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, 2007
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934

For the transition period from _________ to __________

Commission file number: 0-26277

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)

(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 is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.  (Check one):
 Large accelerated filer [ ] accelerated filer [ ] Non-accelerated filer [X]

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 14, 2007, there were 7,105,104 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, 2007 (unaudited) and April 30, 2007
3 – 4
       
   
Condensed consolidated statements of income for the three and six months ended October 31, 2007 and 2006 (unaudited)
5
       
   
Condensed consolidated statement of shareholders’ equity for the six months ended October 31, 2007 (unaudited)
6
       
   
Condensed consolidated statements of cash flows for the six months ended October 31, 2007 and 2006 (unaudited)
7-8
       
   
Notes to unaudited condensed consolidated financial statements
9 – 21
       
 
ITEM 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
22-33
       
 
ITEM 3.
Quantitative and Qualitative Disclosures About Market Risk
34
       
 
ITEM 4.
Controls and Procedures
35
       
PART II.
OTHER INFORMATION
 
       
 
ITEM 1
Legal proceedings
36
 
ITEM 1A
Risk factors
36
 
ITEM 2
Unregistered sales of equity securities and use of proceeds
36
 
ITEM 3
Defaults upon senior securities
36
 
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
 
2007
   
2007
 
   
(Unaudited)
   
(Note 1)
 
CURRENT ASSETS:
           
             
Cash and cash equivalents
  $
11,024,104
    $
21,558,739
 
Accounts receivable, net of allowance of $98,786 at October 31, 2007 and April 30, 2007
   
23,544,604
     
16,560,636
 
Costs and estimated earnings in excess of billings on uncompleted contracts
   
5,136,082
     
2,499,940
 
Inventory
   
3,390,568
     
2,260,082
 
Prepaid expenses and other current assets
   
1,343,722
     
732,043
 
Deferred tax assets
   
35,000
     
27,000
 
Total current assets
   
44,474,080
     
43,638,440
 
                 
PROPERTY AND EQUIPMENT, net
   
6,308,336
     
5,488,920
 
                 
OTHER INTANGIBLE ASSETS, net
   
2,096,281
     
1,683,349
 
                 
GOODWILL
   
22,214,441
     
20,469,608
 
                 
OTHER ASSETS
   
144,275
     
273,353
 
                 
Total assets
  $
75,237,413
    $
71,553,670
 

 
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,
 
   
2007
   
2007
 
   
(Unaudited)
   
(Note 1)
 
CURRENT LIABILITIES:
           
             
Current portion of loans payable
  $
3,231,949
    $
2,598,872
 
Current portion of capital lease obligations
   
22,554
     
-
 
Accounts payable and accrued expenses
   
9,518,305
     
6,802,110
 
Billings in excess of costs and estimated earnings on uncompleted contracts
   
2,344,853
     
2,272,688
 
Deferred revenue
   
656,107
     
504,458
 
Due to shareholders
   
644,000
     
707,000
 
Income taxes payable
   
373,226
     
433,361
 
Total current liabilities
   
16,790,994
     
13,318,489
 
                 
Borrowings under line of credit
   
-
     
4,454,217
 
Loans payable, net of current portion
   
171,706
     
284,016
 
Capital lease obligations, net of current portion
   
347,366
     
-
 
Deferred tax liabilities
   
730,000
     
611,000
 
Total liabilities
   
18,040,066
     
18,667,722
 
                 
Minority interest in subsidiary
   
1,414,753
     
1,353,965
 
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, 7,084,344 and 6,971,698 shares issued and outstanding at October 31, 2007 and April 30, 2007, respectively
   
708
     
696
 
Additional paid-in capital
   
49,267,666
     
47,901,160
 
Retained earnings
   
6,405,343
     
3,631,215
 
Accumulated other comprehensive income (loss) on foreign currency translation
   
108,877
      (1,088 )
                 
Total shareholders' equity
   
55,782,594
     
51,531,983
 
                 
Total liabilities and shareholders' equity
  $
75,237,413
    $
71,553,670
 

 

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,
 
   
2007
   
2006
   
2007
   
2006
 
                         
                         
REVENUE
  $
28,105,044
    $
17,753,044
    $
49,921,050
    $
34,189,322
 
                                 
COSTS AND EXPENSES:
                               
Cost of revenue
   
20,646,816
     
12,360,962
     
35,834,568
     
24,052,430
 
Selling, general and administrative expenses
   
4,518,881
     
3,239,738
     
8,578,137
     
6,336,060
 
Depreciation and amortization
   
468,615
     
337,242
     
998,202
     
570,891
 
                                 
Total costs and expenses
   
25,634,312
     
15,937,942
     
45,410,907
     
30,959,381
 
                                 
OPERATING INCOME
   
2,470,732
     
1,815,102
     
4,510,143
     
3,229,941
 
                                 
OTHER EXPENSE (INCOME):
                               
Interest expense
   
185,636
     
134,502
     
308,218
     
214,436
 
Interest income
    (140,663 )     (74,214 )     (355,175 )     (174,752 )
Minority interest
   
57,140
     
-
     
60,788
     
-
 
                                 
INCOME BEFORE INCOME TAX PROVISION
   
2,368,619
     
1,754,814
     
4,496,312
     
3,190,257
 
                                 
Income tax provision
   
867,106
     
690,167
     
1,722,184
     
1,211,180
 
                                 
NET INCOME
  $
1,501,513
    $
1,064,647
    $
2,774,128
    $
1,979,077
 
                                 
Basic net income per common share
  $
0.21
    $
0.19
    $
0.39
    $
0.37
 
                                 
Diluted net income per common share
  $
0.19
    $
0.18
    $
0.35
    $
0.34
 
                                 
Basic weighted average number of common shares outstanding
   
7,079,977
     
5,500,579
     
7,026,818
     
5,408,531
 
                                 
Diluted weighted average number of common shares outstanding
   
7,953,098
     
6,026,999
     
8,007,103
     
5,849,495
 



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
FOR THE SIX MONTHS ENDED OCTOBER 31, 2007
(Unaudited)

 

   
Preferred Stock   
   
Common Stock   
   
 Additional
Paid-In
   
 Retained
       Accumulated
 Other
Compre-
hensive
   
 Total Shareholders'
 
   
Shares
   
Amount
   
Shares
   
Amount
   
Capital
   
 Earnings
   
Income
   
Equity
 
                                                 
BALANCE, May 1, 2007
   
-
    $
-
     
6,971,698
    $
696
    $
47,901,160
    $
3,631,215
    $ (1,088 )   $
51,531,983
 
                                                                 
Net issuance of common stock, acquisitions of
                                                               
TAGS, Major and Max
   
-
     
-
     
103,815
     
11
     
1,279,989
     
-
     
-
     
1,280,000
 
                                                                 
Fair value of stock options granted to employees
   
-
     
-
     
-
     
-
     
24,435
     
-
     
-
     
24,435
 
                                                                 
Net proceeds from exercise of stock options
   
-
     
-
     
8,831
     
1
     
55,041
     
-
     
-
     
55,042
 
                                                                 
Equity issuance cost
   
-
     
-
     
-
     
-
      (4,959 )    
-
     
-
      (4,959 )
                                                                 
Excess tax benefit from exercise of stock options
   
-
     
-
     
-
     
-
     
12,000
     
-
     
-
     
12,000
 
                                                                 
Accumulated other comprehensive income
   
-
     
-
     
-
     
-
     
-
     
-
     
109,965
     
109,965
 
                                                                 
Net income
   
-
     
-
     
-
     
-
     
-
    $
2,774,128
     
-
     
2,774,128
 
                                                                 
BALANCE, OCTOBER 31, 2007
   
-
    $
-
     
7,084,344
    $
708
    $
49,267,666
    $
6,405,343
    $
108,877
    $
55,782,594
 
 
 

 
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,
 
   
2007
   
2006
 
             
OPERATING ACTIVITIES :
           
Net income
  $
2,774,128
    $
1,979,077
 
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
               
Depreciation and amortization
   
998,202
     
570,891
 
Fair value of stock options granted to employees
   
24,435
     
21,302
 
Recovery of doubtful accounts
   
-
      (6,000 )
Amortization of debt issuance costs
   
-
     
26,354
 
Excess tax benefit from exercise of stock options
    (12,000 )    
-
 
Minority interest
   
60,788
     
-
 
Loss (gain) on sale of fixed assets
   
4,875
      (13,876 )
Deferred income taxes
   
68,000
      (37,000 )
Changes in operating assets and liabilities, net of effects of acquisitions:
               
Accounts receivable
    (2,804,552 )    
1,416,610
 
Costs and estimated earnings in excess of billings on uncompleted contracts
    (862,180 )     (384,956 )
Inventory
    (947,733 )    
186,701
 
Prepaid expenses and other current assets
    (429,078 )     (317,868 )
Other assets
   
139,883
      (119,964 )
Accounts payable and accrued expenses
   
1,619,596
      (758,607 )
Billings in excess of costs and estimated earnings on uncompleted contracts
    (913,039 )    
759,370
 
Deferred revenue
   
151,597
     
291,177
 
Income taxes payable
    (53,918 )    
88,600
 
NET CASH (USED IN) PROVIDED BY OPERATING ACTIVITIES
    (180,996 )    
3,701,811
 
 
 

 
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)


INVESTING ACTIVITIES:
           
Acquisition of property and equipment, net
    (370,230 )     (419,709 )
Acquisition of NECS, net of cash received
    (3,534 )     (4,458,465 )
Acquisition of SECS, net of cash received
   
57,451
      (1,516,545 )
Acquisition of Voacolo, net of cash received
    (66,000 )    
-
 
Acquisition of Major, net of cash received
    (3,091,777 )    
-
 
Acquisition of Max, net of cash received
    (523,045 )    
-
 
NET CASH USED IN INVESTING ACTIVITIES
    (3,997,135 )     (6,394,719 )
                 
FINANCING ACTIVITIES:
               
Net proceeds from exercise of warrants
   
-
     
197,875
 
Net proceeds from exercise of stock options
   
55,042
     
114,911
 
Excess tax benefit from exercise of stock options
   
12,000
     
-
 
Equity issuance costs
    (4,959 )     (50,363 )
(Repayments)/borrowings under lines of credit, net
    (6,540,991 )    
1,437,446
 
Borrowings/(repayments) under loans payable, net
   
399,797
      (288,454 )
Payments of amounts due to shareholders
    (238,420 )     (109,000 )
Payments of capital lease obligations
    (45,009 )     (10,514 )
NET CASH (USED IN) PROVIDED BY FINANCING ACTIVITIES
    (6,362,540 )    
1,291,901
 
                 
Effect of exchange rate changes on cash
   
6,036
     
-
 
                 
NET DECREASE IN CASH AND CASH EQUIVALENTS
    (10,534,635 )     (1,401,007 )
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR
   
21,558,739
     
12,279,646
 
CASH AND CASH EQUIVALENTS, END OF THE PERIOD
  $
11,024,104
    $
10,878,639
 


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, 2007 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 financial position, results of operations and cash flows for the interim periods. Operating results for the three and six month periods ended October 31, 2007 are not necessarily indicative of the results that may be expected for the fiscal year ending April 30, 2008. Certain reclassifications have been made to prior period financial statements to conform to the current presentation. The amounts for the April 30, 2007 balance sheet have been extracted from the audited consolidated financial statements included in Form 10-K for the year ended April 30, 2007.

The accompanying consolidated financial statements include the accounts of WPCS International Incorporated (WPCS) and its wholly 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) from June 1, 2006 (date of acquisition), Southeastern Communication Services, Inc. (SECS) from July 19, 2006 (date of acquisition), Voacolo Electric Incorporated (Voacolo) from March 30, 2007 (date of acquisition), Taian AGS Pipeline Construction Co., Ltd. (TAGS) from April 5, 2007 (date of acquisition), Major Electric, Inc (Major) from August 1, 2007 and Max Engineering LLC ( Max) from August 2, 2007, 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 (additional policies are set forth in the Company’s Annual Report on Form 10-K):

Principles of Consolidation

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


Goodwill and Other Intangible Assets

In accordance with Statement of Financial 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.
 
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 performs its annual impairment test during the fourth quarter absent any interim impairment indicators.
 
 
9

 
 
WPCS INTERNATIONAL INCORPORATED AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 
Changes in goodwill consist of the following during the six months ended October 31, 2007:

Beginning balance, May 1, 2007
  $
20,469,608
 
         
Voacolo acquisition – purchase price adjustment
    (41,366 )
Major acquisition
   
1,487,499
 
Max acquisition
   
302,880
 
NECS- purchase price adjustment
   
35,595
 
SECS- purchase price adjustment
    (39,775 )
         
Ending balance, October 31, 2007
  $
22,214,441
 

Other intangible assets consist of the following at October 31, 2007 and April 30, 2007:

   
Estimated useful life (years)
   
October 31,
2007
   
April 30,
2007
 
                   
Customer lists
   
5 - 9
    $
3,213,000
    $
2,607,000
 
Contract backlog
   
1 - 3
     
455,200
     
325,200
 
             
3,668,200
     
2,932,200
 
Less: accumulated amortization expense
           
(1,571,919
   
(1,248,851
            $
2,096,281
    $
1,683,349
 


Amortization expense for other intangible assets for the six months ended October 31, 2007 and 2006 was approximately $323,066 and $233,750, respectively. There are no expected residual values related to these intangible assets.

Inventory

Inventory consists of materials, parts and supplies principally valued at the lower of cost using the first-in-first-out (FIFO) method, or market.


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 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 contracts.  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. The adoption of FIN 48 on May 1, 2007 had no impact on the Company’s financial position, results of operations, cash flows or financial statements disclosures.

Earnings Per Common Share

Earnings per common share is computed pursuant to SFAS No. 128, "Earnings Per Share". 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 earnings per common share for the three and six months ended October 31, 2007 and 2006, respectively:

Basic earnings per share computation
 
Three Months Ended
   
Six Months Ended
 
   
October 31,
   
October 31,
 
Numerator:
 
2007
   
2006
   
2007
   
2006
 
                         
     Net Income
  $
1,501,513
    $
1,064,647
    $
2,774,128
    $
1,979,077
 
                                 
Denominator:
                               
                                 
     Basic weighted average shares outstanding
   
7,079,977
     
5,500,579
     
7,026,818
     
5,408,531
 
                                 
Basic net income per common share
  $
0.21
    $
0.19
    $
0.39
    $
0.37
 


11

 
 
WPCS INTERNATIONAL INCORPORATED AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


Diluted earnings per share computation
 
Three Months Ended
   
Six Months Ended
 
   
October 31,
   
October 31,
 
Numerator:
 
2007
   
2006
   
2007
   
2006
 
                         
     Net Income
  $
1,501,513
    $
1,064,647
    $
2,774,128
    $
1,979,077
 
                                 
Denominator:
                               
                                 
     Basic weighted average shares outstanding
   
7,079,977
     
5,500,579
     
7,026,818
     
5,408,531
 
                                 
     Incremental shares from assumed conversion:
                               
                                 
          Conversion of stock options
   
195,161
     
170,099
     
215,243
     
151,240
 
                     
 
     
 
 
          Conversion of common stock warrants
   
677,960
     
356,321
     
765,042
     
289,724
 
                                 
     Diluted weighted average shares
   
7,953,098
     
6,026,999
     
8,007,103
     
5,849,495
 
                                 
Diluted net income per common share
  $
0.19
    $
0.18
    $
0.35
    $
0.34
 



For the three months ended October 31, 2007 and 2006, 95,896 and 135,834 stock options were excluded from the computation of the diluted earnings per share, respectively. For the six months ended October 31, 2007 and 2006, 81,725 and 135,834 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.

Other Comprehensive Income

Other comprehensive income for the three and six months ended October 31, 2007 consist of the following:
 
   
Three Months Ended
   
Six Months Ended
 
   
October, 31, 2007
   
October, 31, 2007
 
             
Net income
  $ 1,501,513     $ 2,774,128  
                 
Other comprehensive income – foreign currency translation adjustments
   
46,200
     
109,965
 
                 
Comprehensive income
  $ 1,547,713     $ 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 revenues 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, useful life of customer lists, deferred tax valuation allowance, the fair values of the assets and liabilities of purchased businesses and the factors related to determining if goodwill is impaired. Actual results will likely differ from those estimates.

12

 

 
WPCS INTERNATIONAL INCORPORATED AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


Recently Issued Accounting Pronouncements

On September 15, 2006, the FASB issued SFAS 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. The Company is currently evaluating the potential impact, if any, of the adoption of SFAS 157 on the consolidated financial position, results of operations and cash flows or financial statement disclosures.

In February 2007, the FASB issued SFAS 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 Company has not yet determined the impact SFAS 159 may have on our results of operations or financial position.

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 financial position, or results of operations.

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 to the Voacolo selling shareholders, including acquisition transaction costs of $27,788, was $2,527,788 of which $1,250,000 was paid in cash, and the Company issued 113,534 shares of common stock valued at $1,250,000. In addition, the Company shall pay an additional $2,500,000 in cash or Company common stock if Voacolo’s earnings before interest and taxes for the twelve months ended March 31, 2008 shall equal or exceed $1,100,000. Voacolo was acquired pursuant to a Stock Purchase Agreement among WPCS International Incorporated, 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 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.

13

 
WPCS INTERNATIONAL INCORPORATED AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 
The purchase price allocation has been determined as follows:

Assets purchased:
     
Cash
  $
584,094
 
Accounts receivable
   
2,102,984
 
Inventory
   
217,500
 
Prepaid expenses
   
101,974
 
Costs in excess of billings
   
215,143
 
Fixed assets
   
346,569
 
    Backlog
   
200,200
 
    Customer lists
   
132,000
 
    Goodwill
   
971,227
 
     
4,871,691
 
Liabilities assumed:
       
Accounts payable
    (732,252 )
Accrued expenses
    (98,232 )
Payroll and other payables
    (80,672 )
Deferred income tax payable
    (43,000 )
Loan payable
    (602,984 )
Notes payable
    (100,436 )
Billings in excess of costs
    (686,327 )
      (2,343,903 )
Purchase price
  $
2,527,788
 

TAGS

On April 5, 2007, the Company acquired a 60% Equity Interest and a 60% Profit Interest (together the Interest) in TAGS, a joint venture enterprise in the City of Taian, Shandong province, the People's Republic of China, from American Gas Services, Inc. (AGS) and American Gas Services, Inc. Consultants (AGS Consultants), respectively. The aggregate consideration paid by the Company to AGS and AGS Consultants, including acquisition transaction costs of $185,409, was $1,785,409 of which $800,000 was paid in cash, and the Company issued 68,085 shares of common stock valued at approximately $800,000.

Founded in 1997, TAGS is a communications infrastructure engineering company serving the China market. TAGS is certified by the People's Republic of China as both a Construction Enterprise of Reform Development company and a Technically Advanced Construction Enterprise company for the Province of Shandong. TAGS is also licensed in 17 other provinces and has completed projects for a diverse customer base of businesses and government institutions in over 30 cities in China.  The acquisition of TAGS provides the Company international expansion into China consistent with its emphasis on China and surrounding Pacific Rim countries.

A valuation of certain assets was completed, including property and equipment 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.

14


WPCS INTERNATIONAL INCORPORATED AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

The purchase price allocation has been determined as follows:

Assets purchased:      
 
Cash
  $
141,564
 
 
Accounts receivable
   
1,727,953
 
 
Inventory
   
621,725
 
 
Other current assets
   
399,664
 
 
Fixed assets
   
3,415,035
 
       
6,305,941
 
Liabilities assumed:        
 
Accounts payable
    (72,710 )
 
Accrued expenses and other payable
    (714,126 )
 
Payroll and other payables
    (171,463 )
 
Dividends payable
    (252,724 )
 
Income tax payable
    (235,279 )
 
Notes payable
    (1,681,846 )
 
Deferred Revenue
    (61,519 )
 
Minority Interest
    (1,330,865 )
        (4,520,532 )
Purchase price   $
1,785,409
 


Major

On August 1, 2007, the Company acquired Major, a Washington corporation. The aggregate consideration paid by the Company to the Major selling shareholders, including acquisition transaction costs of $39,158, was $4,039,158, of which $3,000,000 was paid in cash and the Company issued 80,000 shares of common stock valued at $1,000,000. In addition, the Company shall pay an additional $2,750,000 in cash or Company common stock if Major’s earnings before interest and taxes for the year ending December 31, 2007 shall equal or exceed $1,500,000. 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 into the Pacific Northwest region and provides additional wireless and electrical contracting services  in direct digital controls, security, wireless SCADA applications and wireless infrastructure.

Based on the preliminary information currently available, the preliminary allocation has been made resulting in goodwill and other intangible assets of approximately $2,007,000. Upon completion of a final purchase price allocation, there may be an increase or decrease in the amount assigned to goodwill and a corresponding increase or decrease in tangible or other intangible assets.

The preliminary purchase price allocation has been determined as follows:


Assets purchased:
     
 Accounts receivable
   
3,832,389
 
 Inventory
   
162,647
 
 Prepaid expenses
   
117,348
 
 Costs in excess of billings
   
1,769,462
 
 Fixed assets
   
699,472
 
 Other Assets
   
8,855
 
     Backlog
   
130,000
 
     Customer lists
   
390,000
 
     Goodwill
   
1,487,499
 
     
8,597,672
 
 
 
15

 
WPCS INTERNATIONAL INCORPORATED AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 
 
 
Liabilities assumed:       
 
Cash overdraft
  (52,618 )
  Accounts payable    (424,513 )
  Accrued expenses    (6,094 )
 
Payroll and other payable 
  (560,956 )
  Line of credit    (2,086,774 )
 
Loan payable 
  (24,638 )
 
Capital lease obligation 
  (242,297 )
  Shareholder Loan    (175,420 )
  Billings in excess of costs    (985,204 )
        (4,558,514 )
Purchase price  $
4,039,158
 
 
Max

On August 2, 2007, the Company acquired Max, a Texas limited liability company. The aggregate consideration paid by the Company to the Max selling shareholders, including acquisition transaction costs of $28,971, was $828,971, of which $600,000 was paid in cash and the Company issued 17,007 shares of common stock valued at $200,000. In addition, the Company shall pay an additional: (i) $350,000 in cash or Company common stock if Max’s earnings before interest and taxes for the twelve months period ending August 1, 2008 shall equal or exceed $275,000; and (ii) $375,000 in cash or Company common stock if Max’s earnings before interest and taxes for the twelve months period 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.

Based on the preliminary information currently available, the preliminary allocation has been made resulting in goodwill and other intangible assets of approximately $519,000. Upon completion of a final purchase price allocation, there may be an increase or decrease in the amount assigned to goodwill and a corresponding increase or decrease in tangible or other intangible assets.

The preliminary purchase price allocation has been determined as follows:

Assets purchased:
     
Cash
  $
105,926
 
Accounts receivable
   
256,829
 
Costs in excess of billings
   
4,500
 
Fixed assets
   
21,890
 
Other Assets
   
1,950
 
    Customer lists
   
216,000
 
    Goodwill
   
302,880
 
     
909,975
 
Liabilities assumed:
       
Accrued expenses
    (59,186 )
Payroll and other payable
    (19,318 )
Accrued tax payable
    (2,500 )
      (81,004 )
Purchase price
  $
828,971
 

16

 
 
WPCS INTERNATIONAL INCORPORATED AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


Pro forma Information

The following unaudited pro forma financial information presents the combined results of operations of the Company, NECS, SECS, Voacolo, TAGS, Major and Max for the three and six months ended October 31, 2006 as if the acquisitions had occurred at May 1, 2006, including the issuance of the Company’s common stock as part of the consideration for the applicable acquisitions. The pro forma financial information does not necessarily reflect the results of operations that would have occurred had the Company, NECS, SECS, Voacolo, TAGS, Major and Max been a single entity during this period.


   
Consolidated Pro Forma
 
                   
   
Three months ended
   
Six months ended
   
Six months ended
 
   
October 31, 2006
   
October 31, 2007
   
October 31, 2006
 
                   
Revenues
  $
23,127,504
    $
54,075,001
    $
48,334,383
 
                         
Net income
   
1,222,630
     
2,771,805
     
2,779,477
 
                         
Basic weighted common shares
   
5,799,621
     
7,026,818
     
5,799,621
 
Diluted weighted common shares
   
6,326,041
     
8,007,103
     
5,935,488
 
                         
Basic net income per common share
  $
0.21
    $
0.39
    $
0.48
 
Diluted net income per common share
  $
0.19
    $
0.35
    $
0.47
 


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, 2007 and April 30, 2007:

       
   
October 31, 2007
   
April 30, 2007
 
Costs incurred on uncompleted contracts
  $
48,276,474
    $
39,431,006
 
Estimated contract profit
   
15,723,589
     
12,513,277
 
     
64,000,063
     
51,944,283
 
Less: billings to date
   
61,208,834
     
51,717,031
 
                           Net excess of costs
  $
2,791,229
    $
227,252
 
                 
Costs and estimated earnings in excess of billings
  $
5,136,082
    $
2,499,940
 
Billings in excess of costs and estimated earnings
               
  on uncompleted contracts
    (2,344,853 )     (2,272,688 )
                           Net excess of costs
  $
2,791,229
    $
227,252
 

 
17

 
 
WPCS INTERNATIONAL INCORPORATED AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 5 – LONG-TERM DEBT

Line of Credit

On April 10, 2007, the Company entered into a loan agreement with Bank of America, N.A. (BOA). The loan agreement (the Loan Agreement), provides 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. The Company and its subsidiaries also entered into security agreements with BOA, pursuant to which each entity granted a security interest to BOA in all of their 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, 2007, the Company was in compliance with the Loan Agreement covenants. The loan commitment shall expire on April 10, 2010. The Company may prepay 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. The Company has the option to elect to use the optional interest rate of LIBOR plus one hundred seventy-five basis points (5.0225% LIBOR rate plus one and three quarters percent as of October 31, 2007).  As of October 31, 2007, there were no borrowings outstanding under the Loan Agreement.


Loans Payable

The Company’s long-term debt also consists of notes issued by the Company or assumed in acquisitions related to the purchase of property and equipment in the ordinary course of business. At October 31, 2007, loans payable totaled approximately $3,404,000 with interest rates ranging from 0% to 9.49%.


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, 2007 and 2006, the rent paid for this lease was $48,234 and $44,000, respectively.

In connection with the acquisition of Clayborn, an additional $1,100,000 is due by December 31, 2007, payable in quarterly distributions to the Clayborn former shareholders, by payment of 50% of the quarterly post tax profits, as defined, of Clayborn and the payment of the remainder by that date. Through October 31, 2007, payments of $456,000 have been made to the former Clayborn shareholders and the total remaining due by December 31, 2007 is $644,000.

 
In connection with the acquisition of SECS in fiscal 2007, 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, 2007, the rent paid for this lease was $26,065.

 
In connection with the acquisition of Voacolo in fiscal 2007, 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, 2007, the rent paid for this lease was $27,000.


NOTE 7 – STOCK-BASED COMPENSATION

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, 2007, there were no stock options granted under this 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, 2007, options to purchase 326,826 shares were outstanding at exercise prices ranging from $6.14 to $12.10. At October 31, 2007, there were 1,598 options available for grant under the 2006 Incentive Stock Plan.
 
18

 
WPCS INTERNATIONAL INCORPORATED AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 
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, 2007, options to purchase 233,426 shares were outstanding at exercise prices ranging from $4.80 to $16.44. At October 31, 2007, there were 41,724 shares available for grant under the 2002 Plan.

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 $24,435 for the six months ended October 31, 2007, compared to $21,302 for the six months ended October 31, 2006.

At October 31, 2007, 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 $100,000 and is expected to be recognized over a weighted-average period of 2.1 years. For the six months ended October 31, 2007 and 2006, the weighted average fair value of stock options granted was $5.23 and $3.86, respectively.

The Company has elected to adopt the shortcut method provided in Staff Position No. FAS 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 options granted during the three and six months ended October 31, 2007 and 2006, respectively:

   
Three Months Ended
   
Six Months Ended
 
   
October 31,
   
October 31,
 
   
2007
   
2006
   
2007
   
2006
 
                         
Risk-free interest rate
   
4.31%
     
4.73%
   
4.31% to 4.74%
   
4.73% to 4.96%
 
Expected volatility
   
57.0%
     
61.0%
   
57.0% to 58.3%
   
61.0% to 62.4%
 
Expected dividend yield
   
0.00%
     
0.00%
     
0.00%
     
0.00%
 
Expected term ( in years)
   
3.5
     
3.5
     
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 No. 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.

The following table summarizes stock option activity for the six months ended October 31, 2007, during which there were 8,831 options exercised under the Company’s stock option plans:


19


WPCS INTERNATIONAL INCORPORATED AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 
     
2002 Plan           
     
2006 Plan           
 
     
Number of Shares 
     
Weighted-average Exercise Price 
     
Weighted- average Remaining Contractual Term
     
Aggregate
        Intrinsic
Value
     
Number of Shares 
     
Weighted-average Exercise Price 
     
Weighted-average Remaining Contractual Term
     
Aggregate Intrinsic Value
 
Outstanding, May 1, 2007
   
233,575
    $
8.43
                 
327,259
    $
6.22
         
 
 
 
                                                   
 
 
Granted
   
9,200
    $
10.95
                 
6,000
    $
12.10
         
 
 
Exercised
    (3,498 )   $
5.84
                  (5,333 )   $
6.65
         
 
 
Forfeited/Expired
    (5,851 )   $
13.88
                  (1,100 )   $
7.25
         
 
 
 
                                                   
 
 
Outstanding, October 31, 2007
   
233,426
    $
8.44
     
1.7
    $
769,102
     
326,826
    $
6.32
     
3.0
    $
1,678,871
 
 
                                                               
Vested and expected to vested,
   
230,969
    $
8.42
     
1.7
    $
764,079
     
325,183
    $
6.29
     
3.0
    $
1,676,463
 
 October 31, 2007
                                                               
Exercisable, October 31, 2007
   
215,213
    $
8.39
     
1.5
    $
722,580
     
313,933
    $
6.17
     
3.0
    $
1,654,166
 


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. Corporate assets primarily include cash and prepaid expenses.  Segment results for the three and six months ended October 31, 2007 and 2006 are as follows:

   
For Three Months Ended October 31, 2007
   
For Three Months Ended October 31, 2006
 
   
Corporate
   
Wireless Infrastructure
   
Specialty Communication
   
Total
   
Corporate
   
Wireless Infrastructure
   
Specialty Communication
   
Total
 
                                                 
Revenue
  $
-
    $
3,090,764
    $
25,014,280
    $
28,105,044
    $
-
    $
3,729,849
    $
14,023,195
    $
17,753,044
 
                                                                 
Depreciation and amortization
  $
8,786
    $
65,903
    $
393,926
    $
468,615
    $
14,432
    $
90,796
    $
232,014
    $
337,242
 
                                                                 
Income (loss)  before income taxes
  $ (551,427 )   $
220,611
    $
2,699,435
    $
2,368,619
    $ (373,853 )   $
217,397
    $
1,911,270
    $
1,754,814
 


20

 
 
WPCS INTERNATIONAL INCORPORATED AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


   
As of and for the Six Months Ended October 31, 2007
   
As of and for the Six Months Ended October 31, 2006
 
   
Corporate
   
Wireless Infrastructure
   
Specialty Communication
   
Total
   
Corporate
   
Wireless Infrastructure
   
Specialty Communication
   
Total
 
                                                 
Revenue
  $
-
    $
6,593,935
    $
43,327,115
    $
49,921,050
    $
-
    $
6,414,969
    $
27,774,353
    $
34,189,322
 
                                                                 
Depreciation and amortization
  $
19,411
    $
134,398
    $
844,393
    $
998,202
    $
28,843
    $
125,025
    $
417,023
    $
570,891
 
                                                                 
Income (loss)  before income taxes
  $ (1,281,348 )   $
750,550
    $
5,027,110
    $
4,496,312
    $ (1,008,551 )   $
543,125
    $
3,655,683
    $
3,190,257
 
                                                                 
Goodwill
  $
-
    $
4,582,176
    $
17,632,265
    $
22,214,441
    $
-
    $
4,098,917
    $
14,724,821
    $
18,823,738
 
                                                                 
Total assets
  $
3,848,730
    $
11,958,969
    $
59,429,714
    $
75,237,413
    $
4,659,261
    $
10,782,827
    $
36,440,852
    $
51,882,940
 


As of and for the six months ended October 31, 2007, the specialty communication systems segment includes approximately $1,007,000 in revenue and $1,888,000 of net assets held in China related to the Company’s 60% Interest in TAGS.

NOTE 9 – SUBSEQUENT EVENTS

On November 1, 2007, the Company acquired Gomes and Gomes, Inc. dba Empire Electric, a California corporation (Empire). The purchase price was $2,000,000 in cash, subject to adjustment.  In addition, the Company shall pay an additional $1,000,000 in cash if Empire’s earnings before interest and taxes for the twelve months ending October 31, 2007 shall equal or exceed $850,000. Empire was acquired pursuant to a Stock Purchase Agreement among the Company and the former shareholders, dated as of November 1, 2007. In connection with the acquisition, Empire entered into employment agreements with the former president and vice president for a period of two years.  The acquisition of Empire expands the Company’s geographic presence in California and provides additional   electrical contracting services that  specialize in low voltage applications, for customers that include Kaiser Permanente, the State of California and Beale Air Force Base.

On November 30, 2007, the Company acquired James Design Pty Ltd, an Australia corporation (James Design). The purchase price was $1,200,000 in cash, subject to adjustment.   James Design was acquired pursuant to a Stock Purchase Agreement among the Company and the former shareholders, dated as of November 30, 2007. In connection with the acquisition, James Design entered into an employment agreement with the former president for a period of two years.  James Design is a design engineering services company specializing in building automation including mechanical, electrical, hydraulic, fire protection, lift, security access and wireless systems, and has completed projects for many Australian customers including Woolworths Limited, IGA, Spar Group, Hutchinson Builders, Coles Group, Australand Holdings and The Good Guys chain of retail outlets. The acquisition of  James Design provides the Company international expansion into Australia consistent with its emphasis on China, Australia and surrounding Pacific Rim countries.

21

 
 
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 its 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 its 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 its 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.

Business Overview

The increasing demand for wireless services has become the driving force behind the recent growth in the global communications industry. Wireless technology has advanced substantially to the point where wireless networks have proven to be an effective alternative to land line networks, a key factor in its broad acceptance. The advantages of wireless over land line communication are apparent in the aspects of mobility, capacity, cost, and deployment. The use of dedicated wireless networks for specified applications has improved productivity for individuals and organizations alike. We provide design-build engineering services that focus on the implementation requirements of wireless technology. We serve the specialty communication systems and wireless infrastructure sectors. We provide services that include site design, technology integration, electrical contracting, construction, and project management for corporations, government entities and educational institutions worldwide. Because we are technology and vendor independent, we can integrate multiple products and services across a variety of communication requirements. This ability gives our customers the flexibility to obtain the most appropriate solution for their communication needs on a cost effective basis.

Specialty Communication Systems

We provide specialty communication systems which are wireless networks designed to improve productivity for a specified application by communicating data, voice or video information in situations where land line networks are non-existent, more difficult to deploy or too expensive. The types of specialty communication systems that we implement are used for mobile communication and general wireless connectivity purposes. In mobile communication, the most popular applications include asset tracking, telematics and telemetry.

In general wireless connectivity, we design and deploy networks that allow entities to reduce their dependence on high cost leased land lines. We have the engineering expertise to utilize any facet of wireless technology or a combination of various wireless technologies to engineer a cost effective network for a customer’s wireless communication requirement.   In addition, the design and deployment of a specialty communication system is a comprehensive effort that requires an in-depth knowledge of radio frequency engineering so that the wireless network is free from interference with other signals and amplified sufficiently to carry data, voice or video with speed and accuracy. For the six months ended October 31, 2007, specialty communication systems represented approximately 87% of our total revenue.

Wireless Infrastructure Services

We provide wireless infrastructure services to major wireless carriers, which are services that include the engineering, installation, integration and maintenance of wireless carrier equipment. Wireless carriers continue to be focused on building and expanding their networks, increasing capacity, upgrading their networks with new technologies and maintaining their existing infrastructure. Our engineers install, test and commission base station equipment at the carrier cell site, including installation of new equipment, technology upgrades, equipment modifications and reconfigurations. These services may also include tower construction.
 
 
22

 
 
WPCS INTERNATIONAL INCORPORATED AND SUBSIDIARIES

ITEM 2 – MANAGEMENT’S DISCUSSION AND ANALYSIS
 OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 
Major wireless carriers have come to depend on our experience in providing engineering and support services that keep their networks technologically advanced and consistently operational. We have extensive experience in the installation, testing and commissioning of base station equipment. We provide complete services including testing, equipment modification, reconfiguration, structured cabling and relocating equipment at the cell site. In addition, WPCS also performs network modifications, antenna sectorization, electrical work and maintenance. For the six months ended October 31, 2007, wireless infrastructure services represented approximately 13% of our total revenue.

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

 
·
For the six months ended October 31, 2007, the specialty communication systems segment represented approximately 87% of total revenue, and the wireless infrastructure services segment represented approximately 13%. This revenue mix remains consistent with our historical performance, in which over 80% of our total revenue has been derived from specialty communication systems.

 
·
As we continue to search for acquisitions, our primary goal is to identify companies which are performing well financially, that expand our customer base and are compatible with the services that we perform in the specialty communication systems segment. This trend could lead to a further shift in our revenue composition towards the specialty communication systems segment. We believe that the strength of our experience in the design and deployment of specialty communication systems gives us a competitive advantage.
 
 
·
With regard to our acquisition strategy, we are also focused on expanding in the international sector with an emphasis on China, Australia and surrounding Pacific Rim countries.  This trend could lead to a change of revenue composition in which as much as 50% of our revenue could be generated from international sales in the future.

 
·
We also seek to achieve organic growth in our existing business by maximizing the value of our existing customer base, maintaining and expanding our focus in vertical markets and developing our relationships with technology providers.

 
·
We believe that the wireless market continues to display strong growth and the demand for our engineering services remains favorable domestically and in China and Australia, particularly in public safety and healthcare.  We believe that the advancement of wireless technology will create additional opportunities for us to design and deploy wireless solutions. Also, we continue to identify new vertical sectors for wireless technology.
 
 
·
We believe that our two most important economic indicators for measuring our future revenue producing capability is our backlog and bid list.  At October 31, 2007, our backlog of unfilled orders was approximately $36 million and our bid list, which represents project bids under proposal for new and existing customers, was approximately $125 million.
     
  ·
In general, we plan for our consolidated cost of revenue to fall in the range of 70 to 72% of revenue.  For the three months ended October 31, 2007, consolidated cost of revenue was 73% compared to 70% for the three months ended July 31, 2007.  During the second quarter, due to the subprime credit issues and the lack of residential housing projects, in certain markets there are a growing number of general contractors competing for non-wireless projects and bidding down prices. While we are primarily focused on the high-end wireless design and deployment market, we have a modest exposure to this type of low-end contracting work. Accordingly, we experienced modest gross margin pressure for the second quarter of approximately 1%, compared to the first quarter.  However, for the six months ended October 31, 2007, the year to date consolidated cost of revenue was 72%, which was within our plan.
 
 
 

 
23


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, 2007 Compared to the Three Months Ended October 31, 2006

The accompanying consolidated financial statements include the accounts of WPCS International Incorporated (WPCS) and its wholly 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) from June 1, 2006 (date of acquisition), Southeastern Communication Services, Inc. (SECS) from July 19, 2006 (date of acquisition), Voacolo Electric Incorporated (Voacolo) from March 30, 2007 (date of acquisition), Taian AGS Pipeline Construction Co., Ltd. (TAGS) from April 5, 2007 (date of acquisition), Major Electric, Inc ( Major) from August 1, 2007 and Max Engineering LLC ( Max) from August 2, 2007, collectively the "Company".

   
Three Months Ended October 31,
   
2007
   
2006
 
                         
REVENUE
  $
28,105,044
      100.0 %   $
17,753,044
      100.0 %
                                 
COSTS AND EXPENSES:
                               
Cost of revenue
   
20,646,816
      73.4 %    
12,360,962
      69.6 %
Selling, general and administrative expenses
   
4,518,881
      16.1 %    
3,239,738
      18.3 %
Depreciation and amortization
   
468,615
      1.7 %    
337,242
      1.9 %
                                 
Total costs and expenses
   
25,634,312
      91.2 %    
15,937,942
      89.8 %
                                 
OPERATING INCOME
   
2,470,732
      8.8 %    
1,815,102
      10.2 %
                                 
OTHER EXPENSE (INCOME):
                               
Interest expense
   
185,636
      0.7 %    
134,502
      0.7 %
Interest income
    (140,663 )     (0.5 %)     (74,214 )     (0.4 %)
Minority interest
   
57,140