UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
xQUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934
x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended April 30, 2008 OR o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 Commission File Number 0-16231 XETA Technologies, Inc. Oklahoma 73-1130045 (State or other jurisdiction of incorporation or organization) (I.R.S. Employee Identification No.) 1814 W. Tacoma Street, Broken Arrow, OK 74012-1406 (Address of principal executive offices) (Zip Code) 918-664-8200 (Registrant’s telephone number, including area code) (Former name, former address and former fiscal year, if changed since last report) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a Large accelerated filer o Accelerated filer o Non-accelerated filer o Smaller reporting company x (Do not check if a smaller reporting company) Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x INDEX PAGE PART I. FINANCIAL INFORMATION ITEM Consolidated Balance Sheets - 3 4 5 6 7 ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS 2 XETA TECHNOLOGIES, INC. AND SUBSIDIARY ASSETS ASSETS January 31, 2008 October 31, 2007 April 30, 2008 October 31, 2007 ASSETS (Unaudited) Current assets: Cash and cash equivalents $ 151,321 $ 402,918 $ 125,408 $ 402,918 Current portion of net investment in sales-type leases and other receivables 891,311 490,033 716,088 490,033 Trade accounts receivable, net 17,173,985 16,236,137 19,257,903 16,236,137 Inventories, net 5,232,275 4,296,574 4,871,241 4,296,574 Deferred tax asset, net 767,794 916,259 Deferred tax asset 627,154 916,259 Prepaid taxes 31,288 19,737 12,443 19,737 Prepaid expenses and other assets 895,144 517,757 737,608 517,757 Total current assets 25,143,118 22,879,415 26,347,845 22,879,415 Noncurrent assets: Goodwill 26,351,199 26,365,093 26,337,305 26,365,093 Intangible assets, net 265,435 104,042 242,516 104,042 Net investment in sales-type leases, less current portion above 136,519 136,493 115,210 136,493 Property, plant & equipment, net 10,601,999 10,610,820 10,589,866 10,610,820 Other Assets 25,289 — Total noncurrent assets 37,355,152 37,216,448 37,310,186 37,216,448 Total assets $ 62,498,270 $ 60,095,863 $ 63,658,031 $ 60,095,863 LIABILITIES AND SHAREHOLDERS’ EQUITY LIABILITIES AND SHAREHOLDERS’ EQUITY LIABILITIES AND SHAREHOLDERS’ EQUITY Current liabilities: Current portion of long-term debt $ 171,123 $ 171,123 $ 171,123 $ 171,123 Revolving line of credit 4,818,748 2,758,660 4,586,938 2,758,660 Accounts payable 5,718,712 5,670,240 7,249,989 5,670,240 Current unearned revenue 2,692,798 2,212,247 2,547,260 2,212,247 Accrued liabilities 2,833,502 3,565,031 2,440,107 3,565,031 Total current liabilities 16,234,883 14,377,301 16,995,417 14,377,301 Noncurrent liabilities: Long-term debt, less current portion above 1,311,759 1,354,530 1,268,986 1,354,530 Accrued long-term liability 177,700 211,300 144,100 211,300 Noncurrent unearned service revenue 80,245 81,650 62,597 81,650 Noncurrent deferred tax liability, net 4,716,526 4,631,917 Noncurrent deferred tax liability 4,776,708 4,631,917 Total noncurrent liabilities 6,286,230 6,279,397 6,252,391 6,279,397 Contingencies Shareholders’ equity: Preferred stock; $.10 par value; 50,000 shares authorized, 0 issued — — — — Common stock; $.001 par value; 50,000,000 shares authorized, 11,273,098 and 11,233,529 issued at January 31, 2008 and October 31, 2007, respectively 11,272 11,233 Common stock; $.001 par value; 50,000,000 shares authorized, 11,256,193 and 11,233,529 shares issued at April 30, 2008 and October 31, 2007, respectively 11,255 11,233 Paid-in capital 13,300,844 13,189,311 13,362,906 13,189,311 Retained earnings 28,872,509 28,483,280 29,243,530 28,483,280 Less treasury stock, at cost (1,001,883 shares at January 31, 2008 and 1,018,788 October 31, 2007) (2,207,468 ) (2,244,659 ) Less treasury stock, at cost (1,001,883 shares at April 30,2008 and 1,018,788 shares at October 31, 2007) (2,207,468 ) (2,244,659 ) Total shareholders’ equity 39,977,157 39,439,165 40,410,223 39,439,165 Total liabilities and shareholders’ equity $ 62,498,270 $ 60,095,863 $ 63,658,031 $ 60,095,863 The accompanying notes are an integral part of these consolidated balance sheets. 3 XETA TECHNOLOGIES, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED) For the Three Months For the Six Months For the Three Months Ended April 30, Ended April 30, 2008 2007 2008 2007 2008 2007 Systems sales $ 7,714,159 $ 7,026,848 $ 10,271,761 $ 7,762,223 $ 17,985,920 $ 14,789,071 Services 9,724,942 8,776,763 10,134,470 8,792,452 19,859,412 17,569,215 Other revenues 510,634 247,068 405,592 134,363 916,226 381,431 Net sales and service revenues 17,949,735 16,050,679 20,811,823 16,689,038 38,761,558 32,739,717 Cost of systems sales 5,786,822 5,307,829 7,541,560 5,926,906 13,328,382 11,234,735 Services costs 7,130,924 6,348,097 7,600,057 6,116,344 14,730,981 12,464,441 Cost of other revenues & corporate COGS 441,379 443,140 483,972 446,730 925,351 889,870 Total cost of sales and service 13,359,125 12,099,066 15,625,589 12,489,980 28,984,714 24,589,046 Gross profit 4,590,610 3,951,613 5,186,234 4,199,058 9,776,844 8,150,671 Operating expenses Selling, general and administrative 3,662,262 3,528,410 4,263,500 3,713,011 7,925,762 7,241,421 Amortization 202,898 140,277 254,513 146,767 457,411 287,044 Total operating expenses 3,865,160 3,668,687 4,518,013 3,859,778 8,383,173 7,528,465 Income from operations 725,450 282,926 668,221 339,280 1,393,671 622,206 Interest expense (102,985 ) (10,387 ) (68,731 ) — (171,716 ) (10,387 ) Interest and other income 17,764 17,571 9,531 8,890 27,295 26,461 Total interest and other income (expense) (85,221 ) 7,184 (59,200 ) 8,890 (144,421 ) 16,074 Income before provision for income taxes 640,229 290,110 609,021 348,170 1,249,250 638,280 Provision for income taxes 251,000 120,000 238,000 140,000 489,000 260,000 Net income $ 389,229 $ 170,110 $ 371,021 $ 208,170 $ 760,250 $ 378,280 Earnings per share Basic $ 0.04 $ 0.02 $ 0.04 $ 0.02 $ 0.07 $ 0.04 Diluted $ 0.04 $ 0.02 $ 0.04 $ 0.02 $ 0.07 $ 0.04 Weighted average shares outstanding 10,224,971 10,214,741 10,254,310 10,214,741 10,231,120 10,214,741 Weighted average equivalent shares 10,249,693 10,214,741 10,263,297 10,214,741 10,246,272 10,214,741 The accompanying notes are an integral part of these consolidated financial statements. 4 XETA TECHNOLOGIES, INC. AND SUBSIDIARY CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY (UNAUDITED) Common Stock Shares Par Treasury Stock Paid-in Retained Common Stock Treasury Stock Issued Value Shares Amount Capital Earnings Total Shares Issued Par Value Shares Amount Paid-in Capital Retained Earnings Total Balance- October 31, 2007 11,233,529 $ 11,233 1,018,788 $ (2,244,659 ) $ 13,189,311 $ 28,483,280 $ 39,439,165 11,233,529 $ 11,233 1,018,788 $ (2,244,659 ) $ 13,189,311 $ 28,483,280 $ 39,439,165 Stock options exercised $.001 par value 22,664 22 — — 90,193 — 90,215 22,664 22 — — 90,193 — 90,215 Issuance of restricted common stock 16,905 17 (16,905 ) 37,191 (37,208 ) — (16,905 ) 37,191 (37,191 ) — Tax benefit of stock options — — — — 4,032 — 4,032 — — — — 4,032 — 4,032 Stock based compensation — — — — 54,516 — 54,516 — — — — 116,561 — 116,561 Net Income — — — — — 389,229 389,229 — — — — — 760,250 760,250 Balance- January 31, 2008 11,273,098 $ 11,272 1,001,883 $ (2,207,468 ) $ 13,300,844 $ 28,872,509 $ 39,977,157 Balance- April 30, 2008 11,256,193 $ 11,255 1,001,883 $ (2,207,468 ) $ 13,362,906 $ 29,243,530 $ 40,410,223 The accompanying notes are an integral part of this consolidated financial statement. 5 XETA TECHNOLOGIES, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) For the Six Months For the Three Months Ended April 30, 2008 2007 2008 2007 Cash flows from operating activities: Net income $ 389,229 $ 170,110 $ 760,250 $ 378,280 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation 166,810 123,102 338,743 253,561 Amortization 202,899 140,277 457,415 287,045 Stock based compensation 54,516 23,935 116,561 47,869 Loss (gain) on sale of assets 425 (5,000 ) 425 (5,000 ) Provision for excess and obsolete inventory 25,500 25,500 51,000 51,000 Increase in deferred tax liability 102,535 146,243 176,611 315,456 Change in assets and liabilities, net of acquisitions: (Increase) decrease in net investment in sales-type leases & other receivables (401,304 ) 168,834 (Increase) in net investment in sales-type leases & other receivables (204,772 ) (50,020 ) (Increase) decrease in trade account receivables (903,872 ) 2,269,541 (2,987,711 ) 912,191 (Increase) decrease in inventories (931,924 ) 141,631 (Increase) in inventories (596,390 ) (988,439 ) Decrease (increase) in deferred tax asset 148,465 (26,242 ) 289,105 (87,968 ) (Increase) in prepaid expenses and other assets (377,387 ) (301,886 ) (245,140 ) (321,990 ) (Increase) in prepaid taxes (11,551 ) (9,355 ) Increase (decrease) in accounts payable 48,472 (480,320 ) Decrease in prepaid taxes 7,294 8,833 Increase in accounts payable 1,579,670 1,353,466 Increase in unearned revenue 404,992 469,847 241,806 584,838 (Decrease) increase in accrued liabilities and lease payable (949,438 ) 65,707 (1,376,433 ) 428,516 Total adjustments (2,420,862 ) 2,751,814 (2,151,816 ) 2,789,358 Net cash (used in) provided by operating activities (2,031,633 ) 2,921,924 (1,391,566 ) 3,167,638 Cash flows from investing activities: Additions to property, plant & equipment (327,496 ) (279,343 ) (718,893 ) (467,349 ) Proceeds from sale of assets 5,000 — 5,000 Net cash used in investing activities (327,496 ) (274,343 ) (718,893 ) (462,349 ) Cash flows from financing activities: Proceeds from draws on revolving line of credit 11,114,434 5,461,702 19,320,405 11,509,265 Principal payments on debt (42,771 ) (42,773 ) (85,544 ) (85,546 ) Payments on revolving line of credit (9,054,346 ) (7,836,062 ) (17,492,127 ) (14,115,393 ) Exercise of stock options 90,215 90,215 Net cash provided by (used in) financing activities 2,107,532 (2,417,133 ) 1,832,949 (2,691,674 ) Net (decrease) increase in cash and cash equivalents (251,597 ) 230,448 (277,510 ) 13,615 Cash and cash equivalents, beginning of period 402,918 174,567 402,918 174,567 Cash and cash equivalents, end of period $ 151,321 $ 405,015 $ 125,408 $ 188,182 Supplemental disclosure of cash flow information: Cash paid during the period for interest, net of amount capitalized of $0 in 2008 and $64,652 in 2007 $ 97,220 $ 29,226 Cash paid during the period for interest, net of amount capitalized of $0 in 2008 and $114,814 in 2007 $ 179,779 $ 31,233 Cash paid during the period for income taxes $ 11,519 $ 9,355 $ 15,958 $ 23,679 The accompanying notes are an integral part of these consolidated financial statements. 6 XETA TECHNOLOGIES, INC. AND SUBSIDIARY Notes to Consolidated Financial Statements (Unaudited) 1. BASIS OF PRESENTATION: XETA Technologies, Inc. (“XETA” or the “Company”) is a leading provider of communications solutions with nationwide sales and service. XETA serves a diverse group of business clients in sales, engineering, project management, installation, and service support. The Company sells products produced by a variety of manufacturers including Avaya, Inc. (“Avaya”), Nortel Networks Corporation (“Nortel”), and Mitel Corporation (“Mitel”). In addition, the Company manufactures and markets a line of proprietary call accounting systems to the hospitality industry. XETA is an Oklahoma corporation. The Company prepared the accompanying unaudited consolidated financial statements pursuant to the rules and regulations of the Securities and Exchange Commission (the “Commission”). Certain information and footnote disclosures normally included in annual financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to those rules and regulations, although the Company believes that the disclosures made are adequate to make the information presented not misleading. It is suggested that these condensed financial statements be read in conjunction with the consolidated financial statements and 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 7, 2008. Management believes that the financial statements contain all adjustments necessary for a fair statement of the results for the interim periods presented. All adjustments made were of a normal recurring nature. The results of operations for the interim period are not necessarily indicative of the results for the entire fiscal year. Segment Information The Company has three reportable segments: services, commercial system sales, and lodging system sales. Services revenues represent revenues earned from installing and maintaining systems for customers in both the commercial and lodging segments. The Company defines commercial system sales as sales to the non-lodging industry. The reporting segments follow the same accounting policies used for the Company’s consolidated financial statements and described in the Summary of Significant Accounting Policies in the Company’s Form 10-K described above. Company management evaluates a segment’s performance based on gross margins. Assets are not allocated to the segments. Sales The following is a tabulation of business segment information for the three months ended Commercial Lodging Services Commercial Lodging Other Total 2008 Sales $ 9,724,942 $ 6,029,935 $ 1,684,224 $ 510,634 $ 17,949,735 $ 10,134,470 $ 8,775,074 $ 1,496,687 $ 405,592 $ 20,811,823 Cost of sales (7,130,924 ) (4,601,659 ) (1,185,163 ) (441,379 ) (13,359,125 ) (7,600,057 ) (6,483,890 ) (1,057,670 ) (483,972 ) (15,625,589 ) Gross profit $ 2,594,018 $ 1,428,276 $ 499,061 $ 69,255 $ 4,590,610 $ 2,534,413 $ 2,291,184 $ 439,017 $ (78,380 ) $ 5,186,234 2007 Sales $ 8,776,763 $ 5,252,398 $ 1,774,450 $ 247,068 $ 16,050,679 $ 8,792,452 $ 5,478,709 $ 2,283,514 $ 134,363 $ 16,689,038 Cost of sales (6,348,097 ) (3,984,231 ) (1,323,598 ) (443,140 ) (12,099,066 ) (6,116,344 ) (4,192,565 ) (1,734,341 ) (446,730 ) (12,489,980 ) Gross profit $ 2,428,666 $ 1,268,167 $ 450,852 $ (196,072 ) $ 3,951,613 $ 2,676,108 $ 1,286,144 $ 549,173 $ (312,367 ) $ 4,199,058 The following is a tabulation of business segment information for the six months ended April 30, 2008 and 2007. 7 Services Commercial Lodging Other Total 2008 Sales $ 19,859,412 $ 14,805,009 $ 3,180,911 $ 916,226 $ 38,761,558 Cost of sales (14,730,981 ) (11,085,549 ) (2,242,833 ) (925,351 ) (28,984,714 ) Gross profit $ 5,128,431 $ 3,719,460 $ 938,078 $ (9,125 ) $ 9,776,844 2007 Sales $ 17,569,215 $ 10,731,107 $ 4,057,964 $ 381,431 $ 32,739,717 Cost of sales (12,464,441 ) (8,176,796 ) (3,057,939 ) (889,870 ) (24,589,046 ) Gross profit $ 5,104,774 $ 2,554,311 $ 1,000,025 $ (508,439 ) $ 8,150,671 Stock-Based Compensation Plans The Company accounts for 2008 2007 Three months ended January 31, $ 54,516 $ 23,935 2008 2007 Three months ended April 30, $ 62,045 $ 23,935 Six months ended April 30, $ 116,561 $ 47,869 Use of Estimates The preparation of financial statements in conformity with accounting principles generally accepted in the U.S. requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. New Accounting Pronouncements In June 2006, the FASB issued Interpretation No. 48 (“FIN 48”), Accounting for Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109, to clarify certain aspects of accounting for uncertain tax positions, including issues related to the recognition and measurement of those tax positions. The Company adopted this interpretation on November 1, 2007 and there was no impact to the Company’s financial statements. In December 2007, the FASB issued SFAS No. 141 (revised 2007), “Business Combinations” (SFAS No. 141(R)). Under SFAS No. 141(R), an entity is required to recognize the assets acquired, liabilities assumed, contractual contingencies, and contingent consideration at their fair value on the acquisition date. It further requires that acquisition-related costs are recognized separately from the acquisition and expensed as incurred, restructuring costs generally be expensed in periods subsequent to the acquisition date, and changes in accounting for deferred tax asset valuation allowances and acquired income tax uncertainties after the measurement period impact income tax expense. The adoption of SFAS No. 141(R) will change 8 the accounting treatment for business combinations on a prospective basis beginning in the first quarter of fiscal year 2010. In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements—an amendment of ARB No. 51” (SFAS No. 160). SFAS No. 160 changes the accounting and reporting for minority interests, which will be recharacterized as non-controlling interests and classified as a component of equity. SFAS No. 160 is effective for us on a prospective basis for business combinations with an acquisition date beginning in the first quarter of fiscal year 2010. As of January 31, 2008, the Company did not have any minority interests, therefore the adoption of SFAS No. 160 is not expected to have an impact on 2. ACCOUNTS RECEIVABLE: (Audited) (Audited) Trade receivables $ 17,327,095 $ 16,411,981 $ 19,409,504 $ 16,411,981 Less reserve for doubtful accounts (153,110 ) (175,844 ) (151,601 ) (175,844 ) Net trade receivables $ 17,173,985 $ 16,236,137 $ 19,257,903 $ 16,236,137 3. INVENTORIES: Inventories are stated at the lower of cost (first-in, first-out or average) or market and consist of the following: (Audited) (Audited) Finished goods and spare parts $ 6,023,867 $ 5,068,227 $ 5,735,434 $ 5,068,227 Less- reserve for excess and obsolete inventories (791,592 ) (771,653 ) (864,193 ) (771,653 ) Total inventories, net $ 5,232,275 $ 4,296,574 $ 4,871,241 $ 4,296,574 9 4. PROPERTY, PLANT AND EQUIPMENT: Property, plant and equipment Estimated (Audited) Estimated April 30, (Audited) Building and building improvements 3-20 $ 2,729,604 $ 2,686,753 3-20 $ 2,905,362 $ 2,686,753 Data processing and computer field equipment 2-7 2,643,296 2,556,878 2-7 2,646,692 2,556,878 Software development costs, work-in-process N/A 3,869,749 3,792,567 N/A 2,441,832 3,792,567 Software development costs of components placed Into service 3-10 4,442,988 4,355,953 Software development costs of components placed into service 3-10 6,057,508 4,355,953 Hardware 3-5 599,751 599,751 3-5 612,902 599,751 Land — 611,582 611,582 — 611,582 611,582 Office furniture 5-7 954,944 947,094 5-7 944,048 947,094 Auto 5 528,793 539,184 5 528,793 539,184 Other 3-7 253,193 239,533 3-7 265,683 239,533 Total property, plant and equipment 16,633,900 16,329,295 17,014,402 16,329,295 Less- accumulated depreciation (6,031,901 ) (5,718,475 ) (6,424,536 ) (5,718,475 ) Total property, plant and equipment, net $ 10,601,999 $ 10,610,820 $ 10,589,866 $ 10,610,820 Interest costs related to an investment in long-lived assets are capitalized as part of the cost of the asset during the period the asset is being prepared for use. The Company capitalized $0 and 5. INCOME TAXES: The Company has recorded a tax provision of 6. CREDIT AGREEMENTS: The Company’s credit facility consists of a revolving credit and term loan agreement with a commercial bank including a mortgage agreement maturing on September 30, 2009 and amortizing based on a (Audited) 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 $ 1,482,882 $ 1,525,653 Less-current maturities 171,123 171,123 Total long-term debt, less current maturities $ 1,311,759 $ 1,354,530 10 April 30, (Audited) Real estate term note, payable in monthly installments of $14,257 plus interest, plus a fixed payment of $1,198,061 due September 30, 2009, collateralized by a first mortgage on the Company’s building $ 1,440,109 $ 1,525,653 Less-current maturities 171,123 171,123 Total long-term debt, less current maturities $ 1,268,986 $ 1,354,530 Interest on all outstanding debt under the credit facility accrues at either a) the London Interbank Offered Rate 7. EARNINGS PER SHARE: For the Three Months Ended April 30, 2008 Income Shares Per Share Basic EPS Net income $ 371,021 10,254,310 $ 0.04 Dilutive effect of stock options 8,987 Diluted EPS Net income $ 371,021 10,263,297 $ 0.04 For the Three Months Ended April 30, 2007 Income Shares Per Share Basic EPS Net income $ 208,170 10,214,741 $ 0.02 Dilutive effect of stock options — Diluted EPS Net income $ 208,170 10,214,741 $ 0.02 11 For the Six Months Ended April 30, 2008 Income Shares Per Share Basic EPS Net income $ 760,250 10,231,120 $ 0.07 Dilutive effect of stock options 15,152 Diluted EPS Net income $ 760,250 10,246,272 $ 0.07 For the Three Months Ended January 31, 2008 Income Shares Per Share Basic EPS Net income $ 389,229 10,224,971 $ 0.04 Dilutive effect of stock options 24,722 Diluted EPS Net income $ 389,229 10,249,693 $ 0.04 For the Three Months Ended January 31, 2007 For the Six Months Ended April 30, 2007 Income Shares Per Share Income Shares Per Share Basic EPS Net income $ 170,110 10,214,741 $ 0.02 $ 378,280 10,214,741 $ 0.04 Dilutive effect of stock options — — Diluted EPS Net income $ 170,110 10,214,741 $ 0.02 $ 378,280 10,214,741 $ 0.04 Options to purchase ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Preliminary Note Regarding Forward-Looking Statements In the following discussion, we make forward-looking statements about future events, performance and results. Such statements are not guarantees of performance, but rather reflect our current expectations, estimates, and forecasts about the industry and markets where we operate, based on information available to us. Forward-looking statements can generally be identified by words such as “expects,” “anticipates,” “may”, “plans,” “believes,” “intends,” “projects,” “estimates,” “targets,” “may,” “should” and similar words or expressions. These statements are subject to risks and uncertainties that are difficult to predict or are beyond our control, such as customer demand for advanced communications products; capital spending trends within our market; delays in installation schedules for the Miami-Dade County Public School District orders; our ability to successfully develop the Mitel product and services offering; the financial condition of our suppliers and changes in their distribution strategies and support; technological changes; fluctuating margins and product mix; failure to expand our wholesale service relationships; the ability to attract and retain highly skilled personnel and technical competencies; and intense competition. These and 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, 2007 (filed with the Commission on January 7, 2008), and in updates to such risk factors set forth in Item 1A of Part II of this quarterly Strategy. In fiscal 2008, we Our sales efforts target large, multi-location, national, or super-regional customers. Our national technical footprint and 24/7/365 We launched our wholesale service offering in fiscal 2006 and its success Finally, we strive to align our sell equipment to large and medium sized enterprises and to sell Avaya implementation and post-warranty maintenance contracts. Our Nortel initiatives focus on creating relationships with Nortel’s regional sales management to sell equipment and applications. In addition, we work to deepen our relationships with key Nortel services decision makers to create wholesale service offerings for large Nortel end-users. Since starting this initiative in late fiscal 2006, we have Effective November 1, 2007, we completed the acquisition of the commercial division of HCI Technologies, Inc. (“HCI”). Under the terms of the acquisition, we assumed the service responsibilities and the associated revenue stream Operating Summary. In the Financial Position Summary. Our financial condition was relatively unchanged during the first The following discussion presents additional information regarding our financial condition and results of operations for the Cash used by operations for the In addition to the cash used by operations, we invested approximately 14 Additionally, we invested At The table below presents our contractual obligations at Payments due by period Payments due by period Less than 2 — 3 4 — 5 Total Less than 1 year 2 - 3 Years 4 - 5 Years Long-term debt $ 1,619,905 $ 256,815 $ 1,363,090 $ — $ 1,519,029 $ 228,328 $ 1,290,701 $ — Operating leases 601,715 316,849 281,809 3,057 598,593 310,469 284,822 3,302 Total $ 2,221,620 $ 573,664 $ 1,644,899 $ 3,057 $ 2,117,622 $ 538,797 $ 1,575,523 $ 3,302 In the Services Revenues. Services revenues consist of the following: For the Three Months Ended For the Three Months Ended April 30, For the Six Months Ended April 30, 2008 2007 2008 2007 2008 2007 Contract & T&M $ 7,208,000 $ 6,005,000 $ 7,028,000 $ 6,309,000 $ 14,236,000 $ 12,314,000 Implementation 2,042,000 2,132,000 2,344,000 1,781,000 4,386,000 3,913,000 Cabling 475,000 640,000 762,000 702,000 1,237,000 1,342,000 Total Services revenues $ 9,725,000 $ 8,777,000 $ 10,134,000 $ 8,792,000 $ 19,859,000 $ 17,569,000 Systems Systems sales increased approximately Gross Margins. The table below presents the gross margins earned on our primary revenue streams: For the Three Months Ended For the Three Months Ended April 30, For the Six Months Ended April 30, Gross Margins 2008 2007 2008 2007 2008 2007 Services revenues 26.7 % 27.7 % 25.0 % 30.4 % 25.8 % 29.1 % Systems sales 25.0 % 24.5 % 26.6 % 23.6 % 25.9 % 24.0 % Other revenues 89.0 % 62.1 % 79.1 % -6.2 % 84.6 % 38.1 % Corporate cost of goods sold -2.2 % -2.2 % -1.9 % -1.8 % -2.0 % -2.0 % Total 25.6 % 24.6 % 24.9 % 25.2 % 25.2 % 24.9 % The decline in gross margins earned on our Services business in the Gross margins on systems sales in the 16 with these revenues and gross profits. In the first quarter we enjoyed significantly revenues from sales of Avaya maintenance Operating Expenses. Our total operating expenses increased Interest Expense and Other Income. Net interest and other expense was Tax Provision. We recorded a combined federal and state tax provision of 39% for the ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Market risks relating to our operations results primarily from changes in interest rates. We did not use derivative financial instruments for speculative or trading purposes during the three month period ended Interest Rate Risk. Due to utilization of variable interest rate debt, we are subject to the risk of fluctuation in interest rates in the normal course of business. Our credit facility bears interest at a floating rate at either the London Interbank Offered Rate 17 ITEM 4. CONTROLS AND PROCEDURES Evaluation of Disclosure Controls and Procedures. Based on an evaluation conducted as of (“CFO”), our CEO and CFO have concluded that our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”) are effective to reasonably ensure that information required to be disclosed in reports that we file or submit under the Exchange Act, is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms, and that such information is accumulated and communicated to our management, including the CEO and CFO, as appropriate to allow timely decisions regarding required disclosure. Changes in Internal Controls. There were no changes in our internal controls or in other factors that could materially affect, or is reasonably likely to materially affect, these controls subsequent to the date of their evaluation. In addition to the foregoing, we are involved as a defendant in an employment related matter and as a plaintiff in another matter, both of which we consider to be routine and incidental to the operation of our business. We do not believe that either of these proceedings will have a material affect on our financial position or results of operations. The information presented below is an update to the “Risk Factors” included in the Company’s Annual Report on Form 10-K for the fiscal year ended October 31, 2007 and should be read in conjunction therewith. Except as set forth below, the Risk Factors included in the Company’s Form 10-K for its 2007 fiscal year have not materially changed. Avaya’s strategies regarding the provision of services to its customers are changing dramatically and may have a material impact on our operating results. Avaya is repositioning itself as a hardware and software vendor providing a wide range of voice communications hardware and applications to its customers. As part of this strategy, Avaya is segmenting 18 its hardware maintenance and software support. The new software support offerings include technical support for specific voice applications and upgrade services to ensure customers can access all software patches and If in connection with the series of orders from the Miami-Dade County Public School system (“MDCPS”), we incur delays in our anticipated installation schedule, significant installation challenges, product performance issues, weather-related catastrophes and/or delays in the collection of amounts due, our expected revenues, gross profits, and cash flows in fiscal 2008 from the sale of equipment and installation services to MDCPS could be materially different than In November, 2007, we announced the award of a series of orders from M-DCPS totaling in excess of $10 million to provide and install communications equipment. would create additional interest expense If economic conditions in the U.S. continue be uncertain or deteriorate further, our revenues, gross margins and net income could be negatively impacted. In the first half of fiscal 2007, we have seen a decline in order rates for new equipment and for some discretionary services that we offer. We believe that at least a portion of these declines is due to uncertainty about the condition and near-term future of the U.S. economy. These uncertainties have caused some customers to delay capital spending decisions. Should these uncertainties persist or worsen, it is likely that our business would continue to feel its effects. ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS. None. ITEM 3. DEFAULTS UPON SENIOR SECURITIES. None. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. Nominee For Against Abstain Donald T. Duke 8,813,813 690,986 203,310 Greg D. Forrest 9,614,985 84,369 8,755 Ron B. Barber 8,244,689 851,665 611,755 S. Lee Crawley 8,818,070 380,746 509,293 Robert D. Hisrich 9,094,360 413,439 200,310 Edward F. Keller 9,135,656 371,143 201,310 Ronald L. Siegenthaler 9,032,138 667,570 8,401 19 The shareholders also voted at the Annual Meeting to ratify the selection of Tullius Taylor Sartain & Sartain LLP as our independent auditors for the 2008 fiscal year, with votes cast as follows: For Against Withhold 9,290,502 298,844 118,763 Exhibits (filed herewith): SEC Exhibit No. Description 31.1 Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer 31.2 Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer 32.1 Certification of Chief Executive Officer Pursuant to Title 18, United States Code, Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 32.2 Certification of Chief Financial Officer Pursuant to Title 18, United States Code, Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 20 Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. XETA Technologies, Inc. (Registrant) Dated: June 3, 2008 By: /s/ Greg D. Forrest Greg D. Forrest Chief Executive Officer Dated: June 3, 2008 By: /s/ Robert B. Wagner Robert B. Wagner Chief Financial Officer 21 SEC Exhibit No. Description 31.1 Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer 31.2 Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer 32.1 Certification of Chief Executive Officer Pursuant to Title 18, United States Code, Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 32.2 Certification of Chief Financial Officer Pursuant to Title 18, United States Code, Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 22For the quarterly period ended January 31,ORoTRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)OF THE SECURITIES EXCHANGE ACT OF 1934 (Exact(Exact name of registrant as specified in its charter)(I.R.S. Employeenon-accelerated filer. See definition of “accelerated filer and large accelerated filer” insmaller reporting company (as defined by Rule 12b-2 of the Exchange Act. (Check one):Act).(Do not check if a smallerreporting company)Indicate the numberAs of May 30, 2008, there were 10,254,310 shares outstanding of each of the registrant’s classes of common stock, as of the latest practicable date.par value $0.001, outstandingClassOutstanding at January 31, 2008Common Stock, $.001 par value10,231,214INDEX1.FINANCIAL1. FINANCIAL STATEMENTS (Unaudited)January 31,April 30, 2008 and October 31, 2007ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS
1213
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
1617
ITEM 4. CONTROLS AND PROCEDURES
1618
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
1718
ITEM 1A. RISK FACTORS
1718
18191819181918201820(UNAUDITED)
Ended January 31,
Ended January 31,January 31,April 30, 2008to customers located outside of the U.S. are immaterial.January 31,April 30, 2008 and 2007.
Services
Revenues
Systems
Sales
Systems
Sales
Other
Revenue
Total
Revenues
Systems
Sales
Systems
Sales
Revenue
Revenues
Systems
Sales
Systems
Sales
Revenuestock basedstock-based compensation in accordance with Statement of Financial Accounting Standards No. 123 (revised 2004), “Share-Based Payment” (“SFAS 123(R)”). SFAS 123(R) requires companies to measure all employee stock-based compensation awards using a fair value method and recognize compensation cost in its financial statements. The valuation provisions of SFAS 123(R) apply to new awards and to awards that are outstanding at the effective date and subsequently modified or cancelled. The Company adopted on a prospective basis SFAS 123(R) beginning November 1, 2005 for stock-based compensation awards granted after that date and for unvested awards outstanding at that date using the modified prospective application method. The Company recognizes the fair value of stock-based compensation awards as selling, general and administrative expense as appropriate in the consolidated statements of operations on a straight-line basis over the vesting period. Compensation expense was recognized in the statement of operations as follows:ourthe Company’s consolidated financial statements.8
January 31,
2008
October 31,
2007
April 30,
2008
October 31,
2007
January 31,
2008
October 31,
2007
April 30,
2008
October 31,
2007consistsconsist of the following:
Useful
Lives
January 31,
2008
October 31,
2007
Useful
Lives
2008
October 31,
2007$64,652$114,814 in interest costs in the threesix months ended January 31,April 30, 2008 and 2007, respectively.9$251,000$489,000 or 39% and $120,000$260,000 or 41% for the threesix months ended January 31,April 30, 2008 and 2007, respectively, reflecting the statutory federal tax rate of 34% plus a blended state income tax rate of approximately 5% and the impact of minimum income tax payments in certain states. The Company currently estimates its annual effective income tax rate to be approximately 40% for fiscal 2008, compared to a 40% effective income tax rate in fiscal 2007.2008.13 year13-year life and a $7.5 million revolving credit agreement to finance growth in working capital. Trade accounts receivable and inventories collateralize the revolving line of credit At January 31,at April 30, 2008 and October 31, 2007, the2007. The Company had approximately $4.819$4.587 million and $2.759 million, respectively, outstanding on the revolving line of credit. The Company had approximately $2.7$2.9 million available under the revolving line of credit at January 31,April 30, 2008. Advance rates are defined in the agreement, but are generally at the rate of 80% on qualified trade accounts receivable and 40% of qualified inventories. The revolving line of credit matures on September 23, 2008. Long-term debt consisted of the following:
January 31,
2008
October 31,
2007
2008
October 31,
2007(3.14%(2.80% at January 31,April 30, 2008) plus 1.25% to 2.75% depending on the Company’s funded debt to cash flow ratio, or b) the bank’s prime rate (6.0%(5.0% at January 31,April 30, 2008) minus 0% to minus 1.125% also depending on the Company’s funded debt to cash flow ratio. At January 31,April 30, 2008, the Company was paying 4.875%3.875% on the revolving line of credit borrowings and 6.1%4.2% on the mortgage note. The credit facility contains several financial covenants 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 debt service coverage requirements. The Company was in compliance with these covenants at January 31, 2008.DividingThe Company computes basic earnings per common share by dividing net income by the weighted average number of shares of common stock outstanding during the reporting periods computes basic earnings per common share.periods. Dividing net income by the weighted average number of shares of common stock and dilutive potential common stock outstanding during the reporting periods computes diluted earnings per common share. A reconciliation of net income and weighted average shares used in computing basic and diluted earnings per share is as follows:
(Numerator)
(Denominator)
Amount10
(Numerator)
(Denominator)
Amount
(Numerator)
(Denominator)
Amount
(Numerator)
(Denominator)
Amount
(Numerator)
(Denominator)
Amount
(Numerator)
(Denominator)
Amount774,900844,900 shares of common stock at an average exercise price of $8.43$8.08 and 1,104,0681,103,668 shares of common stock at an average exercise price of $7.18$7.17 were not included in the computation of diluted earnings per share for the three months ended January 31,April 30, 2008 and 2007, respectively, because inclusion of these options would be antidilutive. Options to purchase 828,636 shares of common stock at an average exercise price of $8.16 and 1,103,668 shares of common stock at an average exercise price of $7.17 were not included in the computation of diluted earnings per share for the six months ended April 30, 2008 and 2007, respectively, because inclusion of these options would be antidilutive.1112report.report and our quarterly report for the first quarter of fiscal 2007. Because of these risks and uncertainties, actual results may differ materially and adversely from those expressed in forward-looking statements. Consequently, we caution investors to read and consider all forward-looking statements in conjunction with such risk factors and uncertainties. The Private Securities Litigation Reform Act of 1995 provides a safe-harbor for forward-looking statements made by the Company.Overview
will continuehave continued to focus on three primary strategies: acquire, penetrate, and retain targeted customers; expand our wholesale service offerings; and improve alignment with our major business partners.callcontact center are complimentary to the communication needs of these customers. Additionally, these larger enterprises often have a mixture of manufacturer platforms within their communications equipment portfolio and our ability to sell and service both the Avaya and Nortel product lines is an important competitive advantage. Additionally, becauseBecause of our extensive array of products and services, we enjoy multiple sales opportunities with these customers. These includecustomers, including new product sales, implementation of advanced applications, and a variety of potential service relationships. Once we establish a relationship with a customer, we search for opportunities to penetrate deeper into the account. We do thisaccount by assessing the customer’s communications needs, proposing appropriate technologies, establishing or expanding the service relationship, and proposing equipment and service solutions to other divisions or subsidiaries.washas been a key factor in our fiscal 2007 revenue growth and a significant contributor to ourin recurring revenues.revenue. Under this service offering, we partner with manufacturers, network service providers and systems integrators to provide services to their end-user customers. In many instances, we provide field resources to carry out service responsibilities. However, under a full outsourcing arrangement we may provide a broader range of services, including call center support, remote technical support, on-site labor and spare parts to a particular end-user.parts. Our entry into the wholesale services market has been successfulsucceeded because we provide excellent service to end-user customers and demonstrate aour willingness to create and execute flexible service programs and billing arrangements. The continued success of this strategic initiative is a vital ingredient to our long-term goal of shifting our revenue mix toward more recurring services revenues.company’sCompany’s sales, marketing, and services programs with those of our manufacturing partners. Avaya and Nortel approach the communications technology market differently and therefore we have assigned separate executive sales management to each manufacturer’s products and services. Our Avaya sales and marketing efforts focus on partnering with the Avaya national sales force to1213significantly improved our relationships and penetration with both Nortel and Avaya the result isresulting in a demonstrable increase in equipment and services revenues.withof all of HCI’s non-Federal government customers. No cash was paid at closing; however, in exchange for the assets and customer relationships purchased, we agreed to pay HCI a portion of the gross profits earned from the service relationships in place at closing. These payments continue on a quarterly basis for three years.years from the effective date. Before the acquisition, the Companywe occasionally engaged HCI as a third-party contractor to provide technical services to our customers. At the close,closing, HCI owed XETAus $43,000 in accounts receivable plus accrued interest of $6,800. The$6,800, which under the terms of the acquisition, agreementallow us to deduct these amountswas deducted from anythe earn-out payments. We have recorded the assets acquired, including an intangible asset related to the value of the customer relationships, at their fair values on the date of acquisition. We have also recorded an initial estimate of the ultimate earn-out liability. The assets acquired in this transaction were not material to our financial statements.firstsecond quarter of fiscal 2008, we earned net income of $389,000$371,000 on revenues of $17.9$20.8 million compared to net income of $170,000$208,000 on revenues of $16.1$16.7 million in the firstsecond quarter of last year. For the first six months of fiscal 2008, we earned $760,000 in net income on revenues of $38.8 million compared to net income of $378,000 on revenues of $32.7 million. These results reflect our successful execution of the strategies discussed above and other contributing factors that we discussdiscussed in more detail under “Results of Operations” below.quarterhalf of fiscal 2008.2008 as compared to October 31, 2007. Our working capital increased approximately 5%;10% during the first half of fiscal 2008 since October 31, 2007; however temporary growth in our receivables and inventory balances resulted in increased borrowings on our working capital revolver in the first quartersix months of fiscal 2008. We discuss these and other financial items in more detail under “Financial Condition” below.three month periodthree- and six-month periods ended January 31,April 30, 2008 and 2007 and should be readconsidered in conjunction with our above comments above as well as the “Risk Factors” section below.Financial Condition
threesix months ended January 31,April 30, 2008 was $2.0$1.40 million. Increases in accounts receivable and inventories as well as capital expenditures were partially offset by net income and non-cash charges resulting in the cash deficit in the first quarter. Duringhalf of fiscal 2008. For the quarter,six months ended April 30, 2008, our accounts receivable balances grewincreased by approximately $904,000 reflecting$3.0 million. This change reflects strong revenue growth in the last month of the second quarter and temporary declines in the pace of completion and billing of complex equipment projects. These delays reflect the surgeprojects, in systems shipped toward the end of fiscal 2007 coupled with the complexity of many of those systems, which delayed final customer acceptance, and billing of the systems. Another contributing factor to the increase in accounts receivable was the initiation ofparticular our large project with the Miami-Dade County Public Schools (“M-DCPS”). We expect thisthe M-DCPS project to produceyield over $10 million in revenues during fiscal 2008. InInstallation of the M-DCPS systems commenced in the first quarter of the year and we began installinghave received payment only on the systems shipped atinitial month of installations. Additional payments have been delayed due to complexities in configuring the end of fiscal 2007. Shipments and installations continued to accelerate throughout the quarterinvoices to meet the customer’s expectations.M-DCPS and Federal government requirements. The billing and collectingcollection of these projects is a complicated process requiringwith funding from both M-DCPS and the Federal government. While we dothe collectability of these receivables is not expect any prolonged difficulties regardingin question, the collection of M-DCPS receivables, navigating through thepreviously mentioned complexities of the initial billing and collections cycle negativelyhave affected our first quarterhalf cash flows.$327,000$719,000 in capital projects, including $163,000$355,000 in equipment and fixtures, as part of our normal replacement and refurbishment cycles. $164,000$364,000 in the continued implementation of Oracle’s eBusiness Suite..Suite. Early in the second fiscal quarter of fiscal 2008, we completed the cutover of the last portion of ourmajor functional13operations module to the Oracle platform. During the remainder of the year,fiscal 2008, we expect to implement additional features, including sales management, customer relationship management and an online service ticket initiation and tracking system.January 31,April 30, 2008 our total borrowings were $6.3$6.0 million, consisting of a mortgage on our headquarters building of $1.5$1.4 million and $4.8$4.6 million due on our revolving line of credit. At January 31,April 30, 2008 there was $2.7$2.9 million available under the revolver to meet working capital needs. We believe that the current amount of working capital available under our revolving line of credit will beis sufficient to meet our needs for the remainder of fiscal 2008. In addition, we believe that should the need arise, we could arrange supplemental short-term financing under acceptable terms and prices should the need arise.There have been no stock repurchases to date under the repurchase program announced in October 2006. Under the program, our board of directors authorized the Company to utilize up to $960,000 per year to repurchase our common stock in open market, block purchases or in privately negotiated transactions and at prices we deem appropriate.prices.January 31,April 30, 2008 as well as payment obligations over the next five years:
Contractual Obligations
Total
1 year
Years
YearsResults of Operations
firstsecond quarter of fiscal 2008 our revenues increased $1.9$4.1 million or 12%25% compared to the firstsecond quarter last year, and our net income increased $219,000$163,000 or 129%78%. In the first six months of the year, our revenues increased $6 million or 18% resulting in an increase in earnings of $382,000 or 101%. These positive results reflect improvements in all of our major revenue categories, partially offset by lower gross profit margins on services revenues and higher operating costs. The narrative below provides further explanation of these results.
January 31,Services revenues increased 11% in first quarter of fiscal 2008 compared to last year and included a 20% increase in contractContract and time and materials (“T&M”) revenues which was partially offset by decreases in implementationincreased 11% and cabling revenues of 4% and 26%16%, respectively. The increase in contract and T&M revenues was generated primarily from new customer relationships securedrespectively in the acquisition of HCI which was effective on November 1, 2007. In accordance with the terms of the acquisition, we assumed the service responsibilities for HCI’s commercial maintenance contracts as well as stepping in HCI’s position on many customer relationships that produce recurring T&M revenues. We did not secure any major organicsecond quarter and year-to-date periods. These increases reflect additions to our base of maintenance customers in the last half of fiscal 2007 and the addition of HCI contracts and T&M relationships beginning in November 2007. Through the first half of fiscal 2008, organic additions of new contract maintenance or contracted T&M customers during the first quarter.to our base have been modest. However, as discussed above under “Strategy”, the pursuit of contract and T&M revenues, particularly under our wholesale service program is a key strategic initiative in fiscal 2008 and we continue to expect it to be the primary driver of our services revenue growth. Implementation revenues increased 32% and 12%, respectively in the second quarter and year-to-date periods. These increases are attributable to growth in systems sales and also reflect M-DCPS system implementations. The pace of installations at M-DCPS accelerated toward the end of the second quarter of fiscal 2008. Based on the customer’s current schedule, installations are expected to continue at a considerable pace through the first half of our third fiscal quarter followed by a pause during their summer school break. we anticipate completing the 2008project during our fourth fiscal year.quarter. Cabling revenues increased 9% in the second fiscal quarter, but are down approximately 8% in the year-to-date period. We1415Implementationenjoyed strong cabling revenues were slightly less infrom three significant projects during the second quarter as construction delays that hampered first quarter revenues subsided. As a national provider of fiscal 2008 as compared to last year, primarily because of a single, large installation project that occurred in the first quarter of fiscal 2007. In addition, our first quarter implementation revenues were slightly lower than our expectations due to customer-created delays early in the quarter related to the installation of the first set of M-DCPS orders.Cabling revenues were down approximately 26% compared to the first quarter of fiscal 2007 due to construction delays at customer locations. Frequently, our significantstructured cabling installations, we can secure major stand-alone cabling projects occur in conjunction with new construction or major renovations. As is common inas well as significant turn-key projects where the construction industry, delays by other contractorscustomer combines the cabling, equipment and weather often impact our portion of the project.professional services.SalesSales.System10%$2.5 million or 32% in the firstsecond quarter of fiscal 2008 compared to last year. This increase reflectsincludes a 15%$3.3 million or 60% increase in sales of systems to commercial customers. We achieved this increase despite higher than expected seasonal weaknesscustomers and a $787,000 or 35% decrease in the quarter and significantly lower sales of systems and equipment to the Federal government. The lower Federal governmentlodging customers. Year-to-date systems sales reflects the lossincreased $3.2 million or 22% compared to last year. This increase includes an increase in sales of a contract to supply small phone systems to the U.S. Senate as well as continued budget approval delays by Congress. Ourcommercial customers of $4.1 million or 38% and a decrease in sales of systems to lodging customers declined approximately 5%of $877,000 or 22%. The increase in sales to commercial customers primarily reflects sales of systems to M-DCPS. As previously discussed, shipments and installations for M-DCPS accelerated in the first quarterlast half of fiscal 2008 compared to last year reflecting shipments deferred to the second quarter and will remain strong through most of our third quarter. Our Lodging equipment order rates and backlogsWe anticipate this project will complete during our fourth fiscal quarter. Orders for systems to commercial customers other than M-DCPS are higherslightly below last year’s pace. We believe this decline primarily reflects customers extending the sales cycle due the current uncertainty in fiscal 2008the U.S. economy. The decline in sales of systems to date comparedlodging customers reflects difficult comparisons to fiscal 2007 giving us confidence that this segmentresults which were temporarily impacted by an acceleration of orders from customers who were avoiding a mid-year price increase from the manufacturer. In general, our business remains at or abovesales of systems to lodging customers are slightly less than our expectations for the year. Overall, our system sales continue to be an unpredictable segment of our business as the timingexpected run-rates, reflecting uncertainties of the receipt of orders, product delivery, and customer installation schedules may fluctuate dramatically. Systems orders’ backlogs typically range from thirty to forty-five days providing limited visibility of future results for this line of business.economy.
January 31,firstsecond quarter reflects a higher cost structure and lower than expected profitability in our implementation and cabling businesses and slower than expected growth in our Contract and T&M revenues. We experiencedAlthough we have enjoyed strong revenue growth in all three major Services revenue streams, our cost structures to support those revenue streams anticipated higher Services costslevels of growth, particularly in our Contract and T&M revenue category. In response to the slower than anticipated growth rate of these revenues, we have adjusted personnel levels to mitigate some excess capacity. Specific to our implementation business, we are contractually obligated to maintain a significant level of Company-employed personnel to support the M-DCPS project. Due to customer initiated changes in the implementation schedule, the pace of installations has been inconsistent in the first quarterhalf of fiscal 2008 due to higher personnel related expenses, increased training costs,the year and therefore the openingprofitability of a Services branch office in Miami, FL to support our M-DCPS implementation and Services project. This higher cost structure, coupled with lowerthe implementation and cabling revenues resultedportions of the project have been lower than our expectations and normal run-rates. We expect improvement in this area in the erosion of services margins. Our two to four year target for services gross margins is 30% to 35%. Achieving this target is a key ingredient to establishing long-term profitability for the Company.third and fourth fiscal quarters.firstsecond quarter and the year-to-date period were up slightly over last year and withinare above our target of 23% to 25% expectations for systems revenues. The gross margins on systems sold to commercial customers were down slightly compared to the first quarter of last year due entirely to lower gross margins on sales of systems and equipment to the Federal government. Gross margins onThis trend is consistent for both sales of systems to commercial as well as lodging customers were up in the first quarter compared to last year due to a favorable mix of larger, more profitable systems sold during the quarter.customers. We continue to receive strong pricing support from our vendors in the form of project-specific discounts and incentive rebates. These incentives are material to our gross margins and we work diligently to maximize this support; however, no assurance can be given that future support will continue at historical levels.AThe final component toof our gross margins is the margins earned on other revenues and our corporate cost of goods sold. We earn the majority of our other revenues from the sale of Avaya maintenance contracts on which we earn either a commission or gross profit. We have no continuing service obligation associatedincreasedhigher commission15contracts and thesecontracts. These revenues were material to our overall operating income. This is an unpredictable revenue stream that depends on the expiration dates of existing contracts, installation dates of new systems, the customer type as defined by Avaya, and the number of years that customers contract for services. Consequently, it is unlikely that we can sustain the results enjoyed in the first quarter throughouthalf of the fiscal year. Other revenues may also include sales and cost of goods sold on equipment or services outside our normal provisioning processes. These revenues vary significantly in both sales volume and gross margins earned. Corporate cost of goods sold represents our material logistics and purchasing functions that support all of our revenue segments.$196,000$658,000 or 5%17% in the firstsecond quarter of fiscal 2008 compared to the firstsecond quarter of fiscal 2007. Operating expenses were 21.5%21.7% of revenues in the second quarter compared to 23.1% last year. Operating expenses increased $855,000 or 11% for the first half of fiscal 2008 compared to the same period a year ago. Operating expenses were 21.6% of revenues in the first quarterhalf of fiscal 2008 compared to 22.9%23.0% last year. This improvementThe growth rates in operating expense margins includedexpenses in the absorptionfirst half of $50,000fiscal 2008 are slightly above our targets and reflect a number of factors such as personnel additions in sales and general and administrative areas - increased stock compensation expense; increases in costs associated with maintenance of our Oracle software platform; and increases in board of director fees due to expansion of board and increases in director responsibilities. Additionally, our amortization expense resultinghas increased in the first half of fiscal 2008 from increased utilization of the Company’s Oracle platform. In addition,platform to support business operations. Finally, year-to-date operating expense comparisons were favorably impacted by improved sales and marketing incentives from vendors in the first quarter offset increases in sales and general and administrative expenses.quarter. The incentives we receive from vendors to support the sales and marketing of their products come in the form of payments for growth in sales of their products;products, reimbursement for specific, pre-approved marketing programs;programs, and additions to sales headcount. The timingamount of these incentives is unpredictable and frequently we must rely upon suppliers to calculate the value of the award. Also, incentive programs and rules are frequently revised, replaced by new programs, or halted altogether as manufacturers attempt to influence the behavior of their dealers and respond to market conditions. This unpredictability results in fluctuations in the size and timing of recognition of these items in our financial statements. Despite these factors, we make every reasonable effort to understand the various programs and maximize their benefit. The amount of incentives recognized during our first quarterfunds was higher than our normal run-rates, and may not be sustainable throughoutin the remainderfirst quarter due to special growth incentives offered by one of the year.manufacturers that we represent. These funds returned to normal levels in the second quarter. Overall, we are pleased with the direction and progress made in reducing our operating expenses as a percentage of revenues. We have anticipate our operating expense margins towill decline to between 18% and 20% of revenues over the next two to four years through economies of scale and improved operating efficiencies.$85,000$59,000 in the firstsecond quarter of fiscal 2008 compared to $7,000$9,000 in net other income in the firstsecond quarter of fiscal 2007. Net interest and other expense was $144,000 for the six-month period ended April 30, 2008 compared to $16,000 in net other income in the same period last year. This increase in expense reflects higher average borrowings in first quarter as described under “Financial Condition” above and the discontinuation of capitalizing interest expense related to the implementation of the Company’s new software platform.Oracle platform and higher average borrowings in the periods presented.firstsecond quarter of fiscal 2008 compared to a tax provision of 41%40% in the second quarter of fiscal 2007. For the six-month period ended April 30, 2008, we recorded a tax provision of 39% compared to a tax provision of 41% for the first quartersix months of fiscal 2007. The tax provision reflects the effective federal tax rate plus the composite state income tax rates adjusted for states that require minimum tax payments even if tax losses are incurred. Generally, we expect our tax provision rate to be approximately 40%.January 31,April 30, 2008.(3.14%(2.8% at January 31,April 30, 2008) plus 1.25% to 2.75% or the bank’s prime rate (6.0%(5.0% at January 31,April 30, 2008) less 0.0% to minus 1.125%. A hypothetical 1% increase in interest rates would not have a material impact on our financial position or cash flows.January 31,April 30, 2008 by our management, including our Chief Executive Officer (“CEO”) and our Chief Financial Officer16None.On or about April 8, 2008, Design Business Communications, Inc., d/b/a/ American Telephone (“AMTEL”) filed a claim with the American Arbitration Association against the Company and Hitachi Telecom (USA) Inc. (“HITEL”) alleging a breach of AMTEL’s Authorized Distributorship Agreement with HITEL (the “Distributor Agreement”). The Company is involved in this matter by virtue of the fact that in 2006, the Company acquired HITEL’s PBX business and agreed to fulfill HITEL’s surviving service obligations to its authorized distributors under their distributor agreements with HITEL. The AMTEL Distributor Agreement provides that AMTEL may order and the Company shall provide “spare parts, software and third level technical support as required for the maintenance of HITEL PRODUCT for a period of ten years from the ship date of the HITEL PRODUCT.” In April 2007, AMTEL placed an order with the Company under the Distributor Agreement for 48 new telephones totaling approximately $12,200; however, this product had previously been discontinued by HITEL. Because this order has not been fulfilled, AMTEL claims that the Company is in breach of the Distributor Agreement and that as a result, AMTEL has suffered damages in the amount of $5 million (for loss of service and spare part revenues; loss of business reputation; loss of customers; and possible claims by AMTEL customers for breach of its service obligations and sales and service warranties). The Company has filed a response to AMTEL’s arbitration claim and intends to vigorously contest this matter.upgrades..upgrades. Currently, we earn revenues from some of our customers, particularly lodging customers, to provide the products and services now being included by Avaya in its new software support offerings. These changes could have a material, negative impact on our operating results if our revenues or margins are reduced in response to these mandated changes by Avaya.expected.expectedIn the first quarter of fiscal 2008, we installed the initial systems shipped at the end of fiscal 2007. After a customer-driven delay in installations in November, shipments and installations continued satisfactorily throughout the remainder of the quarter. We continue to expect the remaining revenues and gross profits on these orders to be recognized in fiscal 2008 based on current installation schedules. However, overOver the course of the yearproject we may experiencehave experienced delays in the installation schedule due to circumstances out ofbeyond our control as we are reliant on M-DCPS personnelthe customer has substantially altered the installation schedule to assist us in coordinating each installation. Furthermore, we could experienceaccommodate their operational and financial requirements. These changes have compacted the bulk of the installations into a relatively short period of time, thus reducing our ability to maximize the utilization of our staff dedicated to the project. Additional risks associated with this project include delays or a halt in installations due to a variety of other factors including catastrophic weather conditions such as hurricanes, which are prone to the Miami area. Additionally, unexpected technicalwhile not experienced to date, installation challenges or product performance issues could occur also resulting in delays in the recognition of revenues or erosion of gross profits from these orders. Lastly, we have experienced delays in successfully billing and collecting the amounts due on the first wave ofinitial installations. These delays have increased our short-term borrowings and consequently negatively affected our operating results. We expect to workare working through these initial processing details and begin to improve theexpect improved cash flows on this project during our second quarter.for the balance of the year. However, if billing and collection difficulties persist, it17 for us and consume borrowing capacity under our revolving line of credit.None.On April 8, 2008, at our Annual Meeting of Shareholders, the following directors were elected to the Board of Directors. Votes cast for each nominee were as follows:(a) None.(b) On January 23, 2008 the Company’s Board of Directors approved an amendment to the Company’s bylaws which provides for an advance notice procedure for shareholders to nominate individuals for election to the Board (as well as to submit shareholder proposals for consideration at an annual meeting). Shareholders who wish to nominate an individual for election to the Board must comply with the advance notice deadline set forth in the bylaws. This deadline requires that the shareholder provide the Company with written notice no later than 120 days in advance of the anniversary date that proxy materials for the previous year’s annual meeting were first mailed to shareholders; provided, however, that if the meeting date has changed by more than 30 days from the anniversary date of last year’s meeting, then the shareholder must notify the Company and the Company must receive such advance notice no later than the 10th day following the date on which notice of the meeting is first mailed to shareholders or is publicly announced. The notice must also include all of the information specified in the new bylaw provision. The new bylaw provision is set forth in Article 2, Section 2.11 of the Company’s amended and restated bylaws, which are filed as Exhibit 3(ii) to this report. This bylaw amendment was also reported by the Company in its report on Form 8-K filed with the Securities and Exchange Commission (the “Commission”) on January 29, 2008 and is described in the Company’s proxy statement to be filed with the Commission on February 27, 2008.3(ii)Amended and Restated Bylaws of XETA Technologies, Inc. dated January 23, 200831.1Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer31.2Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer32.1Certification 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 2002.1832.2Certification 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 2002.19SIGNATURESPursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.XETA Technologies, Inc.(Registrant)Dated: March 5, 2008By:/s/ Greg D. ForrestGreg D. ForrestChief Executive OfficerDated: March 5, 2008By:/s/ Robert D. WagnerRobert B. WagnerChief Financial Officer20SEC Exhibit No.Description3(ii)Amended and Restated Bylaws of XETA Technologies, Inc. dated January 23, 2008