Table of Contents

 

 

 

**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington,D.C.  20549**

 

**FORM 10-Q**

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

 

**For thequarterly period ended July 31, 2009**

 

**OR**

 
| **o** | **TRANSITION REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|-------|----------------------------------------------------------------------------------------------------|

 

**CommissionFile Number 0-16231**

 

 

**XETATechnologies, 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)

 

Indicate by check mark whether the registrant (1) hasfiled all reports required to be filed by Section 13 or 15(d) of theSecurities Exchange Act of 1934 during the past 12 months (or for such shorterperiod that the registrant was required to file such reports), and (2) hasbeen subject to such filing requirements for the past 90 days. Yes x    No o

 

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

 

Indicate by check mark whether the registrant is a large accelerated filer,an accelerated filer, a non-accelerated filer or a smaller reporting company(as defined by Rule 12b-2 of 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 mark whetherthe registrant is a shell company (as defined in Rule 12b-2 of theExchange Act). Yes o    No x

 

Asof August 28, 2009 there were 10,222,861 shares of the registrant’s commonstock, par value $0.001, outstanding.

 

 

 

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Table ofContents

 

INDEX

 
|                                                                                                     | **PAGE** |
|----------------------------------------------------------------------------------------------------------|----------|
| PART I. FINANCIAL  INFORMATION                                                                      |     |
|                                                                                                     |     |
| ITEM  1. FINANCIAL STATEMENTS (Unaudited)                                                                |     |
|                                                                                                     |     |
| Consolidated Balance Sheets -  July 31, 2009 and October 31, 2008                              | 3        |
|                                                                                                     |     |
| Consolidated Statements of  Operations - For the Three and Nine Months Ended July 31, 2009 and 2008 | 4        |
|                                                                                                     |     |
| Consolidated  Statement of Shareholders’ Equity - For the Nine Months Ended July 31,  2009     | 5        |
|                                                                                                     |     |
| Consolidated  Statements of Cash Flows - For the Nine Months Ended July 31, 2009 and  2008          | 6        |
|                                                                                                     |     |
| Notes to  Consolidated Financial Statements                                                              | 7        |
|                                                                                                     |     |
| ITEM 2.  MANAGEMENT’S DISCUSSION AND ANALYSIS                                                       | 17       |
|                                                                                                     |     |
| ITEM 4T. CONTROLS  AND PROCEDURES                                                                        | 22       |
|                                                                                                     |     |
| PART II. OTHER  INFORMATION                                                                         |     |
|                                                                                                     |     |
| ITEM 1. LEGAL  PROCEEDINGS                                                                               | 22       |
|                                                                                                     |     |
| ITEM 1A. RISK FACTORS                                                                                    | 23       |
|                                                                                                     |     |
| ITEM 2.  UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS                                     | 24       |
|                                                                                                     |     |
| ITEM 3.  DEFAULTS UPON SENIOR SECURITIES                                                                 | 24       |
|                                                                                                     |     |
| ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS                                             | 24       |
|                                                                                                     |     |
| ITEM 5. OTHER  INFORMATION                                                                               | 24       |
|                                                                                                     |     |
| ITEM 6. EXHIBITS                                                                                         | 24       |

 

2

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Table of Contents

 

XETA TECHNOLOGIES,INC. AND SUBSIDIARY

CONSOLIDATED BALANCE SHEETS

 
| ** **                                                                                                                       | ** ** | **(UNAUDITED)**        | ** ** | ** **                | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|---------------------------|------------|
| ** **                                                                                                                       | ** ** | **July 31, 2009** | ** ** | **October 31, 2008** | ** ** |
|                                                                                                                             |       |                   |       |                      |       |
| ASSETS                                                                                                                           |       |                   |       |                      |       |
| Current  assets:                                                                                                                 |       |                   |       |                      |       |
| Cash  and cash equivalents                                                                                                       |       | $                      | 2,980,984  |                      | $          | 63,639 |   |
| Current  portion of net investment in sales-type leases and other receivables                                                    |       | 364,502                |       | 353,216                   |       |
| Trade  accounts receivable, net                                                                                                  |       | 11,382,724             |       | 19,995,498                |       |
| Inventories,  net                                                                                                                |       | 5,108,844              |       | 5,236,565                 |       |
| Deferred  tax asset                                                                                                              |       | 418,420                |       | 588,926                   |       |
| Prepaid  taxes                                                                                                                   |       | 33,374                 |       | 64,593                    |       |
| Prepaid  expenses and other assets                                                                                               |       | 1,622,308              |       | 1,608,113                 |       |
| Total  current assets                                                                                                            |       | 21,911,156             |       | 27,910,550                |       |
|                                                                                                                             |       |                   |       |                      |       |
| Noncurrent  assets:                                                                                                              |       |                   |       |                      |       |
| Goodwill                                                                                                                         |       | 15,845,869             |       | 26,825,498                |       |
| Intangible  assets, net                                                                                                          |       | 729,855                |       | 828,825                   |       |
| Net  investment in sales-type leases, less current portion above                                                                 |       | 358,976                |       | 103,037                   |       |
| Property,  plant & equipment, net                                                                                       |       | 6,997,784              |       | 10,722,539                |       |
| Deferred  tax asset                                                                                                              |       | 213,548                |       | —                    |       |
| Other  assets                                                                                                                    |       | —                 |       | 2,271                     |       |
| Total  noncurrent assets                                                                                                         |       | 24,146,032             |       | 38,482,170                |       |
|                                                                                                                             |       |                   |       |                      |       |
| Total  assets                                                                                                                    |       | $                      | 46,057,188 |                      | $          | 66,392,720 |   |
|                                                                                                                             |       |                   |       |                      |       |
| LIABILITIES AND SHAREHOLDERS’ EQUITY                                                                                        |       |                   |       |                      |       |
|                                                                                                                             |       |                   |       |                      |       |
| Current  liabilities:                                                                                                            |       |                   |       |                      |       |
| Current  portion of long-term debt                                                                                               |       | $                      | 1,226,248  |                      | $          | 1,354,565 |   |
| Revolving  line of credit                                                                                                        |       | —                 |       | 2,524,130                 |       |
| Accounts  payable                                                                                                                |       | 4,001,866              |       | 6,691,550                 |       |
| Current  portion of obligations under capital lease                                                                              |       | 152,589                |       | 148,225                   |       |
| Current  unearned service revenue                                                                                                |       | 3,211,064              |       | 3,237,296                 |       |
| Accrued  liabilities                                                                                                             |       | 3,526,417              |       | 4,593,725                 |       |
| Total  current liabilities                                                                                                       |       | 12,118,184             |       | 18,549,491                |       |
|                                                                                                                             |       |                   |       |                      |       |
| Noncurrent  liabilities:                                                                                                         |       |                   |       |                      |       |
| Accrued  long-term liability                                                                                                     |       | 144,100                |       | 144,100                   |       |
| Long-term  portion of obligations under capital lease                                                                            |       | 145,154                |       | 260,148                   |       |
| Noncurrent  unearned service revenue                                                                                             |       | 55,759                 |       | 56,393                    |       |
| Noncurrent  deferred tax liability                                                                                               |       | —                 |       | 5,545,692                 |       |
| Total  noncurrent liabilities                                                                                                    |       | 345,013                |       | 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 July 31,  2009 and October 31, 2008 |       | 11,255                 |       | 11,255                    |       |
| Paid-in  capital                                                                                                                 |       | 13,636,544             |       | 13,493,395                |       |
| Retained  earnings                                                                                                               |       | 22,126,202             |       | 30,539,714                |       |
| Less  treasury stock, at cost (994,695 shares at July 31, 2009 and 1,001,883  shares at October 31, 2008)              |       | (2,180,010             | )          | (2,207,468                | )          |
| Total  shareholders’ equity                                                                                                 |       | 33,593,991             |       | 41,836,896                |       |
| Total  liabilities and shareholders’ equity                                                                                 |       | $                      | 46,057,188 |                      | $          | 66,392,720 |   |

 

The accompanying notesare an integral part of these consolidated financial statements.

 

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XETA TECHNOLOGIES, INC.AND SUBSIDIARY

CONSOLIDATEDSTATEMENTS OF OPERATIONS

(UNAUDITED)

 
| ** **                                        | ** ** | **For  the Three Months** | ** ** | **For  the Nine Months** | ** ** |
|---------------------------------------------------|------------|---------------------------|------------|--------------------------|------------|
| ** **                                        | ** ** | **Ended  July 31,**       | ** ** | **Ended  July 31,**      | ** ** |
| ** **                                        | ** ** | **2009**                  | ** ** | **2008**                 | ** ** | **2009** | ** ** | **2008** | ** ** |
|                                              |       |                      |       |                     |       |   |   |   |   |
| Systems sales                                     |       | $                         | 6,522,569  |                     | $          | 10,662,567 |   | $ | 22,897,460 |   | $ | 28,648,487 |   |
| Services                                          |       | 10,524,397                |       | 12,028,241               |       | 30,359,279 |   | 31,887,653 |   |
| Other revenues                                    |       | 136,271                   |       | 512,724                  |       | 263,126 |   | 1,428,950 |   |
| Net sales and service  revenues                   |       | 17,183,237                |       | 23,203,532               |       | 53,519,865 |   | 61,965,090 |   |
|                                              |       |                      |       |                     |       |   |   |   |   |
| Cost of systems sales                             |       | 4,639,749                 |       | 7,846,284                |       | 16,791,637 |   | 21,174,666 |   |
| Services costs                                    |       | 7,505,892                 |       | 8,373,080                |       | 21,258,445 |   | 23,104,061 |   |
| Cost of other  revenues & corporate COGS |       | 425,480                   |       | 781,806                  |       | 1,308,525 |   | 1,707,157 |   |
| Total cost of sales and  service                  |       | 12,571,121                |       | 17,001,170               |       | 39,358,607 |   | 45,985,884 |   |
|                                              |       |                      |       |                     |       |   |   |   |   |
| Gross profit                                      |       | 4,612,116                 |       | 6,202,362                |       | 14,161,258 |   | 15,979,206 |   |
|                                              |       |                      |       |                     |       |   |   |   |   |
| Operating expenses                                |       |                      |       |                     |       |   |   |   |   |
| Selling, general and  administrative              |       | 4,388,488                 |       | 4,870,068                |       | 12,925,794 |   | 12,795,830 |   |
| Amortization                                      |       | 344,727                   |       | 265,152                  |       | 1,001,984 |   | 722,563 |   |
| Impairment of  Goodwill & Other Assets   |       | 14,000,000                |       | —                   |       | 14,000,000 |   | — |   |
| Total operating  expenses                         |       | 18,733,215                |       | 5,135,220                |       | 27,927,778 |   | 13,518,393 |   |
|                                              |       |                      |       |                     |       |   |   |   |   |
| (Loss) income from  operations                    |       | (14,121,099               | )          | 1,067,142                |       | (13,766,520 | ) | 2,460,813 |   |
|                                              |       |                      |       |                     |       |   |   |   |   |
| Interest expense                                  |       | (20,810                   | )          | (96,401                  | )          | (79,211 | ) | (268,117 | ) |
| Interest and other  income (expense)              |       | (1,159                    | )          | 99                       |       | 14,219 |   | 27,394 |   |
| Total interest and  other expense                 |       | (21,969                   | )          | (96,302                  | )          | (64,992 | ) | (240,723 | ) |
|                                              |       |                      |       |                     |       |   |   |   |   |
| (Loss) income before  provision for incometaxes   |       | (14,143,068               | )          | 970,840                  |       | (13,831,512 | ) | 2,220,090 |   |
| (Benefit) provision for  income taxes             |       | (5,544,000                | )          | 380,000                  |       | (5,418,000 | ) | 869,000 |   |
|                                              |       |                      |       |                     |       |   |   |   |   |
| Net (loss) income                                 |       | $                         | (8,599,068 | )                        | $          | 590,840 |   | $ | (8,413,512 | ) | $ | 1,351,090 |   |
|                                              |       |                      |       |                     |       |   |   |   |   |
| (Loss) earnings per  share                        |       |                      |       |                     |       |   |   |   |   |
| Basic                                             |       | $                         | (0.84      | )                        | $          | 0.06 |   | $ | (0.82 | ) | $ | 0.13 |   |
|                                              |       |                      |       |                     |       |   |   |   |   |
| Diluted                                           |       | $                         | (0.84      | )                        | $          | 0.06 |   | $ | (0.82 | ) | $ | 0.13 |   |
|                                              |       |                      |       |                     |       |   |   |   |   |
| Weighted average shares  outstanding              |       | 10,223,753                |       | 10,254,310               |       | 10,223,881 |   | 10,241,861 |   |
|                                              |       |                      |       |                     |       |   |   |   |   |
| Weighted average  equivalent shares               |       | 10,223,753                |       | 10,254,310               |       | 10,223,881 |   | 10,246,811 |   |

 

The accompanying notesare an integral part of these consolidated financial statements.

 

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XETA TECHNOLOGIES, INC.AND SUBSIDIARY

CONSOLIDATEDSTATEMENT OF SHAREHOLDERS’ 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                        |       | —            |       | —             |       | 31,728     |       | (58,157    | )          | —              |       | — |   | (58,157 | ) |
| Issuance of restricted  common stock from treasury |       | —            |       | —             |       | (38,916    | )          | 85,615     |       | (85,615             | )          | — |   | — |   |
| Stock based compensation                           |       | —            |       | —             |       | —     |       | —     |       | 228,764             |       | — |   | 228,764 |   |
| Net loss                                           |       | —            |       | —             |       | —     |       | —     |       | —              |       | (8,413,512 | ) | (8,413,512 | ) |
|                                               |       |              |       |               |       |       |       |       |       |                |       |   |   |   |   |
| Balance- July 31,  2009                       |       | 11,256,193        |       | $                  | 11,255     |       | 994,695    |       | $          | (2,180,010          | )          | $ | 13,636,544 |   | $ | 22,126,202 |   | $ | 33,593,991 |   |

 

The accompanying notesare an integral part of these consolidated financial statements.

 

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XETA TECHNOLOGIES, INC.AND SUBSIDIARY

CONSOLIDATEDSTATEMENTS OF CASH FLOWS

(UNAUDITED)

 
| ** **                                                                                           | ** ** | **For  the Nine Months** | ** ** |
|------------------------------------------------------------------------------------------------------|------------|--------------------------|------------|
| ** **                                                                                           | ** ** | **Ended  July 31,** | ** ** |
| ** **                                                                                           | ** ** | **2009**                 | ** ** | **2008** | ** ** |
| Cash flows from  operating activities:                                                               |       |                     |       |   |   |
| Net (loss) income                                                                                    |       | $                        | (8,413,512 | ) | $ | 1,351,090 |   |
|                                                                                                 |       |                     |       |   |   |
| Adjustments to  reconcile net (loss) income to net cash provided by (used in) operating  activities: |       |                     |       |   |   |
| Depreciation                                                                                         |       | 722,945                  |       | 528,811 |   |
| Amortization                                                                                         |       | 1,001,983                |       | 722,563 |   |
| Impairment of  Goodwill & Other Assets                                                      |       | 14,000,000               |       | — |   |
| Stock based  compensation                                                                            |       | 219,476                  |       | 181,782 |   |
| Loss on sale of assets                                                                               |       | 3,764                    |       | 425 |   |
| Provision for  returns & doubtful accounts receivable                                       |       | 395,000                  |       | 7,924 |   |
| Provision for excess  and obsolete inventory                                                         |       | 76,500                   |       | 76,500 |   |
| (Decrease) increase in  deferred tax liability                                                       |       | (5,504,010               | )          | 600,156 |   |
| Change in assets and  liabilities:                                                                   |       |                     |       |   |   |
| Increase in net  investment in sales-type leases & other receivables                        |       | (7,440                   | )          | (265,342 | ) |
| Decrease (increase) in  trade accounts receivable                                                    |       | 8,628,795                |       | (7,180,367 | ) |
| Decrease (increase) in  inventories                                                                  |       | 295,968                  |       | (1,590,301 | ) |
| (Increase) decrease in  deferred tax asset                                                           |       | (43,042                  | )          | 245,561 |   |
| Decrease (increase) in  prepaid expenses and other assets                                            |       | 109,831                  |       | (774,273 | ) |
| Decrease (increase) in  prepaid taxes                                                                |       | 31,219                   |       | (31,956 | ) |
| (Decrease) increase in  accounts payable                                                             |       | (2,739,735               | )          | 1,982,387 |   |
| (Decrease) increase in  unearned revenue                                                             |       | (446,734                 | )          | 1,146,906 |   |
| (Decrease) increase in  accrued liabilities                                                          |       | (408,020                 | )          | 210,632 |   |
| Total adjustments                                                                                    |       | 16,336,500               |       | (4,138,592 | ) |
|                                                                                                 |       |                     |       |   |   |
| Net cash provided by  (used in) operating activities                                                 |       | 7,922,988                |       | (2,787,502 | ) |
|                                                                                                 |       |                     |       |   |   |
| Cash flows from  investing activities:                                                               |       |                     |       |   |   |
| Additions to property,  plant & equipment                                                   |       | (636,586                 | )          | (841,549 | ) |
| Proceeds from sale of  assets                                                                        |       | 5,064                    |       | — |   |
| Acquisitions, net of  cash acquired                                                                  |       | (802,887                 | )          | — |   |
| Investment in  capitalized service contracts                                                         |       | (750,000                 | )          | — |   |
| Net cash used in  investing activities                                                               |       | (2,184,409               | )          | (841,549 | ) |
|                                                                                                 |       |                     |       |   |   |
| Cash flows from  financing activities:                                                               |       |                     |       |   |   |
| Principal payments on debt                                                                           |       | (128,317                 | )          | (128,316 | ) |
| Net (payments) borrowings  on revolving line of credit                                               |       | (2,524,130               | )          | 3,350,390 |   |
| Payments on capital  lease obligations                                                               |       | (110,630                 | )          | (11,979 | ) |
| Payments to acquire  treasury stock                                                                  |       | (58,157                  | )          | — |   |
| Exercise of stock  options                                                                           |       | —                   |       | 90,215 |   |
| Net cash (used in)  provided by financing activities                                                 |       | (2,821,234               | )          | 3,300,310 |   |
|                                                                                                 |       |                     |       |   |   |
| Net increase (decrease)  in cash and cash equivalents                                                |       | 2,917,345                |       | (328,741 | ) |
|                                                                                                 |       |                     |       |   |   |
| Cash and cash  equivalents, beginning of period                                                      |       | 63,639                   |       | 402,918 |   |
| Cash and cash equivalents,  end of period                                                            |       | $                        | 2,980,984  |   | $ | 74,177 |   |
|                                                                                                 |       |                     |       |   |   |
| Supplemental disclosure  of cash flow information:                                                   |       |                     |       |   |   |
|                                                                                                 |       |                     |       |   |   |
| Cash paid during the  period for interest                                                            |       | $                        | 87,523     |   | $ | 268,919 |   |
| Cash paid during the  period for income taxes                                                        |       | $                        | 102,095    |   | $ | 55,208 |   |
| Capital lease  obligations incurred                                                                  |       | $                        | —     |   | $ | 456,520 |   |

 

The accompanying notesare an integral part of these consolidated financial statements.

 

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**XETATECHNOLOGIES, INC. AND SUBSIDIARY**

**Notesto Consolidated Financial Statements**

**July 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 of business clients in sales, engineering,project management, implementation, and service support.  The Company sells products produced by avariety of manufacturers including Avaya, Inc. (“Avaya”), Nortel NetworksCorporation (“Nortel”), and Mitel Corporation (“Mitel”).  In addition, the Company manufactures andmarkets a line of proprietary call accounting systems to the hospitalityindustry.  XETA is an Oklahoma corporation.

 

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 fiscal year.

 

FairValue of Financial Instruments

 

Thefollowing methods and assumptions were used to estimate the fair value of eachclass of financial instruments for which it is practicable to estimate thevalue:

 

The carrying value ofcash and cash equivalents, customer deposits, trade accounts receivable,sales-type leases, accounts payable and short-term debt approximate theirrespective fair values due to their short maturities.

 

Based upon the borrowingrates currently available to the Company for bank loans with similar terms andaverage maturities, the fair value of the long-term debt approximates thecarrying value.

 

Segment Information

 

The Company has threereportable segments: services, commercial system sales, and hospitality systemsales.  Services revenues representrevenues earned from installing and maintaining systems for customers in boththe commercial and hospitality segments. The Company defines commercial system sales as sales to thenon-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 July 31,2009 and 2008:

 

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| ** **     | ** ** | **Services  Revenues** | ** ** | **Commercial  Systems  Sales** | ** ** | **Hospitality  Systems  Sales** | ** ** | **Other  Revenue** | ** ** | **Total**   | ** ** |
|----------------|------------|------------------------|------------|--------------------------------|------------|---------------------------------|------------|--------------------|------------|-------------|------------|
| **2009**       |       |                   |       |                           |       |                            |       |               |       |        |       |
| Sales          |       | $                      | 10,524,397 |                           | $          | 4,032,103                       |       | $                  | 2,490,466  |        | $          | 136,271 |   | $ | 17,183,237 |   |
| Cost  of sales |       | (7,505,892             | )          | (2,828,437                     | )          | (1,811,312                      | )          | (425,480           | )          | (12,571,121 | )          |
| Gross  profit  |       | $                      | 3,018,505  |                           | $          | 1,203,666                       |       | $                  | 679,154    |        | $          | (289,209 | ) | $ | 4,612,116 |   |
|           |       |                   |       |                           |       |                            |       |               |       |        |       |
| **2008**       |       |                   |       |                           |       |                            |       |               |       |        |       |
| Sales          |       | $                      | 12,028,241 |                           | $          | 8,366,333                       |       | $                  | 2,296,234  |        | $          | 512,724 |   | $ | 23,203,532 |   |
| Cost  of sales |       | (8,373,080             | )          | (6,161,782                     | )          | (1,684,502                      | )          | (781,806           | )          | (17,001,170 | )          |
| Gross  profit  |       | $                      | 3,655,161  |                           | $          | 2,204,551                       |       | $                  | 611,732    |        | $          | (269,082 | ) | $ | 6,202,362 |   |

 

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

 
| ** **     | ** ** | **Services  Revenues** | ** ** | **Commercial  Systems  Sales** | ** ** | **Hospitality  Systems  Sales** | ** ** | **Other  Revenue** | ** ** | **Total**   | ** ** |
|----------------|------------|------------------------|------------|--------------------------------|------------|---------------------------------|------------|--------------------|------------|-------------|------------|
| **2009**       |       |                   |       |                           |       |                            |       |               |       |        |       |
| Sales          |       | $                      | 30,359,279 |                           | $          | 15,608,586                      |       | $                  | 7,288,874  |        | $          | 263,126 |   | $ | 53,519,865 |   |
| Cost  of sales |       | (21,258,445            | )          | (11,591,536                    | )          | (5,200,101                      | )          | (1,308,525         | )          | (39,358,607 | )          |
| Gross  profit  |       | $                      | 9,100,834  |                           | $          | 4,017,050                       |       | $                  | 2,088,773  |        | $          | (1,045,399 | ) | $ | 14,161,258 |   |
|           |       |                   |       |                           |       |                            |       |               |       |        |       |
| **2008**       |       |                   |       |                           |       |                            |       |               |       |        |       |
| Sales          |       | $                      | 31,887,653 |                           | $          | 23,171,342                      |       | $                  | 5,477,145  |        | $          | 1,428,950 |   | $ | 61,965,090 |   |
| Cost  of sales |       | (23,104,061            | )          | (17,247,331                    | )          | (3,927,335                      | )          | (1,707,157         | )          | (45,985,884 | )          |
| Gross  profit  |       | $                      | 8,783,592  |                           | $          | 5,924,011                       |       | $                  | 1,549,810  |        | $          | (278,207 | ) | $ | 15,979,206 |   |

 

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 July 31, |       | $        | 74,878     |     | $          | 65,221 |   |
|                              |       |     |       |     |       |
| Nine  months ended July 31,  |       | $        | 219,476    |     | $          | 181,782 |   |

 

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

 

In June 2009 theFinancial Accounting Standards Board (“FASB”) issued Statement of FinancialAccounting Standards No. 168, “The FASBAccounting Standards Codification (“Codification”) and the Hierarchy ofGenerally Accepted Accounting Principles - a replacement of FASB Statement No. 162”(“SFAS No. 168”).  SFAS No. 168establishes the Codification asthe source of authoritative accountingprinciples recognized by the FASB to be applied in the preparation of financialstatements in conformity with GAAP.  The Codification will supersedeexisting non-SEC accounting and reporting standards.  This 

 

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Statement is effectivefor financial statements issued for interim and annual periods ending after September 15,2009.

 

In June 2009 the FASBissued Statement of Financial Accounting Standards No. 167, “Amendments toFASB Interpretation No. 46(R), Consolidationof Variable Interest Entities” (“SFAS No. 167”).  SFAS No. 167 replaces thequantitative based calculation for determining which variable interest entitieshave a controlling financial interest with an approach that is expected to beprimarily qualitative.  The requirementfor consolidation will be based on the reporting entity’s ability to direct theactivities of the other entity’s economic performance as well as the otherentity’s purpose and design.  Thereporting entity will be required to provide additional disclosures regardinginvolvement with variable interest entities and any significant changes in riskexposure resulting from that involvement. SFAS No. 167 will be effective for fiscal years beginning after November 15,2009.  The Company does not currentlyhave any variable interest relationships; therefore, the adoption of SFAS No. 167is not expected to have a material impact on the Company’s financial positionor results of operations.

 

In June 2009 theFASB issued Statement of Financial Accounting Standards No. 166, “Accountingfor Transfers of Financial Assets - an amendment of FASB Statement No. 140”(“SFAS No. 166”). SFAS No. 166 amends FASB Statement No. 140 byremoving the concept of a qualifying special-purpose entity and modifies thefinancial-components approach used in that statement.  SFAS No. 166 limits the circumstances inwhich a transferor derecognizes a portion of a financial asset or when thetransferor has continuing involvement with the financial asset.  The statement establishes conditions forreporting a transfer of a portion of a financial asset as a sale.  SFAS No. 166 will be effective forfiscal years beginning after November 15, 2009.  The adoption of this statement is notexpected to have a material impact on the Company’s financial position orresults of operations.

 

In May 2009the FASB issued Statement of Financial Accounting Standards No. 165, “SubsequentEvents” (“SFAS No. 165”).  SFAS No. 165establishes the general standards of accounting for and disclosures requiredfor events occurring after the balance sheet date but before financialstatements are issued or are available to be issued.  Under SFAS No. 165 the effects of all subsequent events thatprovide additional evidence about conditions that existed at the date of thebalance sheet, including the estimates inherent in the process of preparingfinancial statements, are required to be recognized in the financialstatements.  Subsequent events thatprovide evidence about conditions that did not exist at the date of the balance sheet but arose after thebalance sheet date but before financial statements are issued or are availableto be issued should not be recognized in the financial statements.  Subsequent events that are not recognized inthe financials statements may need to be disclosed to prevent the financialstatements from being misleading.  Thedisclosure should include the nature of event and an estimate of the financialeffect or a statement that an estimate cannot be made.  SFAS No. 165 is effective forinterim and annual financial periods ending after June 15, 2009.

 

In April 2009the FASB issued FASB Staff Position (“FSP”) on Financial Accounting Standard No. 115-2and No. 124-2, “Recognition andPresentation of Other-Than-Temporary Impairments”, which amends theother-than-temporary impairment guidance in U.S. GAAP for debt securities.  The intent of the FSP is to provide guidance onthe presentation and disclosure of other-than-temporary impairments on debt andequity securities in the financial statements; it does not amend existingrecognition and measurement guidance related to other-than-temporaryimpairments of equity securities.  TheFSP is effective for financial statements issued for interim and annual periodsending after June 15, 2009.  Theimplementation of this FSP is not expected to have a material impact on theCompany’s financial position or results of operations.

 

In April 2009the FASB issued FSP FAS No. 107-1 and APB No. 28-1, “Interim Disclosures about Fair Value ofFinancial Instruments”, which requires a company to disclose the fairvalue of its financial instruments for interim reporting periods.  FSP FAS No. 107-1 and APB No. 28-1is effective for interim periods ending after June 15, 2009.

 

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 

 

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measurements;rather, it applies under other accounting pronouncements that require or permitfair value measurements.  The FASB issuedFSP SFAS No. 157-1, “Application of FASB Statement No. 157 to FASBStatement No. 13 and Other Accounting Pronouncements That Address FairValue Measurements for Purposes of Lease Classification or Measurement underStatement 13, which amends SFAS No. 157 to remove certain leasingtransactions from its scope.  The FASBissued FSP SFAS No. 157-2, “EffectiveDate of FASB Statement No. 157”, which delays the effective date ofSFAS No. 157 for all non-financial assets and non-financial liabilities,except for items that are recognized or disclosed at fair value in thefinancial statements on a recurring basis, until fiscal years beginning after November 15,2008.  The FASB issued FSP SFAS No. 157-3,“Determining the Fair Value of aFinancial Asset When the Market for That Asset Is Not Active”, whichclarifies the application of SFAS No. 157 in a market that is not activeand provides guidance in key considerations in determining the fair value of afinancial asset when the market for that financial asset is not active.  On April 2009 the FASB issued FSP SFAS No. 157-4,“Determining the Fair Value When theVolume and Level of Activity for the Asset or Liability Have SignificantlyDecreased and Identifying Transactions That Are Not Orderly”, whichprovides additional guidance for estimating fair value when the volume andlevel of activity for the asset or liability have significantly decreased andguidance on identifying circumstances that indicate a transaction is notorderly.   FSP SFAS No. 157-4 iseffective for interim and periods ending after June 15, 2009.  The adoption of SFAS No. 157 did nothave a material impact on the Company’s consolidated financial position orresults of operations.

 

In December 2007the FASB issued SFAS No. 141 (revised 2007), “Business Combinations” (“SFASNo. 141(R)”). Under SFAS No. 141(R), an entity is required torecognize the assets acquired, liabilities assumed, contractual contingencies,and contingent consideration at their fair value on the acquisition date. Itfurther requires that acquisition-related costs are recognized separately fromthe acquisition and expensed as incurred, restructuring costs generallyexpensed in periods subsequent to the acquisition date, and changes inaccounting for deferred tax asset valuation allowances and acquired income taxuncertainties after the measurement period impact income tax expense.  Theadoption of SFAS No. 141(R) will change the accounting treatment forbusiness combinations on a prospective basis beginning in the first quarter offiscal 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 July 31, 2009, theCompany did not have any minority interests; therefore the adoption of SFAS No. 160is not expected to have an impact on the Company’s consolidated financialstatements.

 

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 over the financial asset. Aninitial transfer of a financial asset and repurchase financing that are enteredinto contemporaneously with, or in contemplation of, one another shall beconsidered linked unless all of the following criteria are met at the inceptionof 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).

 

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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 be disclosedin terms of underlying risk and accounting designation.  The Company isrequired to adopt SFAS No. 161 on or before November 1, 2009. The Company currently does not participate in any derivative instruments orhedging activities as defined under SFAS No. 133 and therefore it isunlikely that the adoption of SFAS No. 161 will have any impact on theCompany’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 in developing renewal or extensionassumptions used to determine the useful life of intangible assets under SFAS No. 142“Goodwill and Other Intangible Assets”.  The intent of this FSP is toimprove the consistency between the useful life of a recognized intangibleasset under SFAS No. 142 and the period of the expected cash flows used tomeasure the fair value of the asset under SFAS No. 141 (revised 2007) “BusinessCombinations” and other U.S. generally accepted accounting principles. The Company will adopt this FSP in the first quarter of fiscal 2010 and willapply the guidance prospectively to 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.

 

Goodwilland Other Long-lived Assets

 

The Company accounts forgoodwill under the provisions of SFAS No. 142, “Goodwill and OtherIntangible Assets” (“SFAS 142”).  UnderSFAS 142, goodwill recorded as a part of a business combination is notamortized, but instead is subject to at least an annual assessment forimpairment by applying a fair-value-based test. During the third quarter the Company experienced a continued decline inrevenues in its commercial equipment reporting unit due to poor economicconditions and uncertainty regarding Nortel’s product line.  Additionally, the Company also experienced asustained decline in its market capitalization. These factors, taken together, prompted an interim test forimpairment.  The Company conducted step 1of its review as of July 31, 2009 and engaged an independent valuationconsultant to assist in the formulation of fair values for each of itsreporting units.  In order to make thisassessment, the Company prepared a long-term forecast of the operating resultsand cash flows associated with the major reporting units of its business.  The forecast was prepared to determine thenet discounted cash flows associated with each of these units.  The Company, with the assistance of itsvaluation consultant, also developed market-based approaches to estimate thevalue of its reporting units.  Thesemarket-based approaches utilize current valuations of businesses similar to theCompany’s and apply various valuation techniques to estimate fair value.  These estimated income-based and market-basedvaluations were weighted and the corresponding valuation was then compared tothe book value of each of the reporting units. Making this assessment requires a great deal of judgment, including thegrowth rates of various business lines, gross margins, operating margins,discount rates, and the capital expenditures needed to support the projected growthin revenues.  The valuation consultantengaged to assist in this evaluation examined additional data regardingcompetitors and market conditions which also required a great amount ofsubjectivity and assumptions.  Themethodologies used in this interim analysis were consistent with themethodologies and valuation techniques used in past impairmentassessments.  Based on completion of step1 of the analysis, management determined that the carrying value of the commercialequipment reporting unit was greater than its estimated fair value andtherefore an impairment of the goodwill associated with this unit exists.  

 

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Management has estimatedthe impairment to be between $9 million and $13 million and an impairmentcharge of $11.0 million was recorded in the third fiscal quarter representingthe Company’s best estimate of the probable impairment at this time.  The Company will adjust the impairmentcharge, if necessary, after completing step two of its impairment test inconnection with its next periodic report filing with the Securities andExchange Commission.

 

In accordance with FASBStatement No. 144, “Accounting for the Impairment or Disposal ofLong-Lived Assets” an impairment loss on long-lived assets used in operationsis recorded when events and circumstances indicate that the carrying amount ofthe asset may not be recoverable.  Duringthe third fiscal quarter, it was determined that certain identifiable assetsrelated to our Oracle ERP platform were impaired because the Company estimatesthat full cost of the system cannot be reasonably recovered based on near-termprojected financial results.  An impairment charge of $3.0 million wasrecorded as of July 31, 2009 to reduce the Company’s carrying value ofthis asset to the mid-point of management’s estimate of the replacement cost ofan ERP system that would be adequate for the Company’s current and near-termoperating needs.

 

2.  ACCOUNTS RECEIVABLE:

 

Accounts receivable consist of the following:

 
| ** **                          | ** ** | **July 31,  2009** | ** ** | **(Audited)  October 31,  2008** | ** ** |
|-------------------------------------|------------|-------------------------|------------|---------------------------------------|------------|
|                                |       |                    |       |                                  |       |
| Trade  accounts receivables         |       | $                       | 11,938,936 |                                  | $          | 20,188,378 |   |
| Less  reserve for doubtful accounts |       | (556,212                | )          | (192,880                              | )          |
| Net  trade accounts receivables     |       | $                       | 11,382,724 |                                  | $          | 19,995,498 |   |

 

On January 14, 2009Nortel filed for bankruptcy protection in the United States.  Theadministrators of the bankruptcy have adopted a business disposalstrategy.  Under this strategy, the administrators have segmented Nortelinto three business units: Virtual Service Switches, CDMA businesses andEnterprise Solutions.  We conduct all of our Nortel business through theEnterprise Solutions unit.  On July 21, 2009, the administrators ofthe bankruptcy announced they had entered into a stalking horse assets andshare sale agreement with Avaya for the Enterprise Solutions unit and thisprocess is proceeding.  Due to the nature of the stalking horse auctionprocess, a final determination of the purchaser of the Enterprise Solutionsunit is not expected until near the end of our fiscal year.  At the time of Nortel’s filing, they owedapproximately $685,000 for services rendered under the Company’s wholesalemanaged services program in which the Company is engaged by Nortel to providefield technical services to Nortel’s end-user customers.  At the time of filing this Form 10-Q thedeadline for filing a plan of reorganization was September 11, 2009, butthis date is subject to extension.  UntilNortel files its reorganization plan; our ability to assess the probability ofrecovering pre-petition amounts due is limited.  As of July 31, 2009we have recorded $350,000 as a reserve against possible bad debts.  On July 17, 2009 the bankruptcy courtgranted the Company’s request for offset of $116,000 in charges the Companyowed Nortel at the time of the filing. We are 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:

 
| ** **                                         | ** ** | **July 31,  2009** | ** ** | **(Audited)  October 31,  2008** | ** ** |
|----------------------------------------------------|------------|-------------------------|------------|---------------------------------------|------------|
|                                               |       |                    |       |                                  |       |
| Finished  goods and spare parts                    |       | $                       | 6,010,738  |                                  | $          | 6,084,830 |   |
| Less-  reserve for excess and obsolete inventories |       | (901,894                | )          | (848,265                              | )          |
| Total  inventories, net                            |       | $                       | 5,108,844  |                                  | $          | 5,236,565 |   |

 

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4.  PROPERTY, PLANT AND EQUIPMENT:

 

Property, plant andequipment consist of the following:

 
| ** **                                                    | ** ** | **Estimated  Useful  Lives** | ** ** | **July 31,  2009** | ** ** | **(Audited)  October 31,  2008** | ** ** |
|---------------------------------------------------------------|------------|------------------------------|------------|-------------------------|------------|---------------------------------------|------------|
|                                                          |       |                         |       |                    |       |                                  |       |
| Building  and building improvements                           |       | 3-20                         |       | $                       | 3,119,404  |                                  | $          | 3,054,563 |   |
| Data  processing and computer field equipment                 |       | 2-7                          |       | 3,225,850               |       | 3,351,229                             |       |
| Software  development costs, work-in-process                  |       | N/A                          |       | 220,911                 |       | 2,069,234                             |       |
| Software  development costs of components placed into service |       | 3-10                         |       | 2,619,700               |       | 6,631,805                             |       |
| Computer  hardware                                            |       | 3-5                          |       | 631,848                 |       | 615,657                               |       |
| Land                                                          |       | —                       |       | 611,582                 |       | 611,582                               |       |
| Office  furniture                                             |       | 5-7                          |       | 779,588                 |       | 944,048                               |       |
| Auto                                                          |       | 5                            |       | 502,521                 |       | 516,185                               |       |
| Other                                                         |       | 3-7                          |       | 293,938                 |       | 239,533                               |       |
|                                                          |       |                         |       |                    |       |                                  |       |
| Total  property, plant and equipment                          |       |                         |       | 12,005,342              |       | 18,033,836                            |       |
| Less-  accumulated depreciation and amortization              |       |                         |       | (5,007,558              | )          | (7,311,297                            | )          |
|                                                          |       |                         |       |                    |       |                                  |       |
| Total  property, plant and equipment, net                     |       |                         |       | $                       | 6,997,784  |                                  | $          | 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%.

 

The tax effect oftemporary differences that give rise to significant portions of the deferredtax assets and deferred tax liabilities are presented below:

 
| ** **                                                 | ** ** | **July 31,  2009** | ** ** | **(Audited)  October 31,  2008** | ** ** |
|------------------------------------------------------------|------------|-------------------------|------------|---------------------------------------|------------|
| Deferred  tax assets:                                      |       |                    |       |                                  |       |
| Net  operating loss carryforward                           |       | $                       | 1,889,299  |                                  | $          | 1,158,195 |   |
| Currently  nondeductible reserves                          |       | 555,173                 |       | 353,000                               |       |
| Accrued  liabilities                                       |       | 451,458                 |       | 172,258                               |       |
| Prepaid  service contracts                                 |       | 34,895                  |       | 43,547                                |       |
| Stock  based compensation expense                          |       | 230,559                 |       | 144,525                               |       |
| Other                                                      |       | 33,067                  |       | 29,488                                |       |
| Total  deferred tax asset                                  |       | 3,194,451               |       | 1,901,013                             |       |
|                                                       |       |                    |       |                                  |       |
| Deferred  tax liabilities:                                 |       |                    |       |                                  |       |
| Intangible  assets                                         |       | 1,219,942               |       | 5,051,498                             |       |
| Depreciation                                               |       | 675,945                 |       | 1,788,933                             |       |
| Other                                                      |       | 643,936                 |       | —                                |       |
| Tax  income to be recognized on sales-type lease contracts |       | 22,660                  |       | 17,348                                |       |
| Total  deferred tax liability                              |       | 2,562,483               |       | 6,857,779                             |       |
| Net  deferred tax asset (liability)                        |       | $                       | 631,968    |                                  | $          | (4,956,766 | ) |

 

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| ** **                                                         | ** ** | **July 31,  2009** | ** ** | **(Audited)  October 31,  2008** | ** ** |
|--------------------------------------------------------------------|------------|-------------------------|------------|---------------------------------------|------------|
| Net  deferred asset (liability) as presented on the balance sheet: |       |                    |       |                                  |       |
| Current  deferred tax asset                                        |       | $                       | 418,420    |                                  | $          | 588,926 |   |
| Noncurrent  deferred tax asset (liability)                         |       | 213,548                 |       | (5,545,692                            | )          |
| Net  deferred tax asset (liability)                                |       | $                       | 631,968    |                                  | $          | (4,956,766 | ) |

 

The tax effect ofimpairment charges recognized as of July 31, 2009 resulted in a decreasein noncurrent deferred tax liabilities of approximately $5.5 million.  For tax purposes the Company is amortizingits goodwill balances over a statutory life of 15 years.  The combination of these tax deductions andlower levels of taxable income generated from operations in recent years hascreated net operating losses that are reflected in the Company’s balance sheetas deferred tax assets.  Managementbelieves that future operating income will be sufficient to realize these losscarryforwards and that no valuation allowance is required.

 

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 line of credit is used tofinance growth in working capital and is collateralized by qualifying tradeaccounts receivable and inventories.  TheCompany is in discussions with several lenders, including its existing lender,to establish a new credit facility and expects to have a new agreementestablished prior to the expiration of its current agreement.

 

At July 31, 2009 theCompany did not have an outstanding balance on the revolving line of credit andhad approximately $2.524 million outstanding at October 31, 2008.  The Company had approximately $5.2 millionavailable under the revolving line of credit at July 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:

 
| ** **                                                                                                                                                                                                | ** ** | **July 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 |       | $                       | 1,226,248  |                                  | $          | 1,354,565 |   |
|                                                                                                                                                                                                      |       |                    |       |                                  |       |
| Less-current  maturities                                                                                                                                                                                  |       | 1,226,248               |       | 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”) (0.279% at July 31, 2009) plus 1.25% to2.75% depending on the Company’s funded debt to cash flow ratio, or b) the bank’sprime rate (3.25% at July 31, 2009) minus 0% to minus 1.125% alsodepending on the Company’s funded debt to cash flow ratio.  At July 31, 2009 the Company was paying2.875% on the revolving line of credit borrowings and 3.00% on the mortgagenote.  The credit facility containsseveral financial covenants common in such agreements including tangible networth requirements, limitations on the amount of funded debt to annual earningsbefore interest, taxes, depreciation and amortization, limitations on capitalspending, and debt service coverage requirements.   At July 31, 2009, the Company waseither in compliance with the covenants of the credit facility or had receivedthe appropriate waivers from its bank.

 

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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 July 31, 2009** | ** ** |
|-----------------------------------|------------|---------------------------------------------------|------------|
| ** **                        | ** ** | **Income  (Numerator)**                           | ** ** | **Shares  (Denominator)** | ** ** | **Per Share  Amount** | ** ** |
| Basic  EPS                        |       |                                              |       |   |   |   |   |
| Net  loss                         |       | $                                                 | (8,599,068 | ) | 10,223,753 |   | $ | (0.84 | ) |
| Dilutive  effect of stock options |       |                                              |       | — |   |   |   |
|                              |       |                                              |       |   |   |   |   |
| Diluted  EPS                      |       |                                              |       |   |   |   |   |
| Net  loss                         |       | $                                                 | (8,599,068 | ) | 10,223,753 |   | $ | (0.84 | ) |

 
| ** **                        | ** ** | **For the Three Months Ended July 31, 2008** | ** ** |
|-----------------------------------|------------|---------------------------------------------------|------------|
| ** **                        | ** ** | **Income  (Numerator)**                           | ** ** | **Shares  (Denominator)** | ** ** | **Per Share  Amount** | ** ** |
| Basic  EPS                        |       |                                              |       |   |   |   |   |
| Net  income                       |       | $                                                 | 590,840    |   | 10,254,310 |   | $ | 0.06 |   |
| Dilutive  effect of stock options |       |                                              |       | — |   |   |   |
|                              |       |                                              |       |   |   |   |   |
| Diluted  EPS                      |       |                                              |       |   |   |   |   |
| Net  income                       |       | $                                                 | 590,840    |   | 10,254,310 |   | $ | 0.06 |   |

 
| ** **                        | ** ** | **For the Nine Months Ended July 31, 2009** | ** ** |
|-----------------------------------|------------|--------------------------------------------------|------------|
| ** **                        | ** ** | **Income  (Numerator)**                          | ** ** | **Shares  (Denominator)** | ** ** | **Per Share  Amount** | ** ** |
| Basic  EPS                        |       |                                             |       |   |   |   |   |
| Net  loss                         |       | $                                                | (8,413,512 | ) | 10,223,881 |   | $ | (0.82 | ) |
| Dilutive  effect of stock options |       |                                             |       | — |   |   |   |
|                              |       |                                             |       |   |   |   |   |
| Diluted  EPS                      |       |                                             |       |   |   |   |   |
| Net  loss                         |       | $                                                | (8,413,512 | ) | 10,223,881 |   | $ | (0.82 | ) |

 
| ** **                        | ** ** | **For the Nine Months Ended July 31, 2008** | ** ** |
|-----------------------------------|------------|--------------------------------------------------|------------|
| ** **                        | ** ** | **Income  (Numerator)**                          | ** ** | **Shares  (Denominator)** | ** ** | **Per Share  Amount** | ** ** |
| Basic  EPS                        |       |                                             |       |   |   |   |   |
| Net  income                       |       | $                                                | 1,351,090  |   | 10,241,861 |   | $ | 0.13 |   |
| Dilutive  effect of stock options |       |                                             |       | 4,950 |   |   |   |
|                              |       |                                             |       |   |   |   |   |
| Diluted  EPS                      |       |                                             |       |   |   |   |   |
| Net  income                       |       | $                                                | 1,351,090  |   | 10,246,811 |   | $ | 0.13 |   |

 

Options to purchase1,269,900 shares of common stock at an average exercise price of $6.42 and1,029,500 shares of common stock at an average exercise price of $7.28 were notincluded in the computation of diluted earnings per share for the three monthsended July 31, 2009 and 2008, respectively, because inclusion of theseoptions would be antidilutive.  Optionsto purchase 1,269,900 shares of common stock at 

 

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an average exercise priceof $6.42 and 844,900 shares of common stock at an average exercise price of$8.08 were not included in the computation of diluted earnings per share forthe nine months ended July 31, 2009 and 2008, respectively, becauseinclusion of these options 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 $291,666 at July 31, 2009.  Accumulated amortization of the leasedlicenses at July 31, 2009 was $168,854. Amortization under the capital lease is included in depreciationexpense.  The future minimum leasepayments required under the capital lease and the present value of the netminimum lease payments as of July 31, 2009, are as follows:

 
| ** **                                           | ** ** | **Capital  Lease Payments** | ** ** |
|------------------------------------------------------|------------|-----------------------------|------------|
|                                                 |       |                        |       |
| 1  Year                                              |       | $                           | 161,435    |   |
| 2  Years                                             |       | 147,982                     |       |
| Total  minimum lease payments                        |       | 309,417                     |       |
| Less-  imputed interest                              |       | 11,674                      |       |
| Present  value of minimum payments                   |       | 297,743                     |       |
| Less-current  maturities of capital lease obligation |       | 152,589                     |       |
| Long-term  capital lease obligation                  |       | $                           | 145,154    |   |

 

9.  SUBSEQUENT EVENTS:

 

The Companyevaluated subsequent events through August 28, 2009.  The Company is not aware of any significantevents that occurred subsequent to the balance sheet date but prior to thefiling of this report that would have a material impact on our financialposition or results of operations.

 

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**ITEM2.  MANAGEMENT’S DISCUSSION AND ANALYSISOF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

**Preliminary Note RegardingForward-Looking Statements**

 

In the followingdiscussion, we make forward-looking statements concerning future performance,events and results. Other than purely historical statements, all others arelikely forward-looking.  Forward-lookingstatements generally include words such as “expects,” “anticipates,” “may,” “plans,”“believes,” “intends,” “projects,” “estimates,” “targets,” “should” and similarexpressions.  Such statements reflect ourperspective on the industry and markets in which we operate.  Any statements containing estimates andforecasts are not guarantees of performance, but rather, our assumptions andbeliefs based upon information currently available to us.  These statements are subject to risks anduncertainties that are difficult to predict or beyond our control.  Examples of these risks include: thecondition of U.S. economy and its impact on capital spending; reducedavailability of credit; the Nortel Networks bankruptcy filing; the financialcondition of our suppliers and changes in their distribution strategies andsupport; our ability to maintain and improve current gross profit margins;unpredictable quarter to quarter revenues; continuing market success of theMitel product and services offerings; intense competition; industryconsolidation; our dependence upon a few large wholesale customers in ourManaged Services offering; and our ability to attract and retain talentedsales, operational and technical personnel. These and other risks and uncertainties are discussed under the heading “RiskFactors” under Part I of the Company’s Form 10-K for the fiscal yearended October 31, 2008 (filed with the Commission on January 23,2009), and in updates to such risk factors set forth in Item 1A of Part IIof our quarterly reports during fiscal 2009. Because of these risks and uncertainties, actual results may differmaterially and adversely from those expressed in forward-lookingstatements.  Consequently, we cautioninvestors to read and consider all forward-looking statements in conjunctionwith such risk factors and uncertainties. The Private Securities Litigation Reform Act of 1995 provides asafe-harbor for forward-looking statements made by the Company.

 

# **Overview**

# ** **

Strategy.

 

During the third quartermanagement continued to lead execution of the five primary strategiesidentified at the outset of fiscal 2009. These strategies include: continue to acquire market share through targeted sales activities; takeadvantage of Avaya’s new channel-centric go-to-market strategy; focus on fastgrowing applications such as unified communications; focus on industryverticals such as hospitality, healthcare and education; and augment growththrough targeted acquisitions.

 

In addition to monitoringtrends in order rates and holding discussions with customers, management alsomonitors macroeconomic conditions, sales trends among our major suppliers, andsales activity across the communications industry.  Based on information derived from these activities,management believes that market conditions will remain challenging for thefourth fiscal quarter and perhaps beyond. As such, in the third quarter management developed and executed amulti-pronged cost reduction plan designed to align sales and operating costswith market conditions.

 

The reductions werecarefully designed to aggressively reduce costs, while preserving the keyresources necessary to fully realize growth opportunities as the marketrecovers.  The beneficial effects ofthese actions were only partially realized in the third quarter.  Management anticipates the full benefit ofthese measures will materialize in the fourth quarter, and into next fiscalyear.

 

Our third quarterfinancial results reflect an impairment charge on goodwill and other assets of$14.0 million.  Poor economic conditionsand uncertainty regarding Nortel’s product line contributed to continueddeterioration of our commercial equipment business.  Additionally, we experienced a sustaineddecline in our market valuation.  Thesefactors, taken together, prompted a review of the value of goodwill and certainother long-lived assets.  Throughapplying the applicable accounting rules, we determined that the carrying costof our Oracle ERP would not be recovered over the near term and that awrite-down of that asset to its estimated replacement cost wasappropriate.  Accordingly, we recorded a$3.0 million impairment on this asset. Likewise, we conducted step one of the impairment test on goodwill anddetermined that the carrying 

 

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value of goodwill isestimated to be impaired between $9.0 million and $13.0 million.  Accordingly, we recorded an impairment chargeof $11.0 million as our best estimate of the impairment at the time of filingthis report.  We will adjust theimpairment charge, if necessary, after completing step two of the impairmenttest during our fourth fiscal quarter. These items are discussed in additional detail in “Results of Operations”below and in Note 1 to the Consolidated Condensed Financial Statements above.

 

In April 2009 XETApurchased the assets of Summatis Communications, LLC (“Summatis”) located inSouthboro, MA.  Summatis providescommunications solutions, integration and maintenance services primarilytargeted at the Nortel product line.  Theacquisition strengthens our presence in the northeastern U.S. and adds to ourNortel competencies.  While theacquisition is not material to our financial position or results of operations,it represents an incremental step in our overall acquisitions strategy.

 

On January 14, 2009Nortel Networks Corporation filed for bankruptcy protection in the UnitedStates Bankruptcy Court for the District of Delaware.  The administrators of the bankruptcy haveadopted a business disposal strategy.  Under this strategy, theadministrators have segmented Nortel into three business units: Virtual ServiceSwitches, CDMA businesses and Enterprise Solutions.  We conduct all of ourNortel business through the Enterprise Solutions unit.  On July 21,2009, the administrators of the bankruptcy announced they had entered into astalking horse assets and share sale agreement with Avaya for the EnterpriseSolutions unit and this process is proceeding.  Due to the nature of thestalking horse auction process, a final determination of the purchaser of theEnterprise Solutions unit is not expected until near the end of our fiscalyear.  Nortel is one of our majorsuppliers and represents a significant portion of our business.  As such this filing is of considerableconcern.  At the time of filing this Form 10-Q,our post-petition relationship with Nortel continues without interruption.  However, management recognizes the potentialimpact of Nortel’s filing on the Company’s financial performance (see Item 1A. “RiskFactors” below).  Nortel owes XETAapproximately $685,000 in pre-petition accounts receivable.  Presently, Nortel has until September 11,2009 to file its reorganization plan. However, this date is subject to further extension.  Until a plan of reorganization is filed, ourability to assess the probability of recovering pre-petition amounts due islimited.  On July 17, 2009 thebankruptcy court granted our request for offset of $116,000 in charges we owedNortel at the time of the filing.  As of July 31,2009 we have recorded $350,000 as a reserve against possible Nortel baddebts.  We are following developments inthe bankruptcy case and will assert our legal rights and defenses asappropriate.

 

OperatingSummary.

 

Inthe third quarter of fiscal 2009 we recorded a net loss of $8.6 million onrevenues of $17.2 million compared to net income of $591,000 on revenues of$23.2 million in the third quarter of last year.  Excluding the $14.0 million impairment chargeand related tax benefit of $5.5 million in the third quarter, our non-GAAP netloss was $87,000.  For the first ninemonths of fiscal 2009 we recorded a net loss of $8.4 million on revenues of$53.5 million compared to net income of $1.4 million on revenues of $62.0million.  Excluding the impairment chargeand tax benefit, our non-GAAP net income for the first nine months of fiscal2009 was $98,000.  Apart from theimpairment charges to goodwill and our Oracle ERP system which are discussed inmore detail above, these results primarily reflect the challenging marketconditions stemming from the ongoing macroeconomic contraction and theassociated decline in demand for commercial systems.  We discuss this and other contributingfactors in more detail under “Results of Operations” below.

 

FinancialPosition Summary.

 

SinceOctober 31, 2008 we have generated positive cash flows from operations of$7.9 million, primarily through the collections of accounts receivable.  We have used these cash flows to reduceborrowings and have improved our working capital approximately 5%.  We discuss these and other financial items inmore detail under “Financial Condition” below.

 

Thefollowing discussion presents additional information regarding our financialcondition and results of operations for the three- and nine-month periods endedJuly 31, 2009 and 2008 and should be considered in conjunction with ourabove comments as well as the “Risk Factors” section below.

 

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# **Financial Condition**

 

Duringthe first three fiscal quarters of 2009 our working capital increased by 5% to$9.8 million.  We generated $7.9 millionin cash flows from operations.  Thesecash flows included a decrease in accounts receivable of $8.6 million and adecrease in inventory of $296,000.  Theseincreases were partially offset by a decrease in deferred tax liabilities of$5.5 million; a decrease in accounts payable of $2.7 million; a decrease inaccrued liabilities of $408,000; and other changes in working capital items,which netted a decrease in cash of $356,000. The impairment charge to goodwill and other assets of $14.0 million didnot impact cash flows in the period. Other Non-cash charges included amortization of $1.0 million;depreciation of $723,000; provisions for doubtful accounts receivable andobsolete inventories of $471,000; stock-based compensation of $219,000; and aloss on the sale of assets of $4,000.

 

Weused these positive cash flows to reduce borrowings on our working capital lineof credit by $2.5 million; to make asset purchases of capitalized hospitalityservice contracts as well as certain net assets of Summatis, together totaling$1.53 million; acquire capital assets of $636,000; reduce our mortgage balancethrough scheduled principal payments by $128,000; and fund other financing andinvesting activities of $169,000.  Theacquisition of capital assets included $414,000 spent as part of normalreplacement of our Information Technology infrastructure and headquartersfacility improvements.  The remaining$222,000 was spent on our Oracle ERP implementation.

 

AtJuly 31, 2009 there were no outstanding draws on our working capitalrevolver.  Based on the collateral basedefined in the credit facility, there was $5.2 million available for borrowingon the $7.5 million facility at the end of the quarter and our cash balance was$3.0 million.  We believe our cash balancesand available borrowing capacity are sufficient to support our operatingrequirements for the foreseeable future. The working capital revolver and the mortgage on our headquartersfacility are scheduled to mature on September 30, 2009.  We are in discussions with several lenders,including our existing bank, to secure a new credit facility prior to theexpiration of our existing agreement.  Weexpect to establish a new credit facility prior to the expiration of thecurrent agreement.  However, givencurrent credit market conditions, it is likely any new credit agreement willcontain higher borrowing costs and/or reduced availability for unsecuredborrowings.  In addition to the availablecapacity under our working capital line of credit, to finance investmentsbeyond our current operating needs we believe we may have access to a varietyof capital sources such as private placements of subordinated debt, and publicor private sales of equity.

 

# **Results of Operations**

# ** **

Inthe third quarter of fiscal 2009 revenues were $17.2 million compared to $23.2million in the third quarter 2008.  Ournet loss in the third quarter of fiscal 2009 was $8.6 million compared to netincome of $591,000 compared to the same quarter a year ago.  In the first nine months of the year,revenues were $53.5 million compared to $62.0 million for the first nine monthsof fiscal 2008.  Our net loss for thefirst nine months of fiscal 2009 was $8.4 million compared to net income of$1.4 million in the first nine months of fiscal 2008.  Net of the impairment charges and tax benefitsrecorded in the third quarter we incurred a non-GAAP net loss of $87,000 in thethird quarter and generated non-GAAP net income of $98,000 year-to-date.  Apart from the impairment charges on goodwilland other assets of $14.0 million which are discussed above under “Overview”,these results primarily reflect lower sales of commercial systems and lowercommissions earned from the sale of Avaya post-warranty maintenancecontracts.  The year-to-date results werealso impacted by the $350,000 bad debt provision associated with Nortel’sbankruptcy filing.  The narrative belowprovides further explanation of these results.

 

SystemsSales.

 

In the third quarter offiscal 2009 systems sales decreased approximately $4.1 million or 39% comparedto the same period last year.  Thisdecrease includes a $4.3 million or 52% decrease in sales of systems tocommercial customers partially offset by a $194,000 or 8% increase in sales ofsystems to hospitality customers. Year-to-date systems sales decreased $5.8 million or 20% compared tolast year.  This decrease includes adecrease in sales of systems to commercial customers of $7.6 million or 33%which was partially offset by an increase in sales of systems to hospitalitycustomers of $1.8 million or 33%.  Thedecrease in systems sales to commercial customers reflects difficultcomparisons related to the revenues earned from the Miami-Dade County PublicSchool’s (“M-DCPS”) project. Additionally macroeconomic conditions, Nortel’s bankruptcy and shipmentsscheduled for the third quarter but delayed at the customers’ request, impactedour sales results.

 

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Throughout fiscal 2008 weenjoyed strong commercial systems sales, installation revenues, and cablingrevenues generated by the series of orders received from M-DCPS.  In total, these orders generated over $10million in revenues for the Company during the year.  We have not received a similar order duringfiscal 2009, making comparisons to last year’s results more difficult.  Additionally, customers continue to reducecapital spending in response to recessionary conditions, and access to creditremains problematic.  As these conditionshave intensified, customers have limited their capital spending to necessitypurchases and investments with clear, rapid returns.  Finally, uncertainty around the Nortelbankruptcy continues to severely dampen demand for equipment in this productline.

 

Thequarterly and year to date growth in sales of systems to hospitality customers,particularly during a challenging hospitality market, reflects our continuedsuccess in this niche market.  Resultssupport our strategy to expand our product offering to Mitel products which hasprovided us with the opportunity to work with hotel chains and propertymanagement companies that have previously standardized on the Mitel productline.  While we anticipate continued successin the hospitality market, given economic conditions, downward pressure onrevenues in this segment may intensify and as such revenues may be at or lessthan historical levels in the fourth quarter of the fiscal year.

 

ServicesRevenues.

 

Servicesrevenues consist of the following:

 
| ** **                   | ** ** | **For the Three Months Ended  July 31,** | ** ** | **For the Nine Months Ended  July 31,** | ** ** |
|------------------------------|------------|-----------------------------------------------|------------|----------------------------------------------|------------|
| ** **                   | ** ** | **2009**                                      | ** ** | **2008**                                     | ** ** | **2009** | ** ** | **2008** | ** ** |
| Contract &  T&M |       | $                                             | 7,358,000  |                                         | $          | 7,202,000 |   | $ | 21,384,000 |   | $ | 21,438,000 |   |
| Implementation               |       | 2,469,000                                     |       | 3,864,000                                    |       | 6,926,000 |   | 8,251,000 |   |
| Cabling                      |       | 697,000                                       |       | 962,000                                      |       | 2,049,000 |   | 2,199,000 |   |
| Total  Services revenues     |       | $                                             | 10,524,000 |                                         | $          | 12,028,000 |   | $ | 30,359,000 |   | $ | 31,888,000 |   |

 

Contractand time-and-materials (T&M) revenues increased 2% and decreased 0.3%,respectively in the third quarter and year-to-date periods.  This year-to-date performance reflectsrelatively flat revenues in our wholesale services programs and a modestdecline in T&M service revenues.  Webelieve T&M revenues were influenced by general economic conditions ascustomers reduced spending on non-critical services.  We continue to aggressively market ournational service footprint and multi-product line technical capabilities toend-users, network service providers, and large integrators of voice and datatechnologies.  In the third quarter werealized beneficial returns from the new service programs with MarriottInternational and Lockheed Martin Corporation that we secured in the secondquarter. Additionally, the acquired customer relationships from Summatisbeneficially influenced our results.  Weexpect these new programs and relationships to positively impact our Contract &T&M revenues for the foreseeable future.

 

Implementationrevenues decreased 36% and 16%, respectively in the third fiscal quarter andyear-to-date periods.  These declines,while significant, reflect a lower rate of decline than the correspondingdecrease in systems sales, traditionally the primary driver of theserevenues.  We attribute this toincreasing demand for more complex communications systems requiring significantfee-generating design and engineering services provided by our ProfessionalServices Organization (“PSO”).  In thenear term, Implementation revenues will continue to be closely aligned with thesale of new systems.  From a long termperspective, however, as customers displace conventional communicationsplatforms and adopt more complex systems, we anticipate growth in this area ofour business through the fee-based utilization of these highly skilledtechnical resources.

 

Cablingrevenues decreased 28% and 7%, respectively in the third fiscal quarter andyear-to-date periods.  The third quarterdecline in cabling revenues is primarily associated with the difficultcomparisons to fiscal 2008 which were helped significantly by the M-DCPS ordersas discussed above.

 

GrossMargins.

 

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

 

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| ** **                    | ** ** | **For the Three  Months Ended  July 31,** | ** ** | **For the Nine  Months Ended  July 31,** | ** ** |
|-------------------------------|------------|------------------------------------------------|------------|-----------------------------------------------|------------|
| **Gross Margins**             | ** ** | **2009**                                       | ** ** | **2008**                                      | ** ** | **2009** | ** ** | **2008** | ** ** |
| Services  revenues            |       | 28.7                                           | %          | 30.4                                          | %          | 30.0 | % | 27.5 | % |
| Systems  sales                |       | 28.9                                           | %          | 26.4                                          | %          | 26.7 | % | 26.1 | % |
| Other  revenues               |       | 41.4                                           | %          | 22.1                                          | %          | 9.6 | % | 62.2 | % |
| Corporate  cost of goods sold |       | -2.0                                           | %          | -1.6                                          | %          | -2.0 | % | -1.9 | % |
| Total                         |       | 26.8                                           | %          | 26.7                                          | %          | 26.5 | % | 25.8 | % |

 

Grossmargins earned on Services revenues reflect mixed results between improvedmargins earned on our contract & T&M services which were offset bysignificantly lower margins earned on implementation activities.  As aresult of improved cost controls and reduced headcounts, we earned higher grossmargins on our contract & T&M services revenues in the thirdquarter and in the year-to-date periods.  However, due to lowerutilization of installation and professional services personnel in theimplementation department and difficult comparisons to the third quarter offiscal 2008, our gross margins in this area suffered dramatically in the thirdquarter.  For the year-to-date period implementation gross margins arealso down, but cost reductions and on-boarding the new Samsung service programhave helped to dampen the impact of lower revenues in this area.  Similar to the Samsung program, developing additionalbillable consulting services which are not directly associated with new systeminstallations is an important aspect of our services strategy to create morepredictability and higher gross margins in this area.

 

Gross margins on systems sales in the third quarterand the year-to-date periods are above our target of 23% to 25% for systemsrevenues.  We continue to receiveconsiderable pricing support from our manufacturers in the form ofproject-specific discounts and incentive rebates.  These incentives are material to our grossmargins and we work diligently to maximize this support; however,no assurance can be given that future support will continue at historicallevels.

 

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 three quarters of fiscal 2009 weexperienced a dramatic drop in other revenues as compared to the same periodlast year.  Some decline in this segmentwas expected as we benefited from accelerated customer decisions throughout2008.  In 2008 many customers acceleratedtheir purchases or renewals of Avaya service contracts in anticipation ofmanufacturer-driven changes in the structure of these service programs.  This is an unpredictable revenue stream thatdepends on the expiration dates of existing contracts, installation dates ofnew systems, the customer type as defined by Avaya, and the number of yearsthat customers contract for services. While no assurance can be given, we expect sales of Avaya servicecontracts to return to pre fiscal 2008 levels. Other revenues may also include sales and cost of goods sold onequipment or services sold outside our normal provisioning processes. Theserevenues vary in both sales volume and gross margins earned.  Corporate cost of goods sold represents ourmaterial logistics and purchasing functions that support all of our revenuesegments.

 

OperatingExpenses.

 

Ourtotal operating expenses increased $13.6 million in the third quarter of fiscal2009 compared to the third quarter of fiscal 2008.  Operating expenses, including the $14.0million impairment charges, were 109.0% of revenues in the third quartercompared to 22.1% in the third quarter last year.  Excluding the impairment charges, operatingexpenses were 27.5% of revenue in the third quarter.  Operating expenses were 52.2% of revenues inthe first three quarters of fiscal 2009 compared to 21.8% last year.  Excluding the impairment charges operatingexpenses in the first three quarters of fiscal 2009 were 26.0% ofrevenues.  Apart from the impairmentcharges recognized in the third quarter, our year-to-date operating expensesreflect the following factors:

 

·                  Asignificant bad debt provision in response to the Nortel bankruptcy filing

·                  Theaddition of sales expense as a result of the Summatis acquisition

·                  Increasedlegal fees to support litigation and board governance activities

·                  Increasedamortization of: the Oracle platform in association with its expandedutilization; and intangible assets associated with recent acquisitions ofservice contracts and customer lists

 

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Thelevel of operating expenses as a percentage of revenues is above our targetsand we took steps in the third quarter to bring these costs more in line withour expectations.  These steps included reductions of our sales force andsales support staffs, company-wide temporary suspension of the matchingcontribution on our 401k Plan, and a mandatory week of unpaid leave for eachemployee in the company.  These steps were taken during the last half ofthe third quarter and had minimal impact to our third quarter results. Presently, rapidly declining systems sales make it difficult to meet ourtargets for operating expenses as a percent of revenues.  Furthermore, we considerit tactically appropriate, given our strong cash flows, to support operatingexpenses above our targets in the near term to take advantage of improvingeconomic conditions in subsequent quarters.

 

InterestExpense and Other Income.

 

Netinterest and other expense was $22,000 in the third quarter of fiscal 2009compared to $96,000 in net other expense in the third quarter of fiscal2008.  Net interest and other expense was$65,000 for the nine-month period ended July 31, 2009 compared to $241,000in net other expense in the same period last year.  This decrease reflects both lower interestrates 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 4T.   CONTROLS AND PROCEDURES**

 

*Evaluation of Disclosure Controls and Procedures.* Basedon an evaluation conducted as of July 31, 2009 by our management,including our Chief Executive Officer (“CEO”) and our Chief Financial Officer (“CFO”),our CEO and CFO have concluded that our disclosure controls and procedures (asdefined in Rules 13a-15(e) and 15d-15(e) under the SecuritiesExchange Act of 1934, as amended (the “Exchange Act”) are effective toreasonably ensure that information required to be disclosed in reports that wefile or submit under the Exchange Act, is recorded, processed, summarized andreported within the time periods specified in Securities and ExchangeCommission rules and forms, and that such information is accumulated andcommunicated to our management, including the CEO and CFO, as appropriate toallow timely decisions regarding required disclosure.

 

*Changes in Internal Controls*.  There were no changes in our internalcontrols during the last fiscal quarter that have materially affected, orare reasonably likely to materially affect, these controls over financialreporting.

 

**PART II.  OTHERINFORMATION**

 

**ITEM1.  LEGAL PROCEEDINGS.**

 

During the fiscalquarter covered by this report, AMTEL had still not filed its dismissal of thearbitration claim filed in April 2008 by Design Business Communications, Inc.,d/b/a/ American Telephone (“AMTEL”) against us and Hitachi Telecom (USA) Inc. (“HITEL”)alleging a breach of AMTEL’s Authorized Distributorship Agreement with HITEL (“DistributorAgreement”).  The dismissal is to be filed pursuant to the terms of asettlement agreement in this case, which has been described in our previousperiodic and annual reports.

 

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 thisproceeding will have a material affect on our financial position or results ofoperations.

 

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**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 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 the ability of our customers to accesscredit may continue to reduce capital spending for the foreseeable future.**

 

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.  Because our business is affectedby capital spending for technology and equipment, we may continue to experiencedeclining demand for our products.  Thiscould have a material, negative impact on our operating results and financialcondition.

 

**We mayincur additional goodwill and other asset impairments.**

 

Our business hasbeen and may continue to be materially adversely affected by the currentmacroeconomic conditions.  During the fiscal year we have experienced asignificant decline in revenues in our commercial equipment reporting unit anda sustained decline in our market capitalization.  Based on the results ofan interim test for impairment, management determined that goodwill associatedwith our commercial equipment reporting unit was impaired and accordingly werecorded an impairment charge of $11.0 million in the third fiscalquarter.  This represents our best estimate of the probable impairment atthis time.  We may have to adjust the impairment charge after completingstep two of the impairment test in connection with our next periodic reportfiling with the Securities and Exchange Commission.  Furthermore, we couldexperience further deterioration in this area or other areas of our businesswhich might create additional impairment of our remaining goodwillbalances.  Additional impairment charges could have a material adverseeffect on our financial condition and results of operations.   SeeNote 1 to our Consolidated Financial Statements for additional informationregarding our goodwill and other asset impairment charges.

 

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

 

Nortel filed avoluntary petition for Chapter 11 bankruptcy protection on January 14,2009.  We are owed approximately $685,000 in pre-petition accountsreceivable less approximately $116,000 in approved offsets for amounts we owedto Nortel at the time of the filing.  If our pre-petition claims are notcollectible either in whole or in large part, we could experience material,negative operating results in the near term.  Based on filings approved bythe bankruptcy court allowing Nortel to fund post-petition business operations,we have continued to provide services to Nortel’s end-user customers under ourwholesale services relationship, which currently produces approximately $3million in annual revenues.  To date, payment for these services have beenpaid generally according to their terms which were significantly tightenedafter the filing.

 

Theadministrators of the bankruptcy have adopted a business disposalstrategy.  Under this strategy, the administrators have segmented Nortelinto three business units: Virtual Service Switches, CDMA businesses andEnterprise Solutions.  We conduct all of our Nortel business through theEnterprise Solutions unit.    On July 21, 2009, theadministrators of the bankruptcy announced they had entered into a stalkinghorse assets and share sale agreement with Avaya for the Enterprise Solutionsunit and this process is proceeding.  Due to the nature of the stalkinghorse auction process, a final determination of the purchaser of the EnterpriseSolutions unit is not expected until near the end of our fiscal year. Because neither Avaya nor other potential bidders have publicly stated theiroperating and marketing strategy should they prevail in the auction process, itis impossible for us to predict the impact of this process to ourbusiness.  We believe we can present compelling value propositions to anypotential purchaser of Nortel enterprise business unit, but the ultimatesuccess of those strategies cannot be assured.

 

**Avaya’s strategies regarding the provision of equipmentand services to their customers are changing and could have a material impacton our operating results.**

 

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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.

 

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

 

(a) None.

 

(b) None.

 

(c) Issuer Purchasesof Equity Securities

 

OnOctober 29, 2008 the Board of Directors approved a stock repurchaseprogram authorizing the Company to use up to $1.0 million to repurchase itsoutstanding common stock on the open market. Since the inception of theprogram, we have repurchased a total of 31,728 shares of our common stock for atotal cash investment of $58,157.  Thisprogram does not have an expiration date. The following table presents repurchase activity for the third quarterof 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** | ** ** |
|--------------------|------------|---------------------------------------|------------|-----------------------------------|------------|----------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------|------------|
| ** **         |       |                                  |       |                              |       |                                                                                         |       |                                                                                                                             |       |
| May   2009    |       | —                                |       | $                                 | —     |                                                                                         | —     |                                                                                                                             | $          | 944,049 |   |
| June 2009     |       | —                                |       | —                            |       | —                                                                                       |       | 944,049                                                                                                                          |       |
| July 2009     |       | 1,000                                 |       | 2.21                              |       | 1,000                                                                                        |       | 941,843                                                                                                                          |       |
| Total              |       | 1,000                                 |       | $                                 | 2.21       |                                                                                         | 1,000      |                                                                                                                             | $          | 941,843 |   |

 

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

 

None.

 

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

 

None.

 

**ITEM 5. OTHER INFORMATION.**

 

(a) None.

 

**ITEM 6.   EXHIBITS.**

 

Exhibits(filed herewith):

 

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| **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: August 28,  2009 | By:                           | /s/ Greg D. Forrest |
|                         |                          | Greg D. Forrest |
|                         |                          | Chief Executive Officer |
|                         |                          |   |
| Dated: August 28,  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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