Table of Contents

 

 

 

**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C.  20549**

 

**FORM 10-Q**

 

| **x**                                                     | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE  SECURITIES EXCHANGE ACT OF 1934** |
|-----------------------------------------------------------|----------------------------------------------------------------------------------------------------|
| ** **                                                |
|                                                      |                                                                                               |
| **For the  quarterly period ended January 31, 2010** |
|                                                      |                                                                                               |
| **OR**                                                    |
|                                                      |                                                                                               |
| **o**                                                     | **TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934** |
| ** **                                                |

 

**CommissionFile Number 0-16231**

 

.

 

**XETA Technologies, Inc.**

(Exact name of registrant as specified in its charter)

 

| **Oklahoma**                                 | ** ** | **73-1130045**       |
|----------------------------------------------|------------|----------------------|
| (State or other  jurisdiction of             |       | (I.R.S. Employee     |
| incorporation or  organization)              |       | Identification  No.) |
|                                         |       |                 |
| **1814 W.  Tacoma Street, Broken Arrow, OK** | ** ** | **74012-1406**       |
| (Address  of principal executive offices)    |       | (Zip  Code)          |

 

**918-664-8200**

(Registrant’stelephone number, including area code)

 

 

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

 

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

 

Indicate by check markwhether the registrant has submitted electronically and posted on its corporateWeb site, if any, every Interactive Data File required to be submitted andposted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter)during the preceding 12 months (or for such shorter period that the registrantwas required to submit and post such files).  Yes o   No x

 

Indicate by check mark whether theregistrant is a large accelerated filer, an accelerated filer, a non-acceleratedfiler or a smaller reporting company (as defined by Rule 12b-2 of theExchange 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

 

Asof February 20, 2010 there were 10,298,302 shares of the registrant’scommon stock, par value $0.001, outstanding.

 

 

 

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INDEX

 
| ** **                          | ** **                                                                                              | **PAGE** |
|-------------------------------------|---------------------------------------------------------------------------------------------------------|----------|
| PART I. FINANCIAL  INFORMATION |                                                                                                    |     |
|                                |                                                                                                    |     |
|                                | ITEM 1. FINANCIAL  STATEMENTS (Unaudited)                                                               |     |   |
|                                |                                                                                                    |     |
|                                | Consolidated  Balance Sheets - January 31, 2010 and October 31, 2009                          |     | 3 |
|                                |                                                                                                    |     |
|                                | Consolidated  Statements of Operations - For the Three Months Ended January 31, 2010  and 2009     |     | 4 |
|                                |                                                                                                    |     |
|                                | Consolidated Statement of Shareholders’ Equity - For  the Three Months Ended January 31, 2010 |     | 5 |
|                                |                                                                                                    |     |
|                                | Consolidated Statements of Cash Flows - For the Three  Months Ended January 31, 2010 and 2009      |     | 6 |
|                                |                                                                                                    |     |
|                                | Notes to Consolidated Financial Statements                                                              |     | 7 |
|                                |                                                                                                    |     |
|                                | ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS                                                       |     | 13 |
|                                |                                                                                                    |     |
|                                | ITEM 4T. CONTROLS AND PROCEDURES                                                                        |     | 16 |
|                                |                                                                                                    |     |
| PART II.  OTHER INFORMATION    |                                                                                                    |     |
|                                |                                                                                                    |     |
|                                | ITEM  1. LEGAL PROCEEDINGS                                                                              |     | 17 |
|                                |                                                                                                    |     |
|                                | ITEM  1A. RISK FACTORS                                                                                  |     | 17 |
|                                |                                                                                                    |     |
|                                | ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND  USE OF PROCEEDS                                    |     | 18 |
|                                |                                                                                                    |     |
|                                | ITEM 3. DEFAULTS UPON SENIOR SECURITIES                                                                 |     | 18 |
|                                |                                                                                                    |     |
|                                | ITEM  4. OTHER INFORMATION                                                                              |     | 18 |
|                                |                                                                                                    |     |
|                                | ITEM 5.  EXHIBITS                                                                                       |     | 19 |
|                                     |                                                                                                         |          |  |  |

 

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XETA TECHNOLOGIES, INC. AND SUBSIDIARY

CONSOLIDATED BALANCE SHEETS

 
| ** **                                                                                                                          | ** ** | **(UNAUDITED)**           | ** ** | ** **                | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------|------------|---------------------------|------------|
| ** **                                                                                                                          | ** ** | **January 31, 2010** | ** ** | **October 31, 2009** | ** ** |
| ASSETS                                                                                                                              |       |                      |       |                      |       |
|                                                                                                                                |       |                      |       |                      |       |
| Current  assets:                                                                                                                    |       |                      |       |                      |       |
| Cash  and cash equivalents                                                                                                          |       | $                         | 5,409,390  |                      | $          | 4,731,926 |   |
| Current  portion of net investment in sales-type leases and other receivables                                                       |       | 533,290                   |       | 470,025                   |       |
| Trade  accounts receivable, net                                                                                                     |       | 13,647,965                |       | 13,832,452                |       |
| Inventories,  net                                                                                                                   |       | 4,918,901                 |       | 5,036,198                 |       |
| Deferred  tax asset                                                                                                                 |       | 1,169,711                 |       | 1,136,351                 |       |
| Prepaid  taxes                                                                                                                      |       | 45,079                    |       | 39,784                    |       |
| Prepaid  expenses and other assets                                                                                                  |       | 2,397,220                 |       | 2,057,514                 |       |
| Total  current assets                                                                                                               |       | 28,121,556                |       | 27,304,250                |       |
|                                                                                                                                |       |                      |       |                      |       |
| Noncurrent  assets:                                                                                                                 |       |                      |       |                      |       |
| Goodwill                                                                                                                            |       | 12,018,081                |       | 12,031,975                |       |
| Intangible  assets, net                                                                                                             |       | 514,175                   |       | 570,740                   |       |
| Net  investment in sales-type leases and other receivables, less current portion  above                                             |       | 349,210                   |       | 335,413                   |       |
| Property,  plant & equipment, net                                                                                          |       | 6,616,018                 |       | 6,825,916                 |       |
| Deferred  tax asset                                                                                                                 |       | 310,749                   |       | 739,216                   |       |
| Total  noncurrent assets                                                                                                            |       | 19,808,233                |       | 20,503,260                |       |
|                                                                                                                                |       |                      |       |                      |       |
| Total  assets                                                                                                                       |       | $                         | 47,929,789 |                      | $          | 47,807,510 |   |
|                                                                                                                                |       |                      |       |                      |       |
| LIABILITIES AND SHAREHOLDERS’ EQUITY                                                                                           |       |                      |       |                      |       |
| Current  liabilities:                                                                                                               |       |                      |       |                      |       |
| Current  portion of long-term debt                                                                                                  |       | $                         | —     |                      | $          | 1,183,475 |   |
| Accounts  payable                                                                                                                   |       | 6,091,355                 |       | 5,785,225                 |       |
| Current  portion of obligations under capital lease                                                                                 |       | 155,569                   |       | 154,072                   |       |
| Current  unearned services revenue                                                                                                  |       | 5,060,093                 |       | 5,194,601                 |       |
| Accrued  liabilities                                                                                                                |       | 3,888,975                 |       | 3,444,396                 |       |
| Total  current liabilities                                                                                                          |       | 15,195,992                |       | 15,761,769                |       |
|                                                                                                                                |       |                      |       |                      |       |
| Noncurrent  liabilities:                                                                                                            |       |                      |       |                      |       |
| Accrued  long-term liability                                                                                                        |       | 144,100                   |       | 144,100                   |       |
| Long-term  portion of obligations under capital lease                                                                               |       | 66,618                    |       | 106,076                   |       |
| Noncurrent  unearned services revenue                                                                                               |       | 53,289                    |       | 36,691                    |       |
| Total  noncurrent liabilities                                                                                                       |       | 264,007                   |       | 286,867                   |       |
|                                                                                                                                |       |                      |       |                      |       |
| Contingencies                                                                                                                       |       |                      |       |                      |       |
|                                                                                                                                |       |                      |       |                      |       |
| Shareholders’  equity:                                                                                                         |       |                      |       |                      |       |
| Preferred  stock; $.10 par value; 50,000 shares authorized, 0 issued                                                                |       | —                    |       | —                    |       |
| Common  stock; $.001 par value; 50,000,000 shares authorized, 11,256,193 issued at January 31,  2010 and October 31, 2009 |       | 11,255                    |       | 11,255                    |       |
| Paid-in  capital                                                                                                                    |       | 13,704,028                |       | 13,704,460                |       |
| Retained  earnings                                                                                                                  |       | 20,855,957                |       | 20,223,169                |       |
| Less  treasury stock, at cost (957,891 shares at January 31, 2010 and 993,763  shares at October 31, 2009)                |       | (2,101,450                | )          | (2,180,010                | )          |
| Total  shareholders’ equity                                                                                                    |       | 32,469,790                |       | 31,758,874                |       |
| Total  liabilities and shareholders’ equity                                                                                    |       | $                         | 47,929,789 |                      | $          | 47,807,510 |   |

 

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

 

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XETA TECHNOLOGIES,INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF OPERATIONS

(UNAUDITED)

 
| ** **                                        | ** ** | **For the Three Months**   | ** ** |
|---------------------------------------------------|------------|----------------------------|------------|
| ** **                                        | ** ** | **Ended January 31,** | ** ** |
| ** **                                        | ** ** | **2010**                   | ** ** | **2009** | ** ** |
|                                              |       |                       |       |   |   |
| Systems  sales                                    |       | $                          | 10,867,058 |   | $ | 8,585,753 |   |
| Services                                          |       | 12,116,857                 |       | 9,993,233 |   |
| Other  revenues                                   |       | 60,228                     |       | 1,039 |   |
| Net  sales and services revenues                  |       | 23,044,143                 |       | 18,580,025 |   |
|                                              |       |                       |       |   |   |
| Cost  of systems sales                            |       | 8,076,587                  |       | 6,342,365 |   |
| Services  costs                                   |       | 8,231,080                  |       | 6,983,739 |   |
| Cost  of other revenues & corporate COGS |       | 397,635                    |       | 447,770 |   |
| Total  cost of sales and services                 |       | 16,705,302                 |       | 13,773,874 |   |
|                                              |       |                       |       |   |   |
| Gross  profit                                     |       | 6,338,841                  |       | 4,806,151 |   |
|                                              |       |                       |       |   |   |
| Operating  expenses                               |       |                       |       |   |   |
| Selling,  general and administrative              |       | 5,125,283                  |       | 4,456,109 |   |
| Amortization                                      |       | 186,855                    |       | 322,251 |   |
| Total  operating expenses                         |       | 5,312,138                  |       | 4,778,360 |   |
|                                              |       |                       |       |   |   |
| Income  from operations                           |       | 1,026,703                  |       | 27,791 |   |
|                                              |       |                       |       |   |   |
| Interest  expense                                 |       | (6,170                     | )          | (29,903 | ) |
| Interest  and other income                        |       | 21,255                     |       | 11,380 |   |
| Net  interest and other income (expense)          |       | 15,085                     |       | (18,523 | ) |
|                                              |       |                       |       |   |   |
| Income  before provision for income taxes         |       | 1,041,788                  |       | 9,268 |   |
| Provision  for income taxes                       |       | 409,000                    |       | 7,000 |   |
|                                              |       |                       |       |   |   |
| Net  income                                       |       | $                          | 632,788    |   | $ | 2,268 |   |
|                                              |       |                       |       |   |   |
| Earnings  per share                               |       |                       |       |   |   |
| Basic                                             |       | $                          | 0.06       |   | $ | 0.00 |   |
|                                              |       |                       |       |   |   |
| Diluted                                           |       | $                          | 0.06       |   | $ | 0.00 |   |
|                                              |       |                       |       |   |   |
| Weighted  average shares outstanding              |       | 10,237,405                 |       | 10,222,494 |   |
|                                              |       |                       |       |   |   |
| Weighted  average equivalent shares               |       | 10,277,361                 |       | 10,222,494 |   |

 

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

 

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XETA TECHNOLOGIES, INC.AND SUBSIDIARY

CONSOLIDATEDSTATEMENT OF SHAREHOLDERS’ EQUITY

(UNAUDITED)

 
| ** **                                         | ** ** | **Common  Stock**  | ** ** | **Treasury  Stock** | ** ** | ** ** | ** ** | ** ** | ** ** | ** **           | ** ** |
|----------------------------------------------------|------------|--------------------|------------|---------------------|------------|------------|------------|------------|------------|----------------------|------------|
| ** **                                         | ** ** | **Shares  Issued** | ** ** | **Par  Value**      | ** ** | **Shares** | ** ** | **Amount** | ** ** | **Paid-in  Capital** | ** ** | **Retained  Earnings** | ** ** | **Total** | ** ** |
|                                               |       |               |       |                |       |       |       |       |       |                 |       |   |   |   |   |
| Balance-  October 31, 2009                    |       | 11,256,193         |       | $                   | 11,255     |       | 993,763    |       | $          | (2,180,010           | )          | $ | 13,704,460 |   | $ | 20,223,169 |   | $ | 31,758,874 |   |
|                                               |       |               |       |                |       |       |       |       |       |                 |       |   |   |   |   |
| Issuance of restricted  common stock from treasury |       | —             |       | —              |       | (35,872    | )          | 78,560     |       | (78,560              | )          | — |   | — |   |
| Stock-based  compensation                          |       | —             |       | —              |       | —     |       | —     |       | 78,128               |       | — |   | 78,128 |   |
|                                               |       |               |       |                |       |       |       |       |       |                 |       |   |   |   |   |
| Net income                                         |       | —             |       | —              |       | —     |       | —     |       | —               |       | 632,788 |   | 632,788 |   |
|                                               |       |               |       |                |       |       |       |       |       |                 |       |   |   |   |   |
| Balance-  January 31, 2010                    |       | 11,256,193         |       | $                   | 11,255     |       | 957,891    |       | $          | (2,101,450           | )          | $ | 13,704,028 |   | $ | 20,855,957 |   | $ | 32,469,790 |   |

 

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

 

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XETA TECHNOLOGIES,INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

 
| ** **                                                                         | ** ** | **For the Three Months**   | ** ** |
|------------------------------------------------------------------------------------|------------|----------------------------|------------|
| ** **                                                                         | ** ** | **Ended January 31,** | ** ** |
| ** **                                                                         | ** ** | **2010**                   | ** ** | **2009** | ** ** |
| Cash  flows from operating activities:                                             |       |                       |       |   |   |
| Net  income                                                                        |       | $                          | 632,788    |   | $ | 2,268 |   |
|                                                                               |       |                       |       |   |   |
| Adjustments  to reconcile net income to net cash provided by operating activities: |       |                       |       |   |   |
| Depreciation                                                                       |       | 285,801                    |       | 224,947 |   |
| Amortization                                                                       |       | 186,855                    |       | 322,251 |   |
| Stock-based  compensation                                                          |       | 74,060                     |       | 70,365 |   |
| Loss  on sale of assets                                                            |       | —                     |       | 3,764 |   |
| Provision  for returns & doubtful accounts receivable                     |       | 15,000                     |       | 365,000 |   |
| Provision  for excess and obsolete inventory                                       |       | 25,500                     |       | 25,500 |   |
| Deferred  taxes                                                                    |       | 409,001                    |       | (28,306 | ) |
| Change  in assets and liabilities:                                                 |       |                       |       |   |   |
| Increase  in net investment in sales-type leases & other receivables      |       | (77,062                    | )          | (145,586 | ) |
| Decrease  in trade accounts receivable                                             |       | 68,599                     |       | 1,593,819 |   |
| Decrease  (increase) in inventories                                                |       | 191,797                    |       | (882,926 | ) |
| Increase  in prepaid expenses and other assets                                     |       | (339,706                   | )          | (73,282 | ) |
| (Increase)  decrease in prepaid taxes                                              |       | (5,295                     | )          | 24,140 |   |
| Increase  (decrease) in accounts payable                                           |       | 306,130                    |       | (1,297,187 | ) |
| (Decrease)  increase in unearned revenue                                           |       | (17,022                    | )          | 400,226 |   |
| Increase  (decrease) in accrued liabilities                                        |       | 348,647                    |       | (80,309 | ) |
| Total  adjustments                                                                 |       | 1,472,305                  |       | 522,416 |   |
|                                                                               |       |                       |       |   |   |
| Net  cash provided by operating activities                                         |       | 2,105,093                  |       | 524,684 |   |
|                                                                               |       |                       |       |   |   |
| Cash  flows from investing activities:                                             |       |                       |       |   |   |
| Additions  to property, plant & equipment                                 |       | (206,193                   | )          | (218,552 | ) |
| Proceeds  from sale of assets                                                      |       | —                     |       | 5,064 |   |
| Investment  in capitalized service contracts                                       |       | —                     |       | (750,000 | ) |
| Net  cash used in investing activities                                             |       | (206,193                   | )          | (963,488 | ) |
|                                                                               |       |                       |       |   |   |
| Cash  flows from financing activities:                                             |       |                       |       |   |   |
| Principal  payments on debt                                                        |       | (1,183,475                 | )          | (42,773 | ) |
| Net  payments on revolving line of credit                                          |       | —                     |       | 655,977 |   |
| Payments  on capital lease obligations                                             |       | (37,961                    | )          | (36,521 | ) |
| Payments  to acquire treasury stock                                                |       | —                     |       | (48,093 | ) |
| Net  cash (used in) provided by financing activities                               |       | (1,221,436                 | )          | 528,590 |   |
|                                                                               |       |                       |       |   |   |
| Net  increase in cash and cash equivalents                                         |       | 677,464                    |       | 89,786 |   |
|                                                                               |       |                       |       |   |   |
| Cash  and cash equivalents, beginning of period                                    |       | 4,731,926                  |       | 63,639 |   |
| Cash  and cash equivalents, end of period                                          |       | $                          | 5,409,390  |   | $ | 153,425 |   |
|                                                                               |       |                       |       |   |   |
| Supplemental  disclosure of cash flow information:                                 |       |                       |       |   |   |
| Cash  paid during the period for interest                                          |       | $                          | 13,651     |   | $ | 30,149 |   |
| Cash  paid during the period for income taxes                                      |       | $                          | 5,295      |   | $ | 12,860 |   |

 

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

 

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**XETATECHNOLOGIES, INC. AND SUBSIDIARY**

**Notesto Consolidated Financial Statements**

**January 31,2010**

(Unaudited)

 

1.  BASIS OF PRESENTATION:

 

XETA Technologies, Inc.(“XETA”, the “Company”, “we”, “us”, or “our”), an Oklahoma corporation formedin 1981, is a leading integrator of advanced communications technologies withnationwide sales and service.  XETA provides sales, design, projectmanagement, implementation, and maintenance services in support of the productsit represents.  The Company sells and/orsupports products produced by several manufacturers including Avaya, Inc.(“Avaya”), Nortel Networks Corporation (“Nortel”), Mitel Corporation (“Mitel”),and Samsung Business Communications Systems (“Samsung”).  In addition, the Company manufactures andmarkets a line of proprietary call accounting systems to the hospitalityindustry.

 

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. TheCompany believes that the disclosures are reasonably adequate to ensure theinformation is not misleading. Management suggests that these condensed financial statements be read inconjunction with the consolidated financial statements and the notes theretomade a part of the Company’s Annual Report on Form 10-K.  The Company filed the 10-K as Commission FileNo. 0-16231, with the Commission on January 8, 2010.  Management believes that the financialstatements contain the necessary adjustments for a fair statement of theresults for the interim periods presented. All adjustments were of a normal recurring nature.  The results of operations for the interimperiod are not necessarily indicative of the results for the entire fiscalyear.

 

FairValue of Financial Instruments

 

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

 

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

 

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

 

Segment Information

 

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

 

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

 

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The following is atabulation of business segment information for the three months ended January 31,2010 and 2009:

 
| ** **     | ** ** | **Services  Revenues** | ** ** | **Commercial  Systems  Sales** | ** ** | **Hospitality  Systems  Sales** | ** ** | **Other  Revenue** | ** ** | **Total**   | ** ** |
|----------------|------------|------------------------|------------|--------------------------------|------------|---------------------------------|------------|--------------------|------------|-------------|------------|
| **2010**       |       |                   |       |                           |       |                            |       |               |       |        |       |
| Sales          |       | $                      | 12,116,857 |                           | $          | 10,038,581                      |       | $                  | 828,477    |        | $          | 60,228 |   | $ | 23,044,143 |   |
| Cost  of sales |       | (8,231,080             | )          | (7,540,985                     | )          | (535,602                        | )          | (397,635           | )          | (16,705,302 | )          |
| Gross  profit  |       | $                      | 3,885,777  |                           | $          | 2,497,596                       |       | $                  | 292,875    |        | $          | (337,407 | ) | $ | 6,338,841 |   |
|           |       |                   |       |                           |       |                            |       |               |       |        |       |
| **2009**       |       |                   |       |                           |       |                            |       |               |       |        |       |
| Sales          |       | $                      | 9,993,233  |                           | $          | 6,296,705                       |       | $                  | 2,289,048  |        | $          | 1,039 |   | $ | 18,580,025 |   |
| Cost  of sales |       | (6,983,739             | )          | (4,801,767                     | )          | (1,540,598                      | )          | (447,770           | )          | (13,773,874 | )          |
| Gross  profit  |       | $                      | 3,009,494  |                           | $          | 1,494,938                       |       | $                  | 748,450    |        | $          | (446,731 | ) | $ | 4,806,151 |   |

 

Stock-Based CompensationPlans

 

The Company applies theprovisions of ASC 718, “Compensation — Stock Compensation”, which requirescompanies to measure all employee stock-based compensation awards using a fairvalue method and recognize compensation cost in its financial statements. The Company recognizes the fair value of stock-based compensation awards asselling, general and administrative expense in the consolidated statements ofoperations on a straight-line basis over the vesting period.  Compensationexpense was recognized in the statements of operations as follows:

 
| ** **                           | ** ** | **2010** | ** ** | **2009** | ** ** |
|--------------------------------------|------------|----------|------------|----------|------------|
| Three  months ended January 31, |       | $        | 74,060     |     | $          | 70,365 |   |
|                                      |            |          |            |          |            |  |  |

 

Use of Estimates

 

The preparation of thefinancial statements conforms to the accounting principles generally acceptedin the U.S., and requires management to make estimates and assumptionsaffecting the reported amounts of assets and liabilities: 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 may differ from theseestimates.

 

New AccountingPronouncements

 

In November 2009 theCompany adopted ASC 810, “Consolidation”.  ASC 810 changes the accountingand reporting for minority interests, which will be recharacterized asnon-controlling interests and classified as a component of equity.  The Company does not have any minority interests; therefore the adoption ofthis statement did not have an impact on the Company’s consolidated financialstatements.

 

In November 2009 theCompany adopted ASC 805, “Business Combinations”.  Under ASC 805, an entity is required torecognize the assets acquired, liabilities assumed, contractual contingencies,and contingent consideration at their fair value on the acquisition date.  It further requires that acquisition-relatedcosts are recognized separately from the acquisition and expensed as incurred,restructuring costs generally expensed in periods subsequent to the acquisitiondate, and changes in accounting for deferred tax asset valuation allowances andacquired income tax uncertainties after the measurement period impact incometax expense.  The Company will apply theguidance prospectively to business combinations.

 

In November 2009 theCompany adopted ASC 350 “Intangibles —Goodwill and Other”.  The guidanceamends the factors that should be considered in developing renewal or extensionassumptions used to determine the useful life of intangible assets.  The intentof the guidance is to improve the consistency between the useful life of arecognized intangible asset under the accounting standards and the period ofthe

 

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expected cash flows usedto measure the fair value of the asset.  The Company will apply theguidance prospectively to intangible assets acquired after adoption.

 

In October 2009, theFASB issued Accounting Standards Update (“ASU”) 2009-13, “RevenueRecognition - Multiple-Deliverable Revenue Arrangements”.  The guidance in ASU 2009-13 amends thecriteria for separating consideration in multiple-deliverablearrangements and expands required disclosures related to a company’smultiple-deliverable revenue arrangements. ASU 2009-13 is effective prospectively for fiscal years beginning on orafter June 15, 2010.  The Company iscurrently assessing the impact that adoption will have on its financialposition or results of operations.

 

Other accountingstandards that have been issued or proposed that do not require adoption untila future date are not expected to have a material impact on our consolidatedfinancial statements upon adoption.

 

2.  ACCOUNTS RECEIVABLE:

 

Trade accounts receivableconsist of the following:

 
| ** **                           | ** ** | **January 31,  2010** | ** ** | **(Audited)  October 31,  2009** | ** ** |
|--------------------------------------|------------|----------------------------|------------|---------------------------------------|------------|
|                                 |       |                       |       |                                  |       |
| Trade  accounts receivables          |       | $                          | 14,198,928 |                                  | $          | 14,393,681 |   |
| Less-  reserve for doubtful accounts |       | (550,963                   | )          | (561,229                              | )          |
| Net  trade accounts receivables      |       | $                          | 13,647,965 |                                  | $          | 13,832,452 |   |

 

On January 14, 2009,Nortel Networks Corporation filed for bankruptcy protection in the UnitedStates Bankruptcy Court for the District of Delaware.  Subsequent to the filing the administratorsof the bankruptcy adopted a business disposal strategy.  Under thestrategy, the administrators segmented Nortel into three primary businessunits: Virtual Service Switches, CDMA businesses and Enterprise Solutions. Weconduct all of our Nortel business through the Enterprise Solutions unit.

 

On December 18,2009, Avaya completed the purchase of Nortel’s Enterprise Solutions businessunit.  Nortel is one of our majorsuppliers and is an important customer. In addition, its product line represents a significant portion of our business.  At the time of filing this Form 10-Q,our post-petition relationship with Nortel continues uninterrupted.  However, management recognizes the potentialimpact of Nortel’s filing on the Company’s financial performance.  Nortel owes XETA approximately $700,000 inpre-petition accounts receivable.  On July 17,2009 the bankruptcy court granted our request for offset of $116,000 in chargeswe owed Nortel at the time of the filing. In fiscal year 2009, we recorded $350,000 as a reserve against possibleNortel bad debts.  Nortel has until July 13,2010 to file its reorganization plan; however, this date is subject to furtherextension.  Until the administrators fileNortel’s reorganization plan our ability to assess the probability ofrecovering pre-petition amounts due is limited.

 

The Company is carefullyfollowing developments associated with the bankruptcy case and will assert itslegal rights and defenses as appropriate.

 

3.  INVENTORIES:

 

Inventoriesare stated at the lower of average cost or market and consist of the following:

 
| ** **                                         | ** ** | **January 31,  2010** | ** ** | **(Audited)  October 31,  2009** | ** ** |
|----------------------------------------------------|------------|----------------------------|------------|---------------------------------------|------------|
|                                               |       |                       |       |                                  |       |
| Finished  goods and spare parts                    |       | $                          | 5,881,709  |                                  | $          | 5,977,703 |   |
| Less-  reserve for excess and obsolete inventories |       | (962,808                   | )          | (941,505                              | )          |
| Total  inventories, net                            |       | $                          | 4,918,901  |                                  | $          | 5,036,198 |   |

 

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4.  PROPERTY, PLANT AND EQUIPMENT:

 

Property, plant andequipment consist of the following:

 
| ** **                                                    | ** ** | **Estimated  Useful  Lives** | ** ** | ** January 31,  2010** | ** ** | **(Audited)  October 31,  2009** | ** ** |
|---------------------------------------------------------------|------------|------------------------------|------------|----------------------------------|------------|---------------------------------------|------------|
|                                                          |       |                         |       |                             |       |                                  |       |
| Building  and building improvements                           |       | 3-20                         |       | $                                | 3,292,623  |                                  | $          | 3,253,693 |   |
| Data  processing and computer field equipment                 |       | 2-7                          |       | 3,396,173                        |       | 3,248,126                             |       |
| Software  development costs, work-in-process                  |       | N/A                          |       | 197,934                          |       | 197,097                               |       |
| Software  development costs of components placed into service |       | 3-10                         |       | 2,708,930                        |       | 2,697,806                             |       |
| Hardware                                                      |       | 3-5                          |       | 643,635                          |       | 643,635                               |       |
| Land                                                          |       | —                       |       | 611,582                          |       | 611,582                               |       |
| Office  furniture                                             |       | 5-7                          |       | 790,547                          |       | 779,588                               |       |
| Auto                                                          |       | 5                            |       | 537,300                          |       | 537,300                               |       |
| Other                                                         |       | 3-7                          |       | 145,779                          |       | 149,484                               |       |
|                                                          |       |                         |       |                             |       |                                  |       |
| Total  property, plant and equipment                          |       |                         |       | 12,324,503                       |       | 12,118,311                            |       |
| Less-  accumulated depreciation and amortization              |       |                         |       | (5,708,485                       | )          | (5,292,395                            | )          |
|                                                          |       |                         |       |                             |       |                                  |       |
| Total  property, plant and equipment, net                     |       |                         |       | $                                | 6,616,018  |                                  | $          | 6,825,916 |   |

 

5.  INCOME TAXES:

 

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

 

6.  CREDIT AGREEMENTS:

 

In November 2009,the Company entered into a one-year loan agreement with a new financialinstitution. This agreement replaced our previous credit facility, which wasscheduled to mature on November 30, 2009. The loan agreement consists of an $8.5 million revolving credit facilitycollateralized by trade accounts receivable, inventories, and real estate.

 

At January 31, 2010,the Company did not have an outstanding balance on the revolving line ofcredit.  The Company had approximately$8.5 million available under the revolving line of credit at January 31,2010.  The advance rates are defined inthe agreement, but are generally at the rate of 75% on qualified trade accountsreceivable and 50% of qualified inventories and real estate.  Long term debt consisted of the following:

 
| ** **                                                                                                                                            | ** ** | **January 31,  2010** | ** ** | **(Audited)  October 31,  2009** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------|------------|---------------------------------------|------------|
|                                                                                                                                                  |       |                       |       |                                  |       |
| Term  note, payable with a fixed payment of $1,183,475 due November 30, 2009,  collateralized by a first mortgage on the Company’s building |       | $                          | —     |                                  | $          | 1,183,475 |   |
|                                                                                                                                                  |       |                       |       |                                  |       |
| Less-current  maturities                                                                                                                              |       | —                     |       | 1,183,475                             |       |
|                                                                                                                                                  |       |                       |       |                                  |       |
| Total  long-term debt, less current maturities                                                                                                        |       | $                          | —     |                                  | $          | 0- |   |

 

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Interest on alloutstanding debt under the credit facility accrues at the greater of either theLondon Interbank Offered Rate (“LIBOR”) (0.229% at January 31, 2010) plus3.0% or 4.5%.  The credit facilitycontains several financial covenants common in such agreements includingtangible net worth requirements, limitations on the amount of funded debt toannual earnings before interest, taxes, depreciation and amortization,limitations on cash dividends, 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 January 31, 2010** | ** ** |
|-----------------------------------|------------|------------------------------------------------------|------------|
| ** **                        | ** ** | **Income  (Numerator)**                              | ** ** | **Shares  (Denominator)** | ** ** | **Per Share  Amount** | ** ** |
| Basic  EPS                        |       |                                                 |       |   |   |   |   |
| Net  income                       |       | $                                                    | 632,788    |   | 10,237,405 |   | $ | 0.06 |   |
| Dilutive  effect of stock options |       |                                                 |       | 39,956 |   |   |   |
|                              |       |                                                 |       |   |   |   |   |
| Diluted  EPS                      |       |                                                 |       |   |   |   |   |
| Net  income                       |       | $                                                    | 632,788    |   | 10,277,361 |   | $ | 0.06 |   |

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

 

Options to purchase993,438 shares of common stock at an average exercise price of $6.63 and1,288,300 shares of common stock at an average exercise price of $6.43 were notincluded in the computation of diluted earnings per share for the three monthsended January 31, 2010 and 2009, respectively, because inclusion of theseoptions would be antidilutive.

 

8.  CONTINGENCIES:

 

In addition to potentiallosses related to Nortel’s pre-petition receivables, the Company may be subjectto preference payment claims asserted by Nortel.  It is routine in bankruptcy proceedings forthe debtor in possession or bankruptcy trustee to assert a statutory “preferenceclaim” to seek to recover payments made by the bankrupt entity to creditorsduring the 90-day period immediately preceding the filing of the bankruptcypetition.  This period is known as the “preference period”.  Althoughthe debtor is entitled to make a claim based solely upon when the payments weremade, the payments are not recoverable if they were made in the debtor’sordinary course of dealings with the creditor.  Nortel has filed aschedule showing approximately $1.6 million in payments made to the Companyduring the preference period.  To dateNortel has not asserted a preference claim against the Company.  However,if a preference claim is brought, the Company believes it has good defenses toany such potential claim against it, including that the subject payments weremade in the ordinary course of the Company’s business dealings withNortel.  These

 

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defenses must be arguedon each individual Company invoice paid during the preference period.  TheCompany has not completed its evaluation of its potential defenses against eachindividual invoice. As such the Company is unable at this time to determine theextent, if any, of any material loss that might occur if a claim torecover preference payments is asserted.  Therefore, no provision forloss has been made beyond the amount discussed above related to unpaid invoicesat the time of the bankruptcy filing.

 

9.  CAPITAL LEASES:

 

During 2008 the Companyleased software licenses under an agreement that is classified as a capitallease. The book value of the licenses is included in the balance sheet asproperty, plant and equipment and was $215,579 at January 31, 2010.  Accumulated amortization of the leasedlicenses at January 31, 2010 was $240,941. Amortization under the capital lease is included in depreciationexpense.  The future minimum leasepayments required under the capital lease and the present value of the netminimum lease payments as of January 31, 2010, are as follows:

 
| ** **                                           | ** ** | **Capital  Lease Payments** | ** ** |
|------------------------------------------------------|------------|-----------------------------|------------|
|                                                 |       |                        |       |
| 2010                                                 |       | $                           | 161,435    |   |
| 2011                                                 |       | 67,265                      |       |
| Total  minimum lease payments                        |       | 228,700                     |       |
| Less-  imputed interest                              |       | 6,513                       |       |
| Present  value of minimum payments                   |       | 222,187                     |       |
| Less-current  maturities of capital lease obligation |       | 155,569                     |       |
| Long-term  capital lease obligation                  |       | $                           | 66,618     |   |

 

10.  SUBSEQUENT EVENTS:

 

The Company is notaware of any significant events that occurred subsequent to the balance sheetdate but prior to the filing of this report that would have a material impacton our financial position or results of operations.

 

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** **

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

 

**Preliminary Note RegardingForward-Looking Statements**

 

This report containsforward-looking statements relating to future events and our future performanceand results.  Many of these statements appear in the discussions under theheadings “Risk Factors,” and “Management’s Discussion and Analysis of FinancialCondition and Results of Operations.” All statements other than those that are purely historical may beforward-looking statements.  Forward-looking statements can generally beidentified by words such as “expects,” “anticipates,” “may”, “plans,” “believes,”“intends,” “projects,” “estimates,” and similar words or expressions.Forward-looking statements are not guarantees of performance, but ratherreflect our current expectations, estimates, and forecasts about the industryand markets in which we operate, and our assumptions and beliefs based uponinformation currently available to us.  These statements are subject torisks and uncertainties which are difficult to predict or which we are unableto control, including but not limited to such factors as the condition of theU.S. economy and its impact on capital spending trends in our markets, thefinancial condition of our suppliers and changes by them in their distributionstrategies and support, Nortel’s bankruptcy proceedings, unpredictable revenuelevels from quarter to quarter, inconsistent gross profit margins, continuingacceptance and success of the Mitel product and services offering, availabilityof credit to finance growth, intense competition and industry consolidation,dependence upon a few large wholesale customers in our Managed Servicesoffering, the availability and retention of revenue professionals and certifiedtechnicians.  These and other risks and uncertainties are discussed underthe heading “Risk Factors” under Part I of the Company’s Form 10-K forthe fiscal year ended October 31, 2009 (filed with the Commission on January 8,2010) and in updates to such risk factors set forth in Item 1A of Part IIof this quarterly report.  As a result ofthese risks and uncertainties, actual results may differ materially andadversely from those expressed in forward-looking statements. Consequently, investors are cautioned to read and consider all forward-lookingstatements in conjunction with such risk factors and uncertainties.  ThePrivate Securities Litigation Reform Act of 1995 provides a safe-harbor forforward-looking statements made by the Company.

 

# **Overview**

# ** **

Strategy.

In advance of fiscal2010, senior management conducted its periodic review of the strategicdirection of the Company.  This reviewresulted in a threefold refinement of the strategic focus and direction of theorganization.  First, the Company willcontinue to emphasize aggressive growth in our managed services business.  Second, the Company will use its uniqueposition to search out and pursue organic and acquisitive growth opportunitiesresulting from Avaya’s acquisition of Nortel’s enterprise business.  Finally the Company will advance alonger-term business initiative focused on the sales, design, development andsupport of collaborative technologies and advanced applications.

 

Management believes theserefinements of our longstanding strategies are necessary to fully realize thebenefits of our investments in high value talent and competencies, the marketrealignment resulting from Avaya’s acquisition of Nortel and in anticipation ofgrowth in demand for advanced applications and collaborative technologies.

 

The market appears to bein the early stages of recovery from the economic downturn that affected ourbusiness throughout fiscal 2009.  Marketindicators, while tepid, point to market growth in 2010.  After successfully weathering 2009 byfocusing on cost control, operating efficiencies and a strengthening of ourbalance sheet, management is optimistic that our refined strategic directionwill capitalize on opportunities resulting from a recovering economy.

 

OperatingSummary.

Inthe first quarter of fiscal 2010, we recorded a net income of $633,000 onrevenues of $23.0 million compared to net income of $2,000 on revenues of $18.6million in the first quarter of last year. These results primarily reflect an increase in demand for commercialsystems.  We discuss this and othercontributing factors in more detail under “Results of Operations” below.

 

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FinancialPosition Summary.

SinceOctober 31, 2009, we have generated positive cash flows from operations of$2.1 million and we primarily used these cash flows to reduce borrowings.  We have improved our working capitalapproximately 12%.  We discuss these andother financial items in more detail under “Financial Condition” below.

 

Thefollowing discussion presents additional information regarding our financialcondition and results of operations for the three month period ended January 31,2010 and 2009 and should be considered in conjunction with our above commentsas well as the “Risk Factors” section below.

 

# **Financial Condition**

# ** **

Duringthe first fiscal quarter of 2010 our working capital increased by 12% to $12.9million.  We generated $2.1 million incash flows from operations.  These cashflows included earnings and non-cash charges of $1.2 million; a decrease inaccounts receivable of $69,000; a decrease in inventory of $192,000; a decreasein deferred taxes of $409,000; an increase in accounts payable of $306,000; andan increase in accrued liabilities of $349,000. These increases were partially offset by a decrease in unearned revenueof $17,000; and other changes in working capital items, which netted a decreasein cash of $422,000.  Non-cash chargesincluded amortization of $187,000; depreciation of $286,000; provisions fordoubtful accounts receivable and obsolete inventories of $41,000; andstock-based compensation of $74,000.

 

Weused these positive cash flows to make the final scheduled payment on themortgage of $1.2 million; acquire capital assets of $206,000; and fund otherfinancing and investing activities of $38,000. The acquisition of capital assets was part of normal replacement ofInformation Technology infrastructure and headquarters facility improvements.

 

AtJanuary 31, 2010, there was no outstanding balance on our working capitalrevolver.  In accordance with thecollateral base defined in the credit facility, $8.5 million was available forborrowing on the $8.5 million facility at the end of the quarter.  Our cash balance at the end of the quarterwas $5.4 million.  Management believesour cash balances and available borrowing capacity are sufficient to supportour expected operating requirements.  Theworking capital revolver is scheduled to mature on November 5, 2010.  We expect to renew this instrument for a12-month period prior to the expiration. It is possible that the renewal could result in higher borrowing costsand/or reduced availability for unsecured borrowings.  In addition to the available capacity underour working capital line of credit, we believe we have access to a variety ofcapital sources such as private placements of subordinated debt, and public orprivate sales of equity to finance investments beyond our current operatingneeds.

 

# **Results of Operations**

# ** **

Inthe first quarter of fiscal 2010, revenues were $23.0 million compared to $18.6million in the first quarter 2009.  Ournet income in the first quarter of fiscal 2010 was $633,000 compared to netincome of $2,000 compared to the same quarter a year ago.  These results primarily reflect increasedsales of commercial systems and services revenues.  The narrative below provides furtherexplanation of these results.

 

SystemsSales.

In the first quarter offiscal 2010, systems sales increased approximately $2.3 million or 27% comparedto the same period last year.  Thisincrease includes a $3.7 million or 59% increase in sales of systems tocommercial customers partially offset by a $1.5 million or 64% decrease insales of systems to hospitality customers. The increase in systems sales to commercial customers reflects acombination of some of our customers spending remaining 2009 budgets,improvement in enterprise spending for communications equipment, and thegeneral unpredictable nature of this segment of our business.  As the U.S economy emerges from recession,management believes economic indicators point to improved market conditions in2010 and our commercial systems sales during the period reflect the improvedeconomic environment.  While we arepleased with our overall results for the first quarter, these results are notnecessarily a predictor of our performance for the remainder of the year.  Economic headwinds remain and we expect 

 

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growth of the U.S. economyin 2010 to be slow and uneven.  While weare cautiously optimistic about 2010, the market is fraught with many complexchallenges, whether positive or negative, that will likely impact our systemssales.  Furthermore, as evidenced by thedecline in revenues in our hospitality systems sales, some sectors of theeconomy remain mired in difficult economic circumstances.  The hospitality industry as a whole isexperiencing continued weakness in demand, and as a result has limited itsexpenditures on new communications equipment and solutions.

 

ServicesRevenues.

Servicesrevenues consist of the following:

 
| ** **                     | ** ** | **For the Three Months Ended  January 31,** | ** ** |
|--------------------------------|------------|--------------------------------------------------|------------|
| ** **                     | ** ** | **2010**                                         | ** ** | **2009** | ** ** |
| Maintenance &  repair |       | $                                                | 8,218,000  |   | $ | 6,980,000 |   |
| Implementation                 |       | 3,042,000                                        |       | 2,181,000 |   |
| Structured  cabling            |       | 857,000                                          |       | 832,000 |   |
| Total  Services revenues       |       | $                                                | 12,117,000 |   | $ | 9,993,000 |   |

 

Maintenanceand repair revenues increased 18% in the first quarter compared to the sameperiod last year.  This performancereflects a modest increase in revenues in our wholesale services programs andrelatively flat T&M service revenues. We continue to aggressively market our national service footprint andmulti-product line technical capabilities to end-users, network service providers,and large integrators of voice and data technologies.  We expect growth in these new programs topositively impact our maintenance & T&M revenues for theforeseeable future.

 

Implementationrevenues increased 39% in the first fiscal quarter compared to the same periodlast year.  This increase is primarilydriven by the increase in systems sales as well as an increase in revenues fromour Professional Services Organization (“PSO”). We attribute this to increasing demand for more complex communicationssystems requiring significant fee-generating design and engineeringservices.  In the near term,Implementation revenues will continue to be closely aligned with the sale ofnew systems.  From a long termperspective, however, as customers displace conventional communicationsplatforms and adopt more complex systems, we anticipate growth in this area ofour business through the fee-based utilization of these highly skilledtechnical resources.

 

Structuredcabling revenues increased 3% in the first fiscal quarter compared to the sameperiod last year.

 

GrossMargins.

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

 
| ** **                    | ** ** | **For the Three Months Ended  January 31,** | ** ** |
|-------------------------------|------------|--------------------------------------------------|------------|
| **Gross  Margins**            | ** ** | **2010**                                         | ** ** | **2009** | ** ** |
| Services  revenues            |       | 32.1                                             | %          | 30.1 | % |
| Systems  sales                |       | 25.7                                             | %          | 26.1 | % |
| Other  revenues               |       | 19.3                                             | %          | -7,869.4 | % |
| Corporate  cost of goods sold |       | -1.5                                             | %          | -2.0 | % |
| Total                         |       | 27.5                                             | %          | 25.9 | % |

 

Theimproved gross margins earned on Services revenues primarily reflect improvedmargins earned on implementation and structured cabling activities.  Theprimary driver for implementation revenues is systems sales.  As a result of strong growth in systems sold,we realized improved utilization of our installation and professional servicespersonnel during the first quarter, significantly improving the margins onthese revenues.  These improvements combined with strong gross marginsearned on our Cabling revenues in the first quarter pushed our overall grossmargins on Services revenues well into our target range of 30-35%.

 

Grossmargins on systems sales in the first quarter are slightly above our target of23% to 25% for systems revenues.  Thissuccess is due to continued focus on costs throughout the supply chain andpricing support 

 

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receivedfrom our manufacturers in the form of project-specific discounts and incentiverebates which are recorded as reductions to cost of goods sold.  These discounts and incentives are material toour gross margins.  Avaya has recently announced significantchanges in its pricing structure and incentive programs which are scheduled totake effect on April 19, 2010. According to Avaya these changes are being made to simplify its pricingstructure and eliminate the need to request special discounts and administercomplex incentive programs.  Avaya hasstated these changes should be neutral to our profit margins; however ourinitial review of these changes contradicts Avaya’s statements regarding theneutrality of these changes on our profit margins.  We are continuing to evaluate these changesand at this time no assurance can be given that the pricing and incentiveprogram changes eventually implemented by Avaya will not have a material,adverse impact on our operating results.

 

Thefinal component of our gross margins is the margins earned on other revenuesand our corporate cost of goods sold.  Weearn the majority of other revenues from the sale of Avaya maintenancecontracts on which we earn either a commission or gross profit.  We have no continuing service obligationassociated with these revenues and gross profits.  This is an unpredictable revenue stream thatdepends on the expiration dates of existing contracts, installation dates ofnew systems, the customer type as defined by Avaya, and the number of yearsthat customers contract for services. Other revenues may also include sales and cost of goods sold onequipment or services sold outside our normal provisioning processes.  These revenues vary in both sales volume andgross margins earned.  Corporate cost ofgoods sold represents our material logistics and purchasing functions thatsupport all of our revenue segments.

 

OperatingExpenses.

Ourtotal operating expenses increased $534,000 in the first quarter of fiscal 2010compared to the first quarter of fiscal 2009. Operating expenses were 23.1% of revenues in the first quarter comparedto 25.7% in the first quarter last year. The level of operating expenses as a percentage of revenues are aboveour targets and reflect a number of factors including increased salescommissions associated with increased gross profit and reduced sales andmarketing incentives from vendors during the first quarter.  We consider it tactically appropriate, givenour strong cash flows, to support operating expenses above our targets in thenear term to take advantage of expected improving economic conditions insubsequent quarters.

 

InterestExpense and Other Income.

Netinterest and other income was $15,000 in the first quarter of fiscal 2010compared to $19,000 in net other expense in the first quarter of fiscal2009.  This reflects both lower interestrates and a reduction in debt.

 

TaxProvision.

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

 

**ITEM 4T.   CONTROLS AND PROCEDURES**

 

*Evaluation of Disclosure Controls and Procedures.* Basedon an evaluation conducted as of January 31, 2010 by our management,including our Chief Executive Officer (“CEO”) and our Chief Financial Officer (“CFO”),our CEO and CFO have concluded that our disclosure controls and procedures (asdefined in Rules 13a-15(e) and 15d-15(e) under the SecuritiesExchange Act of 1934, as amended (the “Exchange Act”) are effective toreasonably ensure that information required to be disclosed in reports that wefile or submit under the Exchange Act, is recorded, processed, summarized andreported within the time periods specified in Securities and ExchangeCommission rules and forms, and that such information is accumulated andcommunicated to our management, including the CEO and CFO, as appropriate toallow timely decisions regarding required disclosure.

 

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

 

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**PART II.  OTHERINFORMATION**

 

**ITEM1.  LEGAL PROCEEDINGS.**

 

On November 10,2009, the Company was named as an additional defendant in a lawsuit originallyfiled on March 16, 2009 by Pangaia Partners against two of Pangaia’sformer employees who subsequently went to work for the Company.  Thelawsuit was filed in Superior Court of New Jersey Law Division, BergenCounty.  Pangaia’s claims against the Company are made in relation to aNortel account to which the employee defendants were assigned when they workedfor Pangaia and which they now service as employees of the Company.  Pangaia’sclaims against the Company and the individual defendants include unfaircompetition, tortuous interference with prospective economic advantage,tortuous interference with contract, misappropriation of trade secrets,conversion and unjust enrichment.  In its original claim against itsformer employees, Pangaia sought but was denied a preliminary injunction toenforce non-competition agreements.  Pangaia now seeks monetary damagesagainst all defendants, but has not alleged a specific dollar amount.  A preliminary investigation indicates theclaims are without merit and the Company expects to mount a vigorous defense.

 

**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 31,2009 and should be read in conjunction therewith.  Except as set forth below, the Risk Factorsincluded in the Company’s Form 10-K for its 2009 fiscal year have notmaterially changed.

 

**Nortel’s Chapter 11 Bankruptcyfiling and subsequent sale of its enterprise solution business to Avaya maynegatively impact our revenues and/or financial condition.**

 

Nortel filed a voluntarypetition for Chapter 11 bankruptcy protection on January 14, 2009.  To date Nortel has not filed its plan ofreorganization.  In the meantime theadministrators of the bankruptcy have adopted a business disposal strategy,pursuant to which they have sold the Nortel enterprise solution business (“NES”)to Avaya.  All of the foregoingdevelopments pose a variety of risks to our business, as follows:

 

·                  Uncertaintysurrounding Nortel’s bankruptcy has significantly dampened demand for equipmentin this product line.  Until Nortel files it plan of reorganization, thisuncertainty is likely to continue. Nortel has until July 13, 2010 to file its plan of reorganizationunless such date is further extended by the court.  Although Avaya’s acquisition of NES may helpto reduce the uncertainly in the market over the course of fiscal 2010, in thenear term we anticipate continued weakness in demand for Nortel equipment.

·                  Weare owed approximately $700,000 in pre-petition accounts receivable lessapproximately $116,000 in approved offsets for amounts we owed to Nortel at thetime of the filing.  If our pre-petitionclaims are not collectible either in whole or in large part, we couldexperience material, negative operating results in the near term.

·                  Nortelhas filed a statement of financial affairs under which it shows payments to theCompany against multiple invoices of approximately $1.6 million which were madeduring the 90-day statutory “preference period” under bankruptcy law.  As such, these payments are considered “preferencepayments” and are subject to a “preference claim” which can be asserted byNortel.   Bankruptcy law allows thedebtor to recover these payments unless the creditor successfully establishesthat the payments were made in the ordinary course of business between thedebtor and creditor.  If Nortel elects toassert a preference claim against the Company for this amount or any portionthereof and the Company is unable to successfully defend the claim, the Companywould have to return any such amounts to Nortel.

·                  Avaya’spurchase of NES may result in a significant disruption and/or material declinein our revenues and gross profits.  NESis both one of our major suppliers and is an important customer in that NESoutsources significant volumes of service calls to us under various managedservices programs NES has with end-user customers.  Avaya and NES are large, complex companieswith global operations.  They have hadvery different marketing strategies and both have long, deep culturaltraditions.  The integration of these twocompanies will be 

 

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challenging anddisruptive to the market.  There can beno assurance given that the combination of Avaya and NES will not havenear-term and/or long-term material, negative impact on our operating results,financial position, market position, and overall reputation.

 

**Avayahas announced a significant change in their pricing structure and incentiveprograms, which may affect our operating results.**

 

Avaya has recentlyannounced significant changes in its pricing structure and incentive programswhich are scheduled to take effect on varying dates during our fourth fiscalquarter.  As a large business partner ofAvaya we receive substantial discounts off of list price and the payments wereceive under Avaya’s various incentive programs are material to our operatingresults.  Avaya may make additionaladjustments to the announced changes before that date and/or may delay theimplementation of some or all of the changes as it continues to receivefeedback from its business partners.  Atthis time, no assurance can be given that the pricing and incentive programchanges eventually implemented by Avaya will not have a material, adverseimpact on our operating results.

 

**Avaya’srecently published requirements regarding minimum level service agreements andhardware and software upgrade requirements could have a material, negativeimpact on our services gross margins.**

 

Avayahas announced new policies, effective July 1, 2010, requiring allcustomers to contract with Avaya for minimum service levels to have access toTier IV hardware and software support and also to maintain their hardware andsoftware at no more than two major version levels less than the currentrelease.  We are evaluating the potential impact of thesechanges to our business which could include a decline in our services grossmargins if we are required to purchase Avaya service contracts on behalf ourcustomers, reduced customer satisfaction with the quality of our services dueto the lack of access to Avaya’s Tier IV support network, and/or reduced salesof new Avaya systems if customers choose to abandon the product line.  Presently, it is too early to determine withspecificity the most likely impact of these changes on our business.  Additionally, these changes are still beingrefined as Avaya receives feedback from both end users and businesspartners.  At this time, no assurance canbe given that these policy changes if implemented by Avaya will not have amaterial, adverse impact on our operating results.

 

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

 

(a) None.

 

(b) None.

 

(c) Issuer Purchasesof Equity Securities

 

In 2008 the Board ofDirectors approved a stock repurchase program authorizing the Company to use upto $1.0 million to repurchase its outstanding common stock on the openmarket.  During the first quarter offiscal 2010 there was no repurchase activity and the program was withdrawn bythe Board of Directors.

 

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

 

None.

 

**ITEM 4. OTHER INFORMATION.**

 

(a)  On December 29, 2009, the Compensation Committee (the “Committee”)approved an annual incentive plan formula for fiscal 2010 which will transitionthe total bonus pool from its current level of approximately 10% of pre-tax,pre-bonus profits to approximately 11% of after-tax net income as net incomeapproaches and exceeds $5 million.  Under the plan the Committee intendsto target 40% of the total annual incentive pool toward the CEO and CFO and topay 25% to 50% of the award in restricted 

 

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Company stock.  The Committee has the discretion to adjust thesetargets when in its opinion, conditions warrant.

 

**ITEM 5.   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: March 1,  2010 | By:                           | /s/ Greg D. Forrest |
|                       |                          | Greg D. Forrest |
|                       |                          | Chief Executive Officer |
|                       |                          |   |
|                       |                          |   |
| Dated: March 1,  2010 | 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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