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 January 31, 2014

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES

EXCHANGE ACT OF 1934

For the transition period from _________ to __________

Commission File Number: 001-34643

WPCS INTERNATIONAL INCORPORATED

(Exact name of registrant as specified in its charter)

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

600 Eagleview Boulevard

Suite 300

Exton, Pennsylvania 19341

(Address of principal executive offices) (zip code)

(484) 359-7228

(Registrant's telephone number, including area code)

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

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

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

As of March 12, 2014, there were 13,913,164 shares of registrant’s common stock outstanding.

WPCS INTERNATIONAL INCORPORATED AND SUBSIDIARIES

INDEX

PART I.	FINANCIAL INFORMATION

	ITEM 1.	Financial Statements

		Condensed consolidated balance sheets at January 31, 2014 (unaudited) and April 30, 2013	3-4

		Condensed consolidated statements of operations for the three and nine months ended January 31, 2014 and 2013 (unaudited)	5

		Condensed consolidated statements of comprehensive loss for the three and nine months ended January 31, 2014 and 2013 (unaudited)	6

		Condensed consolidated statement of equity (deficit) for the nine months ended January 31, 2014 (unaudited)	7

		Condensed consolidated statements of cash flows for the nine months ended January 31, 2014 and 2013 (unaudited)	8-9

		Notes to unaudited condensed consolidated financial statements	10-30

	ITEM 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	31-49

	ITEM 3.	Quantitative and Qualitative Disclosures About Market Risk	50

	ITEM 4.	Controls and Procedures	51

PART II.	OTHER INFORMATION

	ITEM 1.	Legal Proceedings	52
	ITEM 1A.	Risk Factors	52
	ITEM 2.	Unregistered Sales of Equity Securities and Use of Proceeds	52
	ITEM 3.	Defaults Upon Senior Securities	52
	ITEM 4.	Mine Safety Disclosures	52
	ITEM 5.	Other Information	52
	ITEM 6.	Exhibits	52

	SIGNATURES		53

	2

WPCS INTERNATIONAL INCORPORATED AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

	January 31,		April 30,
ASSETS	2014		2013
	(unaudited)		(Note 1)
CURRENT ASSETS:

Cash and cash equivalents	$	2,069,450	$	915,752
Restricted cash		-		1,869,178
Accounts receivable, net of allowance of $998,493 and $1,107,593 at January 31, 2014 and April 30, 2013, respectively		9,427,733		7,085,969
Costs and estimated earnings in excess of billings on uncompleted contracts		996,389		1,079,367
Deferred contract costs		2,073,562		1,597,894
Prepaid expenses and other current assets		383,643		142,307
Current assets held for sale		1,707,332		1,905,449
Total current assets		16,658,109		14,595,916

PROPERTY AND EQUIPMENT, net		2,185,131		2,754,734

CAPITALIZED SOFTWARE COSTS		3,124,741		-

OTHER INTANGIBLE ASSETS, net		-		16,228

OTHER ASSETS		78,467		227,259

OTHER ASSETS HELD FOR SALE		329,725		550,829

Total assets	$	22,376,173	$	18,144,966

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 EQUITY	January 31,		April 30,
	2014		2013
	(unaudited)		(Note 1)
CURRENT LIABILITIES:

Current portion of loans payable	$	51,617	$	43,942
Senior secured convertible notes, net of debt discount of $875,876 and $2,888,889, January 31, 2014 and April 30, 2013, respectively		22,462		1,111,111
Derivative liability - senior secured convertible notes		-		3,088,756
Accounts payable and accrued expenses		4,763,502		4,102,050
Accrued severance		1,300,000		-
Billings in excess of costs and estimated earnings on uncompleted contracts		1,656,874		1,619,307
Deferred revenue		294,827		113,503
Due related party		799,116		-
Other payable to Zurich		1,533,757		1,743,986
Short-term bank loan		3,279,300		2,432,205
Income taxes payable		11,371		139,557
Dividend payable		36,993		-
Current liabilities held for sale		789,555		685,631
Total current liabilities		14,539,374		15,080,048

Loans payable, net of current portion		643,603		133,838
Derivative liability - warrants		-		3,858,508

Total liabilities		15,182,977		19,072,394

COMMITMENTS AND CONTINGENCIES

EQUITY:

WPCS EQUITY (DEFICIT):
Preferred stock - $1,000 stated value, 5,000,000 shares authorized, 2,438 issued; liquidation preference of $7,030,000		2,438,000		-
Common stock - $0.0001 par value, 14,285,714 shares authorized, 13,913,164 and 994,187 shares issued and outstanding at January 31, 2014 and April 30, 2013, respectively		1,391		99
Additional paid-in capital		66,671,222		50,844,183
Accumulated deficit		(64,006,375)		(54,054,389)
Accumulated other comprehensive income on foreign currency translation		1,177,794		1,433,541

Total WPCS equity (deficit)		6,282,032		(1,776,566)

Noncontrolling interest		911,164		849,138
Total equity (deficit)		7,193,196		(927,428)

Total liabilities and equity	$	22,376,173	$	18,144,966

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

	4

WPCS INTERNATIONAL INCORPORATED AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

	Three Months Ended				Nine Months Ended
	January 31,				January 31,
	2014		2013		2014		2013
			(Note 1)		(Note 1)		(Note 1)
REVENUE	$	8,296,132	$	7,573,275	$	23,483,259	$	26,819,535

COSTS AND EXPENSES:
Cost of revenue		6,227,892		5,173,016		17,574,888		19,141,228
Selling, general and administrative expenses		2,278,433		1,674,268		6,116,248		5,830,550
Severance expense		-		-		1,474,277		-
Depreciation and amortization		214,212		268,388		672,164		840,674

		8,720,537		7,115,672		25,837,577		25,812,452

OPERATING (LOSS) INCOME		(424,405)		457,603		(2,354,318)		1,007,083

OTHER EXPENSE:
Interest expense		2,680,909		867,362		4,922,547		1,308,375
Loss on extinguishment of Notes		-		-		1,299,304		-
Change in fair value of derivative liabilities		-		702,574		833,750		702,574

Loss from continuing operations before income tax provision (benefit)		(3,105,314)		(1,112,333)		(9,409,919)		(1,003,866)

Income tax provision (benefit)		104,225		(14,556)		122,513		(79,732)

LOSS FROM CONTINUING OPERATIONS		(3,209,539)		(1,097,777)		(9,532,432)		(924,134)

Discontinued operations:
Loss from operations of discontinued operations, net of tax (benefit) provision of $0, ($199,175), $0, and $70,689, respectively		(185,495)		(59,324)		(225,242)		(1,543,466)
(Loss) gain from disposal		(104,446)		(12,880)		(104,446)		1,826,539

(Loss) income from discontinued operations, net of tax		(289,941)		(72,204)		(329,688)		283,073

CONSOLIDATED NET LOSS		(3,499,480)		(1,169,981)		(9,862,120)		(641,061)

Net income attributable to noncontrolling interest		49,439		54,317		52,873		82,922

NET LOSS ATTRIBUTABLE TO WPCS	$	(3,548,919)	$	(1,224,298)		(9,914,993)	$	(723,983)

Dividend declared on preferred stock	$	(36,993)		-	$	(36,993)		-

NET LOSS ATTRIBUTABLE TO WPCS COMMON SHAREHOLDERS	$	(3,585,912)	$	(1,224,298)		(9,951,986)	$	(723,983)

Basic and diluted net (loss) income attributable to WPCS common shareholders
Loss from continuing operations	$	(0.51)	$	(1.16)	$	(3.30)	$	(1.01)
(Loss) income from discontinued operations	$	(0.04)	$	(0.08)	$	(0.11)	$	0.28
Basic and diluted net loss per common share	$	(0.55)	$	(1.24)	$	(3.41)	$	(0.73)

Basic and diluted weighted average number of common shares outstanding		6,475,773		994,187		2,916,425		994,187

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

	5

WPCS INTERNATIONAL INCORPORATED AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS

(Unaudited)

	Three Months Ended				Nine Months Ended
	January 31,				January 31,
	2014		2013		2014		2013
Consolidated net loss	$	(3,499,480)	$	(1,169,981)	$	(9,862,120)	$	(641,061)
Other comprehensive (loss) income - foreign currency translation adjustments		(118,062)		36,864		(246,594)		46,020
Comprehensive loss		(3,617,542)		(1,133,117)		(10,108,714)		(595,041)

Comprehensive income attributable to noncontrolling interest		48,401		57,321		62,026		93,320
Comprehensive loss attributable to WPCS	$	(3,665,943)	$	(1,190,438)	$	(10,170,740)	$	(688,361)

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

	6

WPCS INTERNATIONAL INCORPORATED AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENT OF EQUITY (DEFICIT)

NINE MONTHS ENDED JANUARY 31, 2014

(Unaudited)

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

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

Stock-based compensation		-		-		-		-		23,651		-		-		23,651		-		23,651

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

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

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

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

Conversion of Notes and accrued interest		-		-		12,880,237		1,288		3,113,528		-		-		3,114,816		-		3,114,816

Issuance of BTX warrants for acquisition of BTX Software		-		-		-		-		1,150,155		-		-		1,150,155		-		1,150,155

Issuance of Series E preferred stock - acquisition of BTX Software		2,438		2,438,000		-		-		197,147		-		-		2,635,147				2,635,147

Dividend declared on Series E preferred stock		-		-		-		-		-		(36,993)		-		(36,993)		-		(36,993)

Other comprehensive income (loss)		-		-		-		-		-		-		(255,747)		(255,747)		9,153		(246,594)

Net income attributable to noncontrolling interest		-		-		-		-		-		-		-		-		52,873		52,873

Net loss attributable to WPCS		-		-		-		-		-		(9,914,993)		-		(9,914,993)		-		(9,914,993)

BALANCE, January 31, 2014		2,438	$	2,438,000		13,913,164	$	1,391	$	66,671,222	$	(64,006,375)	$	1,177,794	$	6,282,032	$	911,164	$	7,193,196

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

	7

WPCS INTERNATIONAL INCORPORATED AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

	Nine Months Ended January 31,
	Nine Months Ended January 31,
	2014		2013
OPERATING ACTIVITIES :
Consolidated net loss	$	(9,862,120)	$	(641,061)

Adjustments to reconcile consolidated net loss to net cash used in operating activities:
Depreciation and amortization		672,164		1,106,806
Gain from disposition of operations		-		(1,826,539)
Amortization of debt discount		4,278,687		688,460
Loss on extinguishment of Notes		1,299,304
Change in the fair value of derivative liabilities		833,750		702,574
Stock-based compensation		23,651		102,673
Provision for doubtful accounts		33,223		(15,226)
Amortization of debt issuance costs		277,970		399,335
Loss (gain) on sale of fixed assets, net		8,601		(31,294)
Deferred income taxes		-		(229,896)
Changes in operating assets and liabilities:
Restricted cash		1,869,178		(926,389)
Accounts receivable		(2,343,976)		1,377,734
Costs and estimated earnings in excess of billings on uncompleted contracts		82,978		142,359
Deferred contract costs		(457,041)		(72,723)
Prepaid expenses and other current assets		(240,886)		(307,623)
Other assets		(26,996)		(113,403)
Other assets held for sale		322,646		-
Accounts payable and accrued expenses		679,703		(1,857,462)
Accrued severance		1,300,000		-
Billings in excess of costs and estimated earnings on uncompleted contracts		37,567		(1,869,180)
Deferred revenue		179,772		661,564
Income taxes payable		(130,326)		(24,002)
NET CASH USED IN OPERATING ACTIVITIES		(1,162,151)		(2,733,293)

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

	8

WPCS INTERNATIONAL INCORPORATED AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)

(Unaudited)

INVESTING ACTIVITIES:
Acquisition of property and equipment, net	$	(54,400)	$	(249,093)
Proceeds from sale of operations, net of transaction costs		-		4,547,049
Cash received from acquisition of BTX software		1,185,000		-
NET CASH PROVIDED BY INVESTING ACTIVITIES		1,130,600		4,297,956

FINANCING ACTIVITIES:
Net proceeds from Section 16(b) settlement		-		222,413
Debt issuance costs		(102,182)		(230,794)
Repayments under lines of credit		-		(4,964,140)
(Repayment) borrowings of senior secured convertible notes		(9,507)		4,000,000
Repayments under loans payable, net		(35,753)		(66,537)
Borrowings (repayments) from related party		790,256		(2,355,526)
Repayments of capital lease obligations		-		(15,465)
Borrowings under short-term bank loan		818,550		2,380,605
Repayments under other payable		(210,229)		-
Borrowings under other payable		-		793,927
NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES		1,251,135		(235,517)

Effect of exchange rate changes on cash		(65,886)		(4,384)

NET INCREASE IN CASH AND CASH EQUIVALENTS		1,153,698		1,324,762
CASH AND CASH EQUIVALENTS, BEGINNING OF THE PERIOD		915,752		811,283
CASH AND CASH EQUIVALENTS, END OF THE PERIOD	$	2,069,450	$	2,136,045

	Nine Months Ended
	January 31,
		2014		2013

SCHEDULE OF NON-CASH INVESTING AND FINANCING ACTIVITIES:

Issuance of common stock for the conversion of Notes and accrued interest		$	3,114,816	$	-

Acquisition of BTX Software from issuance of Series E Preferred Stock		$	2,635,147	$	-

Reclassification of fair value of derivative liability on Notes and Warrants to additional paid-in capital upon the Amendment and Note Amendment		$	7,166,991	$	-

Reclassification of fair value of derivative liability on Notes to additional paid-in capital upon conversion of Notes		$	686,856	$	-

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

	9

WPCS INTERNATIONAL INCORPORATED AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1 - LIQUIDITY AND BASIS OF PRESENTATION

Basis of Presentation

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

The accompanying unaudited condensed consolidated financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (SEC) for quarterly reports on Form 10-Q of Article 10 of Regulation S-X and do not include all of the information and note disclosures required by accounting principles generally accepted in the United States of America. Accordingly, the unaudited condensed consolidated financial statements should be read in conjunction with the Company’s audited consolidated financial statements and notes thereto for the fiscal year ended April 30, 2013 included in the Company’s Annual Report on Form 10-K, filed on July 29, 2013. 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 nine month periods ended January 31, 2014 are not necessarily indicative of the results that may be expected for the fiscal year ending April 30, 2014. The amounts for the April 30, 2013 balance sheet have been extracted from the audited consolidated financial statements included in Form 10-K for the year ended April 30, 2013.

The Company offers low voltage communication infrastructure contracting services to public services, healthcare, energy and corporate enterprise markets and is developing a Bitcoin trading platform through its wholly-owned subsidiary.

Liquidity and Going Concern

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

At January 31, 2014, the Company has losses from operations, and has outstanding balances due to its former surety under a forbearance agreement of $1,533,757. These factors raise substantial doubt about the Company’s ability to continue as a going concern. The financial statements do not include any adjustments to the carrying amount and classification of recorded assets and liabilities should the Company be unable to continue operations. Management’s plans are to continue to raise additional funds through the sales of debt or equity securities. There is no assurance that additional financing will be available when needed or that management will be able to obtain financing on terms acceptable to the Company and whether the Company will become profitable and generate positive operating cash flow. If the Company is unable to raise sufficient additional funds, it will have to develop and implement a plan to further extend payables and reduce overhead until sufficient additional capital is raised to support further operations. There can be no assurance that such a plan will be successful.

	10

WPCS INTERNATIONAL INCORPORATED AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Zurich Forbearance Agreement

As more fully described in Note 13, “Commitments and Contingencies,” on July 12, 2012, the Company executed the Surety Financing and Confession of Judgment Agreement (the Financing Agreement) with Zurich American Insurance Company (Zurich), to assist in the completion of the project contract with the Camden County Improvement Authority for work at the Cooper Medical Center of Rowan University (the Owner or Cooper Project).

On April 17, 2013, the Company executed the Surety Forbearance and Confession of Judgment Agreement (the Forbearance Agreement) with Zurich, which supersedes the Financing Agreement. The Company is currently in default under the Forbearance Agreement due to its failure to: (1) pay the monthly Interim Liability Payment of $25,000 per month since December 1, 2013; and (2) pay the Loss Amount of $1,533,757 that was due December 31, 2013 under the Forbearance Agreement. The Company is currently in discussions with Zurich for the settlement of the Loss Amount due under the Forbearance Agreement. There can be no assurance that the Company will be successful in settling with Zurich the Loss Amount due.

Senior Secured Convertible Notes

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

Effective October 31, 2013, the Company entered into an amendment agreement (the Note Amendment) with the Buyers. The Note Amendment eliminated certain features of the Notes that would otherwise result in substantial accounting charges to the Company. Prior to the Note Amendment, if an event of default existed under the Notes, the Buyers would have been entitled to redeem $3,400,000 in aggregate principal and interest of the Notes for a redemption price equal to the greater of 125% of (x) the deemed value of the shares of common stock underlying the Note (the Intrinsic Value) and (y) the outstanding principal and unpaid interest under the Notes (the Base Value). The Note Amendment reduced and fixed the event of default redemption price by eliminating the Intrinsic Value calculation and modifying the Base Value calculation and interest rate to more accurately make-whole the holders of the Notes from the loss of interest from an early redemption of the Notes and the decreased value of the Notes without such Intrinsic Value rights. As revised, the event of default redemption amount is calculated as the sum of the Conversion Amount (as defined in the Notes) to be redeemed, plus a make-whole amount equal to the amount of any interest that, but for any redemption of the Notes on such given date, would have accrued with respect to the Conversion Amount being redeemed under the Notes at the interest rate then in effect for the period from such given date through October 31, 2023, the amended maturity date of the Notes, discounted to the present value of such interest using a discount rate of 2.5% per annum. As a result, the fixed value of the event of default redemption price was approximately $10,900,000 at the time of the Note Amendment. As a result of Note conversions during the third fiscal quarter, the value of the event of default redemption price was approximately $2,800,000 as of January 31, 2014. In addition, the interest rate of the Notes was amended to 15% per annum, subject to increase to 25% per annum if an event of default occurs and is continuing.

The Notes contain certain customary representations and warranties, affirmative and negative covenants, and events of default. The principal covenant is that the Company shall maintain a current ratio of not less than 0.6 to 1.0 as of the last calendar day of each month. As of January 31, 2014, the Company is in compliance with the covenants.

Cooper Medical Center Claim

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

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

	11

WPCS INTERNATIONAL INCORPORATED AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

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

Principles of Consolidation

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

Cash and Cash Equivalents

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

Restricted Cash

In connection with the terms of the Notes, all payments of accounts receivable of the Company (and its domestic subsidiaries) are deposited into an account (the Lockbox Account) controlled by Worldwide Stock Transfer, LLC (the Collateral Agent). The Company is permitted to receive from the Lockbox Account on a daily basis, such cash equal to (A) (i) the cash balance in the Lockbox Account plus (ii) 95% of the available qualified accounts receivable, less (iii) $250,000, minus (B) the amount of principal, accrued interest and costs and expenses owed pursuant to the Notes. At any given time, the Company considers the cash held in the Lockbox Account that it is not yet permitted to draw down based on the calculation above, to be restricted cash. Restricted cash is classified as a current asset, consistent with the classification of the Notes as a current liability. Based on the calculation above, the Company had the ability to draw down all of the cash held in the Lockbox Account, and as a result there was no restricted cash balance reported at January 31, 2014.

Accounts Receivable

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

Capitalized Software Costs

Costs incurred in the research, design and development of software for sale to others as a separate product or embedded in a product and sold as part of the product as a whole are charged to expense until technological feasibility is established. Thereafter, software development costs, consisting primarily of payroll and related costs, purchased materials and services and software to be used within its products, which significantly enhance the marketability or significantly extend the life of its products are capitalized, and amortized to cost of revenue on a straight-line basis over three years, beginning when the products are offered for sale or when the enhancements are integrated into the product. The Company is required to use professional judgment in determining whether product enhancement costs meet the criteria for immediate expense or capitalization, in accordance with the Accounting Standards Codification (ASC).

Derivative Instruments

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

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WPCS INTERNATIONAL INCORPORATED AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Fair Value of Financial Instruments

The Company’s material financial instruments at January 31, 2014 and for which disclosure of fair value is required by certain accounting standards consisted of cash and cash equivalents, restricted cash, accounts receivable, accounts payable, loans payable, senior secured convertible notes, and short-term bank loan. The fair values of cash and cash equivalents, accounts receivable, and accounts payable are equal to their carrying value because of their liquidity and short-term maturity. Management believes that the fair values of the loans payable, senior secured convertible notes and short-term bank loan do not differ materially from their aggregate carrying values in that substantially all the obligations bear variable interest rates that are based on market rates or interest rates that are periodically adjustable to rates that are based on market rates.

Other Intangible Assets

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

Other intangible assets consist of the following at January 31, 2014 and April 30, 2013:

	Estimated useful life		January 31,		April 30,
	(years)		2014		2013

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

Amortization expense of other intangible assets for the nine months ended January 31, 2014 and 2013 was $16,228 and $48,753, respectively. There are no expected residual values related to these intangible assets.

Revenue Recognition

The Company generates its revenue by offering low voltage communications infrastructure contracting services. The Company’s contracting 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.

The Company has numerous contracts that are in various stages of completion. Such contracts require estimates to determine the appropriate cost and revenue recognition. Cost estimates are reviewed monthly on a contract-by-contract basis, and are revised periodically throughout the life of the contract such that adjustments to profit resulting from revisions are made cumulative to the date of the revision. Significant management judgments and estimates, including the estimated cost to complete projects, which determines the project’s percent complete, must be made and used in connection with the revenue recognized in the accounting period. Current estimates may be revised as additional information becomes available. If estimates of costs to complete long-term contracts indicate a loss, provision is made currently for the total loss anticipated. For the nine months ended January 31, 2014 and 2013, the Company has provided aggregate loss provisions of approximately $18,000 and $46,000, respectively, related to anticipated losses on long-term contracts.

	13

WPCS INTERNATIONAL INCORPORATED AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

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

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

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

Income Taxes

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

On a periodic basis, the Company evaluates its ability to realize its deferred tax assets net of its deferred tax liabilities and adjusts such amounts in light of changing facts and circumstances, including but not limited to the level of past and future taxable income, and the current and future expected utilization of tax benefit carryforwards. The Company considers all available evidence, both positive and negative, to determine whether, based on the weight of that evidence, a valuation allowance is required to reduce the net deferred tax assets to the amount that is more likely than not to be realized in future periods. The Company considers past performance, expected future taxable income and prudent and feasible tax planning strategies in assessing the amount of the valuation allowance. The Company’s forecast of expected future taxable income is based over such future periods that it believes can be reasonably estimated. Based on its analysis as of January 31, 2014, the Company continues to provide a full valuation allowance on its domestic and foreign deferred tax assets. The Company will continue to evaluate the realization of its deferred tax assets and liabilities on a periodic basis, and will adjust such amounts in light of changing facts and circumstances.

The Company performed a review for uncertainty in income tax positions in accordance with authoritative guidance. This review did not result in the recognition of any material unrecognized tax benefits as of January 31, 2014 and April 30, 2013. Management continually evaluates expiring statutes of limitations, audits, proposed settlements, changes in tax law and new authoritative rulings. The Company recognizes interest accrued related to unrecognized tax benefits in interest expense and penalties in selling, general and administrative expenses. For the nine months ended January 31, 2014 and 2013, the Company recognized no interest or penalties. The statute of limitations for the Company's Federal, state and foreign income tax returns prior to fiscal years 2009 are closed.

Net Loss Per Common Share

Basic and diluted net loss per common share is computed as net loss less dividends on preferred stock divided by the weighted average number of common shares outstanding for the period. Diluted net loss per common share reflects the potential dilution that could occur from common stock issuable through exercise of stock options, warrants and Note conversions. The table below presents the computation of basic and diluted net loss per common share from continuing operations for the three and nine months ended January 31, 2014 and 2013, respectively:

	14

WPCS INTERNATIONAL INCORPORATED AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Basic and diluted net loss per share from continuing operations computation

	Three Months Ended				Nine Months Ended
	January 31,				January 31,
	2014			2013	2014			2013
Numerator:

Net loss attributable to WPCS common shareholders	$	(3,295,971)	$	(1,152,094)		(9,622,298)	$	(1,007,056)

Denominator:

Basic and diluted weighted average shares outstanding		6,475,773		994,187		2,916,425		994,187

Basic and diluted net loss per common share attributable to WPCS common shareholders	$	(0.51)	$	(1.16)	$	(3.30)	$	(1.01)

The following were excluded from the computation of diluted shares outstanding due to the losses from continuing operations for the three and nine months ended January 31, 2014 as they would have had an anti-dilutive impact on the Company’s net loss. Below is a tabulation of the potentially dilutive securities that were “in the money” for the periods ended January 31, 2014 and 2013, respectively.

	Three Months Ended		Nine Months Ended
	January 31,		January 31,
	2014	2013	2014	2013
Common stock equivalents:
Conversion of stock options	-	-	918	3,843
Conversion of stock warrants	27,235	49,036	608,237	142,200
Conversion of senior secured convertible notes	4,079,610	223,961	4,186,134	141,776
Conversion of Series E Preferred Stock	-		-
Totals	4,106,845	272,997	4,795,289	287,819

Noncontrolling Interest

The Company presents the 40% non-controlling interests associated with the China Operations as a component of equity, with changes in the Company’s ownership interest while it retains its controlling interest, will be accounted for as an equity transaction, and upon a loss of control, retained ownership interest will be re-measured at fair value, with any gain or loss recognized in earnings. Income and losses attributable to the non-controlling interests associated with the China Operations are presented separately in the Company’s basic financial statements.

Noncontrolling interest for the three and nine months ended January 31, 2014 and 2013 consists of the following:

	Three Months Ended				Nine Months Ended
	January 31,				January 31,
	2014		2013		2014		2013
Balance, beginning of period	$	862,763	$	1,153,321	$	849,138	$	1,117,322

Net income attributable to noncontrolling interest		49,439		54,317		52,873		82,922

Other comprehensive (loss) income attributable to noncontrolling interest		(1,038)		3,004		9,153		10,397

Balance, end of period	$	911,164	$	1,210,642	$	911,164	$	1,210,641

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WPCS INTERNATIONAL INCORPORATED AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Use of Estimates

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

Recently Issued Accounting Pronouncements

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

NOTE 3 – CAPITALIZED SOFTWARE COSTS

Description of the Transaction

On December 17, 2013, the Company entered into various agreements, as more fully described below, which are expected to add a new line of business and reporting segment to the Company’s existing operations. The Company acquired software technology in the emerging Bitcoin industry, that is currently in early-stage beta testing of a cross-exchange trading technology platform that provides access to ninety percent of publicly available Bitcoin liquidity (the BTX Software). The BTX Software is expected to enable users to make informed decisions by providing aggregated and curated market data from all major Bitcoin trading venues.

On December 17, 2013, the Company entered into a Securities Purchase Agreement (the BTX Purchase Agreement) with certain accredited investors (the Investors) pursuant to which the Company sold an aggregate of 2,438 shares of its newly designated Series E Convertible Preferred Stock, $1,000 stated value (the Series E Preferred Stock) and warrants (the BTX Warrants and, collectively with the shares of Series E Preferred Stock, the Securities) to purchase up to an aggregate of 1,500,000 shares of the Company’s common stock (the Financing). As consideration for the purchase of the Securities, the Investors sold their collective interests in BTX Trader. LLC (BTX) to the Company, which such interests constituted 100% of the outstanding membership interests of BTX, causing BTX to become a wholly owned subsidiary of the Company. The Securities are more fully described in Note 10, “Shareholders Equity.” The Investors also hold Notes issued by the Company.

Accounting Treatment of BTX

The Company recorded the transaction for the acquisition of the BTX Software as capitalized software costs. The Company determined that the capitalized acquisition cost of the BTX Software was $3,100,302, based on the fair value of the consideration transferred. The cost of the asset purchase was based on the fair value of the Series E Preferred Stock, fair value of the BTX Warrants, and assumption of a secured promissory note in the principal amount of $500,000, which accrues interest at a rate of 3.32% (the BTX Note), offset by the cash received of $1,185,000 in the transaction. For the three months ended January 31, 2014, the Company capitalized additional software development costs related to the BTX Software of $24,439.

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WPCS INTERNATIONAL INCORPORATED AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Capitalized software costs are determined as follows as of January 31, 2014:

Fair value of Series E Preferred Stock	$	2,635,147
Fair value of BTX Warrants		1,150,155
BTX Note		500,000
Less: Cash received		(1,185,000)
Total acquired value of BTX Software		3,100,302

Additional capitalized software costs		24,439

Total	$	3,124,741

The Company determined the fair value of the Series E Preferred Stock and Make-Whole based on the Conversion Amount (as defined in Series E Preferred Stock Certificate of Designation) using the closing common share market price as of December 18, 2013 of $1.64. The transaction was announced after the market close on December 17, 2013. The first time market participants could have bought or sold the Company’s common stock with the knowledge of the transaction was on December 18, 2013. Therefore, the closing price on December 18, 2013 was considered to be the fair value. The resulting fair value of the Series E Preferred Stock is $2,635,147.

The Company estimated the fair value of the BTX Warrants using the Black-Scholes Merton option pricing model (Black-Scholes) with the following assumptions: conversion price of $5.00 per share; risk free interest rate of 1.52%; expected life of 5 years; expected dividend of zero; and volatility factor of 79.87%; and a common stock price of $1.64 as of December 18, 2013, as discussed above. The expected volatility is based on the historical price volatility of the Company’s common stock. The risk-free interest rate represents the U.S. Treasury constant maturities rate for the expected life of the Warrants. The dividend yield represents anticipated cash dividends to be paid over the expected life of the Warrants to the common shareholders. The resulting fair value of the BTX Warrants is $1,150,155.

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 January 31, 2014 and April 30, 2013:

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WPCS INTERNATIONAL INCORPORATED AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

	January 31, 2014		April 30, 2013

Costs incurred on uncompleted contracts	$	51,678,539	$	72,951,142
Provision for loss on uncompleted contracts		(18,154)		(23,376)
Estimated contract profit		1,975,753		2,391,027
		53,636,138		75,318,793
Less: Billings to date		54,296,623		75,858,733
Total	$	(660,485)	$	(539,940)

Costs and estimated earnings in excess of billings on uncompleted contracts	$	996,389	$	1,079,367
Billings in excess of cost and estimated earnings on uncompleted contracts		1,656,874		1,619,307
Total	$	(660,485)	$	(539,940)

Revisions in the estimated gross profits on contracts and contract amounts are made in the period in which circumstances requiring the revisions become known. During the three and nine months ended January 31, 2014, the effect of such revisions in estimated contract profits resulted in an increase to gross profits of approximately $218,000 and $269,000, respectively, and during the three and nine months ended January 31, 2013, the effect of such revisions resulted in an increase in gross profits of $349,000 and $1,679,000, respectively, from that which would have been reported had the revised estimates been used as the basis of recognition for contract profits in prior years. The increase in gross profits for the nine months ended January 31, 2013 also includes change orders received on the Cooper Project of approximately $1,486,000 for costs previously accrued.

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

NOTE 5 - SENIOR SECURED CONVERTIBLE NOTES

Initial Proceeds from Issuance

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

Pursuant to the terms of the Notes, the Company deposited the initial funds received from the Financing, minus $2,178,516, (the Initial Lending Amount) into the Lockbox Account controlled by the Collateral Agent, as collateral agent on behalf of the Buyers. The Company used the Initial Lending Amount to repay the existing loan of $2,000,000, plus $78,516 of interest accrued and fees and expenses to Sovereign Bank, N.A. (Sovereign), which credit agreement was terminated in connection with the Notes, and $100,000 for Buyer legal fees in connection with the Notes. In addition, all payments of accounts receivable of the Company (and its domestic subsidiaries) shall be deposited into the Lockbox Account. The Company is permitted to receive from the Lockbox Account, on a daily basis, such amount of cash equal to: (A) (i) cash balance in the Lockbox Account plus (ii) 95% of available qualified accounts receivable minus (iii) $250,000 minus (B) amount of principal, accrued interest, fees, costs and expenses owed pursuant to the Notes. The Notes contain certain customary representations and warranties, affirmative and negative covenants, and events of default. The principal covenant is that the Company shall maintain a current ratio of not less than 0.6 to 1.0 as of the last calendar day of each month. As of January 31, 2014, the Company is in compliance with the covenants.

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WPCS INTERNATIONAL INCORPORATED AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Amendment, Waiver and Exchange Agreement

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

Pursuant to the Amendment, the Buyers permanently waived, effective as of October 24, 2013, various provisions of the remaining 2,119,835 Warrants, including the anti-dilution protection from the issuance of securities at a price lower than the Exercise Price, the adjustment to market price on the first anniversary of the date of issuance of the Warrants and the Black-Scholes valuation upon the occurrence of a Fundamental Transaction (as defined in the Warrants). As a result of these waivers, the exercise price of the Warrants will only adjust in the event of any future stock splits or dividends. The Exercise Price of the Warrants remains at $2.1539 per share. The Amendment resulted in 2,119,835 Warrants and 154,961 Exchange Warrants having the same terms, conditions and rights.

Amendment to Notes

Effective October 31, 2013, the Company entered into an amendment agreement (the Note Amendment) with the Buyers. The Note Amendment eliminated certain features of the Notes which would otherwise result in substantial accounting charges to the Company. Pursuant to the Note Amendment, the Buyers permanently waived various provisions of the Notes, including the adjustment to the conversion price under a Fundamental Transaction (as defined in the Notes), the anti-dilution protection from the issuance of securities at a price lower than the current exercise price and the adjustment to market price on the first anniversary of the date of issuance of the Notes. As a result of these waivers, the conversion price of the Notes will only adjust in the event of any future stock splits or dividends.

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

Prior to the Note Amendment, if an event of default existed under the Notes, the Buyers would have been entitled to redeem $3,400,000 in aggregate principal and interest of the Notes for a redemption price equal to the greater of 125% of (x) the deemed value of the shares of common stock underlying the Note (the Intrinsic Value) and (y) the outstanding principal and unpaid interest under the Notes (the Base Value). The Note Amendment reduces and fixes the event of default redemption price by eliminating the Intrinsic Value calculation and modifying the Base Value calculation and interest rate to more accurately make-whole the holders of the Notes from the loss of interest from an early redemption of the Notes and the decreased value of the Notes without such Intrinsic Value rights. As revised, the event of default redemption amount equals the sum of the Conversion Amount (as defined in the Notes) to be redeemed, plus a make-whole amount equal to the amount of any interest that, but for any redemption of the Notes on such given date, would have accrued with respect to the Conversion Amount being redeemed under the Notes at the interest rate then in effect for the period from such given date through October 31, 2023, the amended maturity date of the Notes, discounted to the present value of such interest using a discount rate of 2.5% per annum. As a result, the fixed value of the event of default redemption price was approximately $10,900,000 at the time of the Note Amendment. As a result of Note conversions during the third fiscal quarter, the value of the event of default redemption price was approximately $2,800,000 as of January 31, 2014. In addition, the interest rate of the Notes was amended to 15% per annum, subject to increase to 25% per annum if an event of default occurs and is continuing.

	19

WPCS INTERNATIONAL INCORPORATED AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

As a result of the significant modifications of the Notes, the Company determined that the Notes were extinguished and new Notes were issued. In connection with this modification, the Company compared the present value of the beneficial conversion features of the Notes to the new Notes. The Company determined that the present value of the new Notes exceeded the present value of the old Notes by more than 10%, which resulted in the application of extinguishment accounting. The modification of the Note resulted in the debt instruments being exchanged with substantially different terms and extinguishment accounting was applied resulting in a loss on extinguishment of debt for the unamortized discount related to the Notes of $1,299,304. In addition, the Company recorded a new beneficial conversion feature and associated debt discount of $3,400,000 related to the proceeds of the new Notes based on the fixed conversion rate of $0.20 and the fair market value of the common stock at the amendment date.

Prior to the Note Amendment, $593,923 of Notes was converted into 275,742 shares of the Company’s Common Stock. In addition, $6,077 of Notes was redeemed for cash at the request of a Buyer.

During the three months ended January 31, 2014, $2,501,666 of Notes were converted into 12,508,340 shares of the Company’s Common Stock, resulting in the accelerated write-off of unamortized debt discount of $2,501,666. In addition, $19,231 of accrued interest on Notes was converted into 96,155 shares of the Company’s Common Stock. There were no further conversions of New Notes subsequent to January 31, 2014. The outstanding principal balance of the Notes was $898,334 as of January 31, 2014.

Following the Note Amendment, senior secured convertible notes consist of the following at January 31, 2014:

	Notes		Debt Discount		Total
Beginning balance- Senior secured convertible notes, interest at 4% per annum to maturity June 5, 2014	$	4,000,000	$	(2,888,889)	$	1,111,111
Conversion of Notes before Note Amendment		(593,923)		-		(593,923)
Amortization of debt discount, Notes		-		1,589,585		1,589,585
Redemption of Notes		(6,077)		-		(6,077)
Extinguishment of Notes		(3,400,000)		-		(3,400,000)
Loss on extinguishment of debt , Notes		-		1,299,304		1,299,304
Senior secured convertible notes, interest at 15% per annum to maturity October 31, 2023		3,400,000		-		3,400,000
Debt discount - value attributable to beneficial conversion features, Notes		-		(3,400,000)		(3,400,000)
Conversion of Notes, and accelerated write off of unamortized debt discount after Note Amendment		(2,501,666)		2,501,666		-
Amortization of debt discount, Notes		-		22,458		22,458
Ending balance- Notes	$	898,334	$	(875,876)	$	22,458

Registration Rights of the Shares Issuable Upon Conversion of the Notes

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

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

	20

WPCS INTERNATIONAL INCORPORATED AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Buyers Security Interests and Guarantees

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

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

In connection with the BTX Purchase Agreement, the Company agreed to waive any rights to compel the redemption of the Notes. The Buyers agreed to restrict their ability to convert the Notes and/or exercise the Warrants and Exchange Warrants and receive shares of the Company’s Common Stock such that the number of shares of Common Stock held by the Buyer in the aggregate and its affiliates after such conversion or exercise does not exceed 9.99% of the then issued and outstanding shares of the Company’s Common Stock.

NOTE 6 – OTHER DEBT

Short-Term Bank Loan

Effective August 1, 2013, the China Operations entered into a loan with the Bank of China (the Short-Term Bank Loan). The Short-Term Bank Loan provides for a loan in the amount of $3,279,300. The proceeds from the Short-Term Bank Loan were used to repay outstanding unsecured loans of $2,404,545 due to the Company’s related party and Taian Gas Group (TGG). The Short-Term Bank Loan has an interest rate of 7.38%, and interest is due on a quarterly basis. The Short-Term Bank Loan matures on August 1, 2014, and is secured by the assets of TGG.

Due Related Party

As of January 31, 2014, the China Operations had outstanding payables due a related party, TGG, totaling $799,116 due on demand, representing interest accrued on former working capital loans from TGG to the China Operations.

Loans Payable

At January 31, 2014, loans payable obligations totaled $695,220 with interest rates ranging from 3.22% to 8.99%, and maturity dates ranging from March 2015 to May 2018. Of the Company’s total loans payable, $195,220 relate to long-term debt issued by the Company or assumed in acquisitions for the purchase of property and equipment in the ordinary course of business, and $500,000 relates to the BTX Note.

Covenant Compliance

As of January 31, 2014, the Company is in compliance with all financial and non-financial covenants associated with the Short-Term bank loan, due related party and loans payable.

NOTE 7 – DERIVATIVE LIABILITIES

Senior secured convertible notes- embedded conversion features

Immediately prior to entering into the Amendment and Note Amendment as of October 31, 2013, the Notes met the definition of a hybrid instrument, as defined in ASC 815. The hybrid instrument was comprised of (i) a debt instrument, as the host contract and (ii) an option to convert the debentures into common stock of the Company, as an embedded derivative and recorded as a discount to the Notes. The embedded derivatives derive their value based on the underlying fair value of the Company’s common stock. The embedded derivatives are not clearly and closely related to the underlying host debt instrument since the economic characteristics and risk associated with these derivatives are based on the common stock fair value and the Company recognized derivative liabilities since inception.

As a result of the aforementioned Note Amendment, the Notes no longer contained the provisions that required bifurcation and the classification was changed from liability to an equity instrument. This results in the extinguishment of the derivative liability. The final fair value of the embedded derivatives on the date of the Note Amendment was $4,000,437, which was reclassified to additional paid-in capital. Prior to the Note Amendment, the changes in the fair value of the embedded derivative were recognized in earnings and classified as a gain or loss on the embedded derivative financial instrument in the accompanying condensed consolidated statements of operations. For the three months ended January 31, 2014 and 2013, the Company recognized a loss of $0 and $385,445, respectively. For the nine months ended January 31, 2014 and 2013, the Company recognized a loss of $1,598,537 and $385,445, respectively.