**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington, D.C.  20549**

**FORM 10-Q**
| **x**      | ** ** | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF  1934** |
|------------|------------|------------------------------------------------------------------------------------------------|
| ** ** | ** ** | ** **                                                                                     |
| ** ** | ** ** | **For the  quarterly period ended July 31, 2007**                                              |
| ** ** | ** ** | ** **                                                                                     |
| ** ** | ** ** | **OR**                                                                                         |
| ** ** | ** ** | ** **                                                                                     |
| **o******  | ** ** | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**  |

 

**CommissionFile Number 0-16231**

**XETA Technologies, Inc.**

(Exact name of registrantas specified in its charter)

| **Oklahoma**                     | ** ** | **73-1130045**       |
|----------------------------------|------------|----------------------|
| (State or other  jurisdiction of |       | (I.R.S. Employee     |
| incorporation or  organization)  |       | Identification  No.) |

 

| **1814 W. Tacoma, Broken Arrow, OK**      | ** ** | **74012-1406** |
|-------------------------------------------|------------|----------------|
| (Address of  principal executive offices) |       | (Zip Code)     |

 

**918-664-8200**

(Registrant’stelephone number, including area code)

(Former name,former address and former fiscal year, if changed since last report)

Indicateby check mark whether the registrant (1) has filed all reports required to befiled by Section 13 or 15(d) of the Securities Exchange Act of 1934 during thepast 12 months (or for such shorter period that the registrant was required tofile such reports), and (2) has been subject to such filing requirements forthe past 90 days.
| Yes x |   | No o |
|-------|--------|------|

 

Indicateby check mark whether the registrant is a large accelerated filer, anaccelerated 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 o |   | Accelerated  filer o |   | Non-accelerated  filer x |
|---------------------------|--------|----------------------|--------|--------------------------|

 

Indicateby check mark whether the registrant is a shell company (as defined in Rule12b-2 of the Exchange Act).    Yes o No x

Indicatethe number of shares outstanding of each of the registrant’s classes of commonstock, as of the latest practicable date.
| Class                          | ** ** | **Outstanding at August 30, 2007** | ** ** |
|--------------------------------|------------|--------------------------------------------------------|------------|
| Common Stock,  $.001 par value |       | 10,214,741                                             |       |

 

 

----

INDEX
|                                                                                                      | ** ** | ** ** |
|------------------------------------------------------------------------------------------------------|------------|------------|
| PART I. FINANCIAL INFORMATION                                                                        |       |       |
|                                                                                                 |       |       |
| ITEM 1.FINANCIAL  STATEMENTS (Unaudited)                                                             |       |       |
|                                                                                                 |       |       |
| Consolidated Balance  Sheets - July 31, 2007 and October 31, 2006                                    |       |       |
|                                                                                                 |       |       |
| Consolidated  Statements of Operations - For the Three and Nine Months Ended July 31, 2007  and 2006 |       |       |
|                                                                                                 |       |       |
| Consolidated  Statement of Shareholders’ Equity - For the Nine Months Ended July 31, 2007       |       |       |
|                                                                                                 |       |       |
| Consolidated  Statements of Cash Flows - For the Nine Months Ended July 31, 2007 and 2006            |       |       |
|                                                                                                 |       |       |
| Notes to  Consolidated Financial Statements                                                          |       |       |
|                                                                                                 |       |       |
| ITEM 2.  MANAGEMENT’S DISCUSSION AND ANALYSIS                                                   |       |       |
|                                                                                                 |       |       |
| ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                                  |       |       |
|                                                                                                 |       |       |
| ITEM 4. CONTROLS AND  PROCEDURES                                                                     |       |       |
|                                                                                                 |       |       |
| PART II. OTHER  INFORMATION                                                                          |       |       |
|                                                                                                 |       |       |
| ITEM 1. LEGAL  PROCEEDINGS                                                                           |       |       |
|                                                                                                 |       |       |
| ITEM 1A. RISK FACTORS                                                                                |       |       |
|                                                                                                 |       |       |
| ITEM 2.  UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS                                 |       |       |
|                                                                                                 |       |       |
| ITEM 3.  DEFAULTS UPON SENIOR SECURITIES                                                             |       |       |
|                                                                                                 |       |       |
| ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS                                         |       |       |
|                                                                                                 |       |       |
| ITEM 5.OTHER INFORMATION                                                                             |       |       |
|                                                                                                 |       |       |
| ITEM 6. EXHIBITS                                                                                     |       |       |

 

2

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XETA TECHNOLOGIES,INC. AND SUBSIDIARY

CONSOLIDATED BALANCE SHEETS

(UNAUDITED)
| ** **                                                                                                                                          | ** ** | **July 31, 2007** | ** ** | **October 31, 2006** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------|------------|--------------------------------|------------|
|                                                                                                                                                |       |                        |       |                           |       |
| ASSETS                                                                                                                                              |       |                        |       |                           |       |
| Current assets:                                                                                                                                     |       |                        |       |                           |       |
| Cash  and cash equivalents                                                                                                                          |       | $                           | 55,420     |                           | $          | 174,567 |   |
| Current  portion of net investment in sales-type leases and other receivables                                                                       |       | 436,578                     |       | 329,619                        |       |
| Trade  accounts receivable, net                                                                                                                     |       | 14,597,339                  |       | 12,245,507                     |       |
| Inventories,  net                                                                                                                                   |       | 4,289,405                   |       | 4,942,973                      |       |
| Deferred  tax asset, net                                                                                                                            |       | 999,438                     |       | 709,343                        |       |
| Prepaid  taxes                                                                                                                                      |       | 16,237                      |       | 22,622                         |       |
| Prepaid  expenses and other assets                                                                                                                  |       | 671,616                     |       | 300,738                        |       |
| Total  current assets                                                                                                                               |       | 21,066,033                  |       | 18,725,369                     |       |
|                                                                                                                                                |       |                        |       |                           |       |
| Noncurrent assets:                                                                                                                                  |       |                        |       |                           |       |
| Goodwill                                                                                                                                            |       | 26,378,987                  |       | 26,420,669                     |       |
| Intangible  assets, net                                                                                                                             |       | 113,500                     |       | 141,875                        |       |
| Net  investment in sales-type leases, less current portion above                                                                                    |       | 154,904                     |       | 128,708                        |       |
| Property,  plant & equipment, net                                                                                                               |       | 10,497,650                  |       | 10,485,018                     |       |
| Other  assets                                                                                                                                       |       | 7,657                       |       | 11,124                         |       |
| Total  noncurrent assets                                                                                                                            |       | 37,152,698                  |       | 37,187,394                     |       |
|                                                                                                                                                |       |                        |       |                           |       |
| Total  assets                                                                                                                                       |       | $                           | 58,218,731 |                           | $          | 55,912,763 |   |
|                                                                                                                                                |       |                        |       |                           |       |
| LIABILITIES AND SHAREHOLDERS’ EQUITY                                                                                                           |       |                        |       |                           |       |
| Current liabilities:                                                                                                                                |       |                        |       |                           |       |
| Current  portion of long-term debt                                                                                                                  |       | $                           | 171,123    |                           | $          | 171,123 |   |
| Revolving  line of credit                                                                                                                           |       | 2,476,446                   |       | 3,119,445                      |       |
| Lease  payable                                                                                                                                      |       | —                      |       | 810                            |       |
| Accounts  payable                                                                                                                                   |       | 4,154,745                   |       | 4,325,758                      |       |
| Current  unearned revenue                                                                                                                           |       | 2,667,493                   |       | 1,802,665                      |       |
| Accrued  liabilities                                                                                                                                |       | 4,004,543                   |       | 2,993,831                      |       |
| Total  current liabilities                                                                                                                          |       | 13,474,350                  |       | 12,413,632                     |       |
|                                                                                                                                                |       |                        |       |                           |       |
| Noncurrent liabilities:                                                                                                                             |       |                        |       |                           |       |
| Long-term  debt, less current portion above                                                                                                         |       | 1,397,632                   |       | 1,525,950                      |       |
| Accrued  long-term liability                                                                                                                        |       | 244,900                     |       | 436,850                        |       |
| Noncurrent  unearned service revenue                                                                                                                |       | 91,061                      |       | 79,132                         |       |
| Noncurrent  deferred tax liability, net                                                                                                             |       | 4,291,990                   |       | 3,572,089                      |       |
| Total  noncurrent liabilities                                                                                                                       |       | 6,025,583                   |       | 5,614,021                      |       |
|                                                                                                                                                |       |                        |       |                           |       |
| Contingencies                                                                                                                                       |       |                        |       |                           |       |
|                                                                                                                                                |       |                        |       |                           |       |
| Shareholders’ equity:                                                                                                                          |       |                        |       |                           |       |
| Preferred  stock; $.10 par value; 50,000 shares authorized, 0 issued                                                                                |       | —                      |       | —                         |       |
| Common  stock; $.001 par value; 50,000,000 shares authorized, 11,233,529 and  11,233,529 issued at July 31, 2007 and October 31, 2006, respectively |       | 11,233                      |       | 11,233                         |       |
| Paid-in  capital                                                                                                                                    |       | 13,146,230                  |       | 13,067,676                     |       |
| Retained  earnings                                                                                                                                  |       | 27,805,994                  |       | 27,050,860                     |       |
| Less  treasury stock, at cost (1,018,788 shares at July 31, 2007 and October 31,  2006)                                                             |       | (2,244,659                  | )          | (2,244,659                     | )          |
| Total  shareholders’ equity                                                                                                                    |       | 38,718,798                  |       | 37,885,110                     |       |
| Total  liabilities and shareholders’ equity                                                                                                    |       | $                           | 58,218,731 |                           | $          | 55,912,763 |   |

 

The accompanying notes are an integral part of theseconsolidated balance sheets.

3

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XETA TECHNOLOGIES,INC. AND SUBSIDIARY

CONSOLIDATEDSTATEMENTS OF OPERATIONS

(UNAUDITED)
| ** **                                      | ** ** | **For the Three Months** | ** ** | **For the Nine Months** | ** ** |
|-------------------------------------------------|------------|-----------------------------------------|------------|----------------------------------------|------------|
| ** **                                      | ** ** | **Ended July 31,**            | ** ** | **Ended July 31,**           | ** ** |
| ** **                                      | ** ** | **2007**                                | ** ** | **2006**                               | ** ** | **2007** | ** ** | **2006** | ** ** |
| ** **                                      | ** ** | ** **                              | ** ** | ** **                             | ** ** | ** ** | ** ** | ** ** | ** ** |
| Systems sales                                   |       | $                                       | 8,657,120  |                                   | $          | 7,791,020 |   | $ | 23,446,191 |   | $ | 21,048,745 |   |
| Services                                        |       | 9,463,504                               |       | 7,778,472                              |       | 27,032,719 |   | 21,445,590 |   |
| Other revenues                                  |       | 127,669                                 |       | 91,003                                 |       | 509,100 |   | 742,762 |   |
| Net sales and service revenues                  |       | 18,248,293                              |       | 15,660,495                             |       | 50,988,010 |   | 43,237,097 |   |
|                                            |       |                                    |       |                                   |       |   |   |   |   |
| Cost of systems sales                           |       | 6,684,447                               |       | 6,155,423                              |       | 17,919,182 |   | 15,996,821 |   |
| Services costs                                  |       | 6,557,194                               |       | 5,120,431                              |       | 19,021,635 |   | 15,414,295 |   |
| Cost of other revenues & corporate COGS     |       | 477,190                                 |       | 224,989                                |       | 1,367,060 |   | 1,354,232 |   |
| Total cost of sales and service                 |       | 13,718,831                              |       | 11,500,843                             |       | 38,307,877 |   | 32,765,348 |   |
|                                            |       |                                    |       |                                   |       |   |   |   |   |
| Gross profit                                    |       | 4,529,462                               |       | 4,159,652                              |       | 12,680,133 |   | 10,471,749 |   |
|                                            |       |                                    |       |                                   |       |   |   |   |   |
| Operating expenses                              |       |                                    |       |                                   |       |   |   |   |   |
| Selling, general and administrative             |       | 3,705,080                               |       | 3,574,585                              |       | 10,946,501 |   | 9,716,843 |   |
| Amortization                                    |       | 183,721                                 |       | 103,356                                |       | 470,765 |   | 307,085 |   |
| Total operating expenses                        |       | 3,888,801                               |       | 3,677,941                              |       | 11,417,266 |   | 10,023,928 |   |
|                                            |       |                                    |       |                                   |       |   |   |   |   |
| Income (loss) from operations                   |       | 640,661                                 |       | 481,711                                |       | 1,262,867 |   | 447,821 |   |
|                                            |       |                                    |       |                                   |       |   |   |   |   |
| Interest expense                                |       | (28,536                                 | )          | (25,096                                | )          | (38,923 | ) | (122,895 | ) |
| Interest and other income                       |       | 8,729                                   |       | 13,671                                 |       | 35,190 |   | 33,262 |   |
| Total interest and other income (expense)       |       | (19,807                                 | )          | (11,425                                | )          | (3,733 | ) | (89,633 | ) |
|                                            |       |                                    |       |                                   |       |   |   |   |   |
| Income (loss) before provision for income taxes |       | 620,854                                 |       | 470,286                                |       | 1,259,134 |   | 358,188 |   |
| Provision (benefit) for income taxes            |       | 244,000                                 |       | 184,000                                |       | 504,000 |   | 156,000 |   |
|                                            |       |                                    |       |                                   |       |   |   |   |   |
| Net income (loss)                               |       | $                                       | 376,854    |                                   | $          | 286,286 |   | $ | 755,134 |   | $ | 202,188 |   |
|                                            |       |                                    |       |                                   |       |   |   |   |   |
| Earnings (loss) per share                       |       |                                    |       |                                   |       |   |   |   |   |
| Basic                                           |       | $                                       | 0.04       |                                   | $          | 0.03 |   | $ | 0.07 |   | $ | 0.02 |   |
|                                            |       |                                    |       |                                   |       |   |   |   |   |
| Diluted                                         |       | $                                       | 0.04       |                                   | $          | 0.03 |   | $ | 0.07 |   | $ | 0.02 |   |
|                                            |       |                                    |       |                                   |       |   |   |   |   |
| Weighted average shares outstanding             |       | 10,214,741                              |       | 10,214,741                             |       | 10,214,741 |   | 10,180,728 |   |
|                                            |       |                                    |       |                                   |       |   |   |   |   |
| Weighted average equivalent shares              |       | 10,214,741                              |       | 10,214,741                             |       | 10,214,741 |   | 10,208,553 |   |

 

4

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XETA TECHNOLOGIES, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENT OFSHAREHOLDERS’ EQUITY

(UNAUDITED)
| ** **                | ** ** | **Common Stock**  | ** ** | **Treasury Stock** | ** ** | ** ** | ** ** | ** ** | ** ** | ** **               | ** ** |
|---------------------------|------------|------------------------|------------|-------------------------|------------|------------|------------|------------|------------|--------------------------|------------|
| ** **                | ** ** | **Shares Issued** | ** ** | **Par Value**      | ** ** | **Shares** | ** ** | **Amount** | ** ** | **Paid-in Capital** | ** ** | **Retained Earnings** | ** ** | **Total** | ** ** |
|                      |       |                   |       |                    |       |       |       |       |       |                     |       |   |   |   |   |
| Balance- October 31, 2006 |       | 11,233,529             |       | $                       | 11,233     |       | 1,018,788  |       | $          | (2,244,659               | )          | $ | 13,067,676 |   | $ | 27,050,860 |   | $ | 37,885,110 |   |
|                      |       |                   |       |                    |       |       |       |       |       |                     |       |   |   |   |   |
| Stock based compensation  |       |                   |       |                    |       |       |       |       |       | 78,554                   |       |   |   | 78,554 |   |
| Net Income                |       | —                 |       | —                  |       | —     |       | —     |       | —                   |       | 755,134 |   | 755,134 |   |
|                      |       |                   |       |                    |       |       |       |       |       |                     |       |   |   |   |   |
| Balance- July 31, 2007    |       | 11,233,529             |       | $                       | 11,233     |       | 1,018,788  |       | $          | (2,244,659               | )          | $ | 13,146,230 |   | $ | 27,805,994 |   | $ | 38,718,798 |   |

 

The accompanying notesare an integral part of this consolidated financial statement.

5

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XETA TECHNOLOGIES,INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)
| ** **                                                                                                    | ** ** | **For the Nine Months** | ** ** |
|---------------------------------------------------------------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                                                                                    | ** ** | **Ended July 31,**           | ** ** |
| ** **                                                                                                    | ** ** | **2007**                               | ** ** | **2006** | ** ** |
| Cash flows from operating activities:                                                                         |       |                                   |       |   |   |
| Net income                                                                                                    |       | $                                      | 755,134    |   | $ | 202,188 |   |
|                                                                                                          |       |                                   |       |   |   |
| Adjustments to reconcile net income to net cash provided  by operating activities:                            |       |                                   |       |   |   |
| Depreciation                                                                                                  |       | 393,304                                |       | 380,300 |   |
| Amortization                                                                                                  |       | 470,765                                |       | 307,084 |   |
| Stock based compensation                                                                                      |       | 78,554                                 |       |   |   |
| Loss (gain) on sale of assets                                                                                 |       | (5,000                                 | )          | 4,466 |   |
| Provision for excess and obsolete inventory                                                                   |       | 76,500                                 |       | 76,500 |   |
| Increase in deferred tax liability                                                                            |       | 761,583                                |       | 260,501 |   |
| Change in assets and liabilities, net of  acquisitions:                                                       |       |                                   |       |   |   |
| (Increase) decrease in net investment in sales-type  leases & other receivables                           |       | (133,155                               | )          | 224,028 |   |
| (Increase) in trade account receivables                                                                       |       | (2,351,832                             | )          | (902,672 | ) |
| Decrease in inventories                                                                                       |       | 577,068                                |       | 587,705 |   |
| (Increase) decrease in deferred tax asset                                                                     |       | (290,095                               | )          | 105,682 |   |
| (Increase) in prepaid expenses and other assets                                                               |       | (367,411                               | )          | (215,597 | ) |
| Decrease in prepaid taxes                                                                                     |       | 6,385                                  |       | 57,669 |   |
| (Decrease) in accounts payable                                                                                |       | (171,013                               | )          | (1,078,064 | ) |
| Increase in unearned revenue                                                                                  |       | 876,757                                |       | 464,468 |   |
| Increas in accrued taxes                                                                                      |       | —                                 |       | 28,662 |   |
| Increase in accrued liabilities and lease payable                                                             |       | 817,952                                |       | 582,342 |   |
| Total adjustments                                                                                             |       | 740,362                                |       | 883,074 |   |
|                                                                                                          |       |                                   |       |   |   |
| Net cash provided by operating activities                                                                     |       | 1,495,496                              |       | 1,085,262 |   |
|                                                                                                          |       |                                   |       |   |   |
| Cash flows from investing activities:                                                                         |       |                                   |       |   |   |
| Additions to property, plant & equipment                                                                  |       | (848,326                               | )          | (708,852 | ) |
| Proceeds from sale of assets                                                                                  |       | 5,000                                  |       | 17,632 |   |
| Net cash used in investing activities                                                                         |       | (843,326                               | )          | (691,220 | ) |
|                                                                                                          |       |                                   |       |   |   |
| Cash flows from financing activities:                                                                         |       |                                   |       |   |   |
| Proceeds from draws on revolving line of credit                                                               |       | 19,563,572                             |       | 18,048,711 |   |
| Principal payments on debt                                                                                    |       | (128,318                               | )          | (907,035 | ) |
| Payments on revolving line of credit                                                                          |       | (20,206,571                            | )          | (17,721,118 | ) |
| Exercise of stock options                                                                                     |       | —                                 |       | 52,584 |   |
| Net cash used in financing activities                                                                         |       | (771,317                               | )          | (526,858 | ) |
|                                                                                                          |       |                                   |       |   |   |
| Net (decrease) in cash and cash equivalents                                                                   |       | (119,147                               | )          | (132,816 | ) |
|                                                                                                          |       |                                   |       |   |   |
| Cash and cash equivalents, beginning of period                                                                |       | 174,567                                |       | 176,688 |   |
| Cash and cash equivalents, end of period                                                                      |       | $                                      | 55,420     |   | $ | 43,872 |   |
|                                                                                                          |       |                                   |       |   |   |
| Supplemental disclosure of cash flow information:                                                             |       |                                   |       |   |   |
| Cash paid during the period for interest, net of  amount capitalized of $161,772 in 2007 and $227,934 in 2006 |       | $                                 | 54,234     |   | $  | 119,823 |   |
| Cash paid during the period for income taxes                                                                  |       | $                                      | 26,159     |   | $ | 30,904 |   |

 

The accompanying notes are an integral part of theseconsolidated financial statements.

6

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**XETATECHNOLOGIES, INC. AND SUBSIDIARY**

**Notes toConsolidated Financial Statements**

**July 31,2007**

(Unaudited)

1.  BASIS OF PRESENTATION:

XETATechnologies, Inc. (“XETA” or the “Company”) is a leading provider ofcommunications solutions with nationwide sales and service. XETA serves adiverse group of business clients in sales, engineering, project management,installation, and service support.  TheCompany sells products produced by a variety of manufacturers including Avaya,Inc. (“Avaya”), Nortel Networks Corporation (“Nortel”), and SpectralinkCorporation.  In addition, the Company manufacturesand markets a line of proprietary call accounting systems to the hospitalityindustry.  XETA is an Oklahomacorporation.

Theaccompanying unaudited consolidated financial statements have been prepared bythe Company pursuant to the rules and regulations of the Securities andExchange Commission (the “Commission”). Certain information and footnote disclosures normally included in annualfinancial statements prepared in accordance with accounting principlesgenerally accepted in the United States of America have been condensed oromitted pursuant to those rules and regulations, although the Company believesthat the disclosures made are adequate to make the information presented notmisleading.  It is suggested that thesecondensed financial statements be read in conjunction with the consolidatedfinancial statements and the notes thereto made a part of the Company’s AnnualReport on Form 10-K, Commission File No. 0-16231, which was filed with theCommission on January 16, 2007. Management believes that the financial statements contain alladjustments necessary for a fair statement of the results for the interimperiods presented.  All adjustments madewere of a normal recurring nature.  Theresults of operations for the interim period are not necessarily indicative ofthe results for the entire fiscal year. Certain reclassifications of prior year amounts have been made toconform to current year presentations. These reclassifications had no impact on net income.

Segment Information

TheCompany has three reportable segments: Managed Services, commercial system sales, and lodging systemsales.  Managed Services revenuesrepresent revenues earned from installing and maintaining systems for customersin both the commercial and lodging segments. The Company defines commercial system sales as sales to the non-lodgingindustry.

Thereporting segments follow the same accounting policies used for the Company’sconsolidated financial statements and described in the Summary of SignificantAccounting Policies in the Company’s Form 10-K described above.  Company management evaluates a segment’sperformance based upon gross margins. Assets are not allocated to the segments.  Sales to customers located outside of theU.S. are immaterial.

The following is atabulation of business segment information for the three months ended July 31,2007 and 2006.
| ** **    | ** ** | **Managed  Services  Revenues** | ** ** | **Commercial  Systems  Sales** | ** ** | **Lodging  Systems  Sales** | ** ** | **Other  Revenue** | ** ** | **Total**   | ** ** |
|---------------|------------|---------------------------------|------------|--------------------------------|------------|-----------------------------|------------|--------------------|------------|-------------|------------|
| **2007**      |       |                            |       |                           |       |                        |       |               |       |        |       |
| Sales         |       | $                               | 9,463,504  |                           | $          | 6,522,225                   |       | $                  | 2,134,895  |        | $          | 127,669 |   | $ | 18,248,293 |   |
| Cost of sales |       | (6,557,194                      | )          | (5,152,119                     | )          | (1,532,328                  | )          | (477,190           | )          | (13,718,831 | )          |
| Gross profit  |       | $                               | 2,906,310  |                           | $          | 1,370,106                   |       | $                  | 602,567    |        | $          | (349,521 | ) | $ | 4,529,462 |   |
|          |       |                            |       |                           |       |                        |       |               |       |        |       |
| **2006**      |       |                            |       |                           |       |                        |       |               |       |        |       |
| Sales         |       | $                               | 7,778,472  |                           | $          | 6,280,894                   |       | $                  | 1,510,126  |        | $          | 91,003 |   | $ | 15,660,495 |   |
| Cost of sales |       | (5,120,431                      | )          | (4,987,908                     | )          | (1,167,515                  | )          | (224,989           | )          | (11,500,843 | )          |
| Gross profit  |       | $                               | 2,658,041  |                           | $          | 1,292,986                   |       | $                  | 342,611    |        | $          | (133,986 | ) | $ | 4,159,652 |   |

 

7

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The following is atabulation of business segment information for the nine months ended July 31,2007 and 2006.
| ** **    | ** ** | **Managed  Services  Revenues** | ** ** | **Commercial  Systems  Sales** | ** ** | **Lodging  Systems  Sales** | ** ** | **Other  Revenue** | ** ** | **Total**   | ** ** |
|---------------|------------|---------------------------------|------------|--------------------------------|------------|-----------------------------|------------|--------------------|------------|-------------|------------|
| **2007**      |       |                            |       |                           |       |                        |       |               |       |        |       |
| Sales         |       | $                               | 27,032,719 |                           | $          | 17,253,332                  |       | $                  | 6,192,859  |        | $          | 509,100 |   | $ | 50,988,010 |   |
| Cost of sales |       | (19,021,635                     | )          | (13,328,915                    | )          | (4,590,267                  | )          | (1,367,060         | )          | (38,307,877 | )          |
| Gross profit  |       | $                               | 8,011,084  |                           | $          | 3,924,417                   |       | $                  | 1,602,592  |        | $          | (857,960 | ) | $ | 12,680,133 |   |
|          |       |                            |       |                           |       |                        |       |               |       |        |       |
| **2006**      |       |                            |       |                           |       |                        |       |               |       |        |       |
| Sales         |       | $                               | 21,445,590 |                           | $          | 15,793,785                  |       | $                  | 5,254,960  |        | $          | 742,762 |   | $ | 43,237,097 |   |
| Cost of sales |       | (15,414,295                     | )          | (12,046,562                    | )          | (3,950,259                  | )          | (1,354,232         | )          | (32,765,348 | )          |
| Gross profit  |       | $                               | 6,031,295  |                           | $          | 3,747,223                   |       | $                  | 1,304,701  |        | $          | (611,470 | ) | $ | 10,471,749 |   |

 

Stock-BasedCompensation Plans

InDecember 2004, the Financial Accounting Standards Board (“FASB”) issuedStatement of Financial Accounting Standards No. 123 (revised 2004), “Share-BasedPayment” (“SFAS 123(R)”).  SFAS 123(R)requires companies to measure all employee stock-based compensation awardsusing a fair value method and recognize compensation cost in its financialstatements.  The valuation provisions ofSFAS 123(R) apply to new awards and to awards that are outstanding at theeffective date and subsequently modified or cancelled.  The Company adopted on a prospective basisSFAS 123(R) beginning November 1, 2005 for stock-based compensation awardsgranted after that date and for unvested awards outstanding at that date usingthe modified prospective application method. The Company recognizes the fair value of stock-based compensation awardsas selling, general and administrative expense as appropriate in theconsolidated statements of operations on a straight-line basis over the vestingperiod.  We recognized compensation inthe statement of operations as follows.
|                              | ** ** | **2007** | ** ** | **2006** | ** ** |
|------------------------------|------------|----------|------------|----------|------------|
| Three months  ended July 31, |       | $        | 30,685     |     | $          | — |   |
|                         |       |     |       |     |       |
| Six months ended July  31,   |       | $        | 78,554     |     | $          | — |   |

 

Use of Estimates

Thepreparation of financial statements in conformity with accounting principlesgenerally accepted in the U.S. requires management to make estimates andassumptions that affect the reported amounts of assets and liabilities anddisclosure of contingent assets and liabilities at the date of the financialstatements and the reported amounts of revenues and expenses during thereporting period.  Actual results coulddiffer from those estimates.

Reclassifications

Certainreclassifications of prior year amounts have been made to conform to currentyear presentations.  Thesereclassifications had no impact on net income.

NewAccounting Pronouncements

InJune 2006, the FASB issued Interpretation No. 48 (“FIN 48”), Accounting forUncertainty in Income Taxes—an interpretation of FASB Statement No. 109, toclarify certain aspects of accounting for uncertain tax positions, includingissues related to the recognition and measurement of those tax positions. Thisinterpretation is effective for fiscal years beginning after December 15, 2006,and therefore will apply beginning with the Company’s fiscal year ended October31, 2008. The Company is currently evaluating the impact of thisinterpretation.

8

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InSeptember 2006, the FASB issued Statement of Financial Standards No. 157, “FairValue Measurements” (“SFAS 157”).  SFAS157 defines fair value, establishes a framework for measuring fair value inaccordance with accounting principles generally accepted in the United States,and expands disclosures about fair value measurements.  This statement does not require any new fairvalue measurements; rather, it applies under other accounting pronouncementsthat require or permit fair value measurements. The provisions of SFAS 157 areeffective for fiscal years beginning after November 15, 2007.  The Company does not expect the adoption ofSFAS 157 to have a material impact on the Company’s consolidated financial positionor results of operations.

InFebruary 2007, the FASB issued Statement of Financial Accounting Standards No.159 (“SFAS 159”), “The Fair Value Option for Financial Assets and Liabilities”.  SFAS 159 permits entities to choose tomeasure many financial instruments and certain other items at fair value.  SFAS 159 will be effective for the Company’sfiscal year beginning November 1, 2008. Early adoption is permitted. TheCompany has not determined the impact, if any, that adopting this standard mayhave on its consolidated financial position or results of operations.

2.  ACCOUNTS RECEIVABLE:
|                                      | ** ** | **July 31,  2007** | ** ** | **(Audited)  October 31,  2006** | ** ** |
|--------------------------------------|------------|-------------------------|------------|---------------------------------------|------------|
|                                 |       |                    |       |                                  |       |
| Trade  receivables                   |       | $                       | 14,770,016 |                                  | $          | 12,499,407 |   |
| Less- reserve  for doubtful accounts |       | (172,677                | )          | (253,900                              | )          |
| Net trade receivables                |       | $                       | 14,597,339 |                                  | $          | 12,245,507 |   |

 

3.  INVENTORIES:

Inventoriesare stated at the lower of cost (first-in, first-out or average) or market andconsist of the following:
|                                                    | ** ** | **July 31,  2007** | ** ** | **(Audited)  October 31,  2006** | ** ** |
|----------------------------------------------------|------------|-------------------------|------------|---------------------------------------|------------|
|                                               |       |                    |       |                                  |       |
| Finished goods  and spare parts                    |       | $                       | 5,057,968  |                                  | $          | 5,565,484 |   |
| Less- reserve  for excess and obsolete inventories |       | (768,563                | )          | (622,511                              | )          |
| Total inventories, net                             |       | $                       | 4,289,405  |                                  | $          | 4,942,973 |   |

 

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4.  PROPERTY, PLANT AND EQUIPMENT:

Property,plant and equipment consists of the following:
|                                                               | ** ** | **Estimated  Useful  Lives** | ** ** | **July 31,  2007** | ** ** | **(Audited)  October 31,  2006** | ** ** |
|---------------------------------------------------------------|------------|------------------------------|------------|-------------------------|------------|---------------------------------------|------------|
|                                                          |       |                         |       |                    |       |                                  |       |
| Building and  building improvements                           |       | 3-20                         |       | $                       | 2,500,095  |                                  | $          | 2,397,954 |   |
| Data processing  and computer field equipment                 |       | 2-7                          |       | 2,630,170               |       | 2,469,671                             |       |
| Software  development costs, work-in-process                  |       | N/A                          |       | 3,704,041               |       | 5,274,299                             |       |
| Software  development costs of components placed Into service |       | 3-10                         |       | 4,256,126               |       | 2,339,644                             |       |
| Hardware                                                      |       | 3-5                          |       | 599,751                 |       | 599,751                               |       |
| Land                                                          |       | —                       |       | 611,582                 |       | 611,582                               |       |
| Office furniture                                              |       | 5-7                          |       | 945,578                 |       | 932,252                               |       |
| Auto                                                          |       | 5                            |       | 516,183                 |       | 428,214                               |       |
| Other                                                         |       | 3-7                          |       | 254,780                 |       | 252,780                               |       |
|                                                          |       |                         |       |                    |       |                                  |       |
| Total property,  plant and equipment                          |       |                         |       | 16,018,306              |       | 15,306,147                            |       |
| Less-  accumulated depreciation                               |       |                         |       | (5,520,656              | )          | (4,821,129                            | )          |
|                                                          |       |                         |       |                    |       |                                  |       |
| Total property, plant  and equipment, net                     |       |                         |       | $                       | 10,497,650 |                                  | $          | 10,485,018 |   |

 

Interestcosts related to an investment in long-lived assets are capitalized as part ofthe cost of the asset during the period the asset is being prepared foruse.  The Company capitalized $161,772and $227,934 in interest costs in the nine months ended July 31, 2007 and 2006,respectively.

5.  INCOME TAXES:

Thetax effect of temporary differences that give rise to significant portions ofthe deferred tax assets and deferred tax liabilities are presented below:
|                                                            | ** ** | **July 31,  2007** | ** ** | **(Audited)  October 31,  2006** | ** ** |
|------------------------------------------------------------|------------|-------------------------|------------|---------------------------------------|------------|
| Deferred tax  assets:                                      |       |                    |       |                                  |       |
| Net operating loss carryforward                            |       | $                       | 1,365,031  |                                  | $          | 1,156,913 |   |
| Currently nondeductible reserves                           |       | 309,977                 |       | 256,764                               |       |
| Accrued liabilities                                        |       | 473,352                 |       | 392,449                               |       |
| Prepaid service contracts                                  |       | 191,536                 |       | 30,770                                |       |
| Stock based compensation expense                           |       | 30,793                  |       | —                                |       |
| Other                                                      |       | 35,232                  |       | 40,436                                |       |
| Total deferred tax asset                                   |       | 2,405,921               |       | 1,877,332                             |       |
|                                                       |       |                    |       |                                  |       |
| Deferred tax  liabilities:                                 |       |                    |       |                                  |       |
| Intangible assets                                          |       | 4,205,997               |       | 3,686,779                             |       |
| Depreciation                                               |       | 1,472,738               |       | 1,032,788                             |       |
| Tax income to be recognized on sales-type lease  contracts |       | 19,738                  |       | 20,511                                |       |
| Total deferred tax liability                               |       | 5,698,473               |       | 4,740,078                             |       |
| Net deferred tax  liability                                |       | $                       | (3,292,552 | )                                     | $          | (2,862,746 | ) |

 

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|                                                            | ** ** | **July 31,  2007** | ** ** | **(Audited)  October 31,  2006** | ** ** |
|------------------------------------------------------------|------------|-------------------------|------------|---------------------------------------|------------|
| Net deferred liability  as presented on the balance sheet: |       |                    |       |                                  |       |
| Current  deferred tax asset                                |       | $                       | 999,438    |                                  | $          | 709,343 |   |
| Noncurrent  deferred tax liability                         |       | (4,291,990              | )          | (3,572,089                            | )          |
| Net  deferred tax liability                                |       | $                       | (3,292,552 | )                                     | $          | (2,862,746 | ) |

 

TheCompany has recorded a tax provision of $504,000 or 40% and $156,000 or 44% forthe nine months ended July 31, 2007 and 2006, respectively, reflecting thestatutory federal tax rate of 34% plus a blended state income tax rate ofapproximately 6% and the impact of minimum income tax payments in certainstates.

6.  CREDIT AGREEMENTS:

TheCompany’s credit facility consists of a revolving credit and term loanagreement with a commercial bank including a mortgage agreement maturing onSeptember 30, 2009 and amortizing based on a 13 year life and a $7.5 millionrevolving credit agreement to finance growth in working capital.  The revolving line of credit is collateralizedby trade accounts receivable and inventories. At July 31, 2007 and October 31, 2006, the Company had approximately$2.476 million and $3.119 million, respectively, outstanding on the revolvingline of credit.  The Company hadapproximately $5.0 million available under the revolving line of credit at July31, 2007.  Advance rates are defined inthe agreement, but are generally at the rate of 80% on qualified trade accountsreceivable and 40% of qualified inventories. The revolving line of credit matures on September 28, 2008.  Long-term debt consisted of the following:
|                                                                                                                                                                                                                  | ** ** | **July 31,  2007** | ** ** | **(Audited)  October 31,  2006** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|---------------------------------------|------------|
|                                                                                                                                                                                                             |       |                    |       |                                  |       |
| Real estate term note, payable in monthly  installments of $14,257 plus interest, plus a fixed payment of $1,198,061 due  September 30, 2009, collateralized by a first mortgage on the Company’s  building |       | $                       | 1,568,755  |                                  | $          | 1,697,073 |   |
|                                                                                                                                                                                                             |       |                    |       |                                  |       |
| Less-current maturities                                                                                                                                                                                          |       | 171,123                 |       | 171,123                               |       |
|                                                                                                                                                                                                             |       |                    |       |                                  |       |
| Total long-term debt, less current maturities                                                                                                                                                                    |       | $                       | 1,397,632  |                                  | $          | 1,525,950 |   |

 

Intereston all outstanding debt under the credit facility accrues at either a) theLondon Interbank Offered Rate (which was 5.32% at July 31, 2007) plus 1.25% to2.75% depending on the Company’s funded debt to cash flow ratio, or b) the bank’sprime rate (which was 8.25% at July 31, 2007) minus 0% to minus 1.125% alsodepending on the Company’s funded debt to cash flow ratio.  At July 31, 2007, the Company was paying7.125% on the revolving line of credit borrowings and 6.57% on the mortgagenote.  The credit facility containsseveral financial covenants common in such agreements, including tangible networth requirements, limitations on the amount of funded debt to earnings beforeinterest, taxes, depreciation and amortization, limitations on capitalspending, and debt service coverage requirements.  The Company was in compliance with thesecovenants at July 31, 2007.

7.  EARNINGS PER SHARE:

Basicearnings per common share were computed by dividing net income by the weightedaverage number of shares of common stock outstanding during the reporting periods.  Diluted earnings per common share werecomputed by dividing net income by the weighted average number of shares ofcommon stock and 

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dilutivepotential common stock outstanding during the reporting periods.  A reconciliation of net income and weightedaverage shares used in computing basic and diluted earnings per share is asfollows:
| ** **                        | ** ** | **For the Three Months Ended July 31, 2007** | ** ** |
|-----------------------------------|------------|---------------------------------------------------------------------------------|------------|
| ** **                        | ** ** | **Income  (Numerator)**                                                         | ** ** | **Shares  (Denominator)** | ** ** | **Per Share  Amount** | ** ** |
| Basic EPS                         |       |                                                                            |       |   |   |   |   |
| Net  income                       |       | $                                                                               | 376,854    |   | 10,214,741 |   | $ | 0.04 |   |
| Dilutive  effect of stock options |       |                                                                            |       | — |   |   |   |
|                              |       |                                                                            |       |   |   |   |   |
| Diluted EPS                       |       |                                                                            |       |   |   |   |   |
| Net  income                       |       | $                                                                               | 376,854    |   | 10,214,741 |   | $ | 0.04 |   |

 
| ** **                        | ** ** | **For the Three Months Ended July 31, 2006** | ** ** |
|-----------------------------------|------------|---------------------------------------------------------------------------------|------------|
| ** **                        | ** ** | **Income  (Numerator)**                                                         | ** ** | **Shares  (Denominator)** | ** ** | **Per Share  Amount** | ** ** |
| Basic EPS                         |       |                                                                            |       |   |   |   |   |
| Net  income                       |       | $                                                                               | 286,286    |   | 10,214,741 |   | $ | 0.03 |   |
| Dilutive  effect of stock options |       |                                                                            |       | — |   |   |   |
|                              |       |                                                                            |       |   |   |   |   |
| Diluted EPS                       |       |                                                                            |       |   |   |   |   |
| Net  income                       |       | $                                                                               | 286,286    |   | 10,214,741 |   | $ | 0.03 |   |

 
| ** **                        | ** ** | **For the Nine Months Ended July 31, 2007** | ** ** |
|-----------------------------------|------------|--------------------------------------------------------------------------------|------------|
| ** **                        | ** ** | **Income  (Numerator)**                                                        | ** ** | **Shares  (Denominator)** | ** ** | **Per Share  Amount** | ** ** |
| Basic EPS                         |       |                                                                           |       |   |   |   |   |
| Net  income                       |       | $                                                                              | 755,134    |   | 10,214,741 |   | $ | 0.07 |   |
| Dilutive  effect of stock options |       |                                                                           |       | — |   |   |   |
|                              |       |                                                                           |       |   |   |   |   |
| Diluted EPS                       |       |                                                                           |       |   |   |   |   |
| Net  income                       |       | $                                                                              | 755,134    |   | 10,214,741 |   | $ | 0.07 |   |

 
| ** **                        | ** ** | **For the Nine Months Ended July 31, 2006** | ** ** |
|-----------------------------------|------------|--------------------------------------------------------------------------------|------------|
| ** **                        | ** ** | **Income  (Numerator)**                                                        | ** ** | **Shares  (Denominator)** | ** ** | **Per Share  Amount** | ** ** |
| Basic EPS                         |       |                                                                           |       |   |   |   |   |
| Net  Income                       |       | $                                                                              | 202,188    |   | 10,180,728 |   | $ | 0.02 |   |
| Dilutive  effect of stock options |       |                                                                           |       | 27,825 |   |   |   |
|                              |       |                                                                           |       |   |   |   |   |
| Diluted EPS                       |       |                                                                           |       |   |   |   |   |
| Net  Income                       |       | $                                                                              | 202,188    |   | 10,208,553 |   | $ | 0.02 |   |

 

Optionsto purchase 978,668 shares of common stock at an average exercise price of$7.00 and 1,119,768  shares of commonstock at an average exercise price of $7.17 were not included in thecomputation of diluted earnings per share for the three months ended July 31,2007 and 2006, respectively, because inclusion of these options would beantidilutive.  Options to purchase1,068,668 shares of common stock at an average exercise price of $6.69 and1,105,668 shares of common stock at an average exercise price of $7.17 were notincluded in the computation of diluted earnings per share for the nine monthsended July 31, 2007 and 2006, respectively, because inclusion of these optionswould be antidilutive.

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**ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTSOF OPERATIONS**

**PreliminaryNote Regarding Forward-Looking Statements**

In thefollowing discussion, we make forward-looking statements regarding futureevents and our future performance and results. These and other forward-looking statements are not guarantees ofperformance, but rather reflect our current expectations, estimates, andforecasts about the industry and markets in which we operate.  We base our assumptions and beliefs oninformation currently available to us. Forward-looking statements can generally be identified by words such as “expects,”“anticipates,” “may”, “plans,” “believes,” “intends,” “projects,” “estimates,” “targets,”“may,” “should” and similar words or expressions.  These statements are subject to risks anduncertainties which are difficult to predict or that are beyond control,including but not limited to factors such as customer demand for advancedcommunications products; our dependence upon a few large companies to drivegrowth in our Managed Services revenues; capital spending trends within our market;the financial condition of our suppliers and changes in their distributionstrategies and support,; technological changes,; fluxuating margins and productmix;, the ability to attract and acquiring and retaining highly skilledpersonnel and technical competencies; intense competition.  These and other risks and uncertainties arediscussed under the heading “Risk Factors” under Part I of the Company’s Form10-K for the fiscal year ended October 31, 2006 (filed with the Commission onJanuary 16, 2007), and in updates to such risk factors set forth in Item 1A ofPart II of this and previously filed quarterly reports filed for quartersduring fiscal 2007.  As a result of theserisks and uncertainties, actual results may differ materially and adversely fromthose expressed in forward-looking statements. Consequently, investors are cautioned to read and consider allforward-looking statements in conjunction with such risk factors anduncertainties.  The Private SecuritiesLitigation Reform Act of 1995 provides a safe-harbor for forward-lookingstatements made by the Company.

# **Overview**

Strategy.  In the third quarter of fiscal 2007, wecontinued our efforts to grow our commercial Managed Services business, improveManaged Services margins, and align sales efforts with our major manufacturingpartners.  Our third quarter resultsreflect improvement in all these areas, with the most significant gains comingfrom our wholesale Managed Services offering. Our total Managed Services gross margins were above 30% for the secondconsecutive quarter and year-to-date Managed Services gross margins haveimproved 2 points over the first three quarters of fiscal 2006.  Systems sales increased 11% in the thirdquarter due primarily to success in the sale of Nortel systems to thecommercial and lodging customer segments. Finally, we also realized approximately 2 points of improvement inoperating expense during the quarter. All of these items are discussed more fully below under “Results ofOperations”.

OperatingSummary.  In the third quarter of fiscal 2007, weearned net income of $377,000 on revenues of $18.2 million compared to netincome of $286,000 on revenues of $15.7 million in the third quarter of lastyear.  For the first nine months offiscal 2007, we earned net income of $755,000 on revenues of $50.9 millioncompared to net income of $202,000 on revenues of $43.2 million for the sameperiod last year.  These positive resultsreflect the improvements discussed above, and other contributing factors whichare discussed in more detail under “Results of Operations” below.

FinancialPosition Summary.  Our financial condition improved during thefirst three quarters of fiscal 2007.  Todate in fiscal 2007 we generated positive cash flows from operations of $1.5million., Our working capital position improved 20%, and our total debt wasreduced 16%.  These and other financialitems are discussed in more detail under “Financial Condition” below.

Thefollowing discussion presents additional information regarding our financial conditionand results of operations for the three- and nine-month periods ended July 31,2007 and 2006 and should be read in conjunction with our comments above as wellas the “Risk Factors” section below.

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# **Financial Condition**

Cashprovided by operations for the nine months ended July 31, 2007 was $1.5million, consisting of net income and non-cash charges of $1.8 million, areduction in inventory of $577,000, and an increase in current liabilities of$2.3 million.  These increases werepartially offset by an increase in accounts receivable of $2.4 million andother changes in working capital items which netted to a decrease in cash of$789,000.  We used these cash flows toreduce our borrowings on our working capital line of credit by $643,000, reduceour mortgage balance through scheduled principal payments by $128,000, and tofund capital expenditures of $843,000. Non-cash charges included depreciation expense of $393,000, amortizationexpense of $471,000, stock-based compensation expense of $79,000, and aprovision for obsolete inventory of $77,000.

At July 31, 2007 our total borrowings were $4.1million, consisting of a mortgage on our headquarters building of $1.6 millionand $2.5 million due on our revolving line of credit.  At July 31, 2007 there was $5.0 millionavailable under the revolver to meet working capital needs.  There have been no stock repurchases to dateunder the repurchase program announced in October 2006.  Under the program, our board of directors authorized the Company toutilize up to $960,000 per year to repurchase our common stock in open market,block purchases or in privately negotiated transactions and at prices we deemappropriate.

Thetable below presents our contractual obligations at July 31, 2007 as well aspayment obligations over the next five years:
|                                  | ** ** | **Payments due by period** | ** ** |
|----------------------------------|------------|-------------------------------------------|------------|
| ** **                       | ** ** | **Total**                                 | ** ** | **Less than  1 year** | ** ** | **2 – 3  Years** | ** ** | **4 – 5  Years** | ** ** |
| **Contractual Obligations** |       |                                      |       |   |   |   |   |   |   |
| Long-term debt                   |       | $                                         | 1,783,419  |   | $ | 277,310 |   | $ | 1,506,109 |   | $ | — |   |
| Operating leases                 |       | 422,481                                   |       | 232,655 |   | 189,826 |   | — |   |
| Total                            |       | $                                         | 2,205,900  |   | $ | 509,965 |   | $ | 1,695,935 |   | $ | — |   |

 

# **Results of Operations**

Inthe third quarter of fiscal 2007, our revenues increased 17% or $2.6 millioncompared to the same period last year and our net income increased $91,000 or32%.  In the first nine months of theyear, our revenues increased 18% or $7.8 million and our net income increased$553,000 or 73%.  These positive resultsreflect improvements in all of our major revenue categories.  The narrative below provides further explanationof these results.

ManagedServices Revenues.  Managed Services revenues consist of thefollowing:
|                                 | ** ** | **For the Three Months Ended  July 31,** | ** ** | **For the Nine Months Ended  July 31,** | ** ** |
|---------------------------------|------------|-------------------------------------------------------------------|------------|------------------------------------------------------------------|------------|
| ** **                      | ** ** | **2007**                                                          | ** ** | **2006**                                                         | ** ** | **2007** | ** ** | **2006** | ** ** |
| Contract & T&M          |       | $                                                                 | 6,745,000  |                                                             | $          | 5,762,000 |   | $ | 19,059,000 |   | $ | 16,238,000 |   |
| Implementation                  |       | 2,075,000                                                         |       | 1,628,000                                                        |       | 5,988,000 |   | 4,133,000 |   |
| Cabling                         |       | 644,000                                                           |       | 388,000                                                          |       | 1,986,000 |   | 1,075,000 |   |
| Total Managed Services revenues |       | $                                                                 | 9,464,000  |                                                             | $          | 7,778,000 |   | $ | 27,033,000 |   | $ | 21,446,000 |   |

 

ManagedServices revenues increased 22% for the quarter ended July 31, 2007 compared tothe same period last year and 26% for the first nine months of fiscal 2007compared to the same period in fiscal 2006. This growth is the product of increases in Contract and time andmaterials (“T&M”) revenues in association with customer adoption of ourwholesale Managed Services program. Adding a new customer under the wholesale Managed Services offeringtypically means we begin providing field services support on behalf of ourcustomer to a new end-user..  Revenuesfrom our wholesale service programs are in the form of contract maintenancefees or time charges for services provided. Some accounts provide additional revenues from minimum monthlycharges.  A key aspect to our successwith these programs has been our flexibility in structuring the servicedelivery model to meet the unique needs or demands of our customers’ endusers.  These recurring contract andT&M revenues increased $1.0 million or 17% in third quarter of fiscal 2007and increased $2.8 million or 17% in the year-to-date period ended July 31,2007 compared to a year ago.

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Implementationservices revenues increased 27% and 45% in the quarter and nine month periodsended July 31, 2007, respectively, compared to those same periods lastyear.  These increases reflect highersystems sales and a greater proportion of more complex applications sold todate in fiscal 2007 compared to last year. These complex applications generate disproportionately higherprofessional services and installation fees. In the third quarter of fiscal 2007, implementation revenues were 24% ofsystems sales compared to 21% in the third quarter of fiscal 2006.  In the first nine months of fiscal 2007,implementation revenues were 26% of systems sales compared to 20% in the sameperiod in fiscal 2006.  The complexity ofimplementations varies significantly between projects.  In general we expect implementation revenues,as a proportion of systems sales, to increase over time as the market movestoward high-end, software-oriented voice applications, and as we increase oursales of stand-alone professional services such as call center tune-ups andnetwork traffic studies.

Ourstructured cabling revenues grew 66% in the third quarter and 85% in the firstnine months of fiscal 2007, respectively, compared to those same periods infiscal 2006.  The increases in theserevenues are the result of our success in establishing a national structuredcabling business that markets our cabling services to existing and newcustomers.  With this product and serviceoffering, we are better able to compete for projects where structured cablingis wrapped into an overall communications infrastructure purchase.  We’re also able to compete for stand-alonestructured cabling business often associated with new construction.  Our third quarter results reflect the initialcabling revenues from a $1.2 million cabling project, the largest such projectin our history.  We expect revenues fromthis project to be recognized ratably over the next three fiscal quarters.

SystemsSales.  Systems sales were $8.7 million in the thirdquarter of fiscal 2007 compared to $7.8 million last year, an 11%increase.  Year-to-date systems saleswere $23.4 million in fiscal 2007 compared to $21.0 million last year, also an11% increase.  These increases reflectsuccess in aligning our sales efforts with our major manufacturers.  Sales of Nortel and Avaya products have increasedapproximately 32% and 2%, respectively, in the year-to-date period as comparedto the same period last year.  Systemssales continue to be an unpredictable segment of our business as the timing ofthe receipt of orders, product delivery, and customer installation schedulessometimes fluctuate dramatically. Systems orders’ backlogs typically range from thirty to forty-five daysproviding short visibility into future results for this line of business.

GrossMargins.  The table below presents the gross marginsearned on our primary revenue streams:
|                               | ** ** | **For the Three  Months Ended  July 31,** | ** ** | **For the Nine  Months Ended  July 31,** | ** ** |
|-------------------------------|------------|---------------------------------------------------------------|------------|--------------------------------------------------------------|------------|
| **Gross Margins**        | ** ** | **2007**                                                      | ** ** | **2006**                                                     | ** ** | **2007** | ** ** | **2006** | ** ** |
| Managed Services  revenues    |       | 30.7                                                          | %          | 34.2                                                         | %          | 29.6 | % | 28.1 | % |
| Systems sales                 |       | 22.8                                                          | %          | 21.0                                                         | %          | 23.6 | % | 24.0 | % |
| Other revenues                |       | 40.9                                                          | %          | 243.7                                                        | %          | 38.8 | % | 59.3 | % |
| Corporate cost  of goods sold |       | -2.2                                                          | %          | -2.3                                                         | %          | -2.1 | % | -2.4 | % |
| Total                         |       | 24.8                                                          | %          | 26.6                                                         | %          | 24.9 | % | 24.2 | % |

 

The gross margins earned on our Managed Servicesbusiness in the third quarter represented the second consecutive fiscal quarterin which these margins were above 30%. This level of gross profits must continue to improve to enhance thelong-term profitability of the company. As Managed Services revenues have grown during the year, our grossmargins on these revenues have improved as we have begun to realize a return onthe investments we made to build our Nortel capability.  Gross margins earned on Managed Services inthe third quarter of fiscal 2007 were lower than the same period last year dueto unusually strong margins in the implementation and cabling sectors in thethird quarter of fiscal 2006.  Ouryear-to-date margin improvement of almost 1.5 points better reflects theprogress we have made in this area of our business this year.

Thegross margins on systems sales in the third quarter were slightly improved overlast year and are essentially the same in the year-to-date period.  We expect to earn gross margins of 23% to 25%on systems sales.  The gross marginsearned in the current fiscal quarter are at the low end of that range andreflect strategic decisions to capture important market share near ourheadquarters.  Margins on systems saleshave been under pressure for several years as hardware becomescommoditized.  We believe that we cansustain 

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currentmargins through emphasizing the sale of software applications which typicallycarry greater margins as converged voice and data products continue toevolve.  Another key contributor to oursystems sales margins is the pricing support we receive from our vendors.  We work diligently to maximize this support;however, no assurance can be given that future support will continue athistorical levels.

Afinal component to our gross margins is the margins earned on other revenuesand our corporate cost of goods sold.  Aportion of our other revenues typically represents sales and cost of goods soldon equipment or services outside our normal provisioning processes.   These revenues by their nature varysignificantly in both sales volume and gross margins earned.  Another segment of other revenues representsthe sale of Avaya maintenance contracts for which we earn either a gross profitor commission.  We have no continuingservice obligation associated with these revenues and gross profits.  This is an unpredictable revenue streamdependent upon expiration dates of existing contracts, installation dates ofnew systems, and the number of years that customers contract for services.  Corporate cost of goods sold represents ourmaterial logistics and purchasing functions that support all of our revenuesegments.

OperatingExpenses.  Our total operating expenses increased$211,000 or 6% in the third quarter of fiscal 2007 compared to the thirdquarter of fiscal 2006.  Operatingexpenses increased $1.4 million or 14% for the first nine months of fiscal 2007compared to the same period a year ago. Operating expenses were 21.3% of revenues in the third quarter of fiscal2007 compared to 23.5% a year ago and were 22.4% for the nine month periodended July 31, 2007 compared to 23.2% in the previous year.  This improvement in operating expense marginswas expected as we have made balanced investments in sales and administrativeexpenses to drive top-line growth.  Wehave targeted our operating expense margins to decline to between 18% and 20%over the next three to five years through economies of scale and improvedoperating efficiencies.

InterestExpense and Other Income.  Net interest and other expense was $20,000 inthe third quarter of fiscal 2007 compared to $11,000 in the third quarter offiscal 2006.  For the nine month periodended July 31, 2007, net interest and other expense was $4,000 compared to$90,000 in the same period of fiscal 2006. These changes primarily reflect lower overall borrowing costs in 2007compared to last year due to less outstanding debt.

TaxProvision.  We recorded a combined federal and state taxprovision of 39% for the third quarter of fiscal 2007 and 2006.  For the nine months ended July 31, 2007, werecorded a tax provision of 40% compared to a tax provision of 44% for the sameperiod a year ago.  The tax provisionrecorded for the year-to-date period reflects the effective federal tax rateplus the composite state income tax rates adjusted for states that requireminimum tax payments even if tax losses are incurred.  Generally, we expect our tax provision rateto be approximately 40%.

**ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKETRISK**

Market risksrelating to our operations results primarily from changes in interestrates.  We did not use derivativefinancial instruments for speculative or trading purposes during the three ornine month periods ended July 31, 2007.

*Interest Rate Risk*.   Due to utilization of variable interest rate debt, we are subject to the risk of fluctuation in interest rates in the normal course of business.  Our credit facility bears interest at a floating rate at either the London Interbank Offered Rate (“LIBOR”) (5.32% at July 31, 2007) plus 1.25% to 2.75% or the bank’s prime rate (8.25% at July 31, 2007) less 0.0% to minus 1.125%.  A hypothetical 1% increase in interest rates would not have a material impact on our financial position or cash flows.

**ITEM 4.   CONTROLS ANDPROCEDURES**

*Evaluationof Disclosure Controls and Procedures.* Based on an evaluation conducted as of July 31,2007 by our management, including our Chief Executive Officer (“CEO”) and ourChief Financial Officer (“CFO”), our CEO and CFO have concluded that ourdisclosure controls and procedures (as defined in Rules 13a-15(e) and15d-15(e) under the Securities Exchange Act of 1934, as amended (the “ExchangeAct”) are effective to reasonably ensure that information required to bedisclosed in reports that we file or submit under the Exchange Act, isrecorded, processed, summarized and reported within the time periods 

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specified in Securitiesand Exchange Commission rules and forms, and that such information isaccumulated and communicated to our management, including the CEO and CFO, asappropriate to allow timely decisions regarding required disclosure.

*Changesin Internal Controls.*  There were no changes in ourinternal controls or in other factors that could materially affect, or isreasonably likely to materially affect, these controls subsequent to the dateof their evaluation. There were no significant deficiencies or material weaknessesand, therefore, there were no corrective actions taken.

**PART II.  OTHERINFORMATION**

**ITEM1.  LEGAL PROCEEDINGS.**

None.

**ITEM 1A. RISK FACTORS**

Theinformation presented below is an update to the “Risk Factors” included in theCompany’s Annual Report on Form 10-K for the fiscal year ended October 31, 2006and should be read in conjunction therewith. Except as set forth below, the Risk Factors included in the Company’sForm 10-K for its 2006 fiscal year have not materially changed.

**Ourexpected growth in Managed Services revenues will likely be derived from a fewlarge companies.  This poses the risk ofa significant negative impact in the event one or more of these companies endsits business relationship with us.**

Muchof our success in growing the commercial portion of our Managed Servicesbusiness has come from a small number of very large customers who contract withus as a subcontractor to fulfill service requirements to end-usercompanies.  Our target market for ourManaged Services offerings is manufacturers such as Nortel, largecommunications carriers such as the regional Bell Operating Companies, andsystems integrators.  Typically, thesecompanies contract with us to provide field technical resources on a subcontractbasis and parts fulfillment.  Theend-users served are often some of our customers’ largest and most prestigiousclients.  Therefore it is imperative thatour customer satisfaction ratings remain high. Once these revenue streams are established, the loss of any particularrelationship could result in a material, adverse impact on our operatingresults.

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

None.

**ITEM 3. DEFAULTS UPON SENIOR SECURITIES.**

None.

**ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.**

None.

**ITEM 5. OTHER INFORMATION.**

None.

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**ITEM6.   EXHIBITS.**

Exhibits (filed herewith):

| SEC Exhibit No. | ** ** | **Description**                                                                                                                                                          |
|-----------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|            |       |                                                                                                                                                                     |
| 31.1            |       | Rule  13a-14(a)/15d-14(a) Certification of Chief Executive Officer                                                                                                       |
|            |       |                                                                                                                                                                     |
| 31.2            |       | Rule  13a-14(a)/15d-14(a) Certification of Chief Financial Officer                                                                                                       |
|            |       |                                                                                                                                                                     |
| 32.1            |       | Certification of  Chief Executive Officer Pursuant to Title 18, United States Code, Section  1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
|            |       |                                                                                                                                                                     |
| 32.2            |       | Certification of  Chief Financial Officer Pursuant to Title 18, United States Code, Section  1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |

 

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**SIGNATURES**

Pursuantto the requirements of the Securities Exchange Act of 1934, the Registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.
|                     | XETA Technologies, Inc. |
|--------------------------|-------------------------|
|                     | (Registrant)            |
|                     |                    |
|                     |                    |
| Dated: September 7, 2007 | By:                     |     /s/ Greg D. Forrest |   |
|                     |                    | Greg D. Forrest |
|                     |                    | Chief Executive Officer |
|                     |                    |   |
| Dated: September 7, 2007 | By:                     |     /s/ Robert B. Wagner |   |
|                     |                    | Robert B. Wagner |
|                     |                    | Chief Financial Officer |

 

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EXHIBIT INDEX
| SEC Exhibit No. | ** ** | **Description**                                                                                                                                                          |
|-----------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|            |       |                                                                                                                                                                     |
| 31.1            |       | Rule 13a-14(a)/15d-14(a) Certification of Chief  Executive Officer                                                                                                       |
|            |       |                                                                                                                                                                     |
| 31.2            |       | Rule 13a-14(a)/15d-14(a) Certification of Chief  Financial Officer                                                                                                       |
|            |       |                                                                                                                                                                     |
| 32.1            |       | Certification of Chief Executive Officer Pursuant to  Title 18, United States Code, Section 1350, as adopted pursuant to Section  906 of the Sarbanes-Oxley Act of 2002. |
|            |       |                                                                                                                                                                     |
| 32.2            |       | Certification of Chief Financial Officer Pursuant to  Title 18, United States Code, Section 1350, as adopted pursuant to Section  906 of the Sarbanes-Oxley Act of 2002. |

 

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