**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington,D.C.   20549**

 

**FORM 10-Q**

 

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

 

**For thequarterly period ended January 31, 2008**

** **

**OR**

 

**o****                                ****TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)OF THE SECURITIESEXCHANGE ACT OF 1934**

 

**Commission File Number 0-16231**

 

**XETA Technologies, Inc.**

 (Exact name ofregistrant as specified in its charter)

 

| **Oklahoma**                                 |   | **73-1130045**       |
|----------------------------------------------|--------|----------------------|
| (State  or other jurisdiction of             |   | (I.R.S.  Employee    |
| incorporation  or organization)              |   | Identification  No.) |
|                                         |   |                 |
| **1814 W.  Tacoma Street, 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)

 

                Indicate by check mark whetherthe registrant (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the past 12 months(or for such shorter period that the registrant was required to file suchreports), and (2) has been subject to such filing requirements for thepast 90 days.

 

Yes   x      No  o

 

                Indicate by check mark whether the registrant is alarge accelerated filer, an accelerated filer, or a non-accelerated filer.  See definition of “accelerated filer andlarge accelerated filer”  in Rule 12b-2of the Exchange Act.  (Check one):

 

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

 

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2 of theExchange Act).    Yes  o   Nox

 

Indicate the number ofshares outstanding of each of the registrant’s classes of common stock, as ofthe latest practicable date.

 

| ** ** | **Class**                      |   | **Outstanding  at January 31, 2008** | ** ** |
|------------|--------------------------------|--------|-------------------------------------------|------------|
| ** ** | Common Stock,  $.001 par value |   | 10,231,214                                | ** ** |

 

 

 

----

 

 

INDEX

 
| ** **                                                                                              | **PAGE** |
|---------------------------------------------------------------------------------------------------------|----------|
| PART I. FINANCIAL  INFORMATION                                                                     |     |
| ** **                                                                                              |     |
| ITEM  1.FINANCIAL STATEMENTS (Unaudited)                                                                |     |
|                                                                                                    |     |
| Consolidated Balance Sheets -  January 31, 2008 and October 31, 2007                          | 3        |
|                                                                                                    |     |
| Consolidated Statements of  Operations - For the Three Months Ended January 31, 2008 and 2007      | 4        |
|                                                                                                    |     |
| Consolidated Statement of  Shareholders’ Equity - For the Three Months Ended January 31, 2008 | 5        |
|                                                                                                    |     |
| Consolidated Statements of Cash Flows -  For the Three Months Ended January 31, 2008 and 2007      | 6        |
|                                                                                                    |     |
| Notes to Consolidated  Financial Statements                                                             | 7        |
|                                                                                                    |     |
| ITEM 2.  MANAGEMENT’S DISCUSSION AND ANALYSIS                                                      | 12       |
|                                                                                                    |     |
| ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                                     | 16       |
|                                                                                                    |     |
| ITEM 4.  CONTROLS AND PROCEDURES                                                                        | 16       |
|                                                                                                    |     |
| PART II. OTHER INFORMATION                                                                         |     |
|                                                                                                    |     |
| ITEM 1.  LEGAL PROCEEDINGS                                                                              | 17       |
|                                                                                                    |     |
| ITEM 1A.  RISK FACTORS                                                                                  | 17       |
|                                                                                                    |     |
| ITEM 2. UNREGISTERED SALES OF EQUITY  SECURITIES AND USE OF PROCEEDS                                    | 18       |
|                                                                                                    |     |
| ITEM 3. DEFAULTS UPON SENIOR SECURITIES                                                                 | 18       |
|                                                                                                    |     |
| ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF  SECURITY HOLDERS                                            | 18       |
|                                                                                                    |     |
| ITEM 5. OTHER INFORMATION                                                                               | 18       |
|                                                                                                    |     |
| ITEM 6. EXHIBITS                                                                                        | 18       |

 

2

----

XETA TECHNOLOGIES, INC. AND SUBSIDIARY

CONSOLIDATED BALANCE SHEETS

(UNAUDITED)

 

 
| ** **                                                                                                                                                       | ** ** | **January 31, 2008** | ** ** | **October 31, 2007** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------|------------|---------------------------|------------|
| ASSETS                                                                                                                                                           |       |
| Current assets:                                                                                                                                                  |       |                      |       |                      |       |
| Cash and cash equivalents                                                                                                                                        |       | $                         | 151,321    |                      | $          | 402,918 |   |
| Current portion of net investment in sales-type leases and other  receivables                                                                                    |       | 891,311                   |       | 490,033                   |       |
| Trade accounts receivable, net                                                                                                                                   |       | 17,173,985                |       | 16,236,137                |       |
| Inventories, net                                                                                                                                                 |       | 5,232,275                 |       | 4,296,574                 |       |
| Deferred tax asset, net                                                                                                                                          |       | 767,794                   |       | 916,259                   |       |
| Prepaid taxes                                                                                                                                                    |       | 31,288                    |       | 19,737                    |       |
| Prepaid expenses and other assets                                                                                                                                |       | 895,144                   |       | 517,757                   |       |
| Total current assets                                                                                                                                             |       | 25,143,118                |       | 22,879,415                |       |
|                                                                                                                                                             |       |                      |       |                      |       |
| Noncurrent assets:                                                                                                                                               |       |                      |       |                      |       |
| Goodwill                                                                                                                                                         |       | 26,351,199                |       | 26,365,093                |       |
| Intangible assets, net                                                                                                                                           |       | 265,435                   |       | 104,042                   |       |
| Net investment in sales-type leases, less current portion above                                                                                                  |       | 136,519                   |       | 136,493                   |       |
| Property, plant & equipment, net                                                                                                                        |       | 10,601,999                |       | 10,610,820                |       |
| Total noncurrent assets                                                                                                                                          |       | 37,355,152                |       | 37,216,448                |       |
|                                                                                                                                                             |       |                      |       |                      |       |
| Total assets                                                                                                                                                     |       | $                         | 62,498,270 |                      | $          | 60,095,863 |   |
|                                                                                                                                                             |       |                      |       |                      |       |
| LIABILITIES  AND SHAREHOLDERS’ EQUITY                                                                                                                       |       |
|                                                                                                                                                             |       |                      |       |                      |       |
| Current liabilities:                                                                                                                                             |       |                      |       |                      |       |
| Current portion of long-term debt                                                                                                                                |       | $                         | 171,123    |                      | $          | 171,123 |   |
| Revolving line of credit                                                                                                                                         |       | 4,818,748                 |       | 2,758,660                 |       |
| Accounts payable                                                                                                                                                 |       | 5,718,712                 |       | 5,670,240                 |       |
| Current unearned revenue                                                                                                                                         |       | 2,692,798                 |       | 2,212,247                 |       |
| Accrued liabilities                                                                                                                                              |       | 2,833,502                 |       | 3,565,031                 |       |
| Total current liabilities                                                                                                                                        |       | 16,234,883                |       | 14,377,301                |       |
|                                                                                                                                                             |       |                      |       |                      |       |
| Noncurrent liabilities:                                                                                                                                          |       |                      |       |                      |       |
| Long-term debt, less current portion above                                                                                                                       |       | 1,311,759                 |       | 1,354,530                 |       |
| Accrued long-term liability                                                                                                                                      |       | 177,700                   |       | 211,300                   |       |
| Noncurrent unearned service revenue                                                                                                                              |       | 80,245                    |       | 81,650                    |       |
| Noncurrent deferred tax liability, net                                                                                                                           |       | 4,716,526                 |       | 4,631,917                 |       |
| Total noncurrent liabilities                                                                                                                                     |       | 6,286,230                 |       | 6,279,397                 |       |
|                                                                                                                                                             |       |                      |       |                      |       |
| Contingencies                                                                                                                                                    |       |                      |       |                      |       |
|                                                                                                                                                             |       |                      |       |                      |       |
| Shareholders’ equity:                                                                                                                                       |       |                      |       |                      |       |
| Preferred stock; $.10 par value; 50,000 shares authorized, 0 issued                                                                                              |       | —                    |       | —                    |       |
| Common stock; $.001 par value; 50,000,000 shares authorized,  11,273,098 and 11,233,529 issued at January 31, 2008 and  October 31, 2007, respectively |       | 11,272                    |       | 11,233                    |       |
| Paid-in capital                                                                                                                                                  |       | 13,300,844                |       | 13,189,311                |       |
| Retained earnings                                                                                                                                                |       | 28,872,509                |       | 28,483,280                |       |
| Less treasury stock, at cost (1,001,883 shares at January 31,  2008 and 1,018,788 October 31, 2007)                                                    |       | (2,207,468                | )          | (2,244,659                | )          |
| Total shareholders’ equity                                                                                                                                  |       | 39,977,157                |       | 39,439,165                |       |
| Total liabilities and shareholders’ equity                                                                                                                  |       | $                         | 62,498,270 |                      | $          | 60,095,863 |   |

 

The accompanyingnotes are an integral part of these consolidated balance sheets.

 

 

3

----

 

 

XETA TECHNOLOGIES,INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF OPERATIONS

(UNAUDITED)

 
| ** **                                        | ** ** | **For the Three Months   Ended January 31,** | ** ** |
|---------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                        | ** ** | **2008**                                          | ** ** | **2007** | ** ** |
|                                              |       |                                              |       |   |   |
| Systems sales                                     |       | $                                                 | 7,714,159  |   | $ | 7,026,848 |   |
| Services                                          |       | 9,724,942                                         |       | 8,776,763 |   |
| Other revenues                                    |       | 510,634                                           |       | 247,068 |   |
| Net sales and service revenues                    |       | 17,949,735                                        |       | 16,050,679 |   |
|                                              |       |                                              |       |   |   |
| Cost of systems sales                             |       | 5,786,822                                         |       | 5,307,829 |   |
| Services costs                                    |       | 7,130,924                                         |       | 6,348,097 |   |
| Cost of other  revenues & corporate COGS |       | 441,379                                           |       | 443,140 |   |
| Total cost of sales and service                   |       | 13,359,125                                        |       | 12,099,066 |   |
|                                              |       |                                              |       |   |   |
| Gross profit                                      |       | 4,590,610                                         |       | 3,951,613 |   |
|                                              |       |                                              |       |   |   |
| Operating expenses                                |       |                                              |       |   |   |
| Selling, general and administrative               |       | 3,662,262                                         |       | 3,528,410 |   |
| Amortization                                      |       | 202,898                                           |       | 140,277 |   |
| Total operating expenses                          |       | 3,865,160                                         |       | 3,668,687 |   |
|                                              |       |                                              |       |   |   |
| Income from operations                            |       | 725,450                                           |       | 282,926 |   |
|                                              |       |                                              |       |   |   |
| Interest expense                                  |       | (102,985                                          | )          | (10,387 | ) |
| Interest and other income                         |       | 17,764                                            |       | 17,571 |   |
| Total interest and other income (expense)         |       | (85,221                                           | )          | 7,184 |   |
|                                              |       |                                              |       |   |   |
| Income before provision  for income taxes         |       | 640,229                                           |       | 290,110 |   |
| Provision for income taxes                        |       | 251,000                                           |       | 120,000 |   |
|                                              |       |                                              |       |   |   |
| Net income                                        |       | $                                                 | 389,229    |   | $ | 170,110 |   |
|                                              |       |                                              |       |   |   |
| Earnings per share                                |       |                                              |       |   |   |
| Basic                                             |       | $                                                 | 0.04       |   | $ | 0.02 |   |
|                                              |       |                                              |       |   |   |
| Diluted                                           |       | $                                                 | 0.04       |   | $ | 0.02 |   |
|                                              |       |                                              |       |   |   |
| Weighted average shares  outstanding              |       | 10,224,971                                        |       | 10,214,741 |   |
|                                              |       |                                              |       |   |   |
| Weighted average  equivalent shares               |       | 10,249,693                                        |       | 10,214,741 |   |

 

The accompanyingnotes are an integral part of these consolidated financial statements.

 

 

4

----

 

XETA TECHNOLOGIES, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY

(UNAUDITED)

 
| ** **                              | ** ** | **Common  Stock** | ** ** | ** ** | ** ** | ** **          | ** ** | ** **  | ** ** | ** **   | ** ** |
|-----------------------------------------|------------|-------------------|------------|------------|------------|---------------------|------------|-------------|------------|--------------|------------|
| ** **                              | ** ** | **Shares**        | ** ** | **Par**    | ** ** | **Treasury  Stock** | ** ** | **Paid-in** | ** ** | **Retained** | ** ** | ** ** | ** ** |
| ** **                              | ** ** | **Issued**        | ** ** | **Value**  | ** ** | **Shares**          | ** ** | **Amount**  | ** ** | **Capital**  | ** ** | **Earnings** | ** ** | **Total** | ** ** |
|                                    |       |              |       |       |       |                |       |        |       |         |       |   |   |   |   |
| Balance- October 31, 2007          |       | 11,233,529        |       | $          | 11,233     |                | 1,018,788  |        | $          | (2,244,659   | )          | $ | 13,189,311 |   | $ | 28,483,280 |   | $ | 39,439,165 |   |
|                                    |       |              |       |       |       |                |       |        |       |         |       |   |   |   |   |
| Stock options exercised $.001 par value |       | 22,664            |       | 22         |       | —              |       | —      |       | 90,193       |       | — |   | 90,215 |   |
| Issuance of restricted common stock     |       | 16,905            |       | 17         |       | (16,905             | )          | 37,191      |       | (37,208      | )          |   |   | — |   |
| Tax benefit of stock options            |       | —            |       | —     |       | —              |       | —      |       | 4,032        |       | — |   | 4,032 |   |
| Stock based compensation                |       | —            |       | —     |       | —              |       | —      |       | 54,516       |       | — |   | 54,516 |   |
|                                    |       |              |       |       |       |                |       |        |       |         |       |   |   |   |   |
| Net Income                              |       | —            |       | —     |       | —              |       | —      |       | —       |       | 389,229 |   | 389,229 |   |
|                                    |       |              |       |       |       |                |       |        |       |         |       |   |   |   |   |
| Balance- January 31, 2008          |       | 11,273,098        |       | $          | 11,272     |                | 1,001,883  |        | $          | (2,207,468   | )          | $ | 13,300,844 |   | $ | 28,872,509 |   | $ | 39,977,157 |   |

 

The accompanyingnotes are an integral part of this consolidated financial statement.

 

 

5

----

 

XETA TECHNOLOGIES, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

 
| ** **                                                                                             | ** ** | **For the Three Months   Ended January 31,** | ** ** |
|--------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------|------------|
|                                                                                                   |       | **2008**                                          | ** ** | **2007** |   |
| Cash flows from operating  activities:                                                                 |       |                                              |       |   |   |
| Net income                                                                                             |       | $                                                 | 389,229    |   | $ | 170,110 |   |
|                                                                                                   |       |                                              |       |   |   |
| Adjustments to reconcile net income to net cash provided by operating  activities:                     |       |                                              |       |   |   |
| Depreciation                                                                                           |       | 166,810                                           |       | 123,102 |   |
| Amortization                                                                                           |       | 202,899                                           |       | 140,277 |   |
| Stock based compensation                                                                               |       | 54,516                                            |       | 23,935 |   |
| Loss (gain) on sale of assets                                                                          |       | 425                                               |       | (5,000 | ) |
| Provision for excess and obsolete inventory                                                            |       | 25,500                                            |       | 25,500 |   |
| Increase in deferred tax liability                                                                     |       | 102,535                                           |       | 146,243 |   |
| Change in assets and liabilities, net of acquisitions:                                                 |       |                                              |       |   |   |
| (Increase) decrease in net investment in sales-type leases &  other receivables               |       | (401,304                                          | )          | 168,834 |   |
| (Increase) decrease in trade account receivables                                                       |       | (903,872                                          | )          | 2,269,541 |   |
| (Increase) decrease in inventories                                                                     |       | (931,924                                          | )          | 141,631 |   |
| Decrease (increase) in deferred tax asset                                                              |       | 148,465                                           |       | (26,242 | ) |
| (Increase) in prepaid expenses and other assets                                                        |       | (377,387                                          | )          | (301,886 | ) |
| (Increase) in prepaid taxes                                                                            |       | (11,551                                           | )          | (9,355 | ) |
| Increase (decrease) in accounts payable                                                                |       | 48,472                                            |       | (480,320 | ) |
| Increase in unearned revenue                                                                           |       | 404,992                                           |       | 469,847 |   |
| (Decrease) increase in accrued liabilities and lease payable                                           |       | (949,438                                          | )          | 65,707 |   |
| Total adjustments                                                                                      |       | (2,420,862                                        | )          | 2,751,814 |   |
|                                                                                                   |       |                                              |       |   |   |
| Net cash (used in) provided by operating activities                                                    |       | (2,031,633                                        | )          | 2,921,924 |   |
|                                                                                                   |       |                                              |       |   |   |
| Cash flows from investing  activities:                                                                 |       |                                              |       |   |   |
| Additions to property, plant & equipment                                                      |       | (327,496                                          | )          | (279,343 | ) |
| Proceeds from sale of assets                                                                           |       |                                              |       | 5,000 |   |
| Net cash used in investing activities                                                                  |       | (327,496                                          | )          | (274,343 | ) |
|                                                                                                   |       |                                              |       |   |   |
| Cash flows from financing  activities:                                                                 |       |                                              |       |   |   |
| Proceeds from draws on revolving line of credit                                                        |       | 11,114,434                                        |       | 5,461,702 |   |
| Principal payments on debt                                                                             |       | (42,771                                           | )          | (42,773 | ) |
| Payments on revolving line of credit                                                                   |       | (9,054,346                                        | )          | (7,836,062 | ) |
| Exercise of stock options                                                                              |       | 90,215                                            |       |   |   |
| Net cash provided by (used in) financing activities                                                    |       | 2,107,532                                         |       | (2,417,133 | ) |
|                                                                                                   |       |                                              |       |   |   |
| Net (decrease) increase in cash and cash equivalents                                                   |       | (251,597                                          | )          | 230,448 |   |
|                                                                                                   |       |                                              |       |   |   |
| Cash and cash equivalents,  beginning of period                                                        |       | 402,918                                           |       | 174,567 |   |
| Cash and cash equivalents,  end of period                                                              |       | $                                                 | 151,321    |   | $ | 405,015 |   |
|                                                                                                   |       |                                              |       |   |   |
| Supplemental disclosure of  cash flow information:                                                     |       |                                              |       |   |   |
|                                                                                                   |       |                                              |       |   |   |
| Cash paid during the period for interest, net of amount capitalized  of $0 in 2008 and $64,652 in 2007 |       | $                                                 | 97,220     |   | $ | 29,226 |   |
| Cash paid during the period for income taxes                                                           |       | $                                                 | 11,519     |   | $ | 9,355 |   |

 

The accompanying notes are an integral part of these consolidatedfinancial statements.

 

6

----

 

**XETATECHNOLOGIES, INC. AND SUBSIDIARY**

**Notesto Consolidated Financial Statements**

**January 31,2008**

(Unaudited)

 

1.  BASIS OF PRESENTATION:

 

XETA Technologies, Inc.(“XETA” or the “Company”) is a leading provider of communications solutionswith nationwide sales and service. XETA serves a diverse group of businessclients in sales, engineering, project management, installation, and servicesupport.  The Company sells productsproduced by a variety of manufacturers including Avaya, Inc. (“Avaya”),Nortel Networks Corporation (“Nortel”), and Mitel Corporation (“Mitel”).  In addition, the Company manufactures andmarkets a line of proprietary call accounting systems to the hospitalityindustry.  XETA is an Oklahomacorporation.

 

The Company prepared theaccompanying unaudited consolidated financial statements pursuant to the rules andregulations of the Securities and Exchange Commission (the “Commission”).  Certain information and footnote disclosuresnormally included in annual financial statements prepared in accordance withaccounting principles generally accepted in the United States of America havebeen condensed or omitted pursuant to those rules and regulations,although the Company believes that the disclosures made are adequate to makethe information presented not misleading. It is suggested that these condensed financial statements be read inconjunction with the consolidated financial statements and the notes theretomade a part of the Company’s Annual Report on Form 10-K, Commission File No. 0-16231,which was filed with the Commission on January 7, 2008.  Management believes that the financialstatements contain all adjustments necessary for a fair statement of theresults for the interim periods presented. All adjustments made were of a normal recurring nature.  The results of operations for the interimperiod are not necessarily indicative of the results for the entire fiscalyear.

 

Segment Information

 

The Company has threereportable segments:  services,commercial system sales, and lodging system sales.  Services revenues represent revenues earnedfrom installing and maintaining systems for customers in both the commercialand lodging segments.  The Companydefines commercial system sales as sales to the non-lodging industry.

 

The reporting segmentsfollow the same accounting policies used for the Company’s consolidatedfinancial statements and described in the Summary of Significant AccountingPolicies in the Company’s Form 10-K described above.  Company management evaluates a segment’sperformance based on 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 January 31,2008 and 2007.

 
| ** **    | ** ** | **Services  Revenues** | ** ** | **Commercial  Systems  Sales** | ** ** | **Lodging  Systems  Sales** | ** ** | **Other  Revenue** | ** ** | **Total**   | ** ** |
|---------------|------------|------------------------|------------|--------------------------------|------------|-----------------------------|------------|--------------------|------------|-------------|------------|
| **2008**      | ** ** | ** **             | ** ** | ** **                     | ** ** | ** **                  | ** ** | ** **         | ** ** | ** **  | ** ** |
| Sales         |       | $                      | 9,724,942  |                           | $          | 6,029,935                   |       | $                  | 1,684,224  |        | $          | 510,634 |   | $ | 17,949,735 |   |
| Cost of sales |       | (7,130,924             | )          | (4,601,659                     | )          | (1,185,163                  | )          | (441,379           | )          | (13,359,125 | )          |
| Gross profit  |       | $                      | 2,594,018  |                           | $          | 1,428,276                   |       | $                  | 499,061    |        | $          | 69,255 |   | $ | 4,590,610 |   |
|          |       |                   |       |                           |       |                        |       |               |       |        |       |
| **2007**      | ** ** | ** **             | ** ** | ** **                     | ** ** | ** **                  | ** ** | ** **         | ** ** | ** **  | ** ** |
| Sales         |       | $                      | 8,776,763  |                           | $          | 5,252,398                   |       | $                  | 1,774,450  |        | $          | 247,068 |   | $ | 16,050,679 |   |
| Cost of sales |       | (6,348,097             | )          | (3,984,231                     | )          | (1,323,598                  | )          | (443,140           | )          | (12,099,066 | )          |
| Gross profit  |       | $                      | 2,428,666  |                           | $          | 1,268,167                   |       | $                  | 450,852    |        | $          | (196,072 | ) | $ | 3,951,613 |   |

 

 

7

----

 

Stock-Based CompensationPlans

The Company accounts for stock based compensation in accordance with Statementof Financial Accounting Standards No. 123 (revised 2004), “Share-BasedPayment” (“SFAS 123(R)”).  SFAS 123(R) requirescompanies to measure all employee stock-based compensation awards using a fairvalue method and recognize compensation cost in its financial statements.  The valuation provisions of SFAS 123(R) applyto new awards and to awards that are outstanding at the effective date andsubsequently modified or cancelled.  TheCompany adopted on a prospective basis SFAS 123(R) beginning November 1,2005 for stock-based compensation awards granted after that date and forunvested awards outstanding at that date using the modified prospectiveapplication method.  The Companyrecognizes the fair value of stock-based compensation awards as selling,general and administrative expense as appropriate in the consolidatedstatements of operations on a straight-line basis over the vesting period.  Compensation expense was recognized in thestatement of operations as follows:

 

| ** **                          | ** ** | **2008** | ** ** | **2007** | ** ** |
|-------------------------------------|------------|----------|------------|----------|------------|
| Three months ended January 31, |       | $        | 54,516     |     | $          | 23,935 |   |
|                                     |            |          |            |          |            |  |  |

 

Use of Estimates

 

The preparation offinancial statements in conformity with accounting principles generallyaccepted in the U.S. requires management to make estimates and assumptions thataffect the reported amounts of assets and liabilities and disclosure ofcontingent assets and liabilities at the date of the financial statements andthe reported amounts of revenues and expenses during the reporting period.  Actual results could differ from thoseestimates.

 

New Accounting Pronouncements

 

In June 2006, theFASB issued Interpretation No. 48 (“FIN 48”), Accounting for Uncertaintyin Income Taxes—an interpretation of FASB Statement No. 109, to clarifycertain aspects of accounting for uncertain tax positions, including issuesrelated to the recognition and measurement of those tax positions.  The Company adopted this interpretation on November 1,2007 and there was no impact to the Company’s financial statements.

 

In December 2007,the FASB issued SFAS No. 141 (revised 2007), “Business Combinations” (SFASNo. 141(R)). Under SFAS No. 141(R), an entity is required torecognize the assets acquired, liabilities assumed, contractual contingencies,and contingent consideration at their fair value on the acquisition date. Itfurther requires that acquisition-related costs are recognized separately fromthe acquisition and expensed as incurred, restructuring costs generally beexpensed in periods subsequent to the acquisition date, and changes inaccounting for deferred tax asset valuation allowances and acquired income taxuncertainties after the measurement period impact income tax expense.  The adoption of SFAS No. 141(R) willchange the accounting treatment for business combinations on a prospectivebasis beginning in the first quarter of fiscal year 2010.

 

In December 2007,the FASB issued SFAS No. 160, “Noncontrolling Interests in ConsolidatedFinancial Statements—an amendment of ARB No. 51” (SFAS No. 160).  SFAS No. 160 changes the accounting andreporting for minority interests, which will be recharacterized asnon-controlling interests and classified as a component of equity.  SFAS No. 160 is effective for us on aprospective basis for business combinations with an acquisition date beginningin the first quarter of fiscal year 2010. As of January 31, 2008, the Company did not have any minorityinterests, therefore the adoption of SFAS No. 160 is not expected to havean impact on our consolidated financial statements.

 

8

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2.  ACCOUNTS RECEIVABLE:

 
| ** **                         | ** ** | **January 31,  2008** | ** ** | **(Audited)  October 31,  2007** | ** ** |
|------------------------------------|------------|----------------------------|------------|---------------------------------------|------------|
|                               |       |                       |       |                                  |       |
| Trade receivables                  |       | $                          | 17,327,095 |                                  | $          | 16,411,981 |   |
| Less reserve for doubtful accounts |       | (153,110                   | )          | (175,844                              | )          |
| Net trade receivables              |       | $                          | 17,173,985 |                                  | $          | 16,236,137 |   |

 

3.  INVENTORIES:

 

Inventoriesare stated at the lower of cost (first-in, first-out or average) or market andconsist of the following:

 
| ** **                                        | ** ** | **January 31,  2008** | ** ** | **(Audited)  October 31,  2007** | ** ** |
|---------------------------------------------------|------------|----------------------------|------------|---------------------------------------|------------|
|                                              |       |                       |       |                                  |       |
| Finished goods and spare parts                    |       | $                          | 6,023,867  |                                  | $          | 5,068,227 |   |
| Less- reserve for excess and obsolete inventories |       | (791,592                   | )          | (771,653                              | )          |
| Total inventories, net                            |       | $                          | 5,232,275  |                                  | $          | 4,296,574 |   |

 

4.  PROPERTY, PLANT AND EQUIPMENT:

 

Property, plant andequipment consists of the following:

 
| ** **                                                    | ** ** | **Estimated  Useful  Lives** | ** ** | **January 31,  2008** | ** ** | **(Audited)  October 31,  2007** | ** ** |
|---------------------------------------------------------------|------------|------------------------------|------------|----------------------------|------------|---------------------------------------|------------|
|                                                          |       |                         |       |                       |       |                                  |       |
| Building and building improvements                            |       | 3-20                         |       | $                          | 2,729,604  |                                  | $          | 2,686,753 |   |
| Data processing and computer field equipment                  |       | 2-7                          |       | 2,643,296                  |       | 2,556,878                             |       |
| Software development costs, work-in-process                   |       | N/A                          |       | 3,869,749                  |       | 3,792,567                             |       |
| Software development costs of components placed Into  service |       | 3-10                         |       | 4,442,988                  |       | 4,355,953                             |       |
| Hardware                                                      |       | 3-5                          |       | 599,751                    |       | 599,751                               |       |
| Land                                                          |       | —                       |       | 611,582                    |       | 611,582                               |       |
| Office furniture                                              |       | 5-7                          |       | 954,944                    |       | 947,094                               |       |
| Auto                                                          |       | 5                            |       | 528,793                    |       | 539,184                               |       |
| Other                                                         |       | 3-7                          |       | 253,193                    |       | 239,533                               |       |
|                                                          |       |                         |       |                       |       |                                  |       |
| Total property, plant and equipment                           |       |                         |       | 16,633,900                 |       | 16,329,295                            |       |
| Less- accumulated depreciation                                |       |                         |       | (6,031,901                 | )          | (5,718,475                            | )          |
|                                                          |       |                         |       |                       |       |                                  |       |
| Total property, plant and equipment, net                      |       |                         |       | $                          | 10,601,999 |                                  | $          | 10,610,820 |   |

 

Interest costs related toan investment in long-lived assets are capitalized as part of the cost of theasset during the period the asset is being prepared for use.  The Company capitalized $0 and $64,652 ininterest costs in the three months ended January 31, 2008 and 2007,respectively.

 

 

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5.  INCOME TAXES:

 

The Company has recordeda tax provision of $251,000 or 39% and $120,000 or 41% for the three monthsended January 31, 2008 and 2007, respectively, reflecting the statutoryfederal tax rate of 34% plus a blended state income tax rate of approximately5% and the impact of minimum income tax payments in certain states.  The Company currently estimates its annualeffective income tax rate to be approximately 40% for fiscal 2008, compared toa 40% effective income tax rate in fiscal 2007.

 

6.  CREDIT AGREEMENTS:

 

The Company’s creditfacility consists of a revolving credit and term loan agreement with acommercial bank including a mortgage agreement maturing on September 30,2009 and amortizing based on a 13 year life and a $7.5 million revolving creditagreement to finance growth in working capital. Trade accounts receivable and inventories collateralize the revolvingline of credit At January 31, 2008 and October 31, 2007, the Companyhad approximately $4.819 million and $2.759 million, respectively, outstandingon the revolving line of credit.  TheCompany had approximately $2.7 million available under the revolving line ofcredit at January 31, 2008.  Advancerates are defined in the agreement, but are generally at the rate of 80% onqualified trade accounts receivable and 40% of qualified inventories.  The revolving line of credit matures on September 23,2008.  Long-term debt consisted of thefollowing:

 
| ** **                                                                                                                                                                                                            | ** ** | **January 31,  2008** | ** ** | **(Audited)  October 31,  2007** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------|------------|---------------------------------------|------------|
|                                                                                                                                                                                                                  |       |                       |       |                                  |       |
| 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 |       | $                          | 1,482,882  |                                  | $          | 1,525,653 |   |
|                                                                                                                                                                                                                  |       |                       |       |                                  |       |
| Less-current maturities                                                                                                                                                                                               |       | 171,123                    |       | 171,123                               |       |
|                                                                                                                                                                                                                  |       |                       |       |                                  |       |
| Total long-term debt, less current maturities                                                                                                                                                                         |       | $                          | 1,311,759  |                                  | $          | 1,354,530 |   |

 

Interest on alloutstanding debt under the credit facility accrues at either a) the LondonInterbank Offered Rate (3.14% at January 31, 2008) plus 1.25% to 2.75% dependingon the Company’s funded debt to cash flow ratio, or b) the bank’s prime rate(6.0% at January 31, 2008) minus 0% to minus 1.125% also depending on theCompany’s funded debt to cash flow ratio. At January 31, 2008, the Company was paying 4.875% on the revolvingline of credit borrowings and 6.1% on the mortgage note.  The credit facility contains severalfinancial covenants common in such agreements, including tangible net worthrequirements, 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 January 31, 2008.

 

7.  EARNINGS PER SHARE:

 

Dividing net income bythe weighted average number of shares of common stock outstanding during thereporting periods computes basic earnings per common share.  Dividing net income by the weighted averagenumber of shares of common stock and dilutive potential common stockoutstanding during the reporting periods computes diluted earnings per commonshare.  A reconciliation of net incomeand weighted average shares used in computing basic and diluted earnings pershare is as follows:

 

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| ** **                        | ** ** | **For the Three Months Ended January 31, 2008** | ** ** |
|-----------------------------------|------------|------------------------------------------------------|------------|
| ** **                        | ** ** | **Income  (Numerator)**                              | ** ** | **Shares  (Denominator)** | ** ** | **Per Share  Amount** | ** ** |
| Basic EPS                         |       |                                                 |       |   |   |   |   |
| Net income                        |       | $                                                    | 389,229    |   | 10,224,971 |   | $ | 0.04 |   |
| Dilutive effect  of stock options |       |                                                 |       | 24,722 |   |   |   |
|                              |       |                                                 |       |   |   |   |   |
| Diluted EPS                       |       |                                                 |       |   |   |   |   |
| Net income                        |       | $                                                    | 389,229    |   | 10,249,693 |   | $ | 0.04 |   |

 
| ** **                        | ** ** | **For the Three Months Ended January 31, 2007** | ** ** |
|-----------------------------------|------------|------------------------------------------------------|------------|
| ** **                        | ** ** | **Income  (Numerator)**                              | ** ** | **Shares  (Denominator)** | ** ** | **Per Share  Amount** | ** ** |
| Basic EPS                         |       |                                                 |       |   |   |   |   |
| Net income                        |       | $                                                    | 170,110    |   | 10,214,741 |   | $ | 0.02 |   |
| Dilutive effect  of stock options |       |                                                 |       | — |   |   |   |
|                              |       |                                                 |       |   |   |   |   |
| Diluted EPS                       |       |                                                 |       |   |   |   |   |
| Net income                        |       | $                                                    | 170,110    |   | 10,214,741 |   | $ | 0.02 |   |

 

Options to purchase774,900 shares of common stock at an average exercise price of $8.43 and1,104,068  shares of common stock at anaverage exercise price of $7.18 were not included in the computation of dilutedearnings per share for the three months ended January 31, 2008 and 2007,respectively, because inclusion of these options would be antidilutive.

 

 

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**ITEM2.  MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

**Preliminary Note RegardingForward-Looking Statements**

 

In the followingdiscussion, we make forward-looking statements about future events, performanceand results.  Such statements are notguarantees of performance, but rather reflect our current expectations,estimates, and forecasts about the industry and markets where we operate, basedon information 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 that are difficult to predict or are beyond our control, such ascustomer demand for advanced communications products; capital spending trendswithin our market; delays in installation schedules for the Miami-Dade CountyPublic School District orders; our ability to successfully develop the Mitel productand services offering; the financial condition of our suppliers and changes intheir distribution strategies and support; technological changes; fluctuatingmargins and product mix; failure to expand our wholesale service relationships;the ability to attract and retain highly skilled personnel and technicalcompetencies; and intense competition. These and other risks and uncertainties are discussed under the heading “RiskFactors” under Part I of the Company’s Form 10-K for the fiscal yearended October 31, 2007 (filed with the Commission on January 7,2008), and in updates to such risk factors set forth in Item 1A of Part IIof this quarterly report.  Because ofthese risks and uncertainties, actual results may differ materially andadversely from those expressed in forward-looking statements.  Consequently, we caution investors to readand consider all forward-looking statements in conjunction with such riskfactors and uncertainties.  The PrivateSecurities Litigation Reform Act of 1995 provides a safe-harbor forforward-looking statements made by the Company.

 

# **Overview**

# ** **

Strategy.

In fiscal 2008, we willcontinue to focus on three primary strategies: acquire, penetrate, and retain targeted customers; expand our wholesaleservice offerings; and improve alignment with our major business partners.

 

Our sales efforts targetlarge, multi-location, national, or super-regional customers.  Our national technical footprint and 24/7/365call center are complimentary to the needs of these customers.  Additionally, these larger enterprises oftenhave a mixture of manufacturer platforms within their communications equipmentportfolio and our ability to sell and service both the Avaya and Nortel productlines is an important competitive advantage. Additionally, because of our extensive array of products and services,we enjoy multiple sales opportunities with these customers.  These include new product sales,implementation of advanced applications, and a variety of potential servicerelationships.  Once we establish arelationship with a customer, we search for opportunities to penetrate deeperinto the account.  We do this byassessing the customer’s needs, proposing appropriate technologies,establishing or expanding the service relationship, and proposing equipment andservice solutions to other divisions or subsidiaries.

 

We launched our wholesaleservice offering in fiscal 2006 and its success was a key factor in our fiscal2007 revenue growth and a significant contributor to our recurringrevenues.  Under this service offering,we partner with manufacturers, network service providers and systemsintegrators to provide services to their end-user customers.  In many instances, we provide field resourcesto carry out service responsibilities. However, under a full outsourcing arrangement we may provide a broaderrange of services, including call center support, remote technical support,on-site labor and spare parts to a particular end-user.  Our entry into the wholesale services markethas been successful because we provide excellent service to end-user customersand demonstrate a willingness to create and execute flexible service programsand billing arrangements.  The continuedsuccess of this strategic initiative is a vital ingredient to our long-termgoal of shifting our revenue mix toward more recurring services revenues.

 

Finally, we strive toalign our company’s sales, marketing, and services programs with those of ourmanufacturing partners.  Avaya and Nortelapproach the communications technology market differently and therefore we haveassigned separate executive sales management to each manufacturer’s productsand services.  Our Avaya sales andmarketing efforts focus on partnering with the Avaya national sales force to 

 

 

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sell equipment to largeand medium sized enterprises and to sell Avaya implementation and post-warrantymaintenance contracts.  Our Nortelinitiatives focus on creating relationships with Nortel’s regional salesmanagement to sell equipment and applications. In addition, we work to deepen our relationships with key Nortelservices decision makers to create wholesale service offerings for large Nortelend-users.  Since starting thisinitiative in late fiscal 2006, we have significantly improved ourrelationships and penetration with both Nortel and Avaya, the result is ademonstrable increase in equipment and services revenues.

 

Effective November 1,2007, we completed the acquisition of the commercial division of HCITechnologies, Inc. (“HCI”)  Underthe terms of the acquisition, we assumed the service responsibilities and theassociated revenue stream with all of HCI’s non-Federal governmentcustomers.  No cash was paid at closing;however, in exchange for the assets and customer relationships purchased, weagreed to pay HCI a portion of the gross profits earned from the servicerelationships in place at closing.  Thesepayments continue on a quarterly basis for three years.  Before the acquisition, the Companyoccasionally engaged HCI as a third-party contractor to provide technicalservices to our customers.  At the close,HCI owed XETA $43,000 in accounts receivable plus accrued interest of$6,800.  The terms of the acquisitionagreementallow us to deduct these amounts from any earn-out payments.  We have recorded the assets acquired,including an intangible asset related to the value of the customerrelationships, at their fair values on the date of acquisition.  We have also recorded an initial estimate ofthe earn-out liability.  The assetsacquired in this transaction were not material to our financial statements.

 

OperatingSummary.

Inthe first quarter of fiscal 2008, we earned net income of $389,000 on revenuesof $17.9 million compared to net income of $170,000 on revenues of $16.1million in the first quarter of last year. These results reflect our successful execution of the strategiesdiscussed above and other contributing factors that we discuss in more detailunder “Results of Operations” below.

 

FinancialPosition Summary.

Ourfinancial condition was relatively unchanged during the first quarter of fiscal2008.  Our working capital increasedapproximately 5%; however temporary growth in our receivables and inventorybalances resulted in increased borrowings on our working capital revolver inthe first quarter of fiscal 2008.  Wediscuss these and other financial items in more detail under “FinancialCondition” below.

 

Thefollowing discussion presents additional information regarding our financialcondition and results of operations for the three month period ended January 31,2008 and 2007 and should be read in conjunction with our comments above as wellas the “Risk Factors” section below.

 

# **Financial Condition**

# ** **

Cashused by operations for the three months ended January 31, 2008 was $2.0million.  Increases in accountsreceivable and inventories were partially offset by net income and non-cashcharges resulting in the cash deficit in the first quarter.  During the quarter, our accounts receivablebalances grew by approximately $904,000 reflecting temporary declines in thepace of completion and billing of complex equipment projects.  These delays reflect the surge in systemsshipped toward the end of fiscal 2007 coupled with the complexity of many ofthose systems, which delayed final customer acceptance, and billing of thesystems.  Another contributing factor tothe increase in accounts receivable was the initiation of our large projectwith the Miami-Dade County Public Schools (“M-DCPS”).  We expect this project to produce over $10million in revenues during fiscal 2008. In the first quarter, we began installing the systems shipped at the endof fiscal 2007.  Shipments andinstallations continued to accelerate throughout the quarter to meet thecustomer’s expectations.  The billing andcollecting of these projects is a complicated process requiring funding fromboth M-DCPS and the Federal government. While we do not expect any prolonged difficulties regarding thecollection of M-DCPS receivables, navigating through the complexities of theinitial billing and collections cycle negatively affected our first quartercash flows.

 

Inaddition to the cash used by operations, we invested approximately $327,000 incapital projects, including $163,000 in equipment and fixtures, as part of ournormal replacement and refurbishment cycles. Additionally, we invested $164,000 in the continued implementation ofOracle’s eBusiness Suite..  Early in thesecond fiscal quarter of fiscal 2008, we completed the cutover of the lastportion of our functional

 

 

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operationsto the platform.  During the remainder ofthe year, we expect to implement additional features including, salesmanagement, customer relationship management, and an online service ticketinitiation and tracking system.

 

At January 31, 2008 our total borrowings were $6.3 million,consisting of a mortgage on our headquarters building of $1.5 million and $4.8million due on our revolving line of credit. At January 31, 2008 there was $2.7 million available under therevolver to meet working capital needs. We believe that the current amount of working capital available underour revolving line of credit will be sufficient to meet our needs for theremainder of fiscal 2008.  In addition,we believe that we could arrange supplemental short-term financing underacceptable terms and prices should the need arise.

 

There have been no stock repurchases to date under the repurchaseprogram 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.

 

The table below presentsour contractual obligations at January 31, 2008 as well as paymentobligations over the next five years:

 
| ** **                  | ** ** | ** ** | ** ** | **Payments due by period** | ** ** |
|-----------------------------|------------|------------|------------|----------------------------|------------|
| **Contractual Obligations** | ** ** | **Total**  | ** ** | **Less than  1 year**      | ** ** | **2 — 3  Years** | ** ** | **4 — 5  Years** | ** ** |
| Long-term debt              |       | $          | 1,619,905  |                       | $          | 256,815 |   | $ | 1,363,090 |   | $ | — |   |
| Operating leases            |       | 601,715    |       | 316,849                    |       | 281,809 |   | 3,057 |   |
| Total                       |       | $          | 2,221,620  |                       | $          | 573,664 |   | $ | 1,644,899 |   | $ | 3,057 |   |

 

# **Results of Operations**

# ** **

Inthe first quarter of fiscal 2008, our revenues increased $1.9 million or 12%compared to the first quarter last year and our net income increased $219,000or 129%.  These positive results reflectimprovements in all of our major revenue categories, partially offset by lowergross profit margins on services revenues and higher operating costs.  The narrative below provides furtherexplanation of these results.

 

ServicesRevenues.

Servicesrevenues consist of the following:

 
| ** **                  | ** ** | **For the Three Months Ended   January 31,** | ** ** |
|-----------------------------|------------|---------------------------------------------------|------------|
| ** **                  | ** ** | **2008**                                          | ** ** | **2007** | ** ** |
| Contract & T&M |       | $                                                 | 7,208,000  |   | $ | 6,005,000 |   |
| Implementation              |       | 2,042,000                                         |       | 2,132,000 |   |
| Cabling                     |       | 475,000                                           |       | 640,000 |   |
| Total Services revenues     |       | $                                                 | 9,725,000  |   | $ | 8,777,000 |   |

 

Servicesrevenues increased 11% in first quarter of fiscal 2008 compared to last yearand included a 20% increase in contract and time and materials (“T&M”)revenues which was partially offset by decreases in implementation and cablingrevenues of 4% and 26%, respectively. The increase in contract and T&M revenues was generated primarilyfrom new customer relationships secured in the acquisition of HCI which waseffective on November 1, 2007.  Inaccordance with the terms of the acquisition, we assumed the serviceresponsibilities for HCI’s commercial maintenance contracts as well as steppingin HCI’s position on many customer relationships that produce recurring T&Mrevenues.  We did not secure any majororganic additions to our base of new contract maintenance or contracted T&Mcustomers during the first quarter. However, as discussed above under “Strategy”, the pursuit of contractand T&M revenues, particularly under our wholesale service program is a keystrategic initiative in fiscal 2008 and we expect it to be the primary driverof services revenue growth during the 2008 fiscal year.

 

 

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Implementationrevenues were slightly less in the first quarter of fiscal 2008 as compared tolast year, primarily because of a single, large installation project thatoccurred in the first quarter of fiscal 2007. In addition, our first quarter implementation revenues were slightlylower than our expectations due to customer-created delays early in the quarterrelated to the installation of the first set of M-DCPS orders.

 

Cablingrevenues were down approximately 26% compared to the first quarter of fiscal2007 due to construction delays at customer locations.  Frequently, our significant cabling projectsoccur in conjunction with new construction or major renovations.  As is common in the construction industry,delays by other contractors and weather often impact our portion of theproject.

 

SystemsSales

System sales increased approximately 10% in the first quarter of fiscal2008 compared to last year.  Thisincrease reflects a 15% increase in sales of systems to commercial customers.  We achieved this increase despite higher thanexpected seasonal weakness in the quarter and significantly lower sales ofsystems and equipment to the Federal government.  The lower Federal government sales reflectsthe loss of a contract to supply small phone systems to the U.S. Senate as wellas continued budget approval delays by Congress.  Our sales of systems to  lodging customers declined approximately 5%in the first quarter of fiscal 2008 compared to last year reflecting shipmentsdeferred to the second quarter.  OurLodging equipment order rates and backlogs are higher in fiscal 2008 to datecompared to fiscal 2007, giving us confidence that this segment of our businessremains at or above our expectations for the year.  Overall, our system sales continue to be anunpredictable segment of our business as the timing of the receipt of orders,product delivery, and customer installation schedules may fluctuatedramatically.  Systems orders’ backlogstypically range from thirty to forty-five days providing limited visibility offuture results for this line of business.

 

GrossMargins.

Thetable below presents the gross margins earned on our primary revenue streams:

 
| ** **                   | ** ** | **For the Three Months Ended  January 31,** | ** ** |
|------------------------------|------------|--------------------------------------------------|------------|
| **Gross Margins**            | ** ** | **2008**                                         | ** ** | **2007** | ** ** |
| Services revenues            |       | 26.7                                             | %          | 27.7 | % |
| Systems sales                |       | 25.0                                             | %          | 24.5 | % |
| Other revenues               |       | 89.0                                             | %          | 62.1 | % |
| Corporate cost of goods sold |       | -2.2                                             | %          | -2.2 | % |
| Total                        |       | 25.6                                             | %          | 24.6 | % |

 

The decline in gross margins earned on our Services business in thefirst quarter reflects a higher cost structure and lower implementation andcabling revenues.  We experienced higherServices costs in the first quarter of fiscal 2008 due to higher personnelrelated expenses, increased training costs, and the opening of a Servicesbranch office in Miami, FL to support our M-DCPS implementation and Servicesproject.  This higher cost structure,coupled with lower implementation and cabling revenues resulted in the erosionof services margins.  Our two to fouryear target for services gross margins is 30% to 35%. Achieving this target isa key ingredient to establishing long-term profitability for the Company.

 

Gross margins on systems sales in the first quarterwere up slightly over last year and within our 23% to 25% expectations forsystems revenues. The gross margins on systems sold to commercial customerswere down slightly compared to the first quarter of last year due entirely tolower gross margins on sales of systems and equipment to the Federalgovernment.  Gross margins on sales ofsystems to lodging customers were up in the first quarter compared to last yeardue to a favorable mix of larger, more profitable systems sold during thequarter.  We continue to receive strongpricing support from our vendors in the form of project-specific discounts andincentive rebates.  These incentives arematerial to our gross margins and we work diligently to maximize this support; however,no assurance can be given that future support will continue at historicallevels.

 

Afinal component to our gross margins is the margins earned on other revenuesand our corporate cost of goods sold.  Weearn the majority of our other revenues from the sale of Avaya maintenancecontracts on which we earn either a commission or gross profit.  We have no continuing service obligationassociated with these revenues and gross profits.  In the first quarter we enjoyed significantlyincreased commission 

 

 

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revenuesfrom sales of Avaya maintenance contracts and these revenues were material toour overall operating income.  This is anunpredictable revenue stream that depends on the expiration dates of existingcontracts, installation dates of new systems, the customer type as defined byAvaya, and the number of years that customers contract for services.  Consequently, it is unlikely that we cansustain the results enjoyed in the first quarter throughout the fiscalyear.  Other revenues may also includesales and cost of goods sold on equipment or services outside our normalprovisioning processes. These revenues vary significantly in both sales volumeand gross margins earned.  Corporate costof goods sold represents our material logistics and purchasing functions thatsupport all of our revenue segments.

 

OperatingExpenses.

Ourtotal operating expenses increased $196,000 or 5% in the first quarter offiscal 2008 compared to the first quarter of fiscal 2007.  Operating expenses were 21.5% of revenues inthe first quarter compared to 22.9% last year. This improvement in operating expense margins included the absorption of$50,000 in increased amortization expense resulting from increased utilizationof the Company’s Oracle platform.  Inaddition, improved sales and marketing incentives from vendors in the firstquarter offset increases in sales and general and administrative expenses.  The incentives we receive from vendors tosupport the sales and marketing of their products come in the form of paymentsfor growth in sales of their products; reimbursement for specific, pre-approvedmarketing programs; and additions to sales headcount.  The timing of these incentives isunpredictable and frequently we must rely upon suppliers to calculate the valueof the award.  Also, incentive programsand rules are frequently revised, replaced by new programs, or haltedaltogether as manufacturers attempt to influence the behavior of their dealersand respond to market conditions.  Thisunpredictability results in fluctuations in the size and timing of recognitionof these items in our financial statements. Despite these factors, we make every reasonable effort to understand thevarious programs and maximize their benefit. The amount of incentives recognized during our first quarter was higherthan our normal run-rates, and may not be sustainable throughout the remainderof the year.  We have anticipate ouroperating expense margins to decline to between 18% and 20% of revenues overthe next two to four years through economies of scale and improved operatingefficiencies.

 

InterestExpense and Other Income.

Netinterest and other expense was $85,000 in the first quarter of fiscal 2008compared to $7,000 in net other income in the first quarter of fiscal2007.  This increase in expense reflectshigher average borrowings in first quarter as described under “FinancialCondition” above and the discontinuation of capitalizing interest expenserelated to the implementation of Company’s new software platform.

 

TaxProvision.

Werecorded a combined federal and state tax provision of 39% for the firstquarter of fiscal 2008 compared to a tax provision of 41% in the first quarterof fiscal 2007.  The tax provisionreflects the effective federal tax rate plus the composite state income taxrates adjusted for states that require minimum tax payments even if tax lossesare incurred.  Generally, we expect ourtax provision rate to be approximately 40%.

 

**ITEM 3.QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**

 

Market risksrelating to our operations results primarily from changes in interestrates.  We did not use derivativefinancial instruments for speculative or trading purposes during the threemonth period ended January 31, 2008.

 

*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 (3.14% at January 31, 2008) plus 1.25% to 2.75% or the bank’s prime rate (6.0% at January 31, 2008) 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 AND PROCEDURES**

 

*Evaluationof Disclosure Controls and Procedures.* Based on an evaluation conducted as of January 31,2008 by our management, including our Chief Executive Officer (“CEO”) and ourChief Financial Officer 

 

 

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(“CFO”), our CEOand CFO have concluded that our disclosure controls and procedures (as definedin Rules 13a-15(e) and 15d-15(e) under the Securities ExchangeAct of 1934, as amended (the “Exchange Act”) are effective to reasonably ensurethat information required to be disclosed in reports that we file or submitunder the Exchange Act, is recorded, processed, summarized and reported withinthe time periods specified in Securities and Exchange Commission rules andforms, and that such information is accumulated and communicated to ourmanagement, including the CEO and CFO, as appropriate to allow timely decisionsregarding 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.

 

**PART II.  OTHER INFORMATION**

 

**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 31,2007 and should be read in conjunction therewith.  Except as set forth below, the Risk Factorsincluded in the Company’s Form 10-K for its 2007 fiscal year have notmaterially changed.

 

**Avaya’s strategies regarding the provision ofservices to its customers are changing dramatically and may have a materialimpact on our operating results.**

 

Avayais repositioning itself as a hardware and software vendor providing a widerange of voice communications hardware and applications to its customers.  As part of this strategy, Avaya is segmentingits hardware maintenance and software support. The new software support offerings include technical support forspecific voice applications and upgrade services to ensure customers can accessall software patches and upgrades..

 

**If in connection with the series oforders from the Miami-Dade County Public School system (“MDCPS”), we incurdelays in our anticipated installation schedule, significant installationchallenges, product performance issues, weather-related catastrophes and/ordelays in the collection of amounts due, our expected revenues, gross profits,and cash flows in fiscal 2008 from the sale of equipment and installationservices to MDCPS could be materially different than expected.**

 

In November, 2007, we announced the award of a series of orders fromM-DCPS totaling in excess of $10 million to provide and install communicationsequipment.  In the first quarter offiscal 2008, we installed the initial systems shipped at the end of fiscal2007.  After a customer-driven delay ininstallations in November, shipments and installations continued satisfactorilythroughout the remainder of the quarter. We continue to expect the remaining revenues and gross profits on theseorders to be recognized in fiscal 2008 based on current installationschedules.  However, over the course ofthe year we may experience delays in the installation schedule due tocircumstances out of our control as we are reliant on M-DCPS personnel toassist us in coordinating each installation. Furthermore, we could experience delays or a halt in installations dueto a variety of other factors including catastrophic weather conditions such ashurricanes which are prone to the Miami area. Additionally, unexpected technical installation challenges or productperformance issues could occur, also resulting in delays in the recognition ofrevenues or erosion of gross profits from these orders.  Lastly, we have experienced delays insuccessfully billing and collecting the amounts due on the first wave ofinstallations.  These delays increasedour short-term borrowings and consequently negatively affected our operatingresults.  We expect to work through theseinitial processing details and begin to improve the cash flows on this projectduring our second quarter.  However, ifbilling and collection difficulties persist, it 

 

 

17

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would create additional interest expense for us and consume borrowingcapacity under our revolving line of credit.

 

**ITEM 2.  UNREGISTERED SALES OF EQUITY SECURITIES ANDUSE OF PROCEEDS.**

 

None.

 

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

 

None.

 

**ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITYHOLDERS.**

 

None.

 

**ITEM 5.  OTHER INFORMATION.**

 

(a) None.

 

(b)   On January 23, 2008 the Company’s Boardof Directors approved an amendment to the Company’s bylaws which provides foran advance notice procedure for shareholders to nominate individuals forelection to the Board (as well as to submit shareholder proposals forconsideration at an annual meeting). Shareholders who wish to nominate an individual for election to the Boardmust comply with the advance notice deadline set forth in the bylaws.  This deadline requires that the shareholderprovide the Company with written notice no later than 120 days in advance ofthe anniversary date that proxy materials for the previous year’s annualmeeting were first mailed to shareholders; provided, however, that if themeeting date has changed by more than 30 days from the anniversary date of lastyear’s meeting, then the shareholder must notify the Company and the Companymust receive such advance notice no later than the 10th dayfollowing the date on which notice of the meeting is first mailed toshareholders or is publicly announced.  The notice must also include all of the information specified in the newbylaw provision.  The new bylaw provisionis set forth in Article 2, Section 2.11 of the Company’s amended andrestated bylaws, which are filed as Exhibit 3(ii) to thisreport.  This bylaw amendment was alsoreported by the Company in its report on Form 8-K filed with theSecurities and Exchange Commission (the “Commission”) on January 29, 2008and is described in the Company’s proxy statement to be filed with theCommission on February 27, 2008.

 

**ITEM 6.   EXHIBITS.**

 

Exhibits (filed herewith):

 
| **SEC  Exhibit No.** | ** ** | **Description**                                                                                                                                                                    |
|---------------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                      |       |                                                                                                                                                                               |
| 3(ii)                     |       | Amended and Restated Bylaws of XETA Technologies, Inc.  dated January 23, 2008                                                                                           |
|                      |       |                                                                                                                                                                               |
| 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. |

 

 

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|   |   |                                                                                                                                                                               |
|--------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 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: March 5,  2008 |   |   | By:                                         | /s/ Greg D. Forrest     |
|                       |   |   |                                        | Greg D. Forrest         |
|                       |   |   |                                        | Chief Executive Officer |
|                       |   |   |                                        |                    |
| Dated: March 5,  2008 |   |   | By:                                         | /s/ Robert D. Wagner    |
|                       |   |   |                                        | Robert B. Wagner        |
|                       |   |   |                                        | Chief Financial Officer |
|                            |        |        |                                             |                         |  |

 

 

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EXHIBIT INDEX

 
| **SEC  Exhibit No.** | ** ** | **Description**                                                                                                                                                                    |
|---------------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                      |       |                                                                                                                                                                               |
| 3(ii)                     |       | Amended and Restated Bylaws of XETA  Technologies, Inc. dated January 23, 2008                                                                                           |
|                      |       |                                                                                                                                                                               |
| 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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