested and expected to vested, October 31, 2008
    326,386     $ 6.30       2.0     $ 0  
                                 
Exercisable, October 31, 2008
    320,549     $ 6.24       2.0     $ 0  

   
2007 Plan
 
   
Number of Shares
   
Weighted-average Exercise Price
 
Weighted-average Remaining Contractual Term
   
Aggregate Intrinsic Value
 
 
 
 
 
                         
Outstanding, May 1, 2008
    80,000     $ 6.33              
                             
Granted
    95,000     $ 2.37              
Exercised
    -       -              
Forfeited/Expired
    -       -              
                             
Outstanding, October 31, 2008
    175,000     $ 4.18       4.7     $ 59,850  
                                 
Vested and expected to vested, October 31, 2008
    146,402     $ 4.06       4.7     $ 52,883  
                                 
Exercisable, October 31, 2008
    -     $ 0.00       0.0     $ 0  

Stock-Based Compensation Plans

In accordance with SFAS 123(R) (revised December 2004), “Share-Based Payment, an amendment of SFAS 123, Accounting for Stock-Based Compensation”, the Company recognizes stock-based employee compensation expense. The Company recorded stock-based compensation of $56,339 and $24,435 for the six months ended October 31, 2008 and 2007, respectively.

 
21

 
 
 
 
WPCS INTERNATIONAL INCORPORATED AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

At October 31, 2008, the total compensation cost related to unvested stock options granted to employees under the Company’s stock option plans but not yet recognized was approximately $319,000 and is expected to be recognized over a weighted-average period of 2.68 years. For the three months ended October 31, 2008 and 2007, the weighted average fair value of stock options granted was $1.11 and $4.62, respectively.   For the six months ended October 31, 2008 and 2007, the weighted average fair value of stock options granted was $1.11 and $5.23, respectively.

The Company has elected to adopt the shortcut method provided in Staff Position No. SFAS 123(R)-3, “Transition Election Related to Accounting for the Tax Effects of Share-Based Payment Awards,” for determining the initial pool of excess tax benefits available to absorb tax deficiencies related to stock-based compensation subsequent to the adoption of SFAS 123R. 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. SFAS 123R requires that excess tax benefits related to share-based compensation be reflected as financing cash inflows.

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.  The following assumptions were used to compute the fair value of stock option compensation expense during the three and six months ended October 31, 2008 and 2007, respectively:

   
Three Months Ended
   
Six Months Ended
 
   
October 31,
   
October 31,
 
   
2008
   
2007
   
2008
   
2007
 
                         
Risk-free interest rate
    1.87 - 2.84 %     4.31 %     1.87 - 2.84 %     4.31 - 4.74 %
Expected volatility
    50.8 - 53.3 %     57.0 %     50.8 - 53.3 %     57.0 - 58.3 %
                                 
Expected dividend yield
    0.00 %     0.00 %     0.00 %     0.00 %
Expected term ( in years)
    3.25 - 3.5       3.5       3.25 - 3.5       3.5  

The risk-free rate is based on the rate of U.S Treasury zero-coupon issues with a remaining term equal to the expected term of the option grants.  Expected volatility is based on the historical volatility of the Company’s common stock using the weekly closing price of the Company’s common stock, pursuant to SEC Staff Accounting Bulletin Nos. 107 (SAB 107). The expected dividend yield is zero based on the fact that the Company has never paid cash dividends and has no present intention to pay cash dividends. The expected term represents the period that the Company’s stock-based awards are expected to be outstanding and was calculated using the simplified method pursuant to SAB 107 and SAB 110.
 
Common Stock Purchase Warrants
 
In connection with a private placement of common stock on November 16, 2004, the Company issued common stock purchase warrants.  Each of these warrants is exercisable for a period of five years and the exercise price of is $6.99 per share.  The exercise price of the warrants is subject to adjustment for subsequent lower price issuances by the Company, as well as customary adjustment provisions for stock splits, combinations, dividends and the like.  The warrants are callable by the Company, upon 30 days notice, should the common stock trade at or above $25.20 per share for 25 out of 30 consecutive trading days. A maximum of 20% of the warrants may be called in any three-month period.  1,883,796 common stock purchase warrants are outstanding at October 31, 2008 and April 30, 2008.
 
NOTE 8 - 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 has two reportable segments: wireless infrastructure services and specialty communication systems.  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 subsidiaries.  Corporate assets primarily include cash and prepaid expenses.  Segment results for the three and six months ended and as of October 31, 2008 and 2007 are as follows:


 
22

 
 
 

 
WPCS INTERNATIONAL INCORPORATED AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 
   
For Three Months Ended and as of October 31, 2008
   
For Three Months Ended and as of October 31, 2007
 
   
Corporate
   
Wireless Infrastructure
   
Specialty Communication
   
Total
   
Corporate
   
Wireless Infrastructure
   
Specialty Communication
   
Total
 
                                                 
Revenue
  $ -     $ 3,255,476     $ 25,512,205     $ 28,767,681     $ -     $ 3,090,764     $ 25,014,280     $ 28,105,044  
                                                                 
Depreciation and amortization
  $ 8,664     $ 66,015     $ 576,360     $ 651,039     $ 8,786     $ 65,903     $ 393,926     $ 468,615  
                                                                 
Income (loss)  before income taxes
  $ (975,782