**UNITED STATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington,D.C.   20549**

 

**FORM 10-Q**

 

| x      | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT  OF 1934** |
|--------|-----------------------------------------------------------------------------------------------------|
|   | ** **                                                                                          |
|   | **For the  quarterly period ended April 30, 2008**                                             |
|   | ** **                                                                                          |
|   | **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 incorporation or organization) |   | (I.R.S. Employee Identification No.) |
|                                                                      |   |                                      |
| **1814 W.  Tacoma Street, Broken Arrow, OK**                              |   | **74012-1406**                            |
| (Address of principal  executive offices)                                 |   | (Zip Code)                                |
|                                                                      |   |                                      |

 

**918-664-8200**

(Registrant’stelephone number, including area code)

 

 

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

 

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

 

Yes x                              No o

 

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

 

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

 

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

 

Yes o                              No x

 

As of May 30, 2008,there were 10,254,310 shares of the registrant’s common stock, par value$0.001, outstanding

 

 

 

----

 

 

INDEX

 
| ** **                          | ** **                                                           | ** **                                                                                                | **PAGE** |
|-------------------------------------|----------------------------------------------------------------------|-----------------------------------------------------------------------------------------------------------|----------|
| PART I. FINANCIAL  INFORMATION |                                                                 |
|                                |                                                                 |                                                                                                      |     |
|                                | ITEM 1. FINANCIAL  STATEMENTS (Unaudited)                            |                                                                                                      |
|                                |                                                                 |                                                                                                      |     |
|                                |                                                                 | Consolidated Balance  Sheets - April 30, 2008 and October 31, 2007                              | 3        |
|                                |                                                                 |                                                                                                      |     |
|                                |                                                                 | Consolidated  Statements of Operations - For the Three and Six Months Ended April 30,  2008 and 2007 | 4        |
|                                |                                                                 |                                                                                                      |     |
|                                |                                                                 | Consolidated  Statement of Shareholders’ Equity - For the Six Months Ended April 30,  2008      | 5        |
|                                |                                                                 |                                                                                                      |     |
|                                |                                                                 | Consolidated  Statements of Cash Flows - For the Six Months Ended April 30, 2008 and  2007           | 6        |
|                                |                                                                 |                                                                                                      |     |
|                                |                                                                 | Notes to  Consolidated Financial Statements                                                               | 7        |
|                                |                                                                 |                                                                                                      |     |
|                                | ITEM 2.  MANAGEMENT’S DISCUSSION AND ANALYSIS                   | 13                                                                                                        |
|                                |                                                                 |                                                                                                      |     |
|                                | ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK  | 17                                                                                                        |
|                                |                                                                 |                                                                                                      |     |
|                                | ITEM 4. CONTROLS AND  PROCEDURES                                     | 18                                                                                                        |
|                                |                                                                 |                                                                                                      |     |
| PART II. OTHER  INFORMATION    |                                                                 |
|                                |                                                                 |                                                                                                      |     |
|                                | ITEM 1. LEGAL  PROCEEDINGS                                           | 18                                                                                                        |
|                                |                                                                 |                                                                                                      |     |
|                                | ITEM 1A. RISK FACTORS                                                | 18                                                                                                        |
|                                |                                                                 |                                                                                                      |     |
|                                | ITEM 2.  UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS | 19                                                                                                        |
|                                |                                                                 |                                                                                                      |     |
|                                | ITEM 3.  DEFAULTS UPON SENIOR SECURITIES                             | 19                                                                                                        |
|                                |                                                                 |                                                                                                      |     |
|                                | ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY  HOLDERS         | 19                                                                                                        |
|                                |                                                                 |                                                                                                      |     |
|                                | ITEM 5. OTHER  INFORMATION                                           | 20                                                                                                        |
|                                |                                                                 |                                                                                                      |     |
|                                | ITEM 6. EXHIBITS                                                     | 20                                                                                                        |

 

2

----

XETA TECHNOLOGIES,INC. AND SUBSIDIARY

CONSOLIDATED BALANCE SHEETS

 
| **ASSETS**                                                                                                                                                            | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| ** **                                                                                                                                                            | ** ** | **April 30, 2008** | ** ** | **October 31, 2007** | ** ** |
| ** **                                                                                                                                                            | ** ** | **(Unaudited)** | ** ** | ** ** | ** ** |
|                                                                                                                                                                  |       |   |   |   |   |
| Current assets:                                                                                                                                                       |       |   |   |   |   |
| Cash and cash  equivalents                                                                                                                                            |       | $ | 125,408 |   | $ | 402,918 |   |
| Current portion  of net investment in sales-type leases and other receivables                                                                                         |       | 716,088 |   | 490,033 |   |
| Trade accounts  receivable, net                                                                                                                                       |       | 19,257,903 |   | 16,236,137 |   |
| Inventories, net                                                                                                                                                      |       | 4,871,241 |   | 4,296,574 |   |
| Deferred tax  asset                                                                                                                                                   |       | 627,154 |   | 916,259 |   |
| Prepaid taxes                                                                                                                                                         |       | 12,443 |   | 19,737 |   |
| Prepaid expenses  and other assets                                                                                                                                    |       | 737,608 |   | 517,757 |   |
| Total current  assets                                                                                                                                                 |       | 26,347,845 |   | 22,879,415 |   |
|                                                                                                                                                                  |       |   |   |   |   |
| Noncurrent assets:                                                                                                                                                    |       |   |   |   |   |
| Goodwill                                                                                                                                                              |       | 26,337,305 |   | 26,365,093 |   |
| Intangible  assets, net                                                                                                                                               |       | 242,516 |   | 104,042 |   |
| Net investment  in sales-type leases, less current portion above                                                                                                      |       | 115,210 |   | 136,493 |   |
| Property,  plant & equipment, net                                                                                                                            |       | 10,589,866 |   | 10,610,820 |   |
| Other Assets                                                                                                                                                          |       | 25,289 |   | — |   |
| Total noncurrent  assets                                                                                                                                              |       | 37,310,186 |   | 37,216,448 |   |
|                                                                                                                                                                  |       |   |   |   |   |
| Total assets                                                                                                                                                          |       | $ | 63,658,031 |   | $ | 60,095,863 |   |
|                                                                                                                                                                  |       |   |   |   |   |
| **LIABILITIES  AND SHAREHOLDERS’ EQUITY**                                                                                                                        |       |
|                                                                                                                                                                  |       |   |   |   |   |
| Current liabilities:                                                                                                                                                  |       |   |   |   |   |
| Current portion  of long-term debt                                                                                                                                    |       | $ | 171,123 |   | $ | 171,123 |   |
| Revolving line  of credit                                                                                                                                             |       | 4,586,938 |   | 2,758,660 |   |
| Accounts payable                                                                                                                                                      |       | 7,249,989 |   | 5,670,240 |   |
| Current unearned  revenue                                                                                                                                             |       | 2,547,260 |   | 2,212,247 |   |
| Accrued  liabilities                                                                                                                                                  |       | 2,440,107 |   | 3,565,031 |   |
| Total current  liabilities                                                                                                                                            |       | 16,995,417 |   | 14,377,301 |   |
|                                                                                                                                                                  |       |   |   |   |   |
| Noncurrent liabilities:                                                                                                                                               |       |   |   |   |   |
| Long-term debt,  less current portion above                                                                                                                           |       | 1,268,986 |   | 1,354,530 |   |
| Accrued  long-term liability                                                                                                                                          |       | 144,100 |   | 211,300 |   |
| Noncurrent  unearned service revenue                                                                                                                                  |       | 62,597 |   | 81,650 |   |
| Noncurrent  deferred tax liability                                                                                                                                    |       | 4,776,708 |   | 4,631,917 |   |
| Total noncurrent  liabilities                                                                                                                                         |       | 6,252,391 |   | 6,279,397 |   |
|                                                                                                                                                                  |       |   |   |   |   |
| Contingencies                                                                                                                                                         |       |   |   |   |   |
|                                                                                                                                                                  |       |   |   |   |   |
| Shareholders’ equity:                                                                                                                                            |       |   |   |   |   |
| Preferred stock;  $.10 par value; 50,000 shares authorized, 0 issued                                                                                                  |       | — |   | — |   |
| Common stock;  $.001 par value; 50,000,000 shares authorized, 11,256,193 and 11,233,529  shares issued at April 30, 2008 and October 31, 2007, respectively |       | 11,255 |   | 11,233 |   |
| Paid-in capital                                                                                                                                                       |       | 13,362,906 |   | 13,189,311 |   |
| Retained  earnings                                                                                                                                                    |       | 29,243,530 |   | 28,483,280 |   |
| Less treasury  stock, at cost (1,001,883 shares at April 30,2008 and 1,018,788 shares  at October 31, 2007)                                                 |       | (2,207,468 | ) | (2,244,659 | ) |
| Total  shareholders’ equity                                                                                                                                      |       | 40,410,223 |   | 39,439,165 |   |
| Total  liabilities and shareholders’ equity                                                                                                                      |       | $ | 63,658,031 |   | $ | 60,095,863 |   |

 

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

 

3

----

 

 

XETA TECHNOLOGIES,INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF OPERATIONS

(UNAUDITED)

 
| ** **                                       | ** ** | **For the Three Months** | ** ** | **For the Six Months**   | ** ** |
|--------------------------------------------------|------------|--------------------------|------------|--------------------------|------------|
| ** **                                       | ** ** | **Ended April 30,** | ** ** | **Ended April 30,** | ** ** |
| ** **                                       | ** ** | **2008**                 | ** ** | **2007**                 | ** ** | **2008** | ** ** | **2007** | ** ** |
|                                             |       |                     |       |                     |       |   |   |   |   |
| Systems sales                                    |       | $                        | 10,271,761 |                     | $          | 7,762,223 |   | $ | 17,985,920 |   | $ | 14,789,071 |   |
| Services                                         |       | 10,134,470               |       | 8,792,452                |       | 19,859,412 |   | 17,569,215 |   |
| Other revenues                                   |       | 405,592                  |       | 134,363                  |       | 916,226 |   | 381,431 |   |
| Net sales and  service revenues                  |       | 20,811,823               |       | 16,689,038               |       | 38,761,558 |   | 32,739,717 |   |
|                                             |       |                     |       |                     |       |   |   |   |   |
| Cost of systems sales                            |       | 7,541,560                |       | 5,926,906                |       | 13,328,382 |   | 11,234,735 |   |
| Services costs                                   |       | 7,600,057                |       | 6,116,344                |       | 14,730,981 |   | 12,464,441 |   |
| Cost of other revenues & corporate COGS |       | 483,972                  |       | 446,730                  |       | 925,351 |   | 889,870 |   |
| Total cost of  sales and service                 |       | 15,625,589               |       | 12,489,980               |       | 28,984,714 |   | 24,589,046 |   |
|                                             |       |                     |       |                     |       |   |   |   |   |
| Gross profit                                     |       | 5,186,234                |       | 4,199,058                |       | 9,776,844 |   | 8,150,671 |   |
|                                             |       |                     |       |                     |       |   |   |   |   |
| Operating expenses                               |       |                     |       |                     |       |   |   |   |   |
| Selling, general  and administrative             |       | 4,263,500                |       | 3,713,011                |       | 7,925,762 |   | 7,241,421 |   |
| Amortization                                     |       | 254,513                  |       | 146,767                  |       | 457,411 |   | 287,044 |   |
| Total operating  expenses                        |       | 4,518,013                |       | 3,859,778                |       | 8,383,173 |   | 7,528,465 |   |
|                                             |       |                     |       |                     |       |   |   |   |   |
| Income from operations                           |       | 668,221                  |       | 339,280                  |       | 1,393,671 |   | 622,206 |   |
|                                             |       |                     |       |                     |       |   |   |   |   |
| Interest expense                                 |       | (68,731                  | )          | —                   |       | (171,716 | ) | (10,387 | ) |
| Interest and  other income                       |       | 9,531                    |       | 8,890                    |       | 27,295 |   | 26,461 |   |
| Total interest  and other income (expense)       |       | (59,200                  | )          | 8,890                    |       | (144,421 | ) | 16,074 |   |
|                                             |       |                     |       |                     |       |   |   |   |   |
| Income before provision for income taxes         |       | 609,021                  |       | 348,170                  |       | 1,249,250 |   | 638,280 |   |
| Provision for income taxes                       |       | 238,000                  |       | 140,000                  |       | 489,000 |   | 260,000 |   |
|                                             |       |                     |       |                     |       |   |   |   |   |
| Net income                                       |       | $                        | 371,021    |                     | $          | 208,170 |   | $ | 760,250 |   | $ | 378,280 |   |
|                                             |       |                     |       |                     |       |   |   |   |   |
| Earnings per share                               |       |                     |       |                     |       |   |   |   |   |
| Basic                                            |       | $                        | 0.04       |                     | $          | 0.02 |   | $ | 0.07 |   | $ | 0.04 |   |
|                                             |       |                     |       |                     |       |   |   |   |   |
| Diluted                                          |       | $                        | 0.04       |                     | $          | 0.02 |   | $ | 0.07 |   | $ | 0.04 |   |
|                                             |       |                     |       |                     |       |   |   |   |   |
| Weighted average shares outstanding              |       | 10,254,310               |       | 10,214,741               |       | 10,231,120 |   | 10,214,741 |   |
|                                             |       |                     |       |                     |       |   |   |   |   |
| Weighted average equivalent shares               |       | 10,263,297               |       | 10,214,741               |       | 10,246,272 |   | 10,214,741 |   |

 

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

 

4

----

 

XETA TECHNOLOGIES,INC. AND SUBSIDIARY

CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY

(UNAUDITED)

 
| ** **                               | ** ** | **Common Stock**  | ** ** | **Treasury Stock** | ** ** | ** ** | ** ** | ** ** | ** ** | ** **          | ** ** |
|------------------------------------------|------------|-------------------|------------|--------------------|------------|------------|------------|------------|------------|---------------------|------------|
| ** **                               | ** ** | **Shares Issued** | ** ** | **Par Value**      | ** ** | **Shares** | ** ** | **Amount** | ** ** | **Paid-in Capital** | ** ** | **Retained Earnings** | ** ** | **Total** | ** ** |
|                                     |       |              |       |               |       |       |       |       |       |                |       |   |   |   |   |
| Balance-  October 31, 2007          |       | 11,233,529        |       | $                  | 11,233     |       | 1,018,788  |       | $          | (2,244,659          | )          | $ | 13,189,311 |   | $ | 28,483,280 |   | $ | 39,439,165 |   |
|                                     |       |              |       |               |       |       |       |       |       |                |       |   |   |   |   |
| Stock options  exercised $.001 par value |       | 22,664            |       | 22                 |       | —     |       | —     |       | 90,193              |       | — |   | 90,215 |   |
| Issuance of  restricted common stock     |       |              |       |               |       | (16,905    | )          | 37,191     |       | (37,191             | )          |   |   | — |   |
| Tax benefit of  stock options            |       | —            |       | —             |       | —     |       | —     |       | 4,032               |       | — |   | 4,032 |   |
| Stock based  compensation                |       | —            |       | —             |       | —     |       | —     |       | 116,561             |       | — |   | 116,561 |   |
|                                     |       |              |       |               |       |       |       |       |       |                |       |   |   |   |   |
| Net Income                               |       | —            |       | —             |       | —     |       | —     |       | —              |       | 760,250 |   | 760,250 |   |
|                                     |       |              |       |               |       |       |       |       |       |                |       |   |   |   |   |
| Balance-  April 30, 2008            |       | 11,256,193        |       | $                  | 11,255     |       | 1,001,883  |       | $          | (2,207,468          | )          | $ | 13,362,906 |   | $ | 29,243,530 |   | $ | 40,410,223 |   |

 

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

 

5

----

 

XETA TECHNOLOGIES,INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

 
| ** **                                                                                               | ** ** | **For the Six Months** | ** ** |
|----------------------------------------------------------------------------------------------------------|------------|------------------------|------------|
| ** **                                                                                               | ** ** | **Ended April 30,**    | ** ** |
| ** **                                                                                               | ** ** | **2008**               | ** ** | **2007** | ** ** |
| Cash flows from operating activities:                                                                    |       |                   |       |   |   |
| Net income                                                                                               |       | $                      | 760,250    |   | $ | 378,280 |   |
|                                                                                                     |       |                   |       |   |   |
| Adjustments to  reconcile net income to net cash provided by operating activities:                       |       |                   |       |   |   |
| Depreciation                                                                                             |       | 338,743                |       | 253,561 |   |
| Amortization                                                                                             |       | 457,415                |       | 287,045 |   |
| Stock based compensation                                                                                 |       | 116,561                |       | 47,869 |   |
| Loss (gain) on  sale of assets                                                                           |       | 425                    |       | (5,000 | ) |
| Provision for  excess and obsolete inventory                                                             |       | 51,000                 |       | 51,000 |   |
| Increase in  deferred tax liability                                                                      |       | 176,611                |       | 315,456 |   |
| Change in assets  and liabilities, net of acquisitions:                                                  |       |                   |       |   |   |
| (Increase) in  net investment in sales-type leases & other receivables                               |       | (204,772               | )          | (50,020 | ) |
| (Increase)  decrease in trade account receivables                                                        |       | (2,987,711             | )          | 912,191 |   |
| (Increase) in  inventories                                                                               |       | (596,390               | )          | (988,439 | ) |
| Decrease  (increase) in deferred tax asset                                                               |       | 289,105                |       | (87,968 | ) |
| (Increase) in  prepaid expenses and other assets                                                         |       | (245,140               | )          | (321,990 | ) |
| Decrease in  prepaid taxes                                                                               |       | 7,294                  |       | 8,833 |   |
| Increase in  accounts payable                                                                            |       | 1,579,670              |       | 1,353,466 |   |
| Increase in  unearned revenue                                                                            |       | 241,806                |       | 584,838 |   |
| (Decrease)  increase in accrued liabilities and lease payable                                            |       | (1,376,433             | )          | 428,516 |   |
| Total  adjustments                                                                                       |       | (2,151,816             | )          | 2,789,358 |   |
|                                                                                                     |       |                   |       |   |   |
| Net cash (used  in) provided by operating activities                                                     |       | (1,391,566             | )          | 3,167,638 |   |
|                                                                                                     |       |                   |       |   |   |
| Cash flows from investing activities:                                                                    |       |                   |       |   |   |
| Additions to  property, plant & equipment                                                            |       | (718,893               | )          | (467,349 | ) |
| Proceeds from  sale of assets                                                                            |       | —                 |       | 5,000 |   |
| Net cash used in  investing activities                                                                   |       | (718,893               | )          | (462,349 | ) |
|                                                                                                     |       |                   |       |   |   |
| Cash flows from financing activities:                                                                    |       |                   |       |   |   |
| Proceeds from  draws on revolving line of credit                                                         |       | 19,320,405             |       | 11,509,265 |   |
| Principal  payments on debt                                                                              |       | (85,544                | )          | (85,546 | ) |
| Payments on  revolving line of credit                                                                    |       | (17,492,127            | )          | (14,115,393 | ) |
| Exercise of  stock options                                                                               |       | 90,215                 |       |   |   |
| Net cash  provided by (used in) financing activities                                                     |       | 1,832,949              |       | (2,691,674 | ) |
|                                                                                                     |       |                   |       |   |   |
| Net (decrease)  increase in cash and cash equivalents                                                    |       | (277,510               | )          | 13,615 |   |
|                                                                                                     |       |                   |       |   |   |
| Cash and cash equivalents, beginning of period                                                           |       | 402,918                |       | 174,567 |   |
| Cash and cash equivalents, end of period                                                                 |       | $                      | 125,408    |   | $ | 188,182 |   |
|                                                                                                     |       |                   |       |   |   |
| Supplemental disclosure of cash flow information:                                                        |       |                   |       |   |   |
| Cash paid during  the period for interest, net of amount capitalized of $0 in 2008 and $114,814  in 2007 |       | $                      | 179,779    |   | $ | 31,233 |   |
| Cash paid during  the period for income taxes                                                            |       | $                      | 15,958     |   | $ | 23,679 |   |

 

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

 

6

----

 

**XETATECHNOLOGIES, INC. AND SUBSIDIARY**

**Notesto Consolidated Financial Statements**

**April 30,2008**

(Unaudited)

 

1.  BASIS OF PRESENTATION:

 

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

 

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

 

Segment Information

 

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

 

The reporting segmentsfollow the same accounting policies used for the Company’s consolidatedfinancial statements and described in the Summary of Significant AccountingPolicies in the Company’s Form 10-K described above.  Company management evaluates a segment’sperformance based on gross margins. Assets are not allocated to the segments.  Sales outside of the U.S. are immaterial.

 

The following is atabulation of business segment information for the three months ended April 30,2008 and 2007.

 
| ** **    | ** ** | **Services  Revenues** | ** ** | **Commercial  Systems  Sales** | ** ** | **Lodging  Systems  Sales** | ** ** | **Other  Revenue** | ** ** | **Total**   | ** ** |
|---------------|------------|------------------------|------------|--------------------------------|------------|-----------------------------|------------|--------------------|------------|-------------|------------|
| **2008**      | ** ** | ** **             | ** ** | ** **                     | ** ** | ** **                  | ** ** | ** **         | ** ** | ** **  | ** ** |
| Sales         |       | $                      | 10,134,470 |                           | $          | 8,775,074                   |       | $                  | 1,496,687  |        | $          | 405,592 |   | $ | 20,811,823 |   |
| Cost of sales |       | (7,600,057             | )          | (6,483,890                     | )          | (1,057,670                  | )          | (483,972           | )          | (15,625,589 | )          |
| Gross profit  |       | $                      | 2,534,413  |                           | $          | 2,291,184                   |       | $                  | 439,017    |        | $          | (78,380 | ) | $ | 5,186,234 |   |
|          |       |                   |       |                           |       |                        |       |               |       |        |       |
| **2007**      | ** ** | ** **             | ** ** | ** **                     | ** ** | ** **                  | ** ** | ** **         | ** ** | ** **  | ** ** |
| Sales         |       | $                      | 8,792,452  |                           | $          | 5,478,709                   |       | $                  | 2,283,514  |        | $          | 134,363 |   | $ | 16,689,038 |   |
| Cost of sales |       | (6,116,344             | )          | (4,192,565                     | )          | (1,734,341                  | )          | (446,730           | )          | (12,489,980 | )          |
| Gross profit  |       | $                      | 2,676,108  |                           | $          | 1,286,144                   |       | $                  | 549,173    |        | $          | (312,367 | ) | $ | 4,199,058 |   |

 

The following is atabulation of business segment information for the six months ended April 30,2008 and 2007.

 

 

7

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| ** **    | ** ** | **Services  Revenues** | ** ** | **Commercial  Systems  Sales** | ** ** | **Lodging  Systems  Sales** | ** ** | **Other  Revenue** | ** ** | **Total**   | ** ** |
|---------------|------------|------------------------|------------|--------------------------------|------------|-----------------------------|------------|--------------------|------------|-------------|------------|
| **2008**      | ** ** | ** **             | ** ** | ** **                     | ** ** | ** **                  | ** ** | ** **         | ** ** | ** **  | ** ** |
| Sales         |       | $                      | 19,859,412 |                           | $          | 14,805,009                  |       | $                  | 3,180,911  |        | $          | 916,226 |   | $ | 38,761,558 |   |
| Cost of sales |       | (14,730,981            | )          | (11,085,549                    | )          | (2,242,833                  | )          | (925,351           | )          | (28,984,714 | )          |
| Gross profit  |       | $                      | 5,128,431  |                           | $          | 3,719,460                   |       | $                  | 938,078    |        | $          | (9,125 | ) | $ | 9,776,844 |   |
|          |       |                   |       |                           |       |                        |       |               |       |        |       |
| **2007**      | ** ** | ** **             | ** ** | ** **                     | ** ** | ** **                  | ** ** | ** **         | ** ** | ** **  | ** ** |
| Sales         |       | $                      | 17,569,215 |                           | $          | 10,731,107                  |       | $                  | 4,057,964  |        | $          | 381,431 |   | $ | 32,739,717 |   |
| Cost of sales |       | (12,464,441            | )          | (8,176,796                     | )          | (3,057,939                  | )          | (889,870           | )          | (24,589,046 | )          |
| Gross profit  |       | $                      | 5,104,774  |                           | $          | 2,554,311                   |       | $                  | 1,000,025  |        | $          | (508,439 | ) | $ | 8,150,671 |   |

 

Stock-Based CompensationPlans

 

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

 
| ** **                        | ** ** | **2008** | ** ** | **2007** | ** ** |
|-----------------------------------|------------|----------|------------|----------|------------|
| Three months ended April 30, |       | $        | 62,045     |     | $          | 23,935 |   |
|                              |       |     |       |     |       |
| Six months ended April 30,   |       | $        | 116,561    |     | $          | 47,869 |   |

 

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

 

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

 

 

8

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the accounting treatmentfor business combinations on a prospective basis beginning in the first quarterof fiscal year 2010.

 

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

 

2.  ACCOUNTS RECEIVABLE:

 
| ** **                         | ** ** | **April 30,  2008** | ** ** | **(Audited)  October 31,  2007** | ** ** |
|------------------------------------|------------|--------------------------|------------|---------------------------------------|------------|
| Trade receivables                  |       | $                        | 19,409,504 |                                  | $          | 16,411,981 |   |
| Less reserve for doubtful accounts |       | (151,601                 | )          | (175,844                              | )          |
| Net trade receivables              |       | $                        | 19,257,903 |                                  | $          | 16,236,137 |   |

 

3.  INVENTORIES:

 

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

 
| ** **                                        | ** ** | **April 30,  2008** | ** ** | **(Audited)  October 31,  2007** | ** ** |
|---------------------------------------------------|------------|--------------------------|------------|---------------------------------------|------------|
| Finished goods and spare parts                    |       | $                        | 5,735,434  |                                  | $          | 5,068,227 |   |
| Less- reserve for excess and obsolete inventories |       | (864,193                 | )          | (771,653                              | )          |
| Total inventories, net                            |       | $                        | 4,871,241  |                                  | $          | 4,296,574 |   |

 

 

9

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4.  PROPERTY, PLANT AND EQUIPMENT:

 

Property, plant andequipment consist of the following:

 
| ** **                                                    | ** ** | **Estimated  Useful  Lives** | ** ** | **April 30,  2008** | ** ** | **(Audited)  October 31,  2007** | ** ** |
|---------------------------------------------------------------|------------|------------------------------|------------|--------------------------|------------|---------------------------------------|------------|
| Building and  building improvements                           |       | 3-20                         |       | $                        | 2,905,362  |                                  | $          | 2,686,753 |   |
| Data processing  and computer field equipment                 |       | 2-7                          |       | 2,646,692                |       | 2,556,878                             |       |
| Software  development costs, work-in-process                  |       | N/A                          |       | 2,441,832                |       | 3,792,567                             |       |
| Software development  costs of components placed into service |       | 3-10                         |       | 6,057,508                |       | 4,355,953                             |       |
| Hardware                                                      |       | 3-5                          |       | 612,902                  |       | 599,751                               |       |
| Land                                                          |       | —                       |       | 611,582                  |       | 611,582                               |       |
| Office furniture                                              |       | 5-7                          |       | 944,048                  |       | 947,094                               |       |
| Auto                                                          |       | 5                            |       | 528,793                  |       | 539,184                               |       |
| Other                                                         |       | 3-7                          |       | 265,683                  |       | 239,533                               |       |
|                                                          |       |                         |       |                     |       |                                  |       |
| Total property,  plant and equipment                          |       |                         |       | 17,014,402               |       | 16,329,295                            |       |
| Less-  accumulated depreciation                               |       |                         |       | (6,424,536               | )          | (5,718,475                            | )          |
|                                                          |       |                         |       |                     |       |                                  |       |
| Total property,  plant and equipment, net                     |       |                         |       | $                        | 10,589,866 |                                  | $          | 10,610,820 |   |

 

Interest costs related toan investment in long-lived assets are capitalized as part of the cost of theasset during the period the asset is being prepared for use.  The Company capitalized $0 and $114,814 ininterest costs in the six months ended April 30, 2008 and 2007,respectively.

 

5.  INCOME TAXES:

 

The Company has recordeda tax provision of $489,000 or 39% and $260,000 or 41% for the six months endedApril 30, 2008 and 2007, respectively, reflecting the statutory federaltax rate of 34% plus a blended state income tax rate of approximately 5% andthe impact of minimum income tax payments in certain states.  The Company currently estimates its annualeffective income tax rate to be approximately 40% for fiscal 2008.

 

6.  CREDIT AGREEMENTS:

 

The Company’s creditfacility consists of a revolving credit and term loan agreement with acommercial bank including a mortgage agreement maturing on September 30,2009 and amortizing based on a 13-year life and a $7.5 million revolving creditagreement to finance growth in working capital. Trade accounts receivable and inventories collateralize the revolvingline of credit at April 30, 2008 and October 31, 2007.  The Company had approximately $4.587 millionand $2.759 million, respectively, outstanding on the revolving line ofcredit.  The Company had approximately $2.9million available under the revolving line of credit at April 30,2008.  Advance rates are defined in theagreement, but are generally at the rate of 80% on qualified trade accountsreceivable and 40% of qualified inventories. The revolving line of credit matures on September 23, 2008.  Long-term debt consisted of the following:

 

 

10

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| ** **                                                                                                                                                                                                            | ** ** | **April 30,  2008** | ** ** | **(Audited)  October 31,  2007** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------|------------|---------------------------------------|------------|
| Real estate term  note, payable in monthly installments of $14,257 plus interest, plus a fixed  payment of $1,198,061 due September 30, 2009, collateralized by a first  mortgage on the Company’s building |       | $                        | 1,440,109  |                                  | $          | 1,525,653 |   |
|                                                                                                                                                                                                                  |       |                     |       |                                  |       |
| Less-current  maturities                                                                                                                                                                                              |       | 171,123                  |       | 171,123                               |       |
|                                                                                                                                                                                                                  |       |                     |       |                                  |       |
| Total long-term  debt, less current maturities                                                                                                                                                                        |       | $                        | 1,268,986  |                                  | $          | 1,354,530 |   |

 

Interest on alloutstanding debt under the credit facility accrues at either a) the LondonInterbank Offered Rate (2.80% at April 30, 2008) plus 1.25% to 2.75%depending on the Company’s funded debt to cash flow ratio, or b) the bank’sprime rate (5.0% at April 30, 2008) minus 0% to minus 1.125% alsodepending on the Company’s funded debt to cash flow ratio.  At April 30, 2008, the Company waspaying 3.875% on the revolving line of credit borrowings and 4.2% on themortgage note.  The credit facilitycontains several financial covenants common in such agreements, includingtangible net worth requirements, limitations on the amount of funded debt toearnings before interest, taxes, depreciation and amortization, limitations oncapital spending, and debt service coverage requirements.

 

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 April 30, 2008** | ** ** |
|-----------------------------------|------------|----------------------------------------------------|------------|
| ** **                        | ** ** | **Income  (Numerator)**                            | ** ** | **Shares  (Denominator)** | ** ** | **Per Share  Amount** | ** ** |
| Basic EPS                         |       |                                               |       |   |   |   |   |
| Net income                        |       | $                                                  | 371,021    |   | 10,254,310 |   | $ | 0.04 |   |
| Dilutive effect  of stock options |       |                                               |       | 8,987 |   |   |   |
|                              |       |                                               |       |   |   |   |   |
| Diluted EPS                       |       |                                               |       |   |   |   |   |
| Net income                        |       | $                                                  | 371,021    |   | 10,263,297 |   | $ | 0.04 |   |

 
| ** **                        | ** ** | **For the Three Months Ended April 30, 2007** | ** ** |
|-----------------------------------|------------|----------------------------------------------------|------------|
| ** **                        | ** ** | **Income  (Numerator)**                            | ** ** | **Shares  (Denominator)** | ** ** | **Per Share  Amount** | ** ** |
| Basic EPS                         |       |                                               |       |   |   |   |   |
| Net income                        |       | $                                                  | 208,170    |   | 10,214,741 |   | $ | 0.02 |   |
| Dilutive effect  of stock options |       |                                               |       | — |   |   |   |
|                              |       |                                               |       |   |   |   |   |
| Diluted EPS                       |       |                                               |       |   |   |   |   |
| Net income                        |       | $                                                  | 208,170    |   | 10,214,741 |   | $ | 0.02 |   |

 

 

11

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| ** **                        | ** ** | **For the Six Months Ended April 30, 2008** | ** ** |
|-----------------------------------|------------|--------------------------------------------------|------------|
| ** **                        | ** ** | **Income  (Numerator)**                          | ** ** | **Shares  (Denominator)** | ** ** | **Per Share  Amount** | ** ** |
| Basic EPS                         |       |                                             |       |   |   |   |   |
| Net income                        |       | $                                                | 760,250    |   | 10,231,120 |   | $ | 0.07 |   |
| Dilutive effect  of stock options |       |                                             |       | 15,152 |   |   |   |
|                              |       |                                             |       |   |   |   |   |
| Diluted EPS                       |       |                                             |       |   |   |   |   |
| Net income                        |       | $                                                | 760,250    |   | 10,246,272 |   | $ | 0.07 |   |

 
| ** **                        | ** ** | **For the Six Months Ended April 30, 2007** | ** ** |
|-----------------------------------|------------|--------------------------------------------------|------------|
| ** **                        | ** ** | **Income  (Numerator)**                          | ** ** | **Shares  (Denominator)** | ** ** | **Per Share  Amount** | ** ** |
| Basic EPS                         |       |                                             |       |   |   |   |   |
| Net income                        |       | $                                                | 378,280    |   | 10,214,741 |   | $ | 0.04 |   |
| Dilutive effect  of stock options |       |                                             |       | — |   |   |   |
|                              |       |                                             |       |   |   |   |   |
| Diluted EPS                       |       |                                             |       |   |   |   |   |
| Net income                        |       | $                                                | 378,280    |   | 10,214,741 |   | $ | 0.04 |   |

 

Options to purchase844,900 shares of common stock at an average exercise price of $8.08 and1,103,668 shares of common stock at an average exercise price of $7.17 were notincluded in the computation of diluted earnings per share for the three monthsended April 30, 2008 and 2007, respectively, because inclusion of theseoptions would be antidilutive.  Optionsto purchase 828,636 shares of common stock at an average exercise price of$8.16 and 1,103,668 shares of common stock at an average exercise price of$7.17 were not included in the computation of diluted earnings per share forthe six months ended April 30, 2008 and 2007, respectively, becauseinclusion of these options would be antidilutive.

 

 

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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 about future events, performanceand results.  Such statements are notguarantees of performance, but rather reflect our current expectations,estimates, and forecasts about the industry and markets where we operate, basedon information available to us.  Forward-looking statements can generally be identified by words such as “expects,”“anticipates,” “may”, “plans,” “believes,” “intends,” “projects,” “estimates,” “targets,”“may,” “should” and similar words or expressions.  These statements are subject to risks anduncertainties that are difficult to predict or are beyond our control, such ascustomer demand for advanced communications products; capital spending trendswithin our market; delays in installation schedules for the Miami-Dade CountyPublic School District orders; our ability to successfully develop the Mitelproduct and services offering; the financial condition of our suppliers andchanges in their distribution strategies and support; technological changes;fluctuating margins and product mix; failure to expand our wholesale service relationships;the ability to attract and retain highly skilled personnel and technicalcompetencies; and intense competition. These and other risks and uncertainties are discussed under the heading “RiskFactors” under Part I of the Company’s Form 10-K for the fiscal yearended October 31, 2007 (filed with the Commission on January 7,2008), and in updates to such risk factors set forth in Item 1A of Part IIof this quarterly report and our quarterly report for the first quarter offiscal 2007.  Because of these risks anduncertainties, actual results may differ materially and adversely from thoseexpressed in forward-looking statements. Consequently, we caution investors to read and consider allforward-looking statements in conjunction with such risk factors anduncertainties.  The Private SecuritiesLitigation Reform Act of 1995 provides a safe-harbor for forward-lookingstatements made by the Company.

 

# **Overview**

# ** **

Strategy.

 

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

 

Our sales efforts targetlarge, multi-location, national, or super-regional customers.  Our national technical footprint and 24/7/365contact center are complimentary to the communication needs of thesecustomers.  Additionally, these largerenterprises often have a mixture of manufacturer platforms within theircommunications equipment portfolio and our ability to sell and service both theAvaya and Nortel product lines is an important competitive advantage.  Because of our extensive array of productsand services, we enjoy multiple sales opportunities with these customers,including new product sales, implementation of advanced applications, and avariety of potential service relationships. Once we establish a relationship with a customer, we search foropportunities to penetrate deeper into the account by assessing the customer’scommunications needs, proposing appropriate technologies, establishing orexpanding the service relationship, and proposing equipment and servicesolutions to other divisions or subsidiaries.

 

We launched our wholesaleservice offering in fiscal 2006 and its success has been a key factor in our growthin recurring revenue.  Under this serviceoffering, we partner with manufacturers, network service providers and systemsintegrators to provide services to their end-user customers.  In many instances, we provide field resourcesto carry out service responsibilities. However, under a full outsourcing arrangement we may provide a broaderrange of services, including call center support, remote technical support,on-site labor and spare parts.  Our entryinto the wholesale services market has succeeded because we provide excellentservice to end-user customers and our willingness to create and executeflexible service programs and billing arrangements.  The continued success of this strategicinitiative is a vital ingredient to our long-term goal of shifting our revenuemix toward more recurring services revenues.

 

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

 

 

13

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

 

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

 

OperatingSummary.

 

Inthe second quarter of fiscal 2008, we earned net income of $371,000 on revenuesof $20.8 million compared to net income of $208,000 on revenues of $16.7million in the second quarter of last year.   For the first six months of fiscal 2008, we earned $760,000 in netincome on revenues of $38.8 million compared to net income of $378,000 onrevenues of $32.7 million.  These resultsreflect our successful execution of the strategies discussed above and othercontributing factors discussed in more detail under “Results of Operations”below.

 

FinancialPosition Summary.

 

Ourfinancial condition was relatively unchanged during the first half of fiscal2008 as compared to October 31, 2007. Our working capital increased approximately 10% during the first half offiscal 2008 since October 31, 2007; however growth in our receivables andinventory balances resulted in increased borrowings on our working capitalrevolver in the first six months of fiscal 2008.  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 six-month periods ended April 30,2008 and 2007 and should be considered in conjunction with our above commentsas well as the “Risk Factors” section below.

 

# **Financial Condition**

# ** **

Cashused by operations for the six months ended April 30, 2008 was $1.40million.  Increases in accountsreceivable and inventories as well as capital expenditures were partiallyoffset by net income and non-cash charges resulting in the cash deficit in thefirst half of fiscal 2008.  For the sixmonths ended April 30, 2008, our accounts receivable balances increased byapproximately $3.0 million.  This changereflects strong revenue growth in the last month of the second quarter andtemporary declines in the pace of completion and billing of complex equipmentprojects, in particular our large project with the Miami-Dade County PublicSchools (“M-DCPS”).  We expect the M-DCPSproject to yield over $10 million in revenues during fiscal 2008.  Installation of the M-DCPS systems commencedin the first quarter of the year and we have received payment only on theinitial month of installations. Additional payments have been delayed due to complexities in configuringthe invoices to meet M-DCPS and Federal government requirements.  The billing and collection of these projectsis a complicated process with funding from both M-DCPS and the Federalgovernment.  While the collectability ofthese receivables is not in question, the previously mentioned complexitieshave affected our first half cash flows.

 

Inaddition to the cash used by operations, we invested approximately $719,000 incapital projects, including $355,000 in equipment and fixtures, as part of ournormal replacement and refurbishment cycles. 

 

 

14

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Additionally,we invested $364,000 in the continued implementation of Oracle’s eBusinessSuite.  Early in the second fiscalquarter of fiscal 2008, we completed the cutover of the last major functionalmodule to the Oracle platform.  Duringthe remainder of fiscal 2008, we expect to implement additional features,including sales management, customer relationship management and an onlineservice ticket initiation and tracking system.

 

At April 30, 2008 our total borrowings were $6.0 million,consisting of a mortgage on our headquarters building of $1.4 million and $4.6million due on our revolving line of credit. At April 30, 2008 there was $2.9 million available under therevolver to meet working capital needs. We believe that the current amount of working capital available under ourrevolving line of credit is sufficient to meet our needs for the remainder offiscal 2008.  In addition, we believethat should the need arise, we could arrange supplemental short-term financingunder acceptable terms and prices.

 

The table below presentsour contractual obligations at April 30, 2008 as well as paymentobligations over the next five years:

 
| ** **                  | ** ** | ** ** | ** ** | **Payments due by period** | ** ** |
|-----------------------------|------------|------------|------------|----------------------------|------------|
| **Contractual Obligations** | ** ** | **Total**  | ** ** | **Less  than 1 year**      | ** ** | **2 - 3  Years** | ** ** | **4 - 5  Years** | ** ** |
| Long-term debt              |       | $          | 1,519,029  |                       | $          | 228,328 |   | $ | 1,290,701 |   | $ | — |   |
| Operating leases            |       | 598,593    |       | 310,469                    |       | 284,822 |   | 3,302 |   |
| Total                       |       | $          | 2,117,622  |                       | $          | 538,797 |   | $ | 1,575,523 |   | $ | 3,302 |   |

 

# **Results of Operations**

# ** **

Inthe second quarter of fiscal 2008 our revenues increased $4.1 million or 25%compared to the second quarter last year, and our net income increased $163,000or 78%.  In the first six months of theyear, our revenues increased $6 million or 18% resulting in an increase inearnings of $382,000 or 101%.  Thesepositive results reflect improvements in all of our major revenue categories,partially offset by lower gross profit margins on services revenues and higheroperating costs.  The narrative belowprovides further explanation of these results.

 

ServicesRevenues.

 

Servicesrevenues consist of the following:

 
| ** **                  | ** ** | **For the Three Months Ended April 30,** | ** ** | **For the Six Months Ended April 30,** | ** ** |
|-----------------------------|------------|-----------------------------------------------|------------|---------------------------------------------|------------|
| ** **                  | ** ** | **2008**                                      | ** ** | **2007**                                    | ** ** | **2008** | ** ** | **2007** | ** ** |
| Contract & T&M |       | $                                             | 7,028,000  |                                        | $          | 6,309,000 |   | $ | 14,236,000 |   | $ | 12,314,000 |   |
| Implementation              |       | 2,344,000                                     |       | 1,781,000                                   |       | 4,386,000 |   | 3,913,000 |   |
| Cabling                     |       | 762,000                                       |       | 702,000                                     |       | 1,237,000 |   | 1,342,000 |   |
| Total Services revenues     |       | $                                             | 10,134,000 |                                        | $          | 8,792,000 |   | $ | 19,859,000 |   | $ | 17,569,000 |   |

 

Contractand time and materials (“T&M”) revenues increased 11% and 16%, respectivelyin the second quarter and year-to-date periods. These increases reflect additions to our base of maintenance customersin the last half of fiscal 2007 and the addition of HCI contracts and T&Mrelationships beginning in November 2007. Through the first half of fiscal 2008, organic additions of new contractmaintenance or contracted T&M customers to our base have been modest.  However, as discussed above under “Strategy”,the pursuit of contract and T&M revenues, particularly under our wholesaleservice program is a key strategic initiative in fiscal 2008 and we continue toexpect it to be the primary driver of our services revenue growth.  Implementation revenues increased 32% and12%, respectively in the second quarter and year-to-date periods.  These increases are attributable to growth insystems sales and also reflect M-DCPS system implementations.  The pace of installations at M-DCPSaccelerated toward the end of the second quarter of fiscal 2008.  Based on the customer’s current schedule,installations are expected to continue at a considerable pace through the firsthalf of our third fiscal quarter followed by a pause during their summer schoolbreak.  we anticipate completing theproject during our fourth fiscal quarter. Cabling revenues increased 9% in the second fiscal quarter, but are downapproximately 8% in the year-to-date period. We 

 

 

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enjoyedstrong cabling revenues from three significant projects during the secondquarter as construction delays that hampered first quarter revenuessubsided.  As a national provider ofstructured cabling installations, we can secure major stand-alone cablingprojects as well as significant turn-key projects where the customer combinesthe cabling, equipment and professional services.

 

SystemsSales.

 

Systemssales increased approximately $2.5 million or 32% in the second quarter offiscal 2008 compared to last year.  Thisincrease includes a $3.3 million or 60% increase in sales of systems tocommercial customers and a $787,000 or 35% decrease in sales of systems to lodgingcustomers.  Year-to-date systems salesincreased $3.2 million or 22% compared to last year.  This increase includes an increase in salesof systems to commercial customers of $4.1 million or 38% and a decrease insales of systems to lodging customers of $877,000 or 22%.  The increase in sales to commercial customersprimarily reflects sales of systems to M-DCPS. As previously discussed, shipments and installations for M-DCPSaccelerated in the last half of the second quarter and will remain strong throughmost of our third quarter.  We anticipatethis project will complete during our fourth fiscal quarter.  Orders for systems to commercial customersother than M-DCPS are slightly below last year’s pace.  We believe this decline primarily reflectscustomers extending the sales cycle due the current uncertainty in the U.S.economy.  The decline in sales of systemsto lodging customers reflects difficult comparisons to fiscal 2007 resultswhich were temporarily impacted by an acceleration of orders from customers whowere avoiding a mid-year price increase from the manufacturer.    In general, our sales of systems to lodgingcustomers are slightly less than our expected run-rates, reflectinguncertainties of the economy.

 

GrossMargins.

 

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

 
| ** **                   | ** ** | **For the Three Months Ended April 30,** | ** ** | **For the Six Months Ended April 30,** | ** ** |
|------------------------------|------------|-----------------------------------------------|------------|---------------------------------------------|------------|
| **Gross Margins**            | ** ** | **2008**                                      | ** ** | **2007**                                    | ** ** | **2008** | ** ** | **2007** | ** ** |
| Services revenues            |       | 25.0                                          | %          | 30.4                                        | %          | 25.8 | % | 29.1 | % |
| Systems sales                |       | 26.6                                          | %          | 23.6                                        | %          | 25.9 | % | 24.0 | % |
| Other revenues               |       | 79.1                                          | %          | -6.2                                        | %          | 84.6 | % | 38.1 | % |
| Corporate cost of goods sold |       | -1.9                                          | %          | -1.8                                        | %          | -2.0 | % | -2.0 | % |
| Total                        |       | 24.9                                          | %          | 25.2                                        | %          | 25.2 | % | 24.9 | % |

 

The decline in gross margins earned on our Servicesbusiness in the second quarter reflects lower than expected profitability inour implementation and cabling businesses and slower than expected growth inour Contract and T&M revenues. Although we have enjoyed strong revenue growth in all three major Servicesrevenue streams, our cost structures to support those revenue streamsanticipated higher levels of growth, particularly in our Contract and T&Mrevenue category.  In response to theslower than anticipated growth rate of these revenues, we have adjustedpersonnel levels to mitigate some excess capacity.  Specific to our implementation business, weare contractually obligated to maintain a significant level of Company-employedpersonnel to support the M-DCPS project. Due to customer initiated changes in the implementation schedule, thepace of installations has been inconsistent in the first half of the year andtherefore the profitability of the implementation and cabling portions of theproject have been lower than our expectations and normal run-rates.  We expect improvement in this area in thethird and fourth fiscal quarters.

 

Gross margins on systems sales in the secondquarter and the year-to-date period were up over last year and are above ourtarget of 23% to 25% for systems revenues. This trend is consistent for both sales of systems to commercial as wellas lodging customers.  We continue toreceive strong pricing support from our vendors in the form of project-specificdiscounts and incentive rebates.  These incentivesare material to our gross margins and we work diligently to maximize thissupport; however, no assurancecan be given that future support will continue at historical levels.

 

Thefinal component of our gross margins is the margins earned on other revenuesand our corporate cost of goods sold.  Weearn the majority of our other revenues from the sale of Avaya maintenancecontracts on which we earn either a commission or gross profit.  We have no continuing service obligationassociated

 

 

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withthese revenues and gross profits. In the first quarter we enjoyed significantlyhigher commission revenues from sales of Avaya maintenance contracts.  These revenues were material to our overalloperating income.  This is anunpredictable revenue stream that depends on the expiration dates of existingcontracts, installation dates of new systems, the customer type as defined byAvaya, and the number of years that customers contract for services.  Consequently, it is unlikely that we cansustain the results enjoyed in the first half of the fiscal year.  Other revenues may also include sales andcost of goods sold on equipment or services outside our normal provisioningprocesses. These revenues 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 $658,000 or 17% in the second quarter offiscal 2008 compared to the second quarter of fiscal 2007.  Operating expenses were 21.7% of revenues inthe second quarter compared to 23.1% last year. Operating expenses increased $855,000 or 11% for the first half offiscal 2008 compared to the same period a year ago.  Operating expenses were 21.6% of revenues inthe first half of fiscal 2008 compared to 23.0% last year.  The growth rates in operating expenses in thefirst half of fiscal 2008 are slightly above our targets and reflect a numberof factors such as personnel additions in sales and general and administrativeareas - increased stock compensation expense; increases in costs associatedwith maintenance of our Oracle software platform; and increases in board ofdirector fees due to expansion of board and increases in directorresponsibilities.  Additionally, ouramortization expense has increased in the first half of fiscal 2008 fromincreased utilization of the Oracle platform to support businessoperations.  Finally, year-to-dateoperating expense comparisons were favorably impacted by improved sales andmarketing incentives from vendors in the first quarter.  The incentives we receive from vendors tosupport the sales and marketing of their products come in the form of paymentsfor growth in sales of their products, reimbursement for specific, pre-approvedmarketing programs, and additions to sales headcount.  The amount of these funds was higher thannormal in the first quarter due to special growth incentives offered by one ofthe manufacturers that we represent. These funds returned to normal levels in the second quarter. Overall, weare pleased with the direction and progress made in reducing our operatingexpenses as a percentage of revenues.  Weanticipate our operating expense margins will decline to between 18% and 20% ofrevenues over the next two to four years through economies of scale andimproved operating efficiencies.

 

InterestExpense and Other Income.

 

Netinterest and other expense was $59,000 in the second quarter of fiscal 2008compared to $9,000 in net other income in the second quarter of fiscal2007.  Net interest and other expense was$144,000 for the six-month period ended April 30, 2008 compared to $16,000in net other income in the same period last year.  This increase in expense reflects thediscontinuation of capitalizing interest expense related to the implementationof the Company’s Oracle platform and higher average borrowings in the periodspresented.

 

TaxProvision.

 

Werecorded a combined federal and state tax provision of 39% for the secondquarter of fiscal 2008 compared to a tax provision of 40% in the second quarterof fiscal 2007.  For the six-month periodended April 30, 2008, we recorded a tax provision of 39% compared to a taxprovision of 41% for the first six months of fiscal 2007.  The tax provision reflects the effectivefederal tax rate plus the composite state income tax rates adjusted for statesthat require minimum tax payments even if tax losses are incurred.  Generally, we expect our tax provision rateto be approximately 40%.

 

**ITEM 3. QUANTITATIVE ANDQUALITATIVE DISCLOSURES ABOUT MARKET RISK**

 

Market risksrelating to our operations results primarily from changes in interestrates.  We did not use derivativefinancial instruments for speculative or trading purposes during the threemonth period ended April 30, 2008.

 

*Interest Rate Risk*.   Due to utilization of variable interest rate debt, we are subject to the risk of fluctuation in interest rates in the normal course of business.  Our credit facility bears interest at a floating rate at either the London Interbank Offered Rate (2.8% at April 30, 2008) plus 1.25% to 2.75% or the bank’s prime rate (5.0% at April 30, 2008) less 0.0% to minus 1.125%.  A hypothetical 1% increase in interest rates would not have a material impact on our financial position or cash flows.

 

 

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**ITEM4.   CONTROLS AND PROCEDURES**

 

*Evaluationof Disclosure Controls and Procedures.* Based on an evaluation conducted as of April 30,2008 by our management, including our Chief Executive Officer (“CEO”) and ourChief Financial Officer (“CFO”), our CEO and CFO have concluded that ourdisclosure controls and procedures (as defined in Rules 13a-15(e) and15d-15(e) under the Securities Exchange Act of 1934, as amended (the “ExchangeAct”) are effective to reasonably ensure that information required to be disclosedin reports that we file or submit under the Exchange Act, is recorded,processed, summarized and reported within the time periods specified inSecurities and Exchange Commission rules and forms, and that suchinformation is accumulated and communicated to our management, including theCEO and CFO, as appropriate to allow timely decisions regarding requireddisclosure.

 

*Changesin Internal Controls.*  There were no changes in ourinternal controls or in other factors that could materially affect, or isreasonably likely to materially affect, these controls subsequent to the dateof their evaluation.

 

**PART II.  OTHERINFORMATION**

 

**ITEM1.  LEGAL PROCEEDINGS.**

 

On or about April 8,2008, Design Business Communications, Inc., d/b/a/ American Telephone (“AMTEL”)filed a claim with the American Arbitration Association against the Company andHitachi Telecom (USA) Inc. (“HITEL”) alleging a breach of AMTEL’s AuthorizedDistributorship Agreement with HITEL (the “Distributor Agreement”).  The Company is involved in this matter byvirtue of the fact that in 2006, the Company acquired HITEL’s PBX business andagreed to fulfill HITEL’s surviving service obligations to its authorizeddistributors under their distributor agreements with HITEL.  The AMTEL Distributor Agreement provides thatAMTEL may order and the Company shall provide “spare parts, software and thirdlevel technical support as required for the maintenance of HITEL PRODUCT for aperiod of ten years from the ship date of the HITEL PRODUCT.”  In April 2007, AMTEL placed an orderwith the Company under the Distributor Agreement for 48 new telephones totalingapproximately $12,200; however, this product had previously been discontinuedby HITEL.   Because this order has notbeen fulfilled, AMTEL claims that the Company is in breach of the DistributorAgreement and that as a result, AMTEL has suffered damages in the amount of $5million (for loss of service and spare part revenues; loss of businessreputation; loss of customers; and possible claims by AMTEL customers forbreach of its service obligations and sales and service warranties).   The Company has filed a response to AMTEL’sarbitration claim and intends to vigorously contest this matter.

 

In addition to theforegoing, we are involved as a defendant in an employment related matter andas a plaintiff in another matter, both of which we consider to be routine andincidental to the operation of our business. We do not believe that either of these proceedings will have a materialaffect on our financial position or results of operations.

 

**ITEM 1A.  RISK FACTORS.**

 

Theinformation presented below is an update to the “Risk Factors” included in theCompany’s Annual Report on Form 10-K for the fiscal year ended October 31,2007 and should be read in conjunction therewith.  Except as set forth below, the Risk Factorsincluded in the Company’s Form 10-K for its 2007 fiscal year have notmaterially changed.

 

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

 

Avayais repositioning itself as a hardware and software vendor providing a widerange of voice communications hardware and applications to its customers.  As part of this strategy, Avaya is segmenting

 

 

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itshardware maintenance and software support. The new software support offerings include technical support forspecific voice applications and upgrade services to ensure customers can accessall software patches and upgrades. Currently, we earn revenues from some of our customers, particularlylodging customers, to provide the products and services now being included byAvaya in its new software support offerings.   These changes could have a material, negative impact on our operatingresults if our revenues or margins are reduced in response to these mandatedchanges by Avaya.

 

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

 

In November, 2007, we announced the award of a series of orders fromM-DCPS totaling in excess of $10 million to provide and install communicationsequipment.  Over the course of theproject we have experienced delays in the installation schedule due tocircumstances beyond our control as the customer has substantially altered theinstallation schedule to accommodate their operational and financialrequirements.  These changes havecompacted the bulk of the installations into a relatively short period of time,thus reducing our ability to maximize the utilization of our staff dedicated tothe project.  Additional risks associatedwith this project include delays or a halt in installations due to otherfactors including catastrophic weather conditions such as hurricanes, which areprone to the Miami area.  Additionally,while not experienced to date, installation challenges or product performanceissues could occur resulting in delays in the recognition of revenues orerosion of gross profits from these orders. Lastly, we have experienced delays in successfully billing andcollecting the amounts due on the initial installations.  These delays have increased our short-termborrowings and negatively affected our operating results.  We are working through these processingdetails and expect improved cash flows on this project for the balance of theyear.  However, if billing and collectiondifficulties persist, it would create additional interest expense and consumeborrowing capacity under our revolving line of credit.

 

**If economic conditions in the U.S. continue beuncertain or deteriorate further, our revenues, gross margins and net incomecould be negatively impacted.**

 

Inthe first half of fiscal 2007, we have seen a decline in order rates for newequipment and for some discretionary services that we offer.  We believe that at least a portion of thesedeclines is due to uncertainty about the condition and near-term future of theU.S. economy.  These uncertainties havecaused some customers to delay capital spending decisions.  Should these uncertainties persist or worsen,it is likely that our business would continue to feel its effects.

 

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

 

None.

 

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

 

None.

 

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

 

On April 8, 2008, atour Annual Meeting of Shareholders, the following directors were elected to theBoard of Directors.  Votes cast for eachnominee were as follows:

 
| **Nominee**            | ** ** | **For**   | ** ** | **Against** | ** ** | **Abstain** | ** ** |
|------------------------|------------|-----------|------------|-------------|------------|-------------|------------|
| Donald T. Duke         |       | 8,813,813 |       | 690,986     |       | 203,310     |       |
| Greg D. Forrest        |       | 9,614,985 |       | 84,369      |       | 8,755       |       |
| Ron B. Barber          |       | 8,244,689 |       | 851,665     |       | 611,755     |       |
| S. Lee Crawley         |       | 8,818,070 |       | 380,746     |       | 509,293     |       |
| Robert D. Hisrich      |       | 9,094,360 |       | 413,439     |       | 200,310     |       |
| Edward F. Keller       |       | 9,135,656 |       | 371,143     |       | 201,310     |       |
| Ronald L. Siegenthaler |       | 9,032,138 |       | 667,570     |       | 8,401       |       |

 

 

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The shareholders also voted at theAnnual Meeting to ratify the selection of Tullius Taylor Sartain &Sartain LLP as our independent auditors for the 2008 fiscal year, with votescast as follows:

 

| **For**   | ** ** | **Against** | ** ** | **Withhold** |
|-----------|------------|-------------|------------|--------------|
| 9,290,502 |       | 298,844     |       | 118,763      |

 

**ITEM 5.  OTHER INFORMATION.**

 

None.

 

**ITEM6.   EXHIBITS.**

 

Exhibits (filed herewith):

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

 

 

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**SIGNATURES**

 

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

 

|                      |   | XETA  Technologies, Inc. |
|---------------------------|--------|-------------------------------|
|                      |   | (Registrant)                  |
|                      |   |                          |
| Dated: June 3,  2008 |   | By:                           | /s/ Greg D. Forrest |   |
|                      |   |                          | Greg D. Forrest |   |
|                      |   |                          | Chief Executive Officer |   |
|                      |   |                          |
| Dated: June 3,  2008 |   | 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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