XETA TECHNOLOGIES, INC. AND SUBSIDIARY

CONSOLIDATED BALANCE SHEETS

(UNAUDITED)

July 31, 2008

October 31, 2007

ASSETS

Current assets:

Cash and cash equivalents

$
74,177

$
402,918

Current portion of net investment in sales-type leases and other receivables

773,723

490,033

Trade accounts receivable, net

23,442,635

16,236,137

Inventories, net

5,839,652

4,296,574

Deferred tax asset, net

670,698

916,259

Prepaid taxes

51,693

19,737

Prepaid expenses and other assets

1,276,467

517,757

Total current assets

32,129,045

22,879,415

Noncurrent assets:

Goodwill

26,323,411

26,365,093

Intangible assets, net

219,600

104,042

Net investment in sales-type leases, less current portion above

118,145

136,493

Property, plant & equipment, net

10,736,742

10,610,820

Other assets

15,563

—

Total noncurrent assets

37,413,461

37,216,448

Total assets

$
69,542,506

$
60,095,863

LIABILITIES AND SHAREHOLDERS’ EQUITY

Current liabilities:

Current portion of long-term debt

$
171,123

$
171,123

Revolving line of credit

6,109,050

2,758,660

Accounts payable

7,652,706

5,670,240

Current portion of obligations under capital lease

146,798

—

Current unearned revenue

3,450,622

2,212,247

Accrued liabilities

4,027,172

3,565,031

Total current liabilities

21,557,471

14,377,301

Noncurrent liabilities:

Long-term debt, less current portion above

1,226,214

1,354,530

Accrued long-term liability

144,100

211,300

Long-term portion of obligations under capital lease

297,743

—

Noncurrent unearned service revenue

64,335

81,650

Noncurrent deferred tax liability, net

5,186,359

4,631,917

Total noncurrent liabilities

6,918,751

6,279,397

Contingencies

Shareholders’ equity:

Preferred stock; $.10 par value; 50,000 shares authorized, 0 issued

—

—

Common stock; $.001 par value; 50,000,000 shares authorized, 11,256,193 and 11,233,529 issued at July 31, 2008 and October 31, 2007, respectively

11,256

11,233

Paid-in capital

13,428,126

13,189,311

Retained earnings

29,834,370

28,483,280

Less treasury stock, at cost (1,001,883 shares at July 31,2008 and 1,018,788 shares at October 31, 2007)

(2,207,468
)
(2,244,659
)
Total shareholders’ equity

41,066,284

39,439,165

Total liabilities and shareholders’ equity

$
69,542,506

$
60,095,863

	January 31, 2009			October 31, 2008

ASSETS

Current assets:
Cash and cash equivalents	$	153,425		$	63,639
Current portion of net investment in sales-type leases and other receivables	497,529			353,216
Trade accounts receivable, net	18,036,679			19,995,498
Inventories, net	6,093,991			5,236,565
Deferred tax asset	826,750			588,926
Prepaid taxes	40,453			64,593
Prepaid expenses and other assets	1,682,152			1,608,113
Total current assets	27,330,979			27,910,550

Noncurrent assets:
Goodwill	26,811,604			26,825,498
Intangible assets, net	768,057			828,825
Net investment in sales-type leases, less current portion above	104,310			103,037
Property, plant & equipment, net	10,445,833			10,722,539
Other assets	1,514			2,271
Total noncurrent assets	38,131,318			38,482,170

Total assets	$	65,462,297		$	66,392,720

LIABILITIES AND SHAREHOLDERS’ EQUITY

Current liabilities:
Current portion of long-term debt	$	1,311,792		$	1,354,565
Revolving line of credit	3,180,107			2,524,130
Accounts payable	5,394,363			6,691,550
Current portion of obligations under capital lease	149,665			148,225
Current unearned service revenue	3,625,880			3,237,296
Accrued liabilities	3,761,094			4,593,725
Total current liabilities	17,422,901			18,549,491

Noncurrent liabilities:
Accrued long-term liability	144,100			144,100
Long-term portion of obligations under capital lease	222,187			260,148
Noncurrent unearned service revenue	68,035			56,393
Noncurrent deferred tax liability	5,741,316			5,545,692
Total noncurrent liabilities	6,175,638			6,006,333

Contingencies

Shareholders’ equity:
Preferred stock; $.10 par value; 50,000 shares authorized, 0 issued	—			—
Common stock; $.001 par value; 50,000,000 shares authorized, 11,256,193 issued at January 31, 2009 and October 31, 2008	11,255			11,255
Paid-in capital	13,480,467			13,493,395
Retained earnings	30,541,982			30,539,714
Less treasury stock, at cost (988,501 shares at January 31,2009 and 1,001,883 shares at October 31, 2008)	(2,169,946		)	(2,207,468		)
Total shareholders’ equity	41,863,758			41,836,896
Total liabilities and shareholders’ equity	$	65,462,297		$	66,392,720

The accompanying notes are an integral part of these consolidated ~~balance sheets.~~financial statements.

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XETA TECHNOLOGIES, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF OPERATIONS

(UNAUDITED)

	For the Three Months						For the Nine Months						For the Three Months
	Ended July 31,						Ended July 31,						Ended January 31,
	2008			2007			2008			2007			2009			2008

Systems sales	$	10,662,567		$	8,657,120		$	28,648,487		$	23,446,191		$	8,585,753		$	7,714,159
Services	12,028,241			9,463,504			31,887,653			27,032,719			9,993,233			9,724,942
Other revenues	512,724			127,669			1,428,950			509,100			1,039			510,634
Net sales and service revenues	23,203,532			18,248,293			61,965,090			50,988,010			18,580,025			17,949,735

Cost of systems sales	7,846,284			6,684,447			21,174,666			17,919,182			6,342,365			5,786,822
Services costs	8,373,080			6,557,194			23,104,061			19,021,635			6,983,739			7,130,924
Cost of other revenues & corporate COGS	781,806			477,190			1,707,157			1,367,060			447,770			441,379
Total cost of sales and service	17,001,170			13,718,831			45,985,884			38,307,877			13,773,874			13,359,125

Gross profit	6,202,362			4,529,462			15,979,206			12,680,133			4,806,151			4,590,610

Operating expenses
Selling, general and administrative	4,870,068			3,705,080			12,795,830			10,946,501			4,456,109			3,662,262
Amortization	265,152			183,721			722,563			470,765			322,251			202,898
Total operating expenses	5,135,220			3,888,801			13,518,393			11,417,266			4,778,360			3,865,160

Income from operations	1,067,142			640,661			2,460,813			1,262,867			27,791			725,450

Interest expense	(96,401		)	(28,536		)	(268,117		)	(38,923		)	(29,903		)	(102,985		)
Interest and other income	99			8,729			27,394			35,190			11,380			17,764
Total interest and other expense	(96,302		)	(19,807		)	(240,723		)	(3,733		)	(18,523		)	(85,221		)

Income before provision for income taxes	970,840			620,854			2,220,090			1,259,134			9,268			640,229
Provision for income taxes	380,000			244,000			869,000			504,000			7,000			251,000

Net income	$	590,840		$	376,854		$	1,351,090		$	755,134		$	2,268		$	389,229

Earnings per share
Basic	$	0.06		$	0.04		$	0.13		$	0.07		$	0.00		$	0.04

Diluted	$	0.06		$	0.04		$	0.13		$	0.07		$	0.00		$	0.04

Weighted average shares outstanding	10,254,310			10,214,741			10,241,861			10,214,741			10,222,494			10,224,971

Weighted average equivalent shares	10,254,310			10,214,741			10,246,811			10,214,741			10,222,494			10,249,693

The accompanying notes are an integral part of these consolidated financial statements.

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XETA TECHNOLOGIES, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY

(UNAUDITED)

Common Stock

Treasury Stock

Shares Issued

Par Value

Shares

Amount

Paid-in Capital

Retained Earnings

Total

Balance- October 31, 2007

11,233,529

$
11,233

1,018,788

$
(2,244,659
)
$
13,189,311

$
28,483,280

$
39,439,165

Stock options exercised $.001 par value

22,664

22

—

—

90,193

—

90,215

Issuance of restricted common stock

—

—

(16,905
)
37,191

(37,191
)
—

—

Tax benefit of stock options

—

—

—

—

4,032

—

4,032

Stock based compensation

—

—

—

—

181,782

—

181,782

Net Income

—

—

—

—

—

1,351,090

1,351,090

Balance- July 31, 2008

11,256,193

$
11,255

1,001,883

$
(2,207,468
)
$
13,428,127

$
29,834,370

$
41,066,284

	Common Stock			Treasury Stock
	Shares Issued	Par Value		Shares		Amount			Paid-in Capital			Retained Earnings		Total

Balance- October 31, 2008	11,256,193	$	11,255	1,001,883		$	(2,207,468	)	$	13,493,395		$	30,539,714	$	41,836,896

Purchase of treasury stock	—	—		25,534		(48,093		)	—			—		(48,093		)
Issuance of restricted common stock	—	—		(38,916	)	85,615			(85,615		)	—		—
Stock based compensation	—	—		—		—			72,687			—		72,687
Net income	—	—		—		—			—			2,268		2,268

Balance- January 31, 2009	11,256,193	$	11,255	988,501		$	(2,169,946	)	$	13,480,467		$	30,541,982	$	41,863,758

The accompanying notes are an integral part of ~~this~~these consolidated financial ~~statement.~~statements.

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XETA TECHNOLOGIES, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

For the Nine Months

Ended July 31,

2008

2007

Cash flows from operating activities:

Net income

$
1,351,090

$
755,134

Adjustments to reconcile net income to net cash provided by (used in) operating activities:

Depreciation

528,811

393,304

Amortization

722,563

470,765

Stock based compensation

181,782

78,554

Loss (gain) on sale of assets

425

(5,000
)
Provision for returns and doubtful accounts receivable

7,924

Provision for excess and obsolete inventory

76,500

76,500

Increase in deferred tax liability

600,156

761,583

Change in assets and liabilities, net of acquisitions:

Increase in net investment in sales-type leases and other receivables

(265,342
)
(133,155
)
Increase in trade account receivables

(7,180,367
)
(2,351,832
)
(Increase) decrease in inventories

(1,590,301
)
577,068

Decrease (increase) in deferred tax asset

245,561

(290,095
)
Increase in prepaid expenses and other assets

(774,273
)
(367,411
)
(Increase) decrease in prepaid taxes

(31,956
)
6,385

Increase (decrease) in accounts payable

1,982,387

(171,013
)
Increase in unearned revenue

1,146,906

876,757

Increase in accrued liabilities

210,632

817,952

Total adjustments

(4,138,592
)
740,362

Net cash (used in) provided by operating activities

(2,787,502
)
1,495,496

Cash flows used in investing activities:

Additions to property, plant & equipment

(841,549
)
(848,326
)
Proceeds from sale of property, plant and equipment

—

5,000

Net cash used in investing activities

(841,549
)
(843,326
)

Cash flows from financing activities:

Net borrowings (reductions) on revolving line of credit

3,350,390

(642,999
)
Principal payments on long-term debt

(128,316
)
(128,318
)
Payments on capital lease obligations

(11,979
)
—

Exercise of stock options

90,215

—

Net cash provided by (used in) financing activities

3,300,310

(771,317
)

Net (decrease) in cash and cash equivalents

(328,741
)
(119,147
)

Cash and cash equivalents, beginning of period

402,918

174,567

Cash and cash equivalents, end of period

$
74,177

$
55,420

Supplemental disclosure of cash flow information:

Cash paid during the period for interest, net of $161,772 capitalized in 2007

$
268,919

$
54,234

Cash paid during the period for income taxes

$
55,208

$
26,159

Capital lease obligations incurred

$
456,520

$
—

	For the Three Months
	Ended January 31,
	2009			2008
Cash flows from operating activities:
Net income	$	2,268		$	389,229

Adjustments to reconcile net income to net cash provided by (used in) operating activities:
Depreciation	224,947			166,810
Amortization	322,251			202,899
Stock based compensation	70,365			54,516
Loss on sale of assets	3,764			425
Provision for returns & doubtful accounts receivable	365,000			—
Provision for excess and obsolete inventory	25,500			25,500
Increase in deferred tax liability	209,518			102,535
Change in assets and liabilities:
(Increase) in net investment in sales-type leases & other receivables	(145,586		)	(401,304		)
Decrease (increase) in trade accounts receivable	1,593,819			(903,872		)
(Increase) in inventories	(882,926		)	(931,924		)
(Increase) decrease in deferred tax asset	(237,824		)	148,465
(Increase) in prepaid expenses and other assets	(73,282		)	(377,387		)
Decrease (increase) in prepaid taxes	24,140			(11,551		)
(Decrease) increase in accounts payable	(1,297,187		)	48,472
Increase in unearned revenue	400,226			404,992
(Decrease) in accrued liabilities	(80,309		)	(949,438		)
Total adjustments	522,416			(2,420,862		)

Net cash provided by (used in) operating activities	524,684			(2,031,633		)

Cash flows from investing activities:
Additions to property, plant & equipment	(218,552		)	(327,496		)
Proceeds from sale of assets	5,064			—
Investment in capitalized service contracts	(750,000		)	—
Net cash used in investing activities	(963,488		)	(327,496		)

Cash flows from financing activities:
Principal payments on debt	(42,773		)	(42,771		)
Net borrowings on revolving line of credit	655,977			2,060,088
Payments on capital lease obligations	(36,521		)	—
Payments to acquire treasury stock	(48,093		)	—
Exercise of stock options	—			90,215
Net cash provided by financing activities	528,590			2,107,532

Net increase (decrease) in cash and cash equivalents	89,786			(251,597		)

Cash and cash equivalents, beginning of period	63,639			402,918
Cash and cash equivalents, end of period	$	153,425		$	151,321

Supplemental disclosure of cash flow information:

Cash paid during the period for interest	$	30,149		$	97,220
Cash paid during the period for income taxes	$	12,860		$	11,519

The accompanying notes are an integral part of these consolidated financial statements.

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XETA TECHNOLOGIES, INC. AND SUBSIDIARY

Notes to Consolidated Financial Statements

~~July~~January 31, ~~2008~~2009

(Unaudited)

1. BASIS OF PRESENTATION:

XETA Technologies, Inc. (“XETA” or the “Company”) is a leading ~~provider~~integrator of advanced communications technologies with nationwide sales and service. XETA serves a diverse group of business clients in sales, engineering, project management, ~~installation,~~implementation, 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 are adequate to reasonably insure the information is not misleading. Management suggests 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.~~23, 2009. Management believes that the financial statements contain all adjustments necessary for a fair statement of the results for the interim periods presented. All adjustments 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~~hospitality system sales. Services revenues represent revenues earned from installing and maintaining systems for customers in both the commercial and ~~lodging~~hospitality segments. The Company defines commercial system sales as sales to the ~~non-lodging~~non-hospitality industry.

The reporting segments follow the same accounting policies used for the Company’s consolidated financial statements and are 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 outside of the U.S. are immaterial.

The following is a tabulation of business segment information for the three months ended ~~July~~January 31, ~~2008~~2009 and ~~2007.~~2008:

																Services Revenues			Commercial Systems Sales			Hospitality Systems Sales			Other Revenues			Total
2009
Sales																$	9,993,233		$	6,296,705		$	2,289,048		$	1,039		$	18,580,025
Cost of sales																(6,983,739		)	(4,801,767		)	(1,540,598		)	(447,770		)	(13,773,874		)
Gross profit																$	3,009,494		$	1,494,938		$	748,450		$	(446,731	)	$	4,806,151
	Services Revenues			Commercial Systems Sales			Lodging Systems Sales			Other Revenue			Total
2008
Sales	$	12,028,241		$	8,366,333		$	2,296,234		$	512,724		$	23,203,532		$	9,724,942		$	6,029,935		$	1,684,224		$	510,634		$	17,949,735
Cost of sales	(8,373,080		)	(6,161,782		)	(1,684,502		)	(781,806		)	(17,001,170		)	(7,130,924		)	(4,601,659		)	(1,185,163		)	(441,379		)	(13,359,125		)
Gross profit	$	3,655,161		$	2,204,551		$	611,732		$	(269,082	)	$	6,202,362		$	2,594,018		$	1,428,276		$	499,061		$	69,255		$	4,590,610

2007
Sales	$	9,463,504		$	6,522,225		$	2,134,895		$	127,669		$	18,248,293
Cost of sales	(6,557,194		)	(5,152,119		)	(1,532,328		)	(477,190		)	(13,718,831		)
Gross profit	$	2,906,310		$	1,370,106		$	602,567		$	(349,521	)	$	4,529,462

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~~The following is a tabulation of business segment information for the nine months ended July 31, 2008 and 2007.~~

Services
Revenues

Commercial
Systems
Sales

Lodging
Systems
Sales

Other
Revenue

Total

2008

Sales

$
31,887,653

$
23,171,342

$
5,477,145

$
1,428,950

$
61,965,090

Cost of sales

(23,104,061
)
(17,247,331
)
(3,927,335
)
(1,707,157
)
(45,985,884
)
Gross profit

$
8,783,592

$
5,924,011

$
1,549,810

$
(278,207
)
$
15,979,206

2007

Sales

$
27,032,719

$
17,253,332

$
6,192,859

$
509,100

$
50,988,010

Cost of sales

(19,021,635
)
(13,328,915
)
(4,590,267
)
(1,367,060
)
(38,307,877
)
Gross profit

$
8,011,084

$
3,924,417

$
1,602,592

$
(857,960
)
$
12,680,133

Stock-Based Compensation Plans

The Company accounts for stock-based compensation in accordance with Statement of Financial Accounting Standards No. 123 (revised 2004), “Share-Based Payment” (“SFAS No. 123(R)”). SFAS No. 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 statements of operations as follows:

2008

2007

Three months ended July 31,

$
65,221

$
30,685

Nine months ended July 31,

$
181,782

$
78,554

	2009		2008
Three months ended January 31,	$	70,365	$	54,516

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 Financial Accounting Standards Board (“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 onOn November 1, ~~2007 and there was no impact to~~2008 the ~~Company’s financial statements.~~

~~In September 2006, the FASB issued~~Company adopted Statement of Financial Standards No. 157, “Fair Value Measurements” (“SFAS No. 157”). SFAS No. 157 defines fair value, establishes a framework for measuring fair value in accordance with accounting principles generally accepted in the United States, and expands disclosures about fair value measurements. This statement does not require any new fair value measurements; rather, it applies under other accounting pronouncements that require or permit fair value measurements. The ~~provisions of SFAS 157 are effective for fiscal years beginning after November 15,~~

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over the financial asset. An initial transfer of a financial asset and repurchase financing that are entered into contemporaneously with, or in contemplation of, one another shall be considered linked unless all of the following criteria are met at the inception of the transaction:

· The initial transfer and the repurchase financing are not contractually contingent on one another.

· The repurchase financing provides the initial transferor with recourse to the initial transferee upon default.

· The financial asset subject to the initial transfer and repurchase financing is readily obtainable in the marketplace.

· The financial asset and repurchase agreement are not coterminous (the maturity of the repurchase financing must be before the maturity of the financial asset).

The FSP is effective for financial statements issued for fiscal years beginning after November 15, 2008, and interim periods within those fiscal years. Earlier application is not permitted. The Company does not currently utilize repurchase financing; therefore, the implementation of this FSP is not expected to have a material impact on the Company’s financial position or results of operations.

In March 2008 the FASB issued SFAS No. 161, “Disclosure about Derivative Instruments and Hedging Activities, an amendment of SFAS No. 133”, (“SFAS No. 161”). This statement requires that objectives for using derivative instruments be disclosed in terms of underlying risk and accounting designation. The Company is required to adopt SFAS No. 161 on or before November 1, 2009. The Company currently does not participate in any derivative instruments or hedging activities as defined under SFAS No. 133 and therefore it is unlikely that the adoption of SFAS No. 161 will have any impact on the Company’s consolidated financial statements.

In April 2008 the FASB issued FASB Staff Position on Financial Accounting Standard No. 142-3, “Determination of the Useful Life of Intangible Assets”, which amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of intangible assets under SFAS No. 142 “Goodwill and Other Intangible Assets”. The intent of this FSP is to improve the consistency between the useful life of a recognized intangible asset under SFAS No. 142 and the period of the expected cash flows used to measure the fair value of the asset under SFAS No. 141 (revised 2007) “Business Combinations” and other U.S. generally accepted accounting principles. The Company will adopt this FSP in the first quarter of fiscal 2010 and will apply the guidance prospectively to intangible assets acquired after adoption.

In May 2008 the FASB issued SFAS No. 162, “The Hierarchy of Generally Accepted Accounting Principles” (“~~FAS No.162”~~SFAS No. 162”). SFAS No. 162 identifies the sources of accounting principles and the framework for selecting the principles used in the preparation of financial statements. SFAS No. 162 isbecame effective ~~60 days~~on November 15, 2008 following the SEC’s approval of the Public Company Accounting Oversight Board amendments to AU Section 411, “The Meaning of Present Fairly in Conformity with Generally Accepted Accounting Principles”. The implementation of this standard ~~will~~did not have a material impact on the Company’s consolidated financial position and results of operations.

2. ACCOUNTS RECEIVABLE:

Accounts receivable consists of the following:

July 31,
2008

(Audited)
October 31,
2007

Trade receivables

$
23,597,028

$
16,411,981

Less reserve for doubtful accounts

(154,393
)
(175,844
)
Net trade receivables

$
23,442,635

$
16,236,137

	January 31, 2009			(Audited) October 31, 2008

Trade accounts receivables	$	18,573,112		$	20,188,378
Less reserve for doubtful accounts	(536,433		)	(192,880		)
Net trade accounts receivables	$	18,036,679		$	19,995,498

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On January 14, 2009 Nortel Networks Corporation (“Nortel”) filed for bankruptcy protection in the United States. At the time of the filing, Nortel owed approximately $685,000 for services rendered under the Company’s wholesale managed services program in which the Company is engaged by Nortel to provide field technical services to Nortel’s end-user customers. The bankruptcy is in its early stages and at the time of this filing, Nortel has not filed its reorganization plan. Therefore our ability to assess the probability of recovering pre-petition amounts due is limited. As of January 31, 2009, we have recorded $350,000 as a reserve against possible bad debts. This provision represents fifty percent of the unsecured claim. We are carefully following developments in the bankruptcy case and will assert our available legal rights and defenses when appropriate.

3. INVENTORIES:

Inventories are stated at the lower of cost (first-in, first-out or average) or market and consist of the following:

	July 31, 2008			(Audited) October 31, 2007			January 31, 2009			(Audited) October 31, 2008

Finished goods and spare parts	$	6,709,559		$	5,068,227		$	6,959,016		$	6,084,830
Less- reserve for excess and obsolete inventories	(869,907		)	(771,653		)	(865,025		)	(848,265		)
Total inventories, net	$	5,839,652		$	4,296,574		$	6,093,991		$	5,236,565

4. PROPERTY, PLANT AND EQUIPMENT:

Property, plant and equipment consist of the following:

Estimated
Useful
Lives

July 31,
2008

(Audited)
October 31,
2007

Building and building improvements

3-20

$
2,927,261

$
2,686,753

Data processing and computer field equipment

2-7

3,169,779

2,556,878

Software development costs, work-in-process

N/A

2,291,619

3,792,567

Software development costs of components placed into service

3-10

6,275,087

4,355,953

Hardware

3-5

605,876

599,751

Land

—

611,582

611,582

Office furniture

5-7

944,048

947,094

Auto

5

516,185

539,184

Other

3-7

239,533

239,533

Total property, plant and equipment

17,580,970

16,329,295

Less- accumulated depreciation

(6,844,228
)
(5,718,475
)

Total property, plant and equipment, net

$
10,736,742

$
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 $161,772 in interest costs in the nine months ended July 31, 2007.

	Estimated Useful Lives	January 31, 2009			(Audited) October 31, 2008

Building and building improvements	3-20	$	3,118,424		$	3,054,563
Data processing and computer field equipment	2-7	3,365,902			3,351,229
Software development costs, work-in-process	N/A	1,916,313			2,069,234
Software development costs of components placed into service	3-10	6,873,428			6,631,805
Computer hardware	3-5	626,193			615,657
Land	-	611,582			611,582
Office furniture	5-7	929,885			944,048
Auto	5	497,285			516,185
Other	3-7	238,871			239,533

Total property, plant and equipment		18,177,883			18,033,836
Less- accumulated depreciation and amortization		(7,732,050		)	(7,311,297		)

Total property, plant and equipment, net		$	10,445,833		$	10,722,539

5. INCOME TAXES:

The ~~Company has recorded a~~ tax provision ~~of $869,000 or 39% and $504,000 or 40% for~~reflects the ~~nine months ended July 31, 2008 and 2007, respectively, reflecting the statutory federal~~effective Federal tax rate ~~of 34%~~ plus ~~a blended~~the composite state income tax ~~rate of approximately 5% and the impact of~~rates adjusted for states that require minimum ~~income~~ tax payments ~~in certain states. The Company currently estimates its annual effective income~~even if tax losses are incurred. Generally, we expect our tax provision rate ~~for fiscal 2008 at~~to be approximately 40%.

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6. CREDIT AGREEMENTS:

The ~~Company’s~~Company has a credit facility ~~consists of a revolving line of credit and term loan~~ with a commercial ~~bank. The agreement~~bank that includes a ~~mortgage that matures on September 30, 2009 with amortization based on a 13-year life,~~term loan and a $7.5 million revolving line of credit. The facility matures on September 30, 2009. The term loan, which is collateralized with a first mortgage on the Broken Arrow, Oklahoma, headquarters, amortizes based on a 13 year life. The revolving line of credit ~~agreement~~is used to finance growth in working capital ~~needs. Trade~~and is collateralized by trade accounts receivable and ~~inventories collateralize~~inventories.

At January 31, 2009 and October 31, 2008, the ~~revolving line of credit. The~~ Company had approximately ~~$6.109~~$3.180 million and ~~$2.759~~$2.524 million, respectively, outstanding on the revolving line of credit. The Company had approximately ~~$1.4~~$4.3 million available under the revolving line of credit at ~~July~~January 31, ~~2008.~~2009. 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 30, 2009. Long-term~~Long term debt consisted of the following:

	July 31, 2008		(Audited) October 31, 2007		January 31, 2009		(Audited) October 31, 2008

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	$	1,397,337	$	1,525,653
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					$	1,311,792	$	1,354,565

Less-current maturities	171,123		171,123		1,311,792		1,354,565

Total long-term debt, less current maturities	$	1,226,214	$	1,354,530	$	—	$	—

Interest on all outstanding debt under the credit facility accrues at either a) the London Interbank Offered Rate ~~(2.461%~~(“LIBOR”) (.419% at ~~July~~January 31, ~~2008)~~2009) plus 1.25% to 2.75% depending on the Company’s funded debt to cash flow ratio, or b) the bank’s prime rate ~~(5.0%~~(4.0% at ~~July~~January 31, ~~2008)~~2009) minus 0% to minus 1.125% also depending on the Company’s funded debt to cash flow ratio. At ~~July~~January 31, ~~2008,~~2009 the Company was paying ~~4.125%~~2.875% on the revolving line of credit borrowings and ~~4.211%~~3.00% on the ~~mortgage.~~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 annual earnings before interest, taxes, depreciation and amortization, limitations on capital spending, and debt service coverage requirements. At January 31, 2009 the Company was in compliance with the covenants of the credit facility.

7. EARNINGS PER SHARE:

The 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. 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:

For the Three Months Ended July 31, 2008

Income
(Numerator)

Shares
(Denominator)

Per Share
Amount

Basic EPS

Net income

$
590,840

10,254,310

$
0.06

Dilutive effect of stock options

—

Diluted EPS

Net income

$
590,840

10,254,310

$
0.06

	For the Three Months Ended July 31, 2007					For the Three Months Ended January 31, 2009
	Income (Numerator)		Shares (Denominator)	Per Share Amount		Income (Numerator)		Shares (Denominator)	Per Share Amount
Basic EPS
Net income	$	376,854	10,214,741	$	0.04	$	2,268	10,222,494	$	0.00
Dilutive effect of stock options			—					—

Diluted EPS
Net income	$	376,854	10,214,741	$	0.04	$	2,268	10,222,494	$	0.00

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For the Nine Months Ended July 31, 2008

Income
(Numerator)

Shares
(Denominator)

Per Share
Amount

Basic EPS

Net income

$
1,351,090

10,241,861

$
0.13

Dilutive effect of stock options

4,950

Diluted EPS

Net income

$
1,351,090

10,246,811

$
0.13

	For the Nine Months Ended July 31, 2007					For the Three Months Ended January 31, 2008
	Income (Numerator)		Shares (Denominator)	Per Share Amount		Income (Numerator)		Shares (Denominator)	Per Share Amount
Basic EPS
Net income	$	755,134	10,214,741	$	0.07	$	389,229	10,224,971	$	0.04
Dilutive effect of stock options			—					24,722

Diluted EPS
Net income	$	755,134	10,214,741	$	0.07	$	389,229	10,249,693	$	0.04

Options to purchase ~~1,029,500~~1,288,300 shares of common stock at an average exercise price of ~~$7.28~~$6.43 and ~~978,668~~774,900 shares of common stock at an average exercise price of ~~$7.00~~$8.43 were not included in the computation of diluted earnings per share for the three months ended ~~July~~January 31, ~~2008~~2009 and 2007, respectively, because inclusion of these options would be antidilutive. Options to purchase 844,900 shares of common stock at an average exercise price of $8.08 and 1,068,668 shares of common stock at an average exercise price of $6.69 were not included in the computation of diluted earnings per share for the nine months ended July 31, 2008, ~~and 2007,~~ respectively, because inclusion of these options would be antidilutive.

8. CAPITAL LEASES:

During 2008, the Company leased software licenses under an agreement that is classified as a capital lease. The book value of the licenses is included in the balance sheet as property, plant, and equipment and was ~~$443,839~~$367,752 at ~~July~~January 31, ~~2008.~~2009. Accumulated amortization of the leased equipment at ~~July~~January 31, ~~2008~~2009 was ~~$12,681.~~$88,768. Amortization of assets under the capital lease is included in depreciation expense. The future minimum lease payments required under the capital lease and the present value of the net minimum lease payments as of ~~July~~January 31, ~~2008,~~2009, are as follows:

	Capital Lease Payments		Capital Lease Payments

1 Year	$	161,435	$	161,435
2 Years	161,435		161,435
3 Years	147,982		67,265
Total minimum lease payments	470,852		390,135
Less- imputed interest	26,311		18,283
Present value of minimum payments	444,541		371,852
Less-current maturities of capital lease obligation	146,798		149,665
Long-term capital lease obligation	$	297,743	$	222,187

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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~~relating to future events and our future performance and results. ~~Such~~All statements other than those that are ~~not guarantees of performance, but rather reflect our current expectations, estimates, and forecasts about the industry and markets where we operate.~~purely historical may be forward-looking statements. Forward-looking statements generally include words such as “expects,” “anticipates,” “may”, “plans,”�� “believes,” “intends,” “projects,” “estimates,” “targets,” “may,” “should” and similar words or expressions. Such statements are not guarantees of performance, but rather reflect our current expectation, estimates, and forecasts about the industry and markets in which we operate, and our assumptions and beliefs based upon information currently available to us. 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; an uncertain,~~control. Examples of these risks include: the U.S. ~~economy~~economic crisis and its impact on capital spending trends ~~within~~in our ~~market;~~markets; the tightening of credit availability in the U.S.; the recent bankruptcy filing by Nortel Networks; the financial condition of our suppliers in general and changes by them in their distribution strategies and support; our ability to ~~successfully develop~~maintain and improve upon current gross profit margins; unpredictable revenue levels from quarter to quarter; continuing acceptance and success of the Mitel product and services offering; intense competition and industry consolidation; dependence upon a few large wholesale customers in our Managed Services offering; and the ~~financial condition~~availability and retention of ~~our suppliers~~revenue professionals and ~~changes in their distribution strategies~~certified technicians, 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.other . 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~~2008 (filed with the Commission on January ~~7, 2008)~~23, 2009), and in updates to such risk factors set forth in Item 1A of Part II of this quarterly ~~report and our quarterly reports for the first and second quarter of fiscal 2008.~~report. 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

Strategy.

In fiscal 2009 we have adopted five primary strategies: continue to acquire market share through aggressive sales activities; take advantage of Avaya’s new channel-centric go-to-market strategy; focus on fast growing applications such as unified communications; focus on industry verticals such as hospitality, healthcare and education; and augment growth through targeted acquisitions.

In ~~fiscal 2008, we have continued~~addition to ~~focus~~these strategies, senior management initiated an internal program to improve operational methods and practices. The purpose of this effort is to identify internal opportunities to reduce costs. These efforts are ongoing, and include development of new and refined processes; organize back office activities for improved labor utilization; use internal systems and technologies to automate routine activities; and review workforce utilization to ensure appropriate staffing composition.

Special Considerations.

On January 14, 2009 Nortel Networks Corporation filed for bankruptcy protection in the United States Bankruptcy Court for the District of Delaware. This filing was the culmination of Nortel’s efforts to “put [Nortel] on ~~three primary strategies: acquire, penetrate,~~sound financial footing once and ~~retain targeted customers; expand our wholesale service offerings;~~for all” as stated publicly by Nortel’s president and ~~improve organizational alignment with~~chief executive, Mike Zafirovski. Nortel is one of our major ~~business partners.~~suppliers and represents a significant portion of our business. As such this filing is of considerable concern. Presently we expect our post-petition relationship with Nortel to continue without interruption. However, management clearly recognizes the potential impact of Nortel’s filing on the Company’s financial performance. In response we are closely monitoring developments associated with the filing and will respond appropriately as new information becomes available.

~~Our sales efforts target large, multi-location, national, or super-regional customers. Our national technical footprint~~Nortel currently owes XETA approximately $685,000 in pre-petition accounts receivable at January 31, 2009. At this filing the bankruptcy is in its early stages and 24/7/365 contact 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 andNortel has not filed its reorganization plan. This limits our ability to ~~sell and service both~~assess the ~~Avaya and Nortel product lines is an important competitive advantage. Because~~probability of ~~our extensive array~~recovering pre-petition amounts due. As of products and services, we enjoy multiple sales opportunities with these customers, 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 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.

We launched our wholesale service offering in fiscal 2006 and its success has been a key contributor to our growth in recurring revenue. Under this service offering, we collaborate 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. Our entry into the wholesale services market has succeeded because of excellent service to end-user customers and our 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.

Finally, we strive to align our Company’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 Avaya’s national sales force to sell equipment to large and medium sized enterprises and to sell Avaya implementation and post-warrantyJanuary 31,

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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 2006,2009, we have ~~improved our relationships and penetration with both Nortel and Avaya, resulting in a demonstrable increase in equipment and services revenues.~~

~~In early fiscal 2008 we became a dealer for Mitel, selling their communications systems primarily to smaller properties~~recorded $350,000 as an additional reserve against possible bad debts. This provision represents one-half of the unsecured claim. We are carefully following developments in the ~~hospitality market thereby opening up a new segment of the market for us. Additionally, the Mitel product line provides us an opportunity to serve certain hotel chains~~bankruptcy case and ~~management companies who have standardized on the Mitel platform.~~will assert our legal rights and defenses as appropriate.

Operating Summary.

In the ~~third~~first quarter of fiscal ~~2008~~2009, we earned net income of ~~$591,000~~$2,000 on revenues of ~~$23.2~~$18.58 million compared to net income of ~~$377,000~~$389,000 on revenues of ~~$18.2~~$17.95 million in the ~~third~~first fiscal quarter of ~~last year. For the first nine months of fiscal 2008, we earned $1.351 million in net income on revenues of $61.9 million compared to net income of $755,000 on revenues of $51.0 million.~~2008. These results reflect a cautionary bad debt provision of $350,000 in response to Nortel’s bankruptcy filing and the successful execution of our strategies discussed above and other contributing factors such as our large equipment and implementation project with the Miami Dade County Public School system (“M-DCPS”) system all of which are discussed in more detail under “Results of Operations” below.challenges posed by macroeconomic conditions.

Financial Position Summary.

Since October 31, ~~2007,~~2008, our working capital increased approximately 24%. This is due in part to the receivables associated with the M-DCPS project that have grown rapidly due to the complex procedures required to collect the fundsfinancial condition improved and we generated positive cash flows from both the school district and the Federal agency that administers the project funding . The growth in these receivables has resulted in increased borrowings on our working capital revolver in fiscal 2008.operations. We discuss these and other financial items in more detail under “Financial Condition” below.

The following discussion presents additional information regarding our financial condition and results of operations for the ~~three-~~three month period ended January 31, 2009 and ~~nine-month periods ended July 31,~~ 2008 ~~and 2007~~ and should be considered in conjunction with our above comments as well as the “Risk Factors” section below.

Financial Condition

~~Cash used~~

Our financial condition improved during the first fiscal quarter of 2009 as our working capital grew by ~~operations for the nine months ended July 31, 2008 was $2.8~~6% to $9.9 million. ~~As stated above, the complex and lengthy procedures required to collect funds on the M-DCPS project has resulted~~In addition we generated $525,000 in ~~higher than expected growth~~cash flows from operations. These cash flows included non-cash charges of $1.66 million, a decrease in accounts receivable of $1.59 million, and an increase in deferred tax liabilities of $210,000. These increases were partially offset by a decrease in accounts payable of $1.30 million, an increase in inventory of $883,000 and other changes in working capital items, which netted a decrease in cash of $113,000. We increased ~~short-term borrowing~~borrowings on our ~~revolving~~working capital line of credit ~~facility. The M-DCPS project is jointly funded by the school district~~of $656,000 and the Federal Government. Generally, the school district pays ten percent (10%) of the project plus amounts for certain equipment and services not covered by the program and the federal government pays approximately ninety percent (90%) of the qualifying expenditures. Under the rules of the program, the Universal Service Administration Company which is the agency tasked with administering this program, cannot release funding until they receive proof of paymentreceived proceeds from the ~~school district. These requirements have extended the collection period~~sale of capital assets of $5,000. We used cash to reduce our mortgage balance through scheduled principal payments by $43,000; to purchase capitalized service contracts of $750,000; to fund other financing and investing activities of $85,000; and to acquire capital assets of $219,000. Of these expenditures, $114,000 was spent on these projects beyond our original expectations. The collection of these accounts is not in question and we are regularly receiving payments on projects, however we do not expect collection of all the proceeds until well into the first quarter of fiscal 2009.

~~In addition to the cash used by operations, we invested approximately $842,000 in~~ capital ~~projects, including $417,000 in~~ equipment ~~and fixtures,~~ as part of ~~our~~ normal replacement of our Information Technology infrastructure and ~~refurbishment cycles. Additionally, we invested $424,000 in~~headquarters facility improvements. The remaining $99,000 was spent on our Oracle implementation. Non-cash charges included depreciation of $225,000; amortization of $322,000; stock-based compensation of $70,000; a loss on the ~~continued implementation~~sale of ~~Oracle’s eBusiness Suite. Early in~~assets of $4,000; a provision for doubtful accounts receivable of $365,000; and a provision for obsolete inventory of $26,000.

As noted above, our deferred tax liabilities increased $210,000 during the ~~second~~first fiscal quarter of ~~fiscal 2008, we completed~~2009 and the ~~cutover~~balance of our noncurrent deferred tax liabilities was $5.7 million at January 31, 2009. Most of this balance and the increase in this account are due to the difference in accounting for Goodwill between generally accepted accounting principles (“GAAP”) and the U.S. tax code. Under GAAP, Goodwill is not amortized, but instead is evaluated for impairment. This evaluation is conducted as conditions warrant, but not less than annually under the guidelines set forth in SFAS No. 142, “Goodwill and Other Intangible Assets”. For tax purposes, Goodwill is amortized on a straight-line basis over 15 years. As a result, the Company receives a tax deduction of approximately 1/15th of its Goodwill balance each year in its tax return. This difference between no amortization expense being recorded in the GAAP-based operating statements and approximately $1.8 million in deductions taken on the tax return is recognized in the balance sheet as additional noncurrent deferred tax liabilities. The amount recorded is the difference multiplied by the effective tax rate. This difference is recorded as a noncurrent item because under GAAP deferred taxes are recorded as current or noncurrent based on the classification of the ~~last major functional module~~asset or liability which generated the deferred tax item. The deferred tax liability associated with accounting for Goodwill will not be reduced unless the Company records an impairment charge to the Oracle platform. During the remainder of fiscal 2008, we expect to implement additional features, including sales management, customer relationship management and an online service ticket creation and tracking system.Goodwill in a future accounting period.

At ~~July~~January 31, ~~2008~~2009 the balance on our ~~total~~working capital revolver was $3.2 million, with $4.3 million additional borrowings ~~were $7.5 million, consisting of a~~available. We believe that this capacity is sufficient to support our operating requirements for the foreseeable future. The working capital revolver and the mortgage on our headquarters ~~building of $1.4 million~~facility are scheduled to mature on September 30, 2009. We expect to renew these instruments for 12-month and ~~$6.1 million due on our revolving line of credit. At July 31, 2008 there was $1.4 million~~36-month periods, respectively, prior to their expiration. Given current credit market conditions, it is

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likely that such renewals could result in higher borrowing costs and/or reduced availability for unsecured borrowings. In addition to the available capacity under ~~the revolver to meet~~our working capital ~~needs. We believe that the current amount of working capital available under our revolving~~ line of credit, ~~is 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~~may have access to a variety of capital sources such as bank debt, private placements of subordinated debt, and ~~prices.~~public or private sales of equity.

~~The table below presents our contractual obligations at July 31, 2008 as well as payment obligations over the next five years:~~

Payments due by period

Total

Less than
1 year

2 – 3
Years

4 – 5
Years

Contractual Obligations

Long-term debt

$
1,461,453

$
226,680

$
1,234,773

$
—

Capital lease

470,852

161,435

309,417

—

Operating leases

541,650

299,110

241,580

960

Total

$
2,473,955

$
687,225

$
1,785,770

$
960

Results of Operations

In the ~~third~~first quarter of fiscal ~~2008~~2009 our revenues increased ~~$5.0 million~~$630,000 or ~~27%~~4% compared to the ~~third~~first quarter ~~last year,~~of 2008, and our net income ~~increased $214,000~~decreased $387,000 or ~~57%. In the first nine months of the year, our revenues increased $11.0 million or 22% and our earnings increased $596,000 or 79%~~99%. These results ~~primarily~~ reflect ~~increased revenues~~higher sales in ~~all of~~ our major revenue ~~categories coupled with higher margins on sales~~categories. However, the impact of ~~equipment.~~these increased revenues was offset by a $350,000 bad debt provision in response to Nortel’s bankruptcy filing. The narrative below provides further explanation of these results.

~~Services Revenues~~.

Our services revenues increased $2.6 million or 27% in the third quarter and $4.9 million or 18% for the year-to-date periods compared to the same periods last year. Services revenues consist of the following:

For the Three Months Ended
July 31,

For the Nine Months Ended
July 31,

2008

2007

2008

2007

Contract & T&M

$
7,202,000

$
6,745,000

$
21,438,000

$
19,059,000

Implementation

3,864,000

2,075,000

8,250,000

5,988,000

Cabling

962,000

644,000

2,199,000

1,986,000

Total Services revenues

$
12,028,000

$
9,464,000

$
31,887,000

$
27,033,000

Contract and time-and-materials (T&M) revenues increased 7% and 12%respectively in the third quarter and year-to-date periods. These growth rates reflect slowing growth in our base of commercial contract revenues, weak demand for T&M services throughout fiscal 2008, and the relative stability of our lodging maintenance contract base, which represents approximately 50% of our total Contract and T&M revenues. As discussed above, one of our primary strategies is to grow our commercial maintenance revenues to improve our profit margins and the predictability of our results. We are pleased with the continued growth of this part of our business, even though the rate of growth in commercial contract revenues has decreased during fiscal 2008 due to fewer additions of new customer programs. Under most of our large commercial maintenance contracts, our customer is a network service provider, manufacturer, or a technology integrator who has the direct contractual relationship with the end-user of the equipment. These customers contract with end-users who are often large, national enterprises to provide a range of services which include servicing the communications equipment and ancillary technology. Competition is fierce for the opportunity to contract with these large end-users and a range of service delivery issues must be addressed. This process can take months as details are debated and negotiated. Once the end user selects their service provider, the contracting process is often prolonged as well. Finally, the transition of services to a new provider is often stretched out over several months to minimize the impact to the end-user. Our involvement in this process varies from full participation with our customer in the sales process to being transparent to the end user. Regardless of our role in the sales process, our ability to impact the pace of decisions and the pace of contract negotiations is usually minimal. Because of these reasons and the fact that there a only few large opportunities available at any given time, the timing our acquisition of new revenues in this area is unpredictable. Through the first nine months of fiscal 2008, we are encouraged by the number and size of

~~Table of Contents~~

~~new service program opportunities. and we are confident that we will eventually incorporate many of these opportunities into our service revenue base.~~

Throughout fiscal 2008, we have experienced a decline in T&M revenues. We believe this decline is largely due to macro economic conditions that have slowed the growth of customer workforces and reduced non-essential spending.

Implementation revenues increased 86% and 38%, respectively in the third fiscal 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 fiscal quarter and continued through most of the third quarter generating record implementation revenues for the third fiscal quarter.

Cabling revenues increased 49% and 11%, respectively in the third fiscal quarter and year-to-date periods. This revenue category was also helped by the surge in installations of systems under the M-DCPS contract as a large portion of the schools required reconfiguration of their communications wiring.

Systems Sales.

In the ~~third~~first quarter of fiscal ~~2008,~~2009, systems sales increased approximately ~~$2.0 million~~$872,000 or ~~23%~~11% compared to the same period last year. This increase includes a ~~$1.8 million~~$267,000 or ~~28%~~4% increase in sales of systems to commercial customers and a ~~$161,000~~$605,000 or 8%36% increase in sales of systems to ~~lodging~~hospitality customers. Year-to-date systems sales increased $5.2 million or 22% compared to last year. This includes an increase in sales of systems to commercial customers of $5.9 million or 34% and a decrease in sales of systems to lodging customers of $716,000 or 12%. The increase in sales to commercial customers primarily reflects ~~sales~~the maturation of ~~systems to M-DCPS. Shipments and installations for M-DCPS accelerated in~~our backlog at the conclusion of fiscal 2008. These revenues were balanced across a number of large projects shipped during the last ~~half~~one-third of the ~~second fiscal quarter and continued strong through most of the third fiscal~~ quarter. We anticipate completion of this project during our fourth fiscal quarter. Orders for systems to commercial customers other than M-DCPS are slightly below last year’s pace. We believe this decline primarily reflects customers extending the sales cycle due to uncertainty in the U.S. economy.

The quarterly growth in sales of systems to ~~lodging~~hospitality customers reflects our continued success in this niche ~~market and~~market. Results support our strategy to expand the ~~early success of~~revenues associated with our ~~new~~ Mitel product offering. The Mitel product line provides us with the opportunity to work with ~~certain~~ hotel chains and property management companies that have standardized on the Mitel product line. ~~The year-to-date~~In addition, the Mitel offering is well-suited to properties of 150 rooms and below. This presents us an avenue to aggressively pursue system sales opportunities in this property category. We are pleased with our hospitality results and will continue to exploit opportunities across this segment. While we anticipate continued success in the hospitality market, given economic conditions, we expect future revenue performance at or below historical levels.

Services Revenues.

Our services revenues increased $268,000 or 3% in the first quarter compared to the same period last year. Services revenues consist of the following:

	For the Three Months Ended January 31,
	2009		2008
Contract & T&M	$	6,975,000	$	7,208,000
Implementation	2,186,000		2,042,000
Cabling	832,000		475,000
Total Services revenues	$	9,993,000	$	9,725,000

Contract and time-and-materials (T&M) revenues decreased 3% in the first quarter. This performance reflects relatively flat growth in our wholesale services programs and a modest decline in ~~sales of systems to lodging customers is a difficult comparison to fiscal 2007. Results for fiscal 2007~~T&M service revenues. We believe these revenues were ~~beneficially~~ influenced by ~~an acceleration of orders from~~general economic conditions as customers ~~wanting to avoid a mid-year manufacturer’s price increase. Because of strong order rates~~reduced spending on non-critical services. Also, we experienced some customer churn in our wholesale services business during the quarter.

Implementation revenues increased 7% in the ~~third~~first fiscal ~~quarter,~~quarter. We attribute this to increasing demand for complex communication systems. These projects require significant fee-generating design and engineering services provided by our ~~year-to-date lodging equipment orders~~Professional Services Organization (“PSO”). As the market continues to displace conventional communication platforms and adopt complex systems, we anticipate continued growth in this area of our business through the fee-based utilization of these highly skilled technical resources.

Cabling revenues increased 75% in the first fiscal quarter. This increase is attributed primarily to revenues associated with a small number of major cabling projects. We are ~~outpacing last year.~~pleased with the beneficial growth

~~Table of Contents~~

~~continue to monitor the balance between revenue growth and cost structure to try to maintain our targeted profitability levels for this portion of our business.~~

	For the Three Months Ended January 31,
Gross Margins	2009		2008
Systems sales	26.1	%	25.0	%
Services revenues	30.1	%	26.7	%
Other revenues	-7,869.4	%	89.0	%
Corporate cost of goods sold	-2.0	%	-2.2	%
Total	25.9	%	25.6	%

Gross margins on systems sales in the ~~third~~first fiscal quarter ~~and the year-to-date period were up~~improved slightly over last year ~~and exceed~~exceeding our target of 23% to 25% for systems revenues. ~~This trend is consistent for system sales~~These results are due primarily to strong margins in our ~~commercial and lodging customers.~~hospitality business. We continue to receive ~~strong~~considerable pricing support from our ~~vendors~~manufactures 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.

The gross margins earned on Services revenues reflect improved results in this area of our business. The contributing factors associated with these improved results center on a 43% growth in cabling revenues, a reduction in fixed costs, and the use of third party Quality Service Partners to maximize margins on these revenues. In addition we benefited from improved utilization of our PSO and realized favorable results from cost containment efforts.

The final component of 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 associated with these revenues and gross profits. In the first ~~nine months~~quarter we experienced a dramatic drop in other revenues as compared to the first quarter of ~~the year,~~2008. The decline was expected as we ~~enjoyed significantly~~benefitted from record levels of commissions earned from Avaya throughout 2008 as customers purchased or renewed Avaya service contracts at a higher ~~commission~~than normal pace in anticipation of manufacturer price increases for these services. We expect revenues ~~from sales~~on this element of ~~Avaya maintenance contracts. These revenues were material~~our business to ~~our overall operating income~~return to historical norms in ~~all periods presented.~~2009. 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 three quarters 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 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.

Operating Expenses.

Our total operating expenses increased ~~$1,246,000~~$913,000 or ~~32%~~24% in the ~~third~~first quarter of fiscal ~~2008~~2009 compared to the ~~third~~first quarter of fiscal ~~2007.~~2008. Operating expenses were 22.1% of revenues in the third quarter compared to 21.3% last year. Operating expenses increased $2,101,000 or 18% for the year to date period compared to the same period a year ago. Operating expenses were 21.8%25.7% of revenues in the first ~~three quarters of fiscal 2008~~quarter compared to ~~22.4% for~~21.5% in the ~~same period~~first quarter last year. The growth in operating expenses in the ~~third fiscal~~ quarter over quarter comparison reflects several factors:

· ~~Personnel additions~~Significant bad debt provision in response to ~~exploit new managed services opportunities~~the Nortel bankruptcy filing

· Increased expenditures to support the Oracle ~~eBusiness~~ platform

· Increased board of director fees to support the addition of independent membership to the board

·Increased legal fees to support litigation and board activities

· Increased non-cash charges related to stock compensation expense for equity grants provided to management and key employees

· Increased amortization ~~of the~~of: Oracle platform ~~capitalized costs~~ in association with its expanded utilization; and intangible assets associated with ~~the expanded implementation~~recent acquisitions of customer lists and service contracts

Table of Contents

therewith. Except as set forth below, the Risk Factors included in the Company’s Form 10-K for its ~~2007~~2008 fiscal year have not materially changed.

~~Avaya’s~~Our business is affected by capital spending. Current economic conditions and the ability of our customers to access credit may reduce capital spending over the next twelve months and beyond.

The U.S. economy is mired in a recessionary contraction and, despite efforts by the Federal Government to stabilize the banking and financial systems, credit availability remains limited for nearly all enterprises, hence the outlook for corporate profits is uncertain. These factors are contributing to a high degree of uncertainty concerning capital spending in 2009. Because our business depends on capital spending for technology and equipment, we may experience a decline in demand for our products. Such a decline may have a material, negative impact on our operating results and financial condition.

Nortel’s Chapter 11 bankruptcy filing may result in both a short-term and long-term financial loss for the Company.

Nortel filed a voluntary petition for Chapter 11 bankruptcy protection on January 14, 2009. We are owed approximately $685,000 in pre-petition accounts receivable. Based on filings approved by the bankruptcy court allowing Nortel to fund post-petition business operations, we plan to continue to provide services to Nortel’s end-user customers under our wholesale services relationship, which currently produces approximately $3 million in annual revenues. If our pre-petition claims are not collectible either in whole or in large part, we could experience material, negative operating results in the near term. Furthermore, it is impossible to predict the long term impact of Nortel’s bankruptcy filing on our managed services revenues or our Nortel equipment business. As such, our ongoing revenues and future financial results could be materially impaired in the event that Nortel is unable to fund its future operations; end-users elect to abandon their Nortel equipment for other products; Nortel implements dramatic changes to its business plan and strategies that negatively affect our relationship with Nortel as a business partner and/or vendor; the U.S. and global economic crisis negatively impacts Nortel’s ability to reorganize operations; and/or Nortel is unable to continue as debtor in possession or to emerge from bankruptcy.

Our manufacturers’ strategies regarding the provision of equipment and services to ~~its~~their customers ~~are changing~~may change dramatically and ~~may~~could have a material impact on our operating results.

Avaya is repositioning itself as a hardware and software ~~vendor~~manufacturer providing a wide range of voice communications hardware and applications to its customers. As part of this strategy, Avaya is segmenting 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 upgrades. Currently, we earn revenues from some of our customers, particularly ~~lodging~~hospitality 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.

~~If economic conditions in the U.S. continue be uncertain or deteriorate further,~~As a result of its bankruptcy Nortel could revise its market strategy, and a revision could have a material, negative impact on our operating results if our revenues ~~gross~~or margins ~~and net income could be negatively impacted.~~

Inare reduced as a result of a change in strategy. While we do not currently anticipate changes in Nortel’s strategy, we cannot provide any assurance that the first nine months of fiscal 2008, we have seen a decline in order rates for new equipment and for some discretionary (i.e. T&M) services that we offer. We believe that these declines are largely dueNortel business relationship will produce beneficial contributions to uncertainty about the condition and near-term future of the U.S. economy. These uncertainties have caused some customers to delay capital spending. Should these uncertainties persist or worsen, it is likely that our ~~business would continue to experience the effects.~~

~~Our long-term targeted levels of profitability may not be achievable.~~

~~In fiscal 2007, we set targets for our net profit margins, measured~~financial performance as net income divided by revenues, to be 4% to 6% within three to five years. These targets reflected more detailed key financial goals such as consistently earning gross margins on Services revenues in the 30% to 35% range, earning gross margins on total revenues at more than 30%, and lowering operating expenses to less than 20% of revenues. We believe that economies of scaledescribed in our business, particularly in our Services, Sales, Accounting and Administrative functions, will be the key driver toward meeting these financial targets. To date in fiscal 2008, we have experienced revenue growth of 22%; however we have not realized significant improvements in Services gross margins or in operating expenses when measured as a percent of revenues. While we continue to believe that our profitability targets will ultimately be achieved as we continue to expand our revenue base, we have yet to prove this operating model through actual results.earlier filings.

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

(a) None.

19(b) None.

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

		For the quarterly period ended ~~July~~January 31, ~~2008~~2009

OR
		OR

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

Oklahoma		73-1130045
(State or other jurisdiction of		(I.R.S. Employee
incorporation or organization)		Identification No.)

1814 W. Tacoma Street, Broken Arrow, OK		74012-1406
(Address of principal executive offices)		(Zip Code)

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

		PAGE
PART I. FINANCIAL INFORMATION

	ITEM 1. FINANCIAL STATEMENTS (Unaudited)

	Consolidated Balance Sheets - ~~July~~January 31, ~~2008~~2009 and October 31, ~~2007~~2008		3

	Consolidated Statements of Operations - For the Three ~~and Nine~~ Months Ended ~~July~~January 31, ~~2008~~2009 and ~~2007~~2008		4

	Consolidated Statement of Shareholders’ Equity - For the ~~Nine~~Three Months Ended ~~July~~January 31, ~~2008~~2009		5

	Consolidated Statements of Cash Flows - For the ~~Nine~~Three Months Ended ~~July~~January 31, ~~2008~~2009 and ~~2007~~2008		6

	Notes to Consolidated Financial Statements		7

	ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS		13

~~ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK~~		18

ITEM 4. CONTROLS AND PROCEDURES		1817

PART II. OTHER INFORMATION		17

	ITEM 1. LEGAL PROCEEDINGS	17

	ITEM 1A. RISK FACTORS	17

~~ITEM 1. LEGAL PROCEEDINGS~~		18

~~ITEM 1A. RISK FACTORS~~		19

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS	18

	ITEM 3. DEFAULTS UPON SENIOR SECURITIES	19

~~ITEM 3. DEFAULTS UPON SENIOR SECURITIES~~		20

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS		2019

	ITEM ~~5. OTHER~~5.OTHER INFORMATION		2019

	ITEM 6. EXHIBITS		2019

Fiscal Period	Total Number of Shares Purchased	Average Price Paid per Share		Total Number of Shares Purchased as Part of Publicly Announced Program	Approximate Dollar Value of Shares that May Yet Be Purchased Under the Program

November 2008	3,260	$	1.77	3,260	$	994,223
December 2008	13,768	1.84		13,768	968,903
January 2009	8,506	2.00		8,506	951,907
Total	25,534	$	1.88	25,534	$	951,907

	July 31, 2008			October 31, 2007

ASSETS
Current assets:
Cash and cash equivalents	$	74,177		$	402,918
Current portion of net investment in sales-type leases and other receivables	773,723			490,033
Trade accounts receivable, net	23,442,635			16,236,137
Inventories, net	5,839,652			4,296,574
Deferred tax asset, net	670,698			916,259
Prepaid taxes	51,693			19,737
Prepaid expenses and other assets	1,276,467			517,757
Total current assets	32,129,045			22,879,415

Noncurrent assets:
Goodwill	26,323,411			26,365,093
Intangible assets, net	219,600			104,042
Net investment in sales-type leases, less current portion above	118,145			136,493
Property, plant & equipment, net	10,736,742			10,610,820
Other assets	15,563			—
Total noncurrent assets	37,413,461			37,216,448

Total assets	$	69,542,506		$	60,095,863

LIABILITIES AND SHAREHOLDERS’ EQUITY

Current liabilities:
Current portion of long-term debt	$	171,123		$	171,123
Revolving line of credit	6,109,050			2,758,660
Accounts payable	7,652,706			5,670,240
Current portion of obligations under capital lease	146,798			—
Current unearned revenue	3,450,622			2,212,247
Accrued liabilities	4,027,172			3,565,031
Total current liabilities	21,557,471			14,377,301

Noncurrent liabilities:
Long-term debt, less current portion above	1,226,214			1,354,530
Accrued long-term liability	144,100			211,300
Long-term portion of obligations under capital lease	297,743			—
Noncurrent unearned service revenue	64,335			81,650
Noncurrent deferred tax liability, net	5,186,359			4,631,917
Total noncurrent liabilities	6,918,751			6,279,397

Contingencies

Shareholders’ equity:
Preferred stock; $.10 par value; 50,000 shares authorized, 0 issued	—			—
Common stock; $.001 par value; 50,000,000 shares authorized, 11,256,193 and 11,233,529 issued at July 31, 2008 and October 31, 2007, respectively	11,256			11,233
Paid-in capital	13,428,126			13,189,311
Retained earnings	29,834,370			28,483,280
Less treasury stock, at cost (1,001,883 shares at July 31,2008 and 1,018,788 shares at October 31, 2007)	(2,207,468		)	(2,244,659		)
Total shareholders’ equity	41,066,284			39,439,165
Total liabilities and shareholders’ equity	$	69,542,506		$	60,095,863

	2008		2007
Three months ended July 31,	$	65,221	$	30,685

Nine months ended July 31,	$	181,782	$	78,554

	July 31, 2008			(Audited) October 31, 2007

Trade receivables	$	23,597,028		$	16,411,981
Less reserve for doubtful accounts	(154,393		)	(175,844		)
Net trade receivables	$	23,442,635		$	16,236,137

			Payments due by period
	Total		Less than 1 year		2 – 3 Years		4 – 5 Years
Contractual Obligations
Long-term debt	$	1,461,453	$	226,680	$	1,234,773	$	—
Capital lease	470,852		161,435		309,417		—
Operating leases	541,650		299,110		241,580		960
Total	$	2,473,955	$	687,225	$	1,785,770	$	960

	For the Three Months Ended July 31,				For the Nine Months Ended July 31,
	2008		2007		2008		2007
Contract & T&M	$	7,202,000	$	6,745,000	$	21,438,000	$	19,059,000
Implementation	3,864,000		2,075,000		8,250,000		5,988,000
Cabling	962,000		644,000		2,199,000		1,986,000
Total Services revenues	$	12,028,000	$	9,464,000	$	31,887,000	$	27,033,000

	For the Three Months Ended July 31,				For the Nine Months Ended July 31,
Gross Margins	2008		2007		2008		2007
Services revenues	30.4	%	30.7	%	27.5	%	29.6	%
Systems sales	26.4	%	22.8	%	26.1	%	23.6	%
Other revenues	22.1	%	40.9	%	62.2	%	38.8	%
Corporate cost of goods sold	-1.7	%	-2.2	%	-1.9	%	-2.1	%
Total	26.7	%	24.8	%	25.8	%	24.9	%

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.

	XETA Technologies, Inc.
	(Registrant)


Dated: ~~September 10, 2008~~February 27, 2009	By:	~~/s/~~/s/ Greg D. Forrest
		Greg D. Forrest
		Chief Executive Officer

Dated: ~~September 10, 2008~~February 27, 2009	By:	~~/s/~~/s/ Robert B. Wagner
		Robert B. Wagner
		Chief Financial Officer

Oklahoma

73-1130045

1814 W. Tacoma Street, Broken Arrow, OK

74012-1406

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS

13

18

1817

PART II. OTHER INFORMATION

17

ITEM 1. LEGAL PROCEEDINGS

17

ITEM 1A. RISK FACTORS

17

18

19

Overview

Financial Condition

Results of Operations