**UNITED STATES**

**SECURITIES AND EXCHANGECOMMISSION**

**Washington,D.C.   20549**

**FORM10-Q**

| **x**                              | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15  (d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|------------------------------------|-----------------------------------------------------------------------------------------------|
| ** **                         | ** **                                                                                    |
|                               | **For the quarterly period ended April 30, 2007**                                             |
|                               | ** **                                                                                    |
|                               | **OR**                                                                                        |
|                               | ** **                                                                                    |
| **o**                              | **TRANSITION REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|                               | ** **                                                                                    |
| **Commission File Number 0-16231** |

 

**XETATechnologies, Inc.**

(Exact name of registrant as specified in its charter)

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

 

**918-664-8200**

(Registrant’stelephone number, including area code)

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

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

Yes x       No o

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, or anon-accelerated filer.  See definition of“accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
| Large accelerated filer o | Accelerated  filer o | Non-accelerated filer x |
|---------------------------|----------------------|-------------------------|

 

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2 of theExchange Act). Yes o    No x

Indicate thenumber of shares outstanding of each of the registrant’s classes of commonstock, as of the latest practicable date.

| Class                          | ** ** | **Outstanding at May 25, 2007** |
|--------------------------------|------------|---------------------------------|
| Common Stock,  $.001 par value |       | 10,214,741                      |

 

 

----

INDEX
| PART I. FINANCIAL  INFORMATION |                                                                                                |                                                         |
|--------------------------------|-----------------------------------------------------------------------------------------------------|--------------------------------------------------------------|
|                           |                                                                                                |                                                         |
|                           | ITEM 1. FINANCIAL STATEMENTS (Unaudited)                                                            |                                                         |   |
|                           |                                                                                                |                                                         |
|                           | Consolidated  Balance Sheets - April 30, 2007 and October 31, 2006                                  |                                                         |   |
|                           |                                                                                                |                                                         |   |
|                           | Consolidated Statements of Operations - For the Three  and Six Months Ended April 30, 2007 and 2006 |                                                         |   |
|                           |                                                                                                |                                                         |   |
|                           | Consolidated Statement of Shareholders’ Equity - For  the Six Months Ended April 30, 2007      |                                                         |   |
|                           |                                                                                                |                                                         |   |
|                           | Consolidated Statements of Cash Flows - For the Six  Months Ended April 30, 2007 and 2006           |                                                         |   |
|                           |                                                                                                |                                                         |   |
|                           | Notes to Consolidated Financial Statements                                                          |                                                         |   |
|                           |                                                                                                |                                                         |
|                           | ITEM 2.                                                                                             | MANAGEMENT’S  DISCUSSION AND ANALYSIS                   |   |   |
|                           |                                                                                                |                                                         |   |   |
|                           | ITEM 3.                                                                                             | QUANTITATIVE  AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK  |   |   |
|                           |                                                                                                |                                                         |   |   |
|                           | ITEM 4.                                                                                             | CONTROLS AND  PROCEDURES                                     |   |   |
|                           |                                                                                                |                                                         |
| PART II. OTHER  INFORMATION    |                                                                                                |                                                         |
|                           |                                                                                                |                                                         |
|                           | ITEM 1.                                                                                             | LEGAL PROCEEDINGS                                            |   |   |
|                           |                                                                                                |                                                         |   |
|                           | ITEM 1A. RISK FACTORS                                                                               |                                                         |   |
|                           |                                                                                                |                                                         |   |
|                           | ITEM 2.                                                                                             | UNREGISTERED  SALES OF EQUITY SECURITIES AND USE OF PROCEEDS |   |   |
|                           |                                                                                                |                                                         |   |   |
|                           | ITEM 3.                                                                                             | DEFAULTS UPON  SENIOR SECURITIES                             |   |   |
|                           |                                                                                                |                                                         |   |   |
|                           | ITEM 4.                                                                                             | SUBMISSION OF  MATTERS TO A VOTE OF SECURITY HOLDERS         |   |   |
|                           |                                                                                                |                                                         |   |   |
|                           | ITEM 5.                                                                                             | OTHER INFORMATION                                            |   |   |
|                           |                                                                                                |                                                         |   |   |
|                           | ITEM 6.                                                                                             | EXHIBITS                                                     |   |   |

 

2

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XETA TECHNOLOGIES, INC.AND SUBSIDIARY

CONSOLIDATED BALANCE SHEETS
| ** **                                                                                                              | ** ** | **April 30, 2007** | ** ** | **October 31, 2006** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------|------------|------------------------------|------------|--------------------------------|------------|
| ** **                                                                                                              | ** ** | **(UNAUDITED)**              | ** ** | ** **                     | ** ** |
|                                                                                                                    |       |                         |       |                           |       |
| ASSETS                                                                                                                  |       |                         |       |                           |       |
| Current assets:                                                                                                         |       |                         |       |                           |       |
| Cash and cash  equivalents                                                                                              |       | $                            | 188,182    |                           | $          | 174,567 |   |
| Current portion  of net investment in sales-type leases and other receivables                                           |       | 386,221                      |       | 329,619                        |       |
| Trade accounts  receivable, net                                                                                         |       | 11,333,316                   |       | 12,245,507                     |       |
| Inventories, net                                                                                                        |       | 5,880,412                    |       | 4,942,973                      |       |
| Deferred tax  asset, net                                                                                                |       | 797,311                      |       | 709,343                        |       |
| Prepaid taxes                                                                                                           |       | 13,789                       |       | 22,622                         |       |
| Prepaid expenses  and other assets                                                                                      |       | 606,377                      |       | 300,738                        |       |
| Total current  assets                                                                                                   |       | 19,205,608                   |       | 18,725,369                     |       |
|                                                                                                                    |       |                         |       |                           |       |
| Noncurrent assets:                                                                                                      |       |                         |       |                           |       |
| Goodwill                                                                                                                |       | 26,392,881                   |       | 26,420,669                     |       |
| Intangible  assets, net                                                                                                 |       | 122,959                      |       | 141,875                        |       |
| Net investment  in sales-type leases, less current portion above                                                        |       | 122,126                      |       | 128,708                        |       |
| Property, plant  & equipment, net                                                                                   |       | 10,430,677                   |       | 10,485,018                     |       |
| Other assets                                                                                                            |       | 27,475                       |       | 11,124                         |       |
| Total noncurrent  assets                                                                                                |       | 37,096,118                   |       | 37,187,394                     |       |
|                                                                                                                    |       |                         |       |                           |       |
| Total assets                                                                                                            |       | $                            | 56,301,726 |                           | $          | 55,912,763 |   |
|                                                                                                                    |       |                         |       |                           |       |
| LIABILITIES AND  SHAREHOLDERS’ EQUITY                                                                              |       |                         |       |                           |       |
|                                                                                                                    |       |                         |       |                           |       |
| Current liabilities:                                                                                                    |       |                         |       |                           |       |
| Current portion  of long-term debt                                                                                      |       | $                            | 171,123    |                           | $          | 171,123 |   |
| Revolving line  of credit                                                                                               |       | 513,317                      |       | 3,119,445                      |       |
| Lease payable                                                                                                           |       | —                       |       | 810                            |       |
| Accounts payable                                                                                                        |       | 5,679,224                    |       | 4,325,758                      |       |
| Current unearned  revenue                                                                                               |       | 2,392,342                    |       | 1,802,665                      |       |
| Accrued  liabilities                                                                                                    |       | 3,508,757                    |       | 2,993,831                      |       |
| Total current  liabilities                                                                                              |       | 12,264,763                   |       | 12,413,632                     |       |
|                                                                                                                    |       |                         |       |                           |       |
| Noncurrent liabilities:                                                                                                 |       |                         |       |                           |       |
| Long-term debt,  less current portion above                                                                             |       | 1,440,404                    |       | 1,525,950                      |       |
| Accrued  long-term liability                                                                                            |       | 351,250                      |       | 436,850                        |       |
| Noncurrent  unearned service revenue                                                                                    |       | 74,293                       |       | 79,132                         |       |
| Noncurrent  deferred tax liability, net                                                                                 |       | 3,859,757                    |       | 3,572,089                      |       |
| Total noncurrent  liabilities                                                                                           |       | 5,725,704                    |       | 5,614,021                      |       |
|                                                                                                                    |       |                         |       |                           |       |
| Contingencies                                                                                                           |       |                         |       |                           |       |
|                                                                                                                    |       |                         |       |                           |       |
| Shareholders’ equity:                                                                                              |       |                         |       |                           |       |
| Preferred stock;  $.10 par value; 50,000 shares authorized, 0 issued                                                    |       | —                       |       | —                         |       |
| Common stock;  $.001 par value; 50,000,000 shares authorized, 11,233,529 issued at April 30,  2007 and October 31, 2006 |       | 11,233                       |       | 11,233                         |       |
| Paid-in capital                                                                                                         |       | 13,115,545                   |       | 13,067,676                     |       |
| Retained  earnings                                                                                                      |       | 27,429,140                   |       | 27,050,860                     |       |
| Less 1,018,788  shares of treasury stock, at cost                                                                       |       | (2,244,659                   | )          | (2,244,659                     | )          |
| Total  shareholders’ equity                                                                                        |       | 38,311,259                   |       | 37,885,110                     |       |
| Total liabilities and  shareholders’ equity                                                                        |       | $                            | 56,301,726 |                           | $          | 55,912,763 |   |

 

The accompanying notes arean integral part of these consolidated balance sheets.

3

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XETA TECHNOLOGIES, INC.AND SUBSIDIARY

CONSOLIDATEDSTATEMENTS OF OPERATIONS

(UNAUDITED)
| ** **                                                 | ** ** | **For the Three Months** | ** ** | **For the Six Months** | ** ** |
|------------------------------------------------------------|------------|-----------------------------------------|------------|---------------------------------------|------------|
| ** **                                                 | ** ** | **Ended April 30,**           | ** ** | **Ended April 30,**         | ** ** |
| ** **                                                 | ** ** | **2007**                                | ** ** | **2006**                              | ** ** | **2007** | ** ** | **2006** | ** ** |
|                                                       |       |                                    |       |                                  |       |   |   |   |   |
| Managed Services                                           |       | $                                       | 8,792,452  |                                  | $          | 7,248,178 |   | $ | 17,569,215 |   | $ | 13,667,118 |   |
| Systems sales                                              |       | 7,762,223                               |       | 7,556,449                             |       | 14,789,071 |   | 13,257,725 |   |
| Other revenues                                             |       | 134,363                                 |       | 89,463                                |       | 381,431 |   | 651,759 |   |
| Net sales and service revenues                             |       | 16,689,038                              |       | 14,894,090                            |       | 32,739,717 |   | 27,576,602 |   |
|                                                       |       |                                    |       |                                  |       |   |   |   |   |
| Managed Services  costs                                    |       | 6,116,344                               |       | 5,197,965                             |       | 12,464,441 |   | 10,293,864 |   |
| Cost of systems  sales                                     |       | 5,926,906                               |       | 5,723,797                             |       | 11,234,735 |   | 9,841,398 |   |
| Cost of other  revenues & corporate COGS               |       | 446,730                                 |       | 436,582                               |       | 889,870 |   | 1,129,243 |   |
| Total cost of sales and service                            |       | 12,489,980                              |       | 11,358,344                            |       | 24,589,046 |   | 21,264,505 |   |
|                                                       |       |                                    |       |                                  |       |   |   |   |   |
| Gross profit                                               |       | 4,199,058                               |       | 3,535,746                             |       | 8,150,671 |   | 6,312,097 |   |
|                                                       |       |                                    |       |                                  |       |   |   |   |   |
| Operating  expenses                                        |       |                                    |       |                                  |       |   |   |   |   |
| Selling, general and administrative                        |       | 3,713,011                               |       | 3,315,060                             |       | 7,241,421 |   | 6,142,258 |   |
| Amortization                                               |       | 146,767                                 |       | 102,532                               |       | 287,044 |   | 203,729 |   |
| Total operating expenses                                   |       | 3,859,778                               |       | 3,417,592                             |       | 7,528,465 |   | 6,345,987 |   |
|                                                       |       |                                    |       |                                  |       |   |   |   |   |
| Income (loss)  from operations                             |       | 339,280                                 |       | 118,154                               |       | 622,206 |   | (33,890 | ) |
|                                                       |       |                                    |       |                                  |       |   |   |   |   |
| Interest expense                                           |       | —                                  |       | (25,902                               | )          | (10,387 | ) | (97,799 | ) |
| Interest and other income                                  |       | 8,890                                   |       | 11,377                                |       | 26,461 |   | 19,591 |   |
| Total interest and other income (expense)                  |       | 8,890                                   |       | (14,525                               | )          | 16,074 |   | (78,208 | ) |
|                                                       |       |                                    |       |                                  |       |   |   |   |   |
| Income (loss)  before provision (benefit) for income taxes |       | 348,170                                 |       | 103,629                               |       | 638,280 |   | (112,098 | ) |
| Provision  (benefit) for income taxes                      |       | 140,000                                 |       | 47,000                                |       | 260,000 |   | (28,000 | ) |
|                                                       |       |                                    |       |                                  |       |   |   |   |   |
| Net income  (loss)                                         |       | $                                       | 208,170    |                                  | $          | 56,629 |   | $ | 378,280 |   | $ | (84,098 | ) |
|                                                       |       |                                    |       |                                  |       |   |   |   |   |
| Earnings (loss)  per share                                 |       |                                    |       |                                  |       |   |   |   |   |
| Basic                                                      |       | $                                       | 0.02       |                                  | $          | 0.01 |   | $ | 0.04 |   | $ | (0.01 | ) |
|                                                       |       |                                    |       |                                  |       |   |   |   |   |
| Diluted                                                    |       | $                                       | 0.02       |                                  | $          | 0.01 |   | $ | 0.04 |   | $ | (0.01 | ) |
|                                                       |       |                                    |       |                                  |       |   |   |   |   |
| Weighted average  shares outstanding                       |       | 10,214,741                              |       | 10,214,567                            |       | 10,214,741 |   | 10,201,651 |   |
|                                                       |       |                                    |       |                                  |       |   |   |   |   |
| Weighted average  equivalent shares                        |       | 10,214,741                              |       | 10,214,606                            |       | 10,214,741 |   | 10,205,033 |   |

 

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

4

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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, 2006 |       | 11,233,529             |       | $                       | 11,233     |       | 1,018,788  |       | $          | (2,244,659               | )          | $ | 13,067,676 |   | $ | 27,050,860 |   | $ | 37,885,110 |   |
|                       |       |                   |       |                    |       |       |       |       |       |                     |       |   |   |   |   |
| Stock based  compensation  |       | —                 |       | —                  |       | —     |       | —     |       | 47,869                   |       | — |   | 47,869 |   |
| Net Income                 |       | —                 |       | —                  |       | —     |       | —     |       | —                   |       | 378,280 |   | 378,280 |   |
|                       |       |                   |       |                    |       |       |       |       |       |                     |       |   |   |   |   |
| Balance- April 30, 2007    |       | 11,233,529             |       | $                       | 11,233     |       | 1,018,788  |       | $          | (2,244,659               | )          | $ | 13,115,545 |   | $ | 27,429,140 |   | $ | 38,311,259 |   |

 

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

5

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XETA TECHNOLOGIES, INC.AND SUBSIDIARY

CONSOLIDATEDSTATEMENTS OF CASH FLOWS

(UNAUDITED)
| ** **                                                                                                     | ** ** | **For the Six Months** | ** ** |
|----------------------------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                                                                     | ** ** | **Ended April 30,**         | ** ** |
| ** **                                                                                                     | ** ** | **2007**                              | ** ** | **2006** | ** ** |
| Cash flows from  operating activities:                                                                         |       |                                  |       |   |   |
| Net income  (loss)                                                                                             |       | $                                     | 378,280    |   | $ | (84,098 | ) |
|                                                                                                           |       |                                  |       |   |   |
| Adjustments to  reconcile net income (loss) to net cash provided by operating activities:                      |       |                                  |       |   |   |
| Depreciation                                                                                                   |       | 253,561                               |       | 253,077 |   |
| Amortization                                                                                                   |       | 287,045                               |       | 203,729 |   |
| Stock based  compensation                                                                                      |       | 47,869                                |       | — |   |
| Loss (gain) on  sale of assets                                                                                 |       | (5,000                                | )          | 4,184 |   |
| Provision for  excess and obsolete inventory                                                                   |       | 51,000                                |       | 51,000 |   |
| Increase  (decrease) in deferred taxes                                                                         |       | 315,456                               |       | (221,381 | ) |
| Change in assets  and liabilities:                                                                             |       |                                  |       |   |   |
| (Increase)  decrease in net investment in sales-type leases & other receivables                            |       | (50,020                               | )          | 158,988 |   |
| Decrease in  trade accounts receivable                                                                         |       | 912,191                               |       | 833,235 |   |
| (Increase)  decrease in inventories                                                                            |       | (988,439                              | )          | 979,258 |   |
| (Increase)  decrease in deferred tax asset                                                                     |       | (87,968                               | )          | 146,495 |   |
| Increase in  prepaid expenses and other assets                                                                 |       | (321,990                              | )          | (279,348 | ) |
| Decrease in  prepaid taxes                                                                                     |       | 8,833                                 |       | 61,269 |   |
| Increase  (decrease) in accounts payable                                                                       |       | 1,353,466                             |       | (1,401,362 | ) |
| Increase in  unearned revenue                                                                                  |       | 584,838                               |       | 728,402 |   |
| Increase in  accrued taxes                                                                                     |       | —                                |       | 19,108 |   |
| Increase in  accrued liabilities and lease payable                                                             |       | 428,516                               |       | 158,663 |   |
| Net cash  provided by operating activities                                                                     |       | 3,167,638                             |       | 1,611,219 |   |
|                                                                                                           |       |                                  |       |   |   |
| Cash flows from  investing activities:                                                                         |       |                                  |       |   |   |
| Additions to  property, plant & equipment                                                                  |       | (467,349                              | )          | (507,770 | ) |
| Proceeds from  sale of assets                                                                                  |       | 5,000                                 |       | 17,632 |   |
| Net cash used in  investing activities                                                                         |       | (462,349                              | )          | (490,138 | ) |
|                                                                                                           |       |                                  |       |   |   |
| Cash flows from  financing activities:                                                                         |       |                                  |       |   |   |
| Net payments on  revolving line of credit                                                                      |       | (2,606,128                            | )          | (688,200 | ) |
| Principal  payments on long-term debt                                                                          |       | (85,546                               | )          | (604,691 | ) |
| Exercise of  stock options                                                                                     |       | —                                |       | 52,584 |   |
| Net cash used in  financing activities                                                                         |       | (2,691,674                            | )          | (1,240,307 | ) |
|                                                                                                           |       |                                  |       |   |   |
| Net increase (decrease) in cash and cash equivalents                                                           |       | 13,615                                |       | (119,226 | ) |
|                                                                                                           |       |                                  |       |   |   |
| Cash and cash  equivalents, beginning of period                                                                |       | 174,567                               |       | 176,688 |   |
| Cash and cash  equivalents, end of period                                                                      |       | $                                     | 188,182    |   | $ | 57,462 |   |
|                                                                                                           |       |                                  |       |   |   |
| Supplemental  disclosure of cash flow information:                                                             |       |                                  |       |   |   |
| Cash paid during  the period for interest, net of amount capitalized of $114,814 in 2007 and  $146,596 in 2006 |       | $                                     | 31,233     |   | $ | 88,678 |   |
| Cash paid during the  period for income taxes                                                                  |       | $                                     | 23,679     |   | $ | 27,304 |   |

 

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

6

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**XETA TECHNOLOGIES, INC. ANDSUBSIDIARY**

**Notes to Consolidated Financial Statements**

**April 30, 2007**

(Unaudited)

1.  BASIS OF PRESENTATION:

XETA Technologies,Inc. (“XETA” or the “Company”) is a leading provider of communicationssolutions with sales and service locations nationwide, serving business clientsin sales, engineering, project management, installation, and service support. TheCompany sells products which are manufactured by a variety of manufacturersincluding Avaya, Inc. (“Avaya”), Nortel Networks Corporation (“Nortel”), andSpectralink Corporation. In addition, the Company manufactures and markets aline of proprietary call accounting systems to the hospitality industry. XETAis an Oklahoma corporation.

The accompanyingunaudited consolidated financial statements have been prepared by the Companypursuant to the rules and regulations of the Securities and Exchange Commission(the “Commission”). Certain information and footnote disclosures normallyincluded in annual financial statements prepared in accordance with accountingprinciples generally accepted in the United States of America have beencondensed or omitted pursuant to those rules and regulations, although theCompany believes that the disclosures made are adequate to make the informationpresented not misleading. It is suggested that these condensed financialstatements be read in conjunction with the consolidated financial statementsand the notes thereto made a part of the Company’s Annual Report on Form 10-K,Commission File No. 0-16231, which was filed with the Commission on January 16,2007. Management believes that the financial statements contain all adjustmentsnecessary for a fair statement of the results for the interim periodspresented. All adjustments made were of a normal recurring nature. The resultsof operations for the interim period are not necessarily indicative of theresults for the entire fiscal year. Certain reclassifications of prior yearamounts have been made to conform to current year presentations. Thesereclassifications had no impact on net income.

Segment Information

The Company hasthree reportable segments: Managed Services, commercial system sales, andlodging system sales. Managed Services revenues represent revenues earned frominstalling and maintaining systems for customers in both the commercial andlodging segments. The Company defines commercial system sales as sales to thenon-lodging industry.

The reportingsegments follow the same accounting policies used for the Company’sconsolidated financial statements and described in the Summary of SignificantAccounting Policies in the Company’s Form 10-K described above. Companymanagement evaluates a segment’s performance based upon gross margins. Assetsare not allocated to the segments. Sales to customers located outside of theU.S. are immaterial.

The following is atabulation of business segment information for the three months ended April 30,2007 and 2006.
| ** **    | ** ** | **Managed**  | ** ** | **Commercial** | ** ** | **Lodging** | ** ** | ** **  | ** ** | ** **  | ** ** |
|---------------|------------|--------------|------------|----------------|------------|-------------|------------|-------------|------------|-------------|------------|
| ** **    | ** ** | **Services** | ** ** | **Systems**    | ** ** | **Systems** | ** ** | **Other**   | ** ** | ** **  | ** ** |
| ** **    | ** ** | **Revenues** | ** ** | **Sales**      | ** ** | **Sales**   | ** ** | **Revenue** | ** ** | **Total**   | ** ** |
| **2007**      | ** ** | ** **   | ** ** | ** **     | ** ** | ** **  | ** ** | ** **  | ** ** | ** **  | ** ** |
| Sales         |       | $            | 8,792,452  |           | $          | 5,478,709   |       | $           | 2,283,514  |        | $          | 134,363 |   | $ | 16,689,038 |   |
| Cost of sales |       | (6,116,344   | )          | (4,192,565     | )          | (1,734,341  | )          | (446,730    | )          | (12,489,980 | )          |
| Gross profit  |       | $            | 2,676,108  |           | $          | 1,286,144   |       | $           | 549,173    |        | $          | (312,367 | ) | $ | 4,199,058 |   |
|          |       |         |       |           |       |        |       |        |       |        |       |
| **2006**      | ** ** | ** **   | ** ** | ** **     | ** ** | ** **  | ** ** | ** **  | ** ** | ** **  | ** ** |
| Sales         |       | $            | 7,248,178  |           | $          | 5,324,036   |       | $           | 2,232,413  |        | $          | 89,463 |   | $ | 14,894,090 |   |
| Cost of sales |       | (5,197,965   | )          | (4,044,850     | )          | (1,678,947  | )          | (436,582    | )          | (11,358,344 | )          |
| Gross profit  |       | $            | 2,050,213  |           | $          | 1,279,186   |       | $           | 553,466    |        | $          | (347,119 | ) | $ | 3,535,746 |   |

 

7

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The following is atabulation of business segment information for the six months ended April 30,2007 and 2006.
| ** **    | ** ** | **Managed**  | ** ** | **Commercial** | ** ** | **Lodging** | ** ** | ** **  | ** ** | ** **  | ** ** |
|---------------|------------|--------------|------------|----------------|------------|-------------|------------|-------------|------------|-------------|------------|
| ** **    | ** ** | **Services** | ** ** | **Systems**    | ** ** | **Systems** | ** ** | **Other**   | ** ** | ** **  | ** ** |
| ** **    | ** ** | **Revenues** | ** ** | **Sales**      | ** ** | **Sales**   | ** ** | **Revenue** | ** ** | **Total**   | ** ** |
| **2007**      | ** ** | ** **   | ** ** | ** **     | ** ** | ** **  | ** ** | ** **  | ** ** | ** **  | ** ** |
| Sales         |       | $            | 17,569,215 |           | $          | 10,731,107  |       | $           | 4,057,964  |        | $          | 381,431 |   | $ | 32,739,717 |   |
| Cost of sales |       | (12,464,441  | )          | (8,176,796     | )          | (3,057,939  | )          | (889,870    | )          | (24,589,046 | )          |
| Gross profit  |       | $            | 5,104,774  |           | $          | 2,554,311   |       | $           | 1,000,025  |        | $          | (508,439 | ) | $ | 8,150,671 |   |
|          |       |         |       |           |       |        |       |        |       |        |       |
| **2006**      | ** ** | ** **   | ** ** | ** **     | ** ** | ** **  | ** ** | ** **  | ** ** | ** **  | ** ** |
| Sales         |       | $            | 13,667,118 |           | $          | 9,512,891   |       | $           | 3,744,834  |        | $          | 651,759 |   | $ | 27,576,602 |   |
| Cost of sales |       | (10,293,864  | )          | (7,058,654     | )          | (2,782,744  | )          | (1,129,243  | )          | (21,264,505 | )          |
| Gross profit  |       | $            | 3,373,254  |           | $          | 2,454,237   |       | $           | 962,090    |        | $          | (477,484 | ) | $ | 6,312,097 |   |

 

Stock-Based CompensationPlans

In December 2004,the Financial Accounting Standards Board (“FASB”) issued Statement of FinancialAccounting Standards No. 123 (revised 2004), “Share-Based Payment” (“SFAS123(R)”). SFAS 123(R) requires companies to measure all employee stock-basedcompensation awards using a fair value method and recognize compensation costin its financial statements. The valuation provisions of SFAS 123(R) apply tonew awards and to awards that are outstanding at the effective date and subsequentlymodified or cancelled. The Company adopted on a prospective basis SFAS 123(R)beginning November 1, 2005 for stock-based compensation awards granted afterthat date and for unvested awards outstanding at that date using the modifiedprospective application method. The Company recognizes the fair value ofstock-based compensation awards as selling, general and administrative expenseas appropriate in the consolidated statements of operations on a straight-linebasis over the vesting period. We recognized compensation in the statement ofoperations as follows.
|                               | ** ** | **2007** | ** ** | **2006** | ** ** |
|-------------------------------|------------|----------|------------|----------|------------|
| Three months  ended April 30, |       | $        | 23,935     |     | $          | — |   |
|                          |       |     |       |     |       |
| Six months ended April  30,   |       | $        | 47,869     |     | $          | — |   |

 

Use of Estimates

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

Reclassifications

Certainreclassifications of prior year amounts have been made to conform to currentyear presentations. These reclassifications had no impact on net income.

New AccountingPronouncements

In June 2006, theFASB issued Interpretation No. 48 (“FIN 48”), Accounting for Uncertainty inIncome Taxes—an interpretation of FASB Statement No. 109, to clarify certainaspects of accounting for uncertain tax positions, including issues related tothe recognition and measurement of those tax positions. This interpretation iseffective for fiscal years beginning after December 15, 2006, and thereforewill apply beginning with the Company’s fiscal year ending October 31, 2008.The Company is currently evaluating the impact of this interpretation.

8

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In September 2006,the FASB issued Statement of Financial Standards No. 157, “Fair ValueMeasurements” (“SFAS 157”). SFAS 157 defines fair value, establishes aframework for measuring fair value in accordance with accounting principlesgenerally accepted in the United States, and expands disclosures about fairvalue measurements. This statement does not require any new fair valuemeasurements; rather, it applies under other accounting pronouncements thatrequire or permit fair value measurements. The provisions of SFAS 157 areeffective for fiscal years beginning after November 15, 2007. The Company doesnot expect the adoption of SFAS 157 to have a material impact on the Company’sconsolidated financial position or results of operations.

In February 2007,the FASB issued Statement of Financial Accounting Standards No. 159 (“SFAS 159”),“The Fair Value Option for Financial Assets and Liabilities”. SFAS 159 permitsentities to choose to measure many financial instruments and certain otheritems at fair value. SFAS 159 will be effective for the Company’s fiscal yearbeginning November 1, 2008. Early adoption is permitted. The Company has notdetermined the impact, if any, that adopting this standard may have on itsconsolidated financial position or results of operations.

2.  ACCOUNTS RECEIVABLE:
|                                      | ** ** | ** **         | ** ** | **(Audited)**        | ** ** |
|--------------------------------------|------------|--------------------|------------|----------------------|------------|
| ** **                           | ** ** | **April 30,** | ** ** | **October 31,** | ** ** |
| ** **                           | ** ** | **2007**           | ** ** | **2006**             | ** ** |
|                                 |       |               |       |                 |       |
| Trade  receivables                   |       | $                  | 11,537,159 |                 | $          | 12,499,407 |   |
| Less- reserve  for doubtful accounts |       | (203,843           | )          | (253,900             | )          |
| Net trade receivables                |       | $                  | 11,333,316 |                 | $          | 12,245,507 |   |

 

3.  INVENTORIES:

Inventories are statedat the lower of cost (first-in, first-out or average) or market and consist ofthe following:
|                                                    | ** ** | ** **         | ** ** | **(Audited)**        | ** ** |
|----------------------------------------------------|------------|--------------------|------------|----------------------|------------|
| ** **                                         | ** ** | **April 30,** | ** ** | **October 31,** | ** ** |
| ** **                                         | ** ** | **2007**           | ** ** | **2006**             | ** ** |
|                                               |       |               |       |                 |       |
| Finished goods  and spare parts                    |       | $                  | 6,596,305  |                 | $          | 5,565,484 |   |
| Less- reserve  for excess and obsolete inventories |       | (715,893           | )          | (622,511             | )          |
| Total inventories, net                             |       | $                  | 5,880,412  |                 | $          | 4,942,973 |   |

 

9

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4.  PROPERTY, PLANT AND EQUIPMENT:

Property, plantand equipment consists of the following:
|                                                               | ** ** | **Estimated** | ** ** | ** **         | ** ** | **(Audited)**        | ** ** |
|---------------------------------------------------------------|------------|---------------|------------|--------------------|------------|----------------------|------------|
| ** **                                                    | ** ** | **Useful**    | ** ** | **April 30,** | ** ** | **October 31,** | ** ** |
| ** **                                                    | ** ** | **Lives**     | ** ** | **2007**           | ** ** | **2006**             | ** ** |
|                                                          |       |          |       |               |       |                 |       |
| Building                                                      |       | 20            |       | $                  | 2,397,954  |                 | $          | 2,397,954 |   |
| Data processing  and computer field equipment                 |       | 3-10          |       | 2,614,814          |       | 2,469,671            |       |
| Software  development costs, work-in-process                  |       | N/A           |       | 4,728,432          |       | 5,274,299            |       |
| Software  development costs of components placed Into service |       | 3-10          |       | 3,102,325          |       | 2,339,644            |       |
| Hardware                                                      |       | 3-5           |       | 599,751            |       | 599,751              |       |
| Land                                                          |       | —        |       | 611,582            |       | 611,582              |       |
| Office furniture                                              |       | 5             |       | 932,252            |       | 932,252              |       |
| Auto                                                          |       | 5             |       | 516,183            |       | 428,214              |       |
| Other                                                         |       | 3-7           |       | 261,870            |       | 252,780              |       |
|                                                          |       |          |       |               |       |                 |       |
| Total property,  plant and equipment                          |       |          |       | 15,765,163         |       | 15,306,147           |       |
| Less-  accumulated depreciation                               |       |          |       | (5,334,486         | )          | (4,821,129           | )          |
|                                                          |       |          |       |               |       |                 |       |
| Total property, plant  and equipment, net                     |       |          |       | $                  | 10,430,677 |                 | $          | 10,485,018 |   |

 

Interest costsrelated to an investment in long-lived assets are capitalized as part of thecost of the asset during the period the asset is being prepared for use. TheCompany capitalized $114,814 and $146,596 in interest costs in the six monthsended April 30, 2007 and 2006, respectively.

5.  INCOME TAXES:

The tax effect oftemporary differences that give rise to significant portions of the deferredtax assets and deferred tax liabilities are presented below:
|                                                            | ** ** | ** **         | ** ** | **(Audited)**        | ** ** |
|------------------------------------------------------------|------------|--------------------|------------|----------------------|------------|
| ** **                                                 | ** ** | **April 30,** | ** ** | **October 31,** | ** ** |
| ** **                                                 | ** ** | **2007**           | ** ** | **2006**             | ** ** |
| Deferred tax  assets:                                      |       |               |       |                 |       |
| Net operating loss carryforward                            |       | $                  | 1,576,855  |                 | $          | 1,156,913 |   |
| Currently nondeductible reserves                           |       | 289,044            |       | 256,764              |       |
| Accrued liabilities                                        |       | 372,886            |       | 392,449              |       |
| Prepaid service contracts                                  |       | 113,788            |       | 30,770               |       |
| Other                                                      |       | 32,569             |       | 40,436               |       |
| Total deferred tax asset                                   |       | 2,385,142          |       | 1,877,332            |       |
|                                                       |       |               |       |                 |       |
| Deferred tax  liabilities:                                 |       |               |       |                 |       |
| Intangible assets                                          |       | 4,032,924          |       | 3,686,779            |       |
| Depreciation                                               |       | 1,394,338          |       | 1,032,788            |       |
| Tax income to be recognized on sales-type lease  contracts |       | 20,326             |       | 20,511               |       |
| Total deferred tax liability                               |       | 5,447,588          |       | 4,740,078            |       |
| Net deferred tax  liability                                |       | $                  | (3,062,446 | )                    | $          | (2,862,746 | ) |

 

10

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|                                                            | ** ** | ** **         | ** ** | **(Audited)**        | ** ** |
|------------------------------------------------------------|------------|--------------------|------------|----------------------|------------|
| ** **                                                 | ** ** | **April 30,** | ** ** | **October 31,** | ** ** |
| ** **                                                 | ** ** | **2007**           | ** ** | **2006**             | ** ** |
| Net deferred  liability as presented on the balance sheet: |       |               |       |                 |       |
| Current deferred tax asset                                 |       | $                  | 797,311    |                 | $          | 709,343 |   |
| Noncurrent deferred tax liability                          |       | (3,859,757         | )          | (3,572,089           | )          |
| Net deferred tax  liability                                |       | $                  | (3,062,446 | )                    | $          | (2,862,746 | ) |

 

The Company hasrecorded a tax provision of $260,000 or 41% and a tax benefit of $28,000 or 25%for the six months ended April 30, 2007 and 2006, respectively, reflecting thestatutory federal tax rate of 34% plus a blended state income tax rate ofapproximately 7% and the impact of minimum income tax payments in certainstates.

6.  CREDIT AGREEMENTS:

The Company’scredit facility consists of a revolving credit and term loan agreement with acommercial bank including a mortgage agreement maturing on September 30, 2009and amortizing based on a 13 year life and a $7.5 million revolving creditagreement to finance growth in working capital. The revolving line of credit iscollateralized by trade accounts receivable and inventories. At April 30, 2007and October 31, 2006, the Company had approximately $513 thousand and $3.119million, respectively, outstanding on the revolving line of credit. The Companyhad approximately $6.9 million available under the revolving line of credit atApril 30, 2007. Advance rates are defined in the agreement, but are generallyat the rate of 80% on qualified trade accounts receivable and 40% of qualifiedinventories. The revolving line of credit matures on September 28, 2007. Long-termdebt consisted of the following:
|                                                                                                                                                                                                                  | ** ** | ** **         | ** ** | **(Audited)**        | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------|------------|----------------------|------------|
| ** **                                                                                                                                                                                                       | ** ** | **April 30,** | ** ** | **October 31,** | ** ** |
| ** **                                                                                                                                                                                                       | ** ** | **2007**           | ** ** | **2006**             | ** ** |
|                                                                                                                                                                                                             |       |               |       |                 |       |
| Real estate term  note, payable in monthly installments of $14,257 plus interest, plus a fixed  payment of $1,198,061 due September 30, 2009, collateralized by a first  mortgage on the Company’s building |       | $                  | 1,611,527  |                 | $          | 1,697,073 |   |
|                                                                                                                                                                                                             |       |               |       |                 |       |
| Less-current  maturities                                                                                                                                                                                         |       | 171,123            |       | 171,123              |       |
|                                                                                                                                                                                                             |       |               |       |                 |       |
| Total long-term debt,  less current maturities                                                                                                                                                                   |       | $                  | 1,440,404  |                 | $          | 1,525,950 |   |

 

Interest on alloutstanding debt under the credit facility accrues at either a) the LondonInterbank Offered Rate (which was 5.32% at April 30, 2007) plus 1.25% to 2.75%depending on the Company’s funded debt to cash flow ratio, or b) the bank’sprime rate (which was 8.25% at April 30, 2007) minus 0% to minus 1.125% alsodepending on the Company’s funded debt to cash flow ratio. At April 30, 2007,the Company was paying 7.875% on the revolving line of credit borrowings and7.07% on the mortgage note. The credit facility contains several financialcovenants common in such agreements, including tangible net worth requirements,limitations on the amount of funded debt to earnings before interest, taxes,depreciation and amortization, limitations on capital spending, and debtservice coverage requirements. The Company was in compliance with thesecovenants at April 30, 2007.

7.  EARNINGS PER SHARE:

Basic earnings percommon share were computed by dividing net income by the weighted averagenumber of shares of common stock outstanding during the reporting periods. Dilutedearnings per common share were computed by dividing net income by the weightedaverage number of shares of common stock and

11

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dilutive potentialcommon stock outstanding during the reporting periods. A reconciliation of netincome and weighted average shares used in computing basic and diluted earningsper share is as follows:
|                                  | ** ** | **For the Three Months Ended April 30, 2007** | ** ** |
|----------------------------------|------------|----------------------------------------------------------------------------------|------------|
| ** **                       | ** ** | **Income**                                                                       | ** ** | **Shares** | ** ** | **Per Share** | ** ** |
| ** **                       | ** ** | **(Numerator)**                                                                  | ** ** | **(Denominator)** | ** ** | **Amount** | ** ** |
| Basic EPS                        |       |                                                                             |       |   |   |   |   |
| Net income                       |       | $                                                                                | 208,170    |   | 10,214,741 |   | $ | 0.02 |   |
| Dilutive effect of stock options |       |                                                                             |       | — |   |   |   |
|                             |       |                                                                             |       |   |   |   |   |
| Diluted EPS                      |       |                                                                             |       |   |   |   |   |
| Net income                       |       | $                                                                                | 208,170    |   | 10,214,741 |   | $ | 0.02 |   |

 
|                                  | ** ** | **For the Three Months Ended April 30, 2006** | ** ** |
|----------------------------------|------------|----------------------------------------------------------------------------------|------------|
| ** **                       | ** ** | **Income**                                                                       | ** ** | **Shares** | ** ** | **Per Share** | ** ** |
| ** **                       | ** ** | **(Numerator)**                                                                  | ** ** | **(Denominator)** | ** ** | **Amount** | ** ** |
| Basic EPS                        |       |                                                                             |       |   |   |   |   |
| Net income                       |       | $                                                                                | 56,629     |   | 10,214,567 |   | $ | 0.01 |   |
| Dilutive effect of stock options |       |                                                                             |       | 39 |   |   |   |
|                             |       |                                                                             |       |   |   |   |   |
| Diluted EPS                      |       |                                                                             |       |   |   |   |   |
| Net income                       |       | $                                                                                | 56,629     |   | 10,214,606 |   | $ | 0.01 |   |

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

 
|                                  | ** ** | **For the Six Months Ended April 30, 2006** | ** ** |
|----------------------------------|------------|--------------------------------------------------------------------------------|------------|
| ** **                       | ** ** | **Income**                                                                     | ** ** | **Shares** | ** ** | **Per Share** | ** ** |
| ** **                       | ** ** | **(Numerator)**                                                                | ** ** | **(Denominator)** | ** ** | **Amount** | ** ** |
| Basic EPS                        |       |                                                                           |       |   |   |   |   |
| Net loss                         |       | $                                                                              | (84,098    | ) | 10,201,651 |   | $ | (0.01 | ) |
| Dilutive effect of stock options |       |                                                                           |       | 3,382 |   |   |   |
|                             |       |                                                                           |       |   |   |   |   |
| Diluted EPS                      |       |                                                                           |       |   |   |   |   |
| Net loss                         |       | $                                                                              | (84,098    | ) | 10,205,033 |   | $ | (0.01 | ) |

 

Options topurchase 1,103,668 shares of common stock at an average exercise price of $7.17and 1,119,768 shares of common stock at an average exercise price of $7.17 werenot included in the computation of diluted earnings per share for the three-and six-month periods ended April 30, 2007 and 2006, respectively, becauseinclusion of these options would be antidilutive.

12

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

**Preliminary Note RegardingForward-Looking Statements**

In the followingdiscussion, we make forward-looking statements regarding future events and ourfuture performance and results. These and other forward-looking statements arenot guarantees of performance, but rather reflect our current expectations,estimates, and forecasts about the industry and markets in which we operate,and our assumptions and beliefs based upon information currently available tous. Forward-looking statements can generally be identified by words such as “expects,”“anticipates,” “may”, “plans,” “believes,” “intends,” “projects,” “estimates,”and similar words or expressions. These statements are subject to risks anduncertainties which are difficult to predict or which we are unable to control,including but not limited to such factors as customer demand for advancedcommunications products; our dependence upon a few large companies to drive ourgrowth in Managed Services revenues; capital spending trends within our market,the financial condition of our suppliers and changes by them in theirdistribution strategies and support, technological changes, product mix, theability to attract and retain highly skilled personnel and competition. Theseand other risks and uncertainties are discussed under the heading “Risk Factors”under Part I of the Company’s Form 10-K for the fiscal year ended October 31,2006 (filed with the Commission on January 16, 2007), and in updates to suchrisk factors set forth in Item 1A of Part II of this and previously filedquarterly reports filed for quarters during fiscal 2007. As a result of theserisks and uncertainties, actual results may differ materially and adverselyfrom those expressed in forward-looking statements. Consequently, investors arecautioned to read and consider all forward-looking statements in conjunctionwith such risk factors and uncertainties. The Private Securities Litigation ReformAct of 1995 provides a safe-harbor for forward-looking statements made by theCompany.

# **Overview**

Strategy.  Our financial results in fiscal 2007 reflectour continued success in building our commercial Managed Services business. Thismost important portion of our business which includes recurring contractmaintenance fees and time and materials (“T&M”) revenues, implementationfees, and cabling revenues earned from commercial customers increased $2.6million or 75% in the first half of fiscal 2007 compared to last year. It isour foremost strategy to continue to build these revenues through acquisitionof new services customers and deeper penetration into existing customers. Thisinitiative is integral to our long-term strategy to reduce our dependence onsystems sales in favor of more predictable, recurring services revenues.

Operating Summary.  In the second quarter of fiscal 2007, weearned $208,000 in net income on revenues of $16.7 million compared to netincome of $57,000 on revenues of $14.9 million in the second quarter of lastyear. For the first six months of fiscal 2007, we earned $378,000 in net incomeon revenues of $32.7 million compared to a net loss of $84,000 on revenues of$27.6 million. These improvements primarily reflect the increases in theManaged Services revenues earned from commercial customers as discussed abovecoupled with improved gross margins on those revenues. These items as well asother contributing factors are discussed in more detail under “Results ofOperations” below.

Financial PositionSummary.  Our financial condition improved during thefirst half of fiscal 2007. We generated positive cash flows from operations of$3.2 million in the quarter and used that cash primarily to reduce theborrowings on our working capital revolver by $2.6 million or over 83%. Theseand other financial position items are discussed in more detail under “FinancialCondition” below.

The following discussionpresents additional information regarding our financial condition and resultsof operations for the three- and six-month periods ending April 30, 2007 and2006 and should be read in conjunction with our comments above as well as the “RiskFactors” section below.

13

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# **Financial Condition**

Cash provided byoperations for the six months ended April 30, 2007 was $3.2 million, consistingof net income and non-cash charges of $1 million, a reduction in accountsreceivable of $912,000, and an increase in current liabilities of $2.7 million.These increases were partially offset by an increase in inventories of $988,000and other changes in working capital items which netted to a decrease in cashof $456,000. We used these cash flows to reduce our borrowings on our workingcapital line of credit by $2.6 million, reduce our mortgage balance by $85,000,and to fund capital expenditures of $462,000. Non-cash charges includeddepreciation expense of $254,000, amortization expense of $287,000, stock-basedcompensation expense of $48,000, and a provision for obsolete inventory of$51,000.

At April 30, 2007 our total borrowings were $2.1million, consisting of a mortgage on our headquarters building of $1.6 millionand $513,000 due on our revolving line of credit. At April 30, 2007 there was$6.9 million available under the revolver to meet working capital needs. Therehave been no stock repurchases to date under the repurchase program announcedin October 2006. Under the program, our board of directors authorized the Company to utilize up to $960,000per year to repurchase our common stock in open market, block purchases or inprivately negotiated transactions and at prices we deem appropriate.

The table belowpresents our contractual obligations at April 30, 2007 as well as paymentobligations over the next five years:
|                                  | ** ** | ** ** | ** ** | **Payments due by period** | ** ** |
|----------------------------------|------------|------------|------------|-------------------------------------------|------------|
| ** **                       | ** ** | ** ** | ** ** | **Less than**                        | ** ** | **2 – 3** | ** ** | **4 – 5** | ** ** |
| ** **                       | ** ** | **Total**  | ** ** | **1 year**                           | ** ** | **Years** | ** ** | **Years** | ** ** |
| **Contractual Obligations** |       |       |       |                                      |       |   |   |   |   |
| Long-term debt                   |       | $          | 1,852,830  |                                      | $          | 279,543 |   | $ | 1,573,287 |   | $ | — |   |
| Operating leases                 |       | 474,332    |       | 228,747                                   |       | 231,801 |   | 13,784 |   |
| Total                            |       |       | $          | 2,327,162                                 |       | $ | 508,290 |   | $ | 1,805,088 |   | $ | 13,784 |   |
|                                  |            |            |            |                                           |            |  |  |  |  |  |  |  |  |  |

 

# **Results of Operations**

In the second quarter offiscal 2007, our revenues increased 12% or $1.8 million compared to the sameperiod last year resulting in an increase in net income of $152,000 or 268%. Inthe first six months of the year, our revenues increased 19% or $5.2 millionresulting in an increase in earnings of $462,000. These improved resultsreflect improvements in all of our major revenue categories and improvedmargins in our Managed Services business. The narrative below provides furtherexplanation of these results.

Managed ServicesRevenues.  Managed Services revenues consist of thefollowing:
|                                  | ** ** | **For the Three Months Ended** | ** ** | **For the Six Months Ended** | ** ** |
|----------------------------------|------------|----------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                       | ** ** | **April 30,**                                 | ** ** | **April 30,**                               | ** ** |
| ** **                       | ** ** | **2007**                                           | ** ** | **2006**                                         | ** ** | **2007** | ** ** | **2006** | ** ** |
| Contract &  T&M          |       | $                                                  | 6,309,000  |                                             | $          | 5,491,000 |   | $ | 12,314,000 |   | $ | 10,476,000 |   |
| Implementation                   |       | 1,781,000                                          |       | 1,451,000                                        |       | 3,913,000 |   | 2,505,000 |   |
| Cabling                          |       | 702,000                                            |       | 306,000                                          |       | 1,342,000 |   | 686,000 |   |
| Total Managed Services  revenues |       | $                                                  | 8,792,000  |                                             | $          | 7,248,000 |   | $ | 17,569,000 |   | $ | 13,667,000 |   |

 

Managed Servicesrevenues increased 21% for the quarter ending April 30, 2007 compared to thesame period last year and 29% for the first half of fiscal 2007 compared to thesame period in fiscal 2006. This growth came from the acquisition of newcommercial customers and penetration of previously acquired customers adoptingour Managed Services offerings and from increases in revenues from our nationalstructured cabling initiative. Recurring contract and T&M revenues earnedfrom commercial customers increased 48% in the second quarter and 59% in theyear-to-date period compared to those same periods last year. Recurringservices revenues from lodging customers increased 1% and 2% in the quarter andsix month periods ended April 30, 2007, respectively, compared to those sameperiods last year. The primary driver in the growth of our recurring commercialservices revenues is from our newly established relationships with networkproviders, manufacturers, and systems integrators. Under these relationships,we

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provide services onbehalf of these customers, usually supporting the end user with our nationalfield resources.

Implementation servicesrevenues increased 23% and 56% in the quarter and six month periods ended April30, 2007, respectively, compared to those same periods last year. Theseincreases primarily reflect a higher proportion of more complex applications todate in fiscal 2007, which generates disproportionately higher professionalservices and installation fees. In the second quarter of fiscal 2007,implementation revenues were 23% of systems sales compared to 19% in the secondquarter of fiscal 2006. In the first six months of fiscal 2007, implementationrevenues were 27% of systems sales compared to 19% in the same period in fiscal2006. The complexity of implementations varies significantly between projects,but in general we expect implementation revenues as a proportion of systemssales to increase over time as the market continues to move toward high-end,software-oriented voice applications and as we increase our sales ofstand-alone professional services such as call center tune-ups and networktraffic studies.

Our structured cablinginitiative grew 129% in the second quarter and 96% in the first half of fiscal2007, respectively, compared to those same periods in fiscal 2006. Theincreases in these revenues are the result of our success in establishing anational structured cabling business that markets our cabling services toexisting and new enterprise and lodging customers. We expect revenues from thisportion of our Managed Services business will improve over time, but is not yeta predictable revenue stream.

Systems Sales.  Systems sales were $7.8 million in the secondquarter of fiscal 2007 compared to $7.5 million last year. Year-to-date systemssales were $14.8 million in fiscal 2007 compared to $13.3 million last year. Theseincreases reflect the strong systems sales experienced in the first quarter offiscal 2007 which was due primarily to favorable timing of equipment shipmentsand low prior year comparisons. As expected, our year-to-date systems salescame into balance with the first half results from last year and produced amodest 3% increase. These increases included small increases in systems salesto both commercial and lodging customers. We expect our historical trend ofstronger second half systems sales to be reflected in the results for thebalance of the year.

Gross Margins.  The table below presents the gross marginsearned on our primary revenue streams:
|                               | ** ** | **For the Three** | ** ** | **For the Six** | ** ** |
|-------------------------------|------------|-----------------------------|------------|---------------------------|------------|
| ** **                    | ** ** | **Months Ended**       | ** ** | **Months Ended**     | ** ** |
| ** **                    | ** ** | **April 30,**          | ** ** | **April 30,**        | ** ** |
| ** **                    | ** ** | **2007**                    | ** ** | **2006**                  | ** ** | **2007** | ** ** | **2006** | ** ** |
| Gross Margins            |       |                        |       |                      |       |   |   |   |   |
| Managed Services  revenues    |       | 30.4                        | %          | 28.3                      | %          | 29.0 | % | 24.7 | % |
| Systems sales                 |       | 23.6                        | %          | 24.3                      | %          | 24.0 | % | 25.8 | % |
| Other revenues                |       | -6.2                        | %          | 10.1                      | %          | 38.1 | % | 33.6 | % |
| Corporate cost  of goods sold |       | -1.8                        | %          | -2.4                      | %          | -2.0 | % | -2.5 | % |
| Total                         |       | 25.2                        | %          | 23.7                      | %          | 24.9 | % | 22.9 | % |

 

Wehave enjoyed improved gross margins from our Managed Services in the first halfof fiscal 2007 as our revenues have increased sufficiently to absorb ourinvestments in all three major service initiatives. The most significant factorin the improvement in Managed Services gross margins is the growth of ourrecurring revenues from commercial customers. As these revenues began to growduring fiscal 2006, our gross margins on overall Managed Services revenuesimproved as we were able to absorb the extra costs we incurred to build ourNortel capability. As discussed above, this portion of our business is our mostimportant growth driver, as it represents the greatest opportunity for revenuegrowth while at the same time improving overall gross margins. Another factorhelping improve overall Managed Services gross margins has been sustainedhigher implementation revenues during fiscal 2007. As discussed above, we haveenjoyed higher levels of implementation and professional service fees as aproportion of total project orders to date in fiscal 2007. These higherrevenues have helped to absorb our fixed personnel costs associated withmaintaining our ability to design, sell and implement advanced communicationsnetworks. Finally, our success in increasing our structured cabling revenueshas also helped to improve our Managed Services margins. The gross margins weearn on our structured cabling revenues depends upon the mix of cablingprojects that are fulfilled with third party providers versus Companyemployees. This mix is determined primarily by the location and timing of theproject.

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The gross margins onsystems sales in the second quarter of fiscal 2007 and for the first half ofthe fiscal year are within our targets for this revenue stream. The products wesell are becoming commoditized, putting greater pressure on pricing as theindustry moves to server-based technology. As such, the primary value of thesystems sold resides in the software applications installed on the hardwareand, more importantly, in the design and configuration of those softwareapplications. We expect these trends to continue and possibly accelerate. Tooffset these factors, we emphasize our in-house installation expertise,nationwide geographic presence, and after-installation care to focus customerson the value of purchasing systems from us. Additionally, we work closely withour distributors and manufacturers to maximize their pricing support. Ourdesire to maintain the gross margins at their historical levels may impact ourrevenue volumes and may limit our ability to increase our revenues.

A final component to ourgross margins is the margins earned on other revenues and our corporate cost ofgoods sold. A portion of our other revenues typically represents sales and costof goods sold on equipment or services outside our normal provisioningprocesses and by their nature vary significantly in both sales volume and grossmargins earned. Another segment of other revenues represents the sale of Avayamaintenance contracts for which we earn either a gross profit or commissionfrom Avaya. We have no continuing service obligation associated with these revenuesand gross profits. This is an unpredictable revenue stream which is dependentupon expiration dates of existing contracts, installation dates of new systems,and the number of years that customers contract for services. Corporate cost ofgoods sold represents our material logistics and purchasing functions thatsupport all of our revenue segments.

Operating Expenses.  Our total operating expenses increased$442,000 or 13% in the second quarter of fiscal 2007 compared to the secondquarter of fiscal 2006. Operating expenses increased $1.2 million or 19% forthe first half of fiscal 2007 compared to the same period a year ago. Operatingexpenses have remained at approximately 23% of total revenues for all thecomparison periods reflecting the fact that most of the increases related toincreased commissions and incentive compensation costs due to higher revenuesand gross profits. Other increases in operating expenses included increasedpersonnel costs and additional marketing expenses. Amortization expense in thesecond quarter was $147,000 compared to $103,000 in the second quarter lastyear. Year-to-date amortization expense was $287,000 compared to $204,000 forthe same period last year.

Interest Expense andOther Income.  Other income was $9,000 in the second quarterof fiscal 2007 compared to net interest and other expense of $15,000 in thesecond quarter of fiscal 2006. For the six month period ended April 30, 2007,net interest and other income was $16,000 compared to $78,000 in net expense inthe same period of fiscal 2006. These changes reflect lower overall borrowingcosts in 2007 compared to last year as a result of lower outstanding debt.

Tax Provision.  We recorded a combined federal and state taxprovision of 40% for the second quarter of fiscal 2007 compared to 45% for thesecond quarter of fiscal 2006. At lower levels of profitability, as experiencedin the second quarter of fiscal 2006, minimum taxes required by certain statejurisdictions increases the tax provision rate. For the six month period endedApril 30, 2007, we recorded a tax provision of 41% compared to a tax benefit of25% for the first six months of fiscal 2006. As stated above, the effect ofminimum state taxes reduced the impact of tax benefits resulting from the smalloperating loss reported in the first half of last year. Generally, we expectour tax provision rate to be approximately 40%.

**ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKETRISK**

Market risks relating toour operations result primarily from changes in interest rates. We did not usederivative financial instruments for speculative or trading purposes during thethree or six month periods ending April 30, 2007.

*Interest Rate Risk*. We are subject to the risk of fluctuation in interest rates in the normal course of business due to our utilization of variable debt. Our credit facility bears interest at a floating rate at either the London Interbank Offered Rate (“LIBOR”) (5.32% at April 30, 2007) plus 1.25% to 2.75% or the bank’s prime rate (8.25% at April 30, 2007) less 0.0% to minus 1.125%. A hypothetical 1% increase in interest rates would not have a material impact on our financial position or cash flows.

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**ITEM 4.   CONTROLS ANDPROCEDURES**

*Evaluation of Disclosure Controlsand Procedures.* Basedon an evaluation conducted as of April 30, 2007 by our management, includingour 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 internal controls or in other factors thatcould materially affect, or is reasonably likely to materially affect, thesecontrols subsequent to the date of their evaluation. There were no significantdeficiencies or material weaknesses and, therefore, there were no correctiveactions taken.

**PART II.  OTHER INFORMATION**

**ITEM1.  LEGAL PROCEEDINGS.**

None

**ITEM1A.  RISK FACTORS**

The informationpresented below is an update to the “Risk Factors” included in the Company’sAnnual Report on Form 10-K for the fiscal year ended October 31, 2006 andshould be read in conjunction therewith. Except as set forth below, the Risk Factors included in the Company’sForm 10-K for its 2006 fiscal year have not materially changed.

**Our expected growth in ManagedServices revenues will likely be derived from a handful of large companies,therefore exposing us to the risk of a significant negative impact in the eventof the loss of any one of such companies as a customer.**

To date, much of oursuccess in growing the commercial portion of our Managed Services business hascome from Nortel who contracts us to serve as a subcontractor to fulfillservice requirements to end-user companies. Our target market for our Managed Services offerings is manufacturerssuch as Nortel, large communications carriers such as the regional BellOperating Companies, and systems integrators. Typically, these companies will contract with us to provide technicalresources in the field on a subcontract basis and parts fulfillment.  The end-users served are often some of ourcustomers’ largest and most prestigious clients and therefore it is imperativethat our customer satisfaction ratings remain high.  Once these revenue streams are established,the loss of any particular relationship could result in a material, adverseimpact on our operating results.

**ITEM2.  UNREGISTERED SALES OF EQUITYSECURITIES AND USE OF PROCEEDS.**

None.

**ITEM3.  DEFAULTS UPON SENIOR SECURITIES.**

None.

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**ITEM4.  SUBMISSION OF MATTERS TO A VOTE OFSECURITY HOLDERS.**

On April3, 2007, at our Annual Meeting of Shareholders, the following directors wereelected to the Board of Directors, and the votes cast for each nominee were asfollows:
| Nominee                | ** ** | **For**   | ** ** | **Withhold** | ** ** |
|------------------------|------------|-----------|------------|--------------|------------|
|                   |       |      |       |         |       |
| Ron B. Barber          |       | 9,145,783 |       | 426,254      |       |
| Donald T. Duke         |       | 9,144,983 |       | 427,054      |       |
| Edward F. Keller       |       | 9,288,590 |       | 283,447      |       |
| Robert D. Hisrich      |       | 7,939,308 |       | 1,632,729    |       |
| Jack R. Ingram         |       | 9,292,358 |       | 279,679      |       |
| Ronald L. Siegenthaler |       | 9,104,381 |       | 467,656      |       |

 

Theshareholders also voted at the Annual Meeting to ratify the selection ofTullius Taylor Sartain & Sartain LLP as our independent auditors, withvotes cast as follows:
| For       | ** ** | **Against** | ** ** | **Withhold** | ** ** |
|-----------|------------|-------------|------------|--------------|------------|
| 9,290,484 |       | 258,674     |       | 22,879       |       |

 

**ITEM5.  OTHER INFORMATION.**

On May 21, 2007 the AuditCommittee of the Board of Directors retained Ron Barber to serve as an advisorto the Audit Committee for a fee of $15,000. Mr. Barber, a director of the Company, is not a member of the AuditCommittee.

**ITEM6.   EXHIBITS.**

Exhibits (filed herewith):
| SEC Exhibit No. | ** ** | **Description**                                                                                                                                                          |
|-----------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|            |       |                                                                                                                                                                     |
| 10.1            |       | Letter Agreement with Ron Barber                                                                                                                                         |
|            |       |                                                                                                                                                                     |
| 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: May 25,  2007 | By:                     | /s/ Jack R.  Ingram |   |
|                 |                    | Jack R. Ingram |
|                 |                    | Chief Executive Officer |
|                 |                    |   |
| Dated: May 25,  2007 | By:                     | /s/ Robert B.  Wagner |   |
|                 |                    | Robert B. Wagner |
|                 |                    | Chief Financial  Officer |

 

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EXHIBITINDEX
| SEC Exhibit No. | ** ** | **Description**                                                                                                                                                          |
|-----------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|            |       |                                                                                                                                                                     |
| 10.1            |       | Letter Agreement with Ron Barber                                                                                                                                         |
|            |       |                                                                                                                                                                     |
| 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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