Table of Contents

 

 

 

**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C.  20549**

 

**FORM 10-Q**

 

| **x**      | ** ** | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR  15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|------------|------------|----------------------------------------------------------------------------------------------------|
| ** ** | ** ** | ** **                                                                                         |
| ** ** | ** ** | **For the quarterly period ended  January 31, 2009**                                          |
| ** ** | ** ** | ** **                                                                                         |
| ** ** | ** ** | **OR**                                                                                             |
|       |       |                                                                                               |
| **o**      | ** ** | **TRANSITION REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |

 

**Commission File Number 0-16231**

 

.

 

**XETA Technologies, Inc.**

(Exact name of registrant 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)

 

Indicateby check mark whether the registrant (1) has filed all reports required tobe filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the past 12 months (or for such shorter period that the registrantwas required to file such reports), and (2) has been subject to suchfiling requirements for the past 90 days.

 

Yes  x     No  o

 

Indicate by check mark whether theregistrant is a large accelerated filer, an accelerated filer, anon-accelerated filer or a smaller reporting company (as defined by Rule 12b-2of the Exchange Act).

 

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

 

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

 

Yes  o     No  x

 

As of February 20,2009, there were 10,226,209 shares of the registrant’s common stock, par value$0.001, outstanding.

 

 

 

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Tableof Contents

 

INDEX

 
|                                |                                                                                                     | **PAGE** |
|-------------------------------------|----------------------------------------------------------------------------------------------------------|----------|
| PART I. FINANCIAL  INFORMATION |                                                                                                     |
|                                |                                                                                                     |     |
|                                | ITEM 1. FINANCIAL  STATEMENTS (Unaudited)                                                                |     |
|                                |                                                                                                     |     |
|                                | Consolidated Balance Sheets - January 31,  2009 and October 31, 2008                           | 3        |
|                                |                                                                                                     |     |
|                                | Consolidated  Statements of Operations - For the Three Months Ended January 31, 2009  and 2008      | 4        |
|                                |                                                                                                     |     |
|                                | Consolidated  Statement of Shareholders’ Equity - For the Three Months Ended  January 31, 2009 | 5        |
|                                |                                                                                                     |     |
|                                | Consolidated  Statements of Cash Flows - For the Three Months Ended January 31, 2009  and 2008      | 6        |
|                                |                                                                                                     |     |
|                                | Notes to Consolidated Financial Statements                                                               | 7        |
|                                |                                                                                                     |     |
|                                | ITEM  2. MANAGEMENT’S DISCUSSION AND ANALYSIS                                                       | 13       |
|                                |                                                                                                     |     |
|                                | ITEM 4.  CONTROLS AND PROCEDURES                                                                         | 17       |
|                                |                                                                                                     |     |
| PART II.  OTHER INFORMATION    | 17                                                                                                       |
|                                |                                                                                                     |     |
|                                | 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                                                                  | 19       |
|                                |                                                                                                     |     |
|                                | ITEM  4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS                                             | 19       |
|                                |                                                                                                     |     |
|                                | ITEM  5.OTHER INFORMATION                                                                                | 19       |
|                                |                                                                                                     |     |
|                                | ITEM 6.  EXHIBITS                                                                                        | 19       |

 

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XETA TECHNOLOGIES, INC. AND SUBSIDIARY

CONSOLIDATED BALANCE SHEETS

(UNAUDITED)

 

 
| ** **                                                                                                                          | ** ** | **January 31, 2009** | ** ** | **October 31, 2008** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------|------------|--------------------------------|------------|
|                                                                                                                                |       |                           |       |                           |       |
| ASSETS                                                                                                                              |       |
|                                                                                                                                |       |
| Current assets:                                                                                                                     |       |                           |       |                           |       |
| Cash and cash equivalents                                                                                                           |       | $                              | 153,425    |                           | $          | 63,639 |   |
| Current portion of net investment in sales-type  leases and other receivables                                                       |       | 497,529                        |       | 353,216                        |       |
| Trade accounts receivable, net                                                                                                      |       | 18,036,679                     |       | 19,995,498                     |       |
| Inventories, net                                                                                                                    |       | 6,093,991                      |       | 5,236,565                      |       |
| Deferred tax asset                                                                                                                  |       | 826,750                        |       | 588,926                        |       |
| Prepaid taxes                                                                                                                       |       | 40,453                         |       | 64,593                         |       |
| Prepaid expenses and other assets                                                                                                   |       | 1,682,152                      |       | 1,608,113                      |       |
| Total current assets                                                                                                                |       | 27,330,979                     |       | 27,910,550                     |       |
|                                                                                                                                |       |                           |       |                           |       |
| Noncurrent assets:                                                                                                                  |       |                           |       |                           |       |
| Goodwill                                                                                                                            |       | 26,811,604                     |       | 26,825,498                     |       |
| Intangible assets, net                                                                                                              |       | 768,057                        |       | 828,825                        |       |
| Net investment in sales-type leases, less  current portion above                                                                    |       | 104,310                        |       | 103,037                        |       |
| Property, plant & equipment, net                                                                                           |       | 10,445,833                     |       | 10,722,539                     |       |
| Other assets                                                                                                                        |       | 1,514                          |       | 2,271                          |       |
| Total noncurrent assets                                                                                                             |       | 38,131,318                     |       | 38,482,170                     |       |
|                                                                                                                                |       |                           |       |                           |       |
| Total assets                                                                                                                        |       | $                              | 65,462,297 |                           | $          | 66,392,720 |   |
|                                                                                                                                |       |                           |       |                           |       |
| LIABILITIES  AND SHAREHOLDERS’ EQUITY                                                                                          |       |
|                                                                                                                                |       |                           |       |                           |       |
| Current liabilities:                                                                                                                |       |                           |       |                           |       |
| Current portion of long-term debt                                                                                                   |       | $                              | 1,311,792  |                           | $          | 1,354,565 |   |
| Revolving line of credit                                                                                                            |       | 3,180,107                      |       | 2,524,130                      |       |
| Accounts payable                                                                                                                    |       | 5,394,363                      |       | 6,691,550                      |       |
| Current portion of obligations under  capital lease                                                                                 |       | 149,665                        |       | 148,225                        |       |
| Current unearned service revenue                                                                                                    |       | 3,625,880                      |       | 3,237,296                      |       |
| Accrued liabilities                                                                                                                 |       | 3,761,094                      |       | 4,593,725                      |       |
| Total current liabilities                                                                                                           |       | 17,422,901                     |       | 18,549,491                     |       |
|                                                                                                                                |       |                           |       |                           |       |
| Noncurrent liabilities:                                                                                                             |       |                           |       |                           |       |
| Accrued long-term liability                                                                                                         |       | 144,100                        |       | 144,100                        |       |
| Long-term portion of obligations under  capital lease                                                                               |       | 222,187                        |       | 260,148                        |       |
| Noncurrent unearned service revenue                                                                                                 |       | 68,035                         |       | 56,393                         |       |
| Noncurrent deferred tax liability                                                                                                   |       | 5,741,316                      |       | 5,545,692                      |       |
| Total noncurrent liabilities                                                                                                        |       | 6,175,638                      |       | 6,006,333                      |       |
|                                                                                                                                |       |                           |       |                           |       |
| Contingencies                                                                                                                       |       |                           |       |                           |       |
|                                                                                                                                |       |                           |       |                           |       |
| Shareholders’ equity:                                                                                                          |       |                           |       |                           |       |
| Preferred stock; $.10 par value; 50,000  shares authorized, 0 issued                                                                |       | —                         |       | —                         |       |
| Common stock; $.001 par value; 50,000,000 shares  authorized, 11,256,193 issued at January 31, 2009 and October 31,  2008 |       | 11,255                         |       | 11,255                         |       |
| Paid-in capital                                                                                                                     |       | 13,480,467                     |       | 13,493,395                     |       |
| Retained earnings                                                                                                                   |       | 30,541,982                     |       | 30,539,714                     |       |
| Less treasury stock, at cost (988,501  shares at January 31,2009 and 1,001,883 shares at October 31, 2008)                |       | (2,169,946                     | )          | (2,207,468                     | )          |
| Total shareholders’ equity                                                                                                     |       | 41,863,758                     |       | 41,836,896                     |       |
| Total liabilities and shareholders’ equity                                                                                     |       | $                              | 65,462,297 |                           | $          | 66,392,720 |   |

 

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

 

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XETA TECHNOLOGIES, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OFOPERATIONS

(UNAUDITED)

 
| ** **                                        | ** ** | **For the Three Months** | ** ** |
|---------------------------------------------------|------------|-----------------------------------------|------------|
| ** **                                        | ** ** | **Ended January 31,**         | ** ** |
| ** **                                        | ** ** | **2009**                                | ** ** | **2008** | ** ** |
|                                              |       |                                    |       |   |   |
| Systems sales                                     |       | $                                       | 8,585,753  |   | $ | 7,714,159 |   |
| Services                                          |       | 9,993,233                               |       | 9,724,942 |   |
| Other revenues                                    |       | 1,039                                   |       | 510,634 |   |
| Net sales and service revenues                    |       | 18,580,025                              |       | 17,949,735 |   |
|                                              |       |                                    |       |   |   |
| Cost of systems sales                             |       | 6,342,365                               |       | 5,786,822 |   |
| Services costs                                    |       | 6,983,739                               |       | 7,130,924 |   |
| Cost of other revenues & corporate  COGS |       | 447,770                                 |       | 441,379 |   |
| Total cost of sales and service                   |       | 13,773,874                              |       | 13,359,125 |   |
|                                              |       |                                    |       |   |   |
| Gross profit                                      |       | 4,806,151                               |       | 4,590,610 |   |
|                                              |       |                                    |       |   |   |
| Operating expenses                                |       |                                    |       |   |   |
| Selling, general and administrative               |       | 4,456,109                               |       | 3,662,262 |   |
| Amortization                                      |       | 322,251                                 |       | 202,898 |   |
| Total operating expenses                          |       | 4,778,360                               |       | 3,865,160 |   |
|                                              |       |                                    |       |   |   |
| Income from operations                            |       | 27,791                                  |       | 725,450 |   |
|                                              |       |                                    |       |   |   |
| Interest expense                                  |       | (29,903                                 | )          | (102,985 | ) |
| Interest and other income                         |       | 11,380                                  |       | 17,764 |   |
| Total interest and other expense                  |       | (18,523                                 | )          | (85,221 | ) |
|                                              |       |                                    |       |   |   |
| Income before provision for income taxes          |       | 9,268                                   |       | 640,229 |   |
| Provision for income taxes                        |       | 7,000                                   |       | 251,000 |   |
|                                              |       |                                    |       |   |   |
| Net income                                        |       | $                                       | 2,268      |   | $ | 389,229 |   |
|                                              |       |                                    |       |   |   |
| Earnings per share                                |       |                                    |       |   |   |
| Basic                                             |       | $                                       | 0.00       |   | $ | 0.04 |   |
|                                              |       |                                    |       |   |   |
| Diluted                                           |       | $                                       | 0.00       |   | $ | 0.04 |   |
|                                              |       |                                    |       |   |   |
| Weighted average shares outstanding               |       | 10,222,494                              |       | 10,224,971 |   |
|                                              |       |                                    |       |   |   |
| Weighted average equivalent shares                |       | 10,222,494                              |       | 10,249,693 |   |

 

Theaccompanying notes are an integral part of these consolidated financialstatements.

 

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XETA TECHNOLOGIES, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENT OFSHAREHOLDERS’ EQUITY

(UNAUDITED)

 
| ** **                           | ** ** | **Common Stock**  | ** ** | **Treasury Stock** | ** ** | ** ** | ** ** | ** ** | ** ** | ** **               | ** ** |
|--------------------------------------|------------|------------------------|------------|-------------------------|------------|------------|------------|------------|------------|--------------------------|------------|
| ** **                           | ** ** | **Shares Issued** | ** ** | **Par Value**      | ** ** | **Shares** | ** ** | **Amount** | ** ** | **Paid-in Capital** | ** ** | **Retained Earnings** | ** ** | **Total** | ** ** |
|                                 |       |                   |       |                    |       |       |       |       |       |                     |       |   |   |   |   |
| Balance-  October 31, 2008      |       | 11,256,193             |       | $                       | 11,255     |       | 1,001,883  |       | $          | (2,207,468               | )          | $ | 13,493,395 |   | $ | 30,539,714 |   | $ | 41,836,896 |   |
|                                 |       |                   |       |                    |       |       |       |       |       |                     |       |   |   |   |   |
| Purchase of  treasury stock          |       | —                 |       | —                  |       | 25,534     |       | (48,093    | )          | —                   |       | — |   | (48,093 | ) |
| Issuance of  restricted common stock |       | —                 |       | —                  |       | (38,916    | )          | 85,615     |       | (85,615                  | )          | — |   | — |   |
| Stock based  compensation            |       | —                 |       | —                  |       | —     |       | —     |       | 72,687                   |       | — |   | 72,687 |   |
| Net income                           |       | —                 |       | —                  |       | —     |       | —     |       | —                   |       | 2,268 |   | 2,268 |   |
|                                 |       |                   |       |                    |       |       |       |       |       |                     |       |   |   |   |   |
| Balance-  January 31, 2009      |       | 11,256,193             |       | $                       | 11,255     |       | 988,501    |       | $          | (2,169,946               | )          | $ | 13,480,467 |   | $ | 30,541,982 |   | $ | 41,863,758 |   |

 

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

 

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XETA TECHNOLOGIES, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OFCASH FLOWS

(UNAUDITED)

 
| ** **                                                                                   | ** ** | **For the Three Months** | ** ** |
|----------------------------------------------------------------------------------------------|------------|-----------------------------------------|------------|
| ** **                                                                                   | ** ** | **Ended January 31,**         | ** ** |
| ** **                                                                                   | ** ** | **2009**                                | ** ** | **2008** | ** ** |
| Cash flows from operating activities:                                                        |       |                                    |       |   |   |
| Net income                                                                                   |       | $                                       | 2,268      |   | $ | 389,229 |   |
|                                                                                         |       |                                    |       |   |   |
| Adjustments to reconcile net income to net cash  provided by (used in) operating activities: |       |                                    |       |   |   |
| Depreciation                                                                                 |       | 224,947                                 |       | 166,810 |   |
| Amortization                                                                                 |       | 322,251                                 |       | 202,899 |   |
| Stock based compensation                                                                     |       | 70,365                                  |       | 54,516 |   |
| Loss on sale of assets                                                                       |       | 3,764                                   |       | 425 |   |
| Provision for returns & doubtful  accounts receivable                               |       | 365,000                                 |       | — |   |
| Provision for excess and obsolete inventory                                                  |       | 25,500                                  |       | 25,500 |   |
| Increase in deferred tax liability                                                           |       | 209,518                                 |       | 102,535 |   |
| Change in assets and liabilities:                                                            |       |                                    |       |   |   |
| (Increase) in net investment in sales-type  leases & other receivables              |       | (145,586                                | )          | (401,304 | ) |
| Decrease (increase) in trade accounts  receivable                                            |       | 1,593,819                               |       | (903,872 | ) |
| (Increase) in inventories                                                                    |       | (882,926                                | )          | (931,924 | ) |
| (Increase) decrease in deferred tax asset                                                    |       | (237,824                                | )          | 148,465 |   |
| (Increase) in prepaid expenses and other  assets                                             |       | (73,282                                 | )          | (377,387 | ) |
| Decrease (increase) in prepaid taxes                                                         |       | 24,140                                  |       | (11,551 | ) |
| (Decrease) increase in accounts payable                                                      |       | (1,297,187                              | )          | 48,472 |   |
| Increase in unearned revenue                                                                 |       | 400,226                                 |       | 404,992 |   |
| (Decrease) in accrued liabilities                                                            |       | (80,309                                 | )          | (949,438 | ) |
| Total adjustments                                                                            |       | 522,416                                 |       | (2,420,862 | ) |
|                                                                                         |       |                                    |       |   |   |
| Net cash provided by (used in) operating  activities                                         |       | 524,684                                 |       | (2,031,633 | ) |
|                                                                                         |       |                                    |       |   |   |
| Cash flows from investing activities:                                                        |       |                                    |       |   |   |
| Additions to property, plant &  equipment                                           |       | (218,552                                | )          | (327,496 | ) |
| Proceeds from sale of assets                                                                 |       | 5,064                                   |       | — |   |
| Investment in capitalized service contracts                                                  |       | (750,000                                | )          | — |   |
| Net cash used in investing activities                                                        |       | (963,488                                | )          | (327,496 | ) |
|                                                                                         |       |                                    |       |   |   |
| Cash flows from financing activities:                                                        |       |                                    |       |   |   |
| Principal payments on debt                                                                   |       | (42,773                                 | )          | (42,771 | ) |
| Net borrowings on revolving line of credit                                                   |       | 655,977                                 |       | 2,060,088 |   |
| Payments on capital lease obligations                                                        |       | (36,521                                 | )          | — |   |
| Payments to acquire treasury stock                                                           |       | (48,093                                 | )          | — |   |
| Exercise of stock options                                                                    |       | —                                  |       | 90,215 |   |
| Net cash provided by financing activities                                                    |       | 528,590                                 |       | 2,107,532 |   |
|                                                                                         |       |                                    |       |   |   |
| Net increase (decrease) in cash and cash  equivalents                                        |       | 89,786                                  |       | (251,597 | ) |
|                                                                                         |       |                                    |       |   |   |
| Cash and cash equivalents, beginning of  period                                              |       | 63,639                                  |       | 402,918 |   |
| Cash and cash equivalents, end of period                                                     |       | $                                       | 153,425    |   | $ | 151,321 |   |
|                                                                                         |       |                                    |       |   |   |
| Supplemental disclosure of cash flow  information:                                           |       |                                    |       |   |   |
|                                                                                         |       |                                    |       |   |   |
| Cash paid during the period for interest                                                     |       | $                                       | 30,149     |   | $ | 97,220 |   |
| Cash paid during the period for income  taxes                                                |       | $                                       | 12,860     |   | $ | 11,519 |   |

 

Theaccompanying notes are an integral part of these consolidated financialstatements.

 

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**XETATECHNOLOGIES, INC. AND SUBSIDIARY**

**Notesto Consolidated Financial Statements**

**January 31,2009**

(Unaudited)

 

1.  BASIS OF PRESENTATION:

 

XETA Technologies, Inc.(“XETA” or the “Company”) is a leading integrator of advanced communicationstechnologies with nationwide sales and service. XETA serves a diverse group ofbusiness clients in sales, engineering, project management, implementation, andservice support.  The Company sellsproducts produced 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 are adequate to reasonablyinsure the information is not misleading. Management suggests 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 23, 2009.  Management believes that the financialstatements contain all adjustments necessary for a fair statement of theresults for the interim periods presented. All adjustments 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 hospitality system sales.  Services revenues represent revenues earnedfrom installing and maintaining systems for customers in both the commercialand hospitality segments.  The Companydefines commercial system sales as sales to the non-hospitality industry.

 

The reporting segmentsfollow the same accounting policies used for the Company’s consolidatedfinancial statements and are 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 outside of the U.S. are immaterial.

 

The following is atabulation of business segment information for the three months ended January 31,2009 and 2008:

 
| ** **    | ** ** | **Services  Revenues** | ** ** | **Commercial  Systems  Sales** | ** ** | **Hospitality  Systems  Sales** | ** ** | **Other  Revenues** | ** ** | **Total**   | ** ** |
|---------------|------------|------------------------|------------|--------------------------------|------------|---------------------------------|------------|---------------------|------------|-------------|------------|
| **2009**      |       |                   |       |                           |       |                            |       |                |       |        |       |
| Sales         |       | $                      | 9,993,233  |                           | $          | 6,296,705                       |       | $                   | 2,289,048  |        | $          | 1,039 |   | $ | 18,580,025 |   |
| Cost of sales |       | (6,983,739             | )          | (4,801,767                     | )          | (1,540,598                      | )          | (447,770            | )          | (13,773,874 | )          |
| Gross profit  |       | $                      | 3,009,494  |                           | $          | 1,494,938                       |       | $                   | 748,450    |        | $          | (446,731 | ) | $ | 4,806,151 |   |
|          |       |                   |       |                           |       |                            |       |                |       |        |       |
| **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 |   |

 

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Stock-Based CompensationPlans

 

The Company accounts forstock-based compensation in accordance with Statement of Financial AccountingStandards No. 123 (revised 2004), “Share-Based Payment” (“SFAS No. 123(R)”).  SFAS No. 123(R) requires companiesto measure all employee stock-based compensation awards using a fair valuemethod and recognize compensation cost in its financial statements.  The Company recognizes the fair value ofstock-based compensation awards as selling, general and administrative expenseas appropriate in the consolidated statements of operations on a straight-linebasis over the vesting period. Compensation expense was recognized in the statements of operations asfollows:

 
| ** **                           | ** ** | **2009** | ** ** | **2008** | ** ** |
|--------------------------------------|------------|----------|------------|----------|------------|
| Three months  ended January 31, |       | $        | 70,365     |     | $          | 54,516 |   |
|                                      |            |          |            |          |            |  |  |

 

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 AccountingPronouncements

 

On November 1,2008 the Company adopted Statement of Financial Standards No. 157, “FairValue Measurements” (“SFAS No. 157”).  SFAS No. 157 defines fairvalue, establishes a framework for measuring fair value in accordance withaccounting principles generally accepted in the United States, and expandsdisclosures about fair value measurements.  This statement does notrequire any new fair value measurements; rather, it applies under otheraccounting pronouncements that require or permit fair value measurements. Theadoption of SFAS No. 157 did not have a material impact on the Company’sconsolidated financial position or results of operations.

 

In December 2007the Financial Accounting Standards Board (“FASB”) issued SFAS No. 141(revised 2007), “Business Combinations” (“SFAS No. 141(R)”). Under SFAS No. 141(R),an entity is required to recognize the assets acquired, liabilities assumed,contractual contingencies, and contingent consideration at their fair value onthe acquisition date. It further requires that acquisition-related costs arerecognized separately from the acquisition and expensed as incurred,restructuring costs generally expensed in periods subsequent to the acquisitiondate, and changes in accounting for deferred tax asset valuation allowances andacquired income tax uncertainties after the measurement period impact incometax expense.  The adoption of SFAS No. 141(R) will change theaccounting treatment for business combinations on a prospective basis beginningin the first quarter of fiscal year 2010.

 

In December 2007the 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 and reporting for minority interests,which will be recharacterized as non-controlling interests and classified as acomponent 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 October 31, 2008,the Company did not have any minority interests; therefore the adoption of SFASNo. 160 is not expected to have an impact on the Company’s consolidatedfinancial statements.

 

On February 20,2008 the FASB issued FASB Staff Position (“FSP”) on Financial AccountingStandards No. 140-3, “Accounting for Transfers of Financial Assets andRepurchase Financing Transactions”. The FSP provides guidance on the accountingfor a transfer of a financial asset and a repurchase financing. Repurchase financing is a repurchase agreement that relates to a previouslytransferred financial asset between the same counterparties (or consolidatedaffiliates of either counterparty), that is entered into contemporaneouslywith, or in contemplation of, the initial transfer.  Under the FSP, atransferor and transferee will not separately account for a transfer of afinancial asset and a related repurchase financing unless: (a) the twotransactions have a valid and distinct business or economic purpose for beingentered into separately; and (b) the repurchase financing does not resultin the initial transferor regaining control 

 

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over the financialasset. An initial transfer of a financial asset and repurchase financing thatare entered into contemporaneously with, or in contemplation of, one anothershall be considered linked unless all of the following criteria are met at theinception of the transaction:

 

·                  Theinitial transfer and the repurchase financing are not contractually contingenton one another.

·                  Therepurchase financing provides the initial transferor with recourse to theinitial transferee upon default.

·                  Thefinancial asset subject to the initial transfer and repurchase financing isreadily obtainable in the marketplace.

·                  Thefinancial asset and repurchase agreement are not coterminous (the maturity ofthe repurchase financing must be before the maturity of the financial asset).

 

The FSP iseffective for financial statements issued for fiscal years beginning after November 15,2008, and interim periods within those fiscal years. Earlier application is notpermitted.  The Company does not currently utilize repurchase financing;therefore, the implementation of this FSP is not expected to have a materialimpact on the Company’s financial position or results of operations.

 

In March 2008the FASB issued SFAS No. 161, “Disclosure about Derivative Instruments andHedging Activities, an amendment of SFAS No. 133”, (“SFAS No. 161”).This statement requires that objectives for using derivative instruments bedisclosed in terms of underlying risk and accounting designation.  TheCompany is required to adopt SFAS No. 161 on or before November 1,2009.  The Company currently does not participate in any derivativeinstruments or hedging activities as defined under SFAS No. 133 andtherefore it is unlikely that the adoption of SFAS No. 161 will have anyimpact on the Company’s consolidated financial statements.

 

In April 2008the FASB issued FASB Staff Position on Financial Accounting Standard No. 142-3,“Determination of the Useful Life of Intangible Assets”, which amends thefactors that  should be considered indeveloping renewal or extension assumptions used to determine the useful lifeof intangible assets under SFAS No. 142 “Goodwill and Other IntangibleAssets”.  The intent of this FSP is to improve the consistency between theuseful life of a recognized intangible asset under SFAS No. 142 and theperiod of the expected cash flows used to measure the fair value of the assetunder SFAS No. 141 (revised 2007) “Business Combinations” and other U.S.generally accepted accounting principles.  The Company will adopt this FSPin the first quarter of fiscal 2010 and will apply the guidance prospectivelyto intangible assets acquired after adoption.

 

In May 2008the FASB issued SFAS No. 162, “The Hierarchy of Generally AcceptedAccounting Principles” (“SFAS No. 162”). SFAS No. 162 identifiesthe sources of accounting principles and the framework for selecting theprinciples used in the preparation of financial statements. SFAS No. 162became effective on November 15, 2008 following the SEC’s approval of thePublic Company Accounting Oversight Board amendments to AU Section 411, “TheMeaning of Present Fairly in Conformity with Generally Accepted AccountingPrinciples”. The implementation of this standard did not have a material impacton the Company’s consolidated financial position and results of operations.

 

2.  ACCOUNTS RECEIVABLE:

 

Accounts receivableconsists of the following:

 
| ** **                          | ** ** | **January 31,  2009** | ** ** | **(Audited)  October 31,  2008** | ** ** |
|-------------------------------------|------------|----------------------------|------------|---------------------------------------|------------|
|                                |       |                       |       |                                  |       |
| Trade accounts  receivables         |       | $                          | 18,573,112 |                                  | $          | 20,188,378 |   |
| Less reserve for  doubtful accounts |       | (536,433                   | )          | (192,880                              | )          |
| Net trade  accounts receivables     |       | $                          | 18,036,679 |                                  | $          | 19,995,498 |   |

 

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On January 14, 2009Nortel Networks Corporation (“Nortel”) filed for bankruptcy protection in theUnited States.  At the time of the filing, Nortel owed approximately$685,000 for services rendered under the Company’s wholesale managed servicesprogram in which the Company is engaged by Nortel to provide field technicalservices to Nortel’s end-user customers. The bankruptcy is in its early stages and at the time of this filing,Nortel has not filed its reorganization plan. Therefore our ability to assessthe probability of recovering pre-petition amounts due is limited.  As of January 31,2009, we have recorded $350,000 as  areserve against possible bad debts.  Thisprovision represents fifty percent of the unsecured claim.  We arecarefully following developments in the bankruptcy case and will assert ouravailable legal rights and defenses when appropriate.

 

3.  INVENTORIES:

 

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

 
| ** **                                         | ** ** | **January 31,  2009** | ** ** | **(Audited)  October 31,  2008** | ** ** |
|----------------------------------------------------|------------|----------------------------|------------|---------------------------------------|------------|
|                                               |       |                       |       |                                  |       |
| Finished goods  and spare parts                    |       | $                          | 6,959,016  |                                  | $          | 6,084,830 |   |
| Less- reserve  for excess and obsolete inventories |       | (865,025                   | )          | (848,265                              | )          |
| Total  inventories, net                            |       | $                          | 6,093,991  |                                  | $          | 5,236,565 |   |

 

4.  PROPERTY, PLANT AND EQUIPMENT:

 

Property, plant andequipment consist of the following:

 
| ** **                                                    | ** ** | **Estimated  Useful  Lives** | ** ** | **January 31,  2009** | ** ** | **(Audited)  October 31,  2008** | ** ** |
|---------------------------------------------------------------|------------|------------------------------|------------|----------------------------|------------|---------------------------------------|------------|
|                                                          |       |                         |       |                       |       |                                  |       |
| Building and  building improvements                           |       | 3-20                         |       | $                          | 3,118,424  |                                  | $          | 3,054,563 |   |
| Data processing  and computer field equipment                 |       | 2-7                          |       | 3,365,902                  |       | 3,351,229                             |       |
| Software  development costs, work-in-process                  |       | N/A                          |       | 1,916,313                  |       | 2,069,234                             |       |
| Software  development costs of components placed into service |       | 3-10                         |       | 6,873,428                  |       | 6,631,805                             |       |
| Computer  hardware                                            |       | 3-5                          |       | 626,193                    |       | 615,657                               |       |
| Land                                                          |       | -                            |       | 611,582                    |       | 611,582                               |       |
| Office furniture                                              |       | 5-7                          |       | 929,885                    |       | 944,048                               |       |
| Auto                                                          |       | 5                            |       | 497,285                    |       | 516,185                               |       |
| Other                                                         |       | 3-7                          |       | 238,871                    |       | 239,533                               |       |
|                                                          |       |                         |       |                       |       |                                  |       |
| Total property,  plant and equipment                          |       |                         |       | 18,177,883                 |       | 18,033,836                            |       |
| Less-  accumulated depreciation and amortization              |       |                         |       | (7,732,050                 | )          | (7,311,297                            | )          |
|                                                          |       |                         |       |                       |       |                                  |       |
| Total property,  plant and equipment, net                     |       |                         |       | $                          | 10,445,833 |                                  | $          | 10,722,539 |   |

 

5.  INCOME TAXES:

 

Thetax provision reflects the effective Federal tax rate plus the composite stateincome tax rates adjusted for states that require minimum tax payments even iftax losses are incurred.  Generally, weexpect our tax provision rate to be approximately 40%.

 

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6.  CREDIT AGREEMENTS:

 

The Company has a creditfacility with a commercial bank that includes a term loan and a $7.5 millionrevolving line of credit.  The facilitymatures on September 30, 2009.  Theterm loan, which is collateralized with a first mortgage on the Broken Arrow,Oklahoma, headquarters, amortizes based on a 13 year life. The revolving lineof credit is used to finance growth in working capital and is collateralized bytrade accounts receivable and inventories.

 

At January 31, 2009and October 31, 2008, the Company had approximately $3.180 million and$2.524 million, respectively, outstanding on the revolving line of credit.  The Company had approximately $4.3 millionavailable under the revolving line of credit at January 31, 2009.  Advance rates are defined in the agreement,but are generally at the rate of 80% on qualified trade accounts receivable and40% of qualified inventories.  Long termdebt consisted of the following:

 
| ** **                                                                                                                                                                                                | ** ** | **January 31,  2009** | ** ** | **(Audited)  October 31,  2008** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------|------------|---------------------------------------|------------|
|                                                                                                                                                                                                      |       |                       |       |                                  |       |
| 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 |       | $                          | 1,311,792  |                                  | $          | 1,354,565 |   |
|                                                                                                                                                                                                      |       |                       |       |                                  |       |
| Less-current  maturities                                                                                                                                                                                  |       | 1,311,792                  |       | 1,354,565                             |       |
|                                                                                                                                                                                                      |       |                       |       |                                  |       |
| Total long-term  debt, less current maturities                                                                                                                                                            |       | $                          | —     |                                  | $          | — |   |

 

Interest on alloutstanding debt under the credit facility accrues at either a) the LondonInterbank Offered Rate (“LIBOR”) (.419% at January 31, 2009) plus 1.25% to2.75% depending on the Company’s funded debt to cash flow ratio, or b) the bank’sprime rate (4.0% at January 31, 2009) minus 0% to minus 1.125% alsodepending on the Company’s funded debt to cash flow ratio.  At January 31, 2009 the Company waspaying 2.875% on the revolving line of credit borrowings and 3.00% on themortgage note.  The credit facilitycontains several financial covenants common in such agreements includingtangible net worth requirements, limitations on the amount of funded debt toannual earnings before interest, taxes, depreciation and amortization,limitations on capital spending, and debt service coverage requirements.  At January 31, 2009 the Company was incompliance with the covenants of the credit facility.

 

7.  EARNINGS PER SHARE:

 

The Company computesbasic earnings per common share by dividing net income by the weighted averagenumber of shares of common stock outstanding during the reporting periods.  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:

 
| ** **                        | ** ** | **For the Three Months Ended January 31, 2009** | ** ** |
|-----------------------------------|------------|------------------------------------------------------------------------------------|------------|
| ** **                        | ** ** | **Income  (Numerator)**                                                            | ** ** | **Shares  (Denominator)** | ** ** | **Per Share  Amount** | ** ** |
| Basic EPS                         |       |                                                                               |       |   |   |   |   |
| Net income                        |       | $                                                                                  | 2,268      |   | 10,222,494 |   | $ | 0.00 |   |
| Dilutive effect  of stock options |       |                                                                               |       | — |   |   |   |
|                              |       |                                                                               |       |   |   |   |   |
| Diluted EPS                       |       |                                                                               |       |   |   |   |   |
| Net income                        |       | $                                                                                  | 2,268      |   | 10,222,494 |   | $ | 0.00 |   |

 

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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 |   |

 

Options to purchase1,288,300 shares of common stock at an average exercise price of $6.43 and774,900 shares of common stock at an average exercise price of $8.43 were notincluded in the computation of diluted earnings per share for the three monthsended January 31, 2009 and 2008, respectively, because inclusion of theseoptions would be antidilutive.

 

8.  CAPITAL LEASES:

 

During 2008, the Companyleased software licenses under an agreement that is classified as a capitallease. The book value of the licenses is included in the balance sheet asproperty, plant, and equipment and was $367,752 at January 31, 2009.  Accumulated amortization of the leased equipmentat January 31, 2009 was $88,768. Amortization of assets under the capital lease is included indepreciation expense.  The future minimumlease payments required under the capital lease and the present value of thenet minimum lease payments as of January 31, 2009, are as follows:

 
| ** **                                           | ** ** | **Capital  Lease Payments** | ** ** |
|------------------------------------------------------|------------|----------------------------------|------------|
|                                                 |       |                             |       |
| 1 Year                                               |       | $                                | 161,435    |   |
| 2 Years                                              |       | 161,435                          |       |
| 3 Years                                              |       | 67,265                           |       |
| Total minimum  lease payments                        |       | 390,135                          |       |
| Less- imputed  interest                              |       | 18,283                           |       |
| Present value of  minimum payments                   |       | 371,852                          |       |
| Less-current  maturities of capital lease obligation |       | 149,665                          |       |
| Long-term  capital lease obligation                  |       | $                                | 222,187    |   |

 

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**ITEM2.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIALCONDITION AND RESULTS OF OPERATIONS**

 

**Preliminary Note RegardingForward-Looking Statements**

 

In the followingdiscussion, we make forward-looking statements relating to future events andour future performance and results.  Allstatements other than those that are purely historical may be forward-lookingstatements.  Forward-looking statementsgenerally include words such as “expects,” “anticipates,” “may”, “plans,” “believes,”“intends,” “projects,” “estimates,” “targets,” “may,” “should” and similarwords or expressions.  Such statementsare not guarantees of performance, but rather reflect our current expectation,estimates, and forecasts about the industry and markets in which we operate,and our assumptions and beliefs based upon information currently available tous.  These statements are subject torisks and uncertainties that are difficult to predict or are beyond ourcontrol.  Examples of these risksinclude: the U.S. economic crisis and its impact on capital spending trends inour markets; the tightening of credit availability in the U.S.; the recentbankruptcy filing by Nortel Networks; the financial condition of our suppliersin general and changes by them in their distribution strategies and support;our ability to maintain and improve upon current gross profit margins;unpredictable revenue levels from quarter to quarter; continuing acceptance andsuccess of the Mitel product and services offering; intense competition andindustry consolidation; dependence upon a few large wholesale customers in ourManaged Services offering; and the availability and retention of revenueprofessionals and certified technicians, and other .  These and other risks and uncertainties arediscussed under the heading “Risk Factors” under Part I of the Company’s Form 10-Kfor the fiscal year ended October 31, 2008 (filed with the Commission on January 23,2009), 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 2009 we haveadopted five primary strategies: continue to acquire market share through aggressive sales activities;take advantage of Avaya’s new channel-centric go-to-market strategy; focus onfast growing applications such as unified communications; focus on industryverticals such as hospitality, healthcare and education; and augment growththrough targeted acquisitions.

 

In addition to thesestrategies, senior management initiated an internal program to improveoperational methods and practices.  Thepurpose of this effort is to identify internal opportunities to reducecosts.  These efforts are ongoing, andinclude development of new and refined processes; organize back officeactivities for improved labor utilization; use internal systems andtechnologies to automate routine activities; and review workforce utilizationto ensure appropriate staffing composition.

 

Special Considerations.

On January 14, 2009Nortel Networks Corporation filed for bankruptcy protection in the United StatesBankruptcy Court for the District of Delaware. This filing was the culmination of Nortel’s efforts to “put [Nortel] onsound financial footing once and for all” as stated publicly by Nortel’spresident and chief executive, Mike Zafirovski. Nortel is one of our major suppliers and represents a significantportion of our business.  As such thisfiling is of considerable concern. Presently we expect our post-petition relationship with Nortel tocontinue without interruption.  However,management clearly recognizes the potential impact of Nortel’s filing on theCompany’s financial performance.  Inresponse we are closely monitoring developments associated with the filing andwill respond appropriately as new information becomes available.

 

Nortel currently owesXETA approximately $685,000 in pre-petition accounts receivable at January 31,2009.  At this filing the bankruptcy isin its early stages and Nortel has not filed its reorganization plan.   This limits our ability to assess theprobability of recovering pre-petition amounts due.  As of January 31, 

 

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2009, we have recorded$350,000 as an additional reserve against possible bad debts.  This provision represents one-half of theunsecured claim.  We are carefullyfollowing developments in the bankruptcy case and will assert our legal rightsand defenses as appropriate.

 

OperatingSummary.

Inthe first quarter of fiscal 2009, we earned net income of $2,000 on revenues of$18.58 million compared to net income of $389,000 on revenues of $17.95 millionin the first fiscal quarter of 2008. These results reflect a cautionary bad debt provision of  $350,000 in response to Nortel’s bankruptcyfiling and the challenges posed by macroeconomic conditions.

 

FinancialPosition Summary.

SinceOctober 31, 2008, our financial condition improved and we generatedpositive cash flows from operations.  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 31,2009 and 2008 and should be considered in conjunction with our above commentsas well as the “Risk Factors” section below.

 

# **Financial Condition**

 

Ourfinancial condition improved during the first fiscal quarter of 2009 as ourworking capital grew by 6% to $9.9 million. In addition we generated $525,000 in cash flows from operations.  These cash flows included non-cash charges of$1.66 million, a decrease in accounts receivable of $1.59 million, and anincrease in deferred tax liabilities of $210,000.  These increases were partially offset by adecrease in accounts payable of $1.30 million, an increase in inventory of$883,000 and other changes in working capital items, which netted a decrease incash of $113,000.  We increasedborrowings on our working capital line of credit of $656,000 and receivedproceeds from the sale of capital assets of $5,000.  We used cash to reduce our mortgage balancethrough scheduled principal payments by $43,000; to purchase capitalizedservice contracts of $750,000; to fund other financing and investing activitiesof $85,000; and to acquire capital assets of $219,000.  Of these expenditures, $114,000 was spent oncapital equipment as part of normal replacement of our Information Technologyinfrastructure and headquarters facility improvements.  The remaining $99,000 was spent on our Oracleimplementation.  Non-cash chargesincluded depreciation of $225,000; amortization of $322,000; stock-basedcompensation of $70,000; a loss on the sale of assets of $4,000; a provisionfor doubtful accounts receivable of $365,000; and a provision for obsoleteinventory of $26,000.

 

Asnoted above, our deferred tax liabilities increased $210,000 during the firstfiscal quarter of 2009 and the balance of our noncurrent deferred taxliabilities was $5.7 million at January 31, 2009.  Most of this balance and the increase in thisaccount are due to the difference in accounting for Goodwill between generallyaccepted accounting principles (“GAAP”) and the U.S. tax code.  Under GAAP, Goodwill is not amortized, butinstead is evaluated for impairment. This evaluation is conducted as conditions warrant, but not less thanannually under the guidelines set forth in SFAS No. 142, “Goodwill andOther Intangible Assets”.  For taxpurposes, Goodwill is amortized on a straight-line basis over 15 years.  As a result, the Company receives a taxdeduction of approximately 1/15th of its Goodwill balance each year in its taxreturn.  This difference between noamortization expense being recorded in the GAAP-based operating statements andapproximately $1.8 million in deductions taken on the tax return is recognizedin the balance sheet as additional noncurrent deferred tax liabilities.  The amount recorded is the differencemultiplied by the effective tax rate. This difference is recorded as a noncurrent item because under GAAPdeferred taxes are recorded as current or noncurrent based on theclassification of the asset or liability which generated the deferred taxitem.  The deferred tax liability associatedwith accounting for Goodwill will not be reduced unless the Company records animpairment charge to Goodwill in a future accounting period.

 

AtJanuary 31, 2009 the balance on our working capital revolver was $3.2million, with $4.3 million additional borrowings available.  We believe that this capacity is sufficientto support our operating requirements for the foreseeable future.  The working capital revolver and the mortgageon our headquarters facility are scheduled to mature on September 30,2009. We expect to renew these instruments for 12-month and 36-month periods,respectively, prior to their expiration. Given current credit market conditions, it is 

 

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likelythat such renewals could result in higher borrowing costs and/or reducedavailability for unsecured borrowings. In addition to the available capacity under our working capital line ofcredit, we believe we may have access to a variety of capital sources such asbank debt, private placements of subordinated debt, and public or private salesof equity.

 

# **Results of Operations**

 

Inthe first quarter of fiscal 2009 our revenues increased $630,000 or 4% comparedto the first quarter of 2008, and our net income decreased $387,000 or99%.   These results reflect higher salesin our major revenue categories. However, the impact of these increased revenues was offset by a $350,000bad debt provision in response to Nortel’s bankruptcy filing.  The narrative below provides furtherexplanation of these results.

 

SystemsSales.

In the first quarter offiscal 2009, systems sales increased approximately $872,000 or 11% compared tothe same period last year.  This increaseincludes a $267,000 or 4% increase in sales of systems to commercial customersand a $605,000 or 36% increase in sales of systems to hospitalitycustomers.  The increase in sales tocommercial customers primarily reflects the maturation of our backlog at theconclusion of fiscal 2008. These revenues were balanced across a number oflarge projects shipped during the last one-third of the quarter.

 

Thequarterly growth in sales of systems to hospitality customers reflects ourcontinued success in this niche market. Results support our strategy to expand the revenues associated with ourMitel product offering.  The Mitelproduct line provides us with the opportunity to work with hotel chains andproperty management companies that have standardized on the Mitel productline.  In addition, the Mitel offering iswell-suited to properties of 150 rooms and below.  This presents us an avenue to aggressivelypursue system sales opportunities in this property category.  We are pleased with our hospitality resultsand will continue to exploit opportunities across this segment.   While we anticipate continued success in thehospitality market, given economic conditions, we expect future revenueperformance at or below historical levels.

 

ServicesRevenues.

Ourservices revenues increased $268,000 or 3% in the first quarter compared to thesame period last year.  Services revenuesconsist of the following:

 
| ** **                   | ** ** | **For the Three Months Ended  January 31,** | ** ** |
|------------------------------|------------|----------------------------------------------------------------------|------------|
| ** **                   | ** ** | **2009**                                                             | ** ** | **2008** | ** ** |
| Contract &  T&M |       | $                                                                    | 6,975,000  |   | $ | 7,208,000 |   |
| Implementation               |       | 2,186,000                                                            |       | 2,042,000 |   |
| Cabling                      |       | 832,000                                                              |       | 475,000 |   |
| Total Services  revenues     |       | $                                                                    | 9,993,000  |   | $ | 9,725,000 |   |

 

Contractand time-and-materials (T&M) revenues decreased 3% in the firstquarter.  This performance reflectsrelatively flat growth in our wholesale services programs and a modest declinein T&M service revenues.  We believethese revenues were influenced by general economic conditions as customersreduced spending on non-critical services. Also, we experienced some customer churn in our wholesale servicesbusiness during the quarter.

 

Implementationrevenues increased 7% in the first fiscal quarter.  We attribute this to increasing demand forcomplex communication systems.  Theseprojects require significant fee-generating design and engineering servicesprovided by our Professional Services Organization (“PSO”).  As the market continues to displaceconventional communication platforms and adopt complex systems, we anticipatecontinued growth in this area of our business through the fee-based utilizationof these highly skilled technical resources.

 

Cablingrevenues increased 75% in the first fiscal quarter.  This increase is attributed primarily torevenues associated with a small number of major cabling projects.  We are pleased with the beneficial growth 

 

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providedby these projects and continue to aggressively market our national cablingcapabilities.  However, no assurance canbe given that subsequent periods will produce similar performance.

 

GrossMargins.

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

 
| ** **                    | ** ** | **For the Three Months  Ended  January 31,** | ** ** |
|-------------------------------|------------|------------------------------------------------------------------|------------|
| **Gross Margins**        | ** ** | **2009**                                                         | ** ** | **2008** | ** ** |
| Systems sales                 |       | 26.1                                                             | %          | 25.0 | % |
| Services  revenues            |       | 30.1                                                             | %          | 26.7 | % |
| Other revenues                |       | -7,869.4                                                         | %          | 89.0 | % |
| Corporate cost  of goods sold |       | -2.0                                                             | %          | -2.2 | % |
| Total                         |       | 25.9                                                             | %          | 25.6 | % |

 

Gross margins on systems sales in the first fiscalquarter improved slightly over last year exceeding our target of 23% to 25% forsystems revenues.  These results are dueprimarily to strong margins in our hospitality business.  We continue to receive considerable pricingsupport from our manufactures 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.

 

The gross margins earned on Services revenuesreflect improved results in this area of our business.  The contributing factors associated withthese improved results center on a 43% growth in cabling revenues, a reductionin fixed costs, and the use of third party Quality Service Partners to maximizemargins on these revenues.   In additionwe benefited from improved utilization of our PSO and realized favorableresults from cost containment efforts.

 

Thefinal component of our gross margins is the margins earned on other revenuesand our corporate cost of goods sold.  Weearn the majority of 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 experienced adramatic drop in other revenues as compared to the first quarter of 2008.  The decline was expected as we benefittedfrom record levels of commissions earned from Avaya throughout 2008 ascustomers purchased or renewed Avaya service contracts at a higher than normalpace in anticipation of manufacturer price increases for these services.  We expect revenues on this element of ourbusiness to return to historical norms in 2009. This is an unpredictable revenue stream that depends on the expirationdates of existing contracts, installation dates of new systems, the customertype as defined by Avaya, and the number of years that customers contract forservices.  Other revenues may alsoinclude sales and cost of goods sold on equipment or services outside ournormal provisioning processes. These revenues vary in both sales volume andgross margins earned.  Corporate cost ofgoods sold represents our material logistics and purchasing functions thatsupport all of our revenue segments.

 

OperatingExpenses.

Ourtotal operating expenses increased $913,000 or 24% in the first quarter offiscal 2009 compared to the first quarter of fiscal 2008.  Operating expenses were 25.7% of revenues inthe first quarter compared to 21.5% in the first quarter last year.  The growth in operating expenses in thequarter over quarter comparison reflects several factors:

 

·                  Significantbad debt provision in response to the Nortel bankruptcy filing

·                  Increasedexpenditures to support the Oracle platform

·                  Increasedboard of director fees to support the addition of independent membership to theboard

·                  Increasedlegal fees to support litigation and board activities

·                  Increasednon-cash charges related to stock compensation expense for equity grantsprovided to management and key employees

·                  Increasedamortization of: Oracle platform in association with its expanded utilization;and intangible assets associated with recent acquisitions of customer lists andservice contracts

 

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Forthe quarter operating expenses were impacted by all of the factors listedabove.  Unfortunately these expenses grewfaster than our revenues due in part to the bad debt provision associated withthe Nortel bankruptcy.  However, evenconsidering the Nortel provision, operating expenses were higher than ourtargets.  We are targeting operatingexpenses of 18% to 20% of revenues over the next two to four years as we realizeeconomies of scale.

 

InterestExpense and Other Income.

Netinterest and other expense was $19,000 in the first quarter of fiscal 2009compared to $85,000 in net interest and other expense in the first quarter offiscal 2008.  This decrease reflects bothlower interest rates, and a reduction in borrowings.

 

TaxProvision.

Thetax provision reflects the effective Federal tax rate plus the composite stateincome tax rates adjusted for states that require minimum tax payments even iftax losses are incurred.  Generally, weexpect our tax provision rate to be approximately 40%.

 

**ITEM 4.   CONTROLS ANDPROCEDURES**

 

*Evaluationof Disclosure Controls and Procedures.* Based on an evaluation conducted as of January 31,2009 by our management, including our Chief Executive Officer (“CEO”) and ourChief Financial Officer (“CFO”), our CEO and CFO have concluded that ourdisclosure controls and procedures (as defined in Rules 13a-15(e) and15d-15(e) under the Securities Exchange Act of 1934, as amended (the “ExchangeAct”) are effective to reasonably ensure that information required to bedisclosed in reports that we file or submit under the Exchange Act, isrecorded, processed, summarized and reported within the time periods specifiedin Securities and Exchange Commission rules and forms, and that suchinformation is accumulated and communicated to our management, including theCEO and CFO, as appropriate to allow timely decisions regarding requireddisclosure.

 

*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.  OTHERINFORMATION**

 

**ITEM1.  LEGAL PROCEEDINGS.**

 

There has been no changein the status of the Design Business Communications, Inc., d/b/a/ AmericanTelephone (“AMTEL”) matter since we last reported on it in our Annual Report onForm 10-K for the fiscal year ended October 31, 2008, filed on January 23,2009.

 

Subsequent to the end ofour first quarter for fiscal 2009, we reached a settlement agreement with aformer employee in a routine employment related matter first referenced in our Form 10-Qfor the quarter ended April 30, 2008, filed on June 5, 2008.  The settlement did not have a material impacton our financial position or results of operations.

 

Additionally, we areinvolved as a plaintiff in another matter which we consider to be routine andincidental to the operation of our business. We do not believe this proceeding will have a material affect on ourfinancial position or results of operations.

 

**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 31,2008 and should be read in conjunction 

 

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therewith.  Except as set forth below, the Risk Factorsincluded in the Company’s Form 10-K for its 2008 fiscal year have notmaterially changed.

 

**Ourbusiness is affected by capital spending. Current economic conditions and theability of our customers to access credit may reduce capital spending over thenext twelve months and beyond.**

 

The U.S. economyis mired in a recessionary contraction and, despite efforts by the FederalGovernment to stabilize the banking and financial systems, credit availabilityremains limited for nearly all enterprises, hence the outlook for corporateprofits is uncertain.  These factors are contributing to a high degree ofuncertainty concerning capital spending in 2009.  Because our businessdepends on capital spending for technology and equipment, we may experience adecline in demand for our products.  Such a decline may have a material,negative impact on our operating results and financial condition.

 

**Nortel’sChapter 11 bankruptcy filing may result in both a short-term and long-termfinancial loss for the Company.**

 

Nortel filed a voluntarypetition for Chapter 11 bankruptcy protection on January 14, 2009. We are owed approximately $685,000 in pre-petition accounts receivable.  Based on filings approved by the bankruptcycourt allowing Nortel to fund post-petition business operations, we plan tocontinue to provide services to Nortel’s end-user customers under our wholesaleservices relationship, which currently produces approximately $3 million inannual revenues.  If our pre-petitionclaims are not collectible either in whole or in large part, we couldexperience material, negative operating results in the near term. Furthermore, it is impossible to predict the long term impact of Nortel’sbankruptcy filing on our managed services revenues or our Nortel equipmentbusiness.  As such, our ongoing revenues and future financial resultscould be materially impaired in the event that Nortel is unable to fund itsfuture operations; end-users elect to abandon their Nortel equipment for otherproducts; Nortel implements dramatic changes to its business plan andstrategies that negatively affect our relationship with Nortel as a businesspartner and/or vendor; the U.S. and global economic crisis negatively impactsNortel’s ability to reorganize operations; and/or Nortel is unable to continue asdebtor in possession or to emerge from bankruptcy.

 

**Our manufacturers’ strategies regarding theprovision of equipment and services to their customers may change dramaticallyand could have a material impact on our operating results.**

 

Avayais repositioning itself as a hardware and software manufacturer providing awide range of voice communications hardware and applications to itscustomers.  As part of this strategy,Avaya is segmenting its hardware maintenance and software support.  The new software support offerings includetechnical support for specific voice applications and upgrade services toensure customers can access all software patches and upgrades.  Currently, we earn revenues from some of ourcustomers, particularly hospitality customers, to provide the products andservices now being included by Avaya in its new software supportofferings.    These changes could have amaterial, negative impact on our operating results if our revenues or marginsare reduced in response to these mandated changes by Avaya.

 

Asa result of its bankruptcy Nortel could revise its market strategy, and arevision could have a material, negative impact on our operating results if ourrevenues or margins are reduced as a result of a change in strategy.  While we do not currently anticipate changesin Nortel’s strategy, we cannot provide any assurance that the Nortel businessrelationship will produce beneficial contributions to our financial performanceas described in our earlier filings.

 

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

 

(a) None.

 

(b) None.

 

(c) Issuer Purchasesof Equity Securities

 

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On October 29, 2008the Board of Directors approved a stock repurchase program authorizing theCompany to use up to $1,000,000 to repurchase its outstanding common stock onthe open market.  This program does nothave an expiration date.  The followingtable presents repurchase activity for the first quarter of fiscal 2009:

 
| **Fiscal  Period** | ** ** | **Total Number  of Shares  Purchased** | ** ** | **Average  Price Paid  per Share** | ** ** | **Total  Number of  Shares  Purchased  as Part of  Publicly  Announced  Program** | ** ** | **Approximate  Dollar Value  of Shares  that May Yet  Be Purchased  Under the  Program** | ** ** |
|--------------------|------------|--------------------------------------------------|------------|----------------------------------------------|------------|--------------------------------------------------------------------------------------------------|------------|------------------------------------------------------------------------------------------------------------------------|------------|
|               |       |                                             |       |                                         |       |                                                                                             |       |                                                                                                                   |       |
| November 2008 |       | 3,260                                            |       | $                                            | 1.77       |                                                                                             | 3,260      |                                                                                                                   | $          | 994,223 |   |
| December 2008 |       | 13,768                                           |       | 1.84                                         |       | 13,768                                                                                           |       | 968,903                                                                                                                |       |
| January 2009  |       | 8,506                                            |       | 2.00                                         |       | 8,506                                                                                            |       | 951,907                                                                                                                |       |
| Total              |       | 25,534                                           |       | $                                            | 1.88       |                                                                                             | 25,534     |                                                                                                                   | $          | 951,907 |   |

 

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

 

None.

 

**ITEM 4. SUBMISSION OF MATTERS TOA VOTE OF SECURITY HOLDERS.**

 

None.

 

**ITEM 5. OTHER INFORMATION.**

 

(a) None.

 

**ITEM 6.  EXHIBITS.**

 

Exhibits(filed herewith):

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

 

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**SIGNATURES**

 

Pursuantto the requirements of the Securities Exchange Act of 1934, the Registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.

 
|                           | XETA  Technologies, Inc. |
|--------------------------------|-------------------------------|
|                           | (Registrant)                  |
|                           |                          |
|                           |                          |   |
| Dated:  February 27, 2009 | By:                           | /s/ Greg D. Forrest |
|                           |                          | Greg D. Forrest |
|                           |                          | Chief Executive Officer |
|                           |                          |   |
| Dated:  February 27, 2009 | By:                           | /s/ Robert B. Wagner |
|                           |                          | Robert B. Wagner |
|                           |                          | Chief Financial Officer |

 

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EXHIBIT INDEX

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

 

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