UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

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

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.

(Exact name of registrant as specified in its charter)

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

918-664-8200

Securities registered pursuant to Section 12(g) of the Act:

Common Stock, $0.001 par value
(Title of Class)

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o No þ

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o No þ

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 þ No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Not applicable þ

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of “large accelerated filer, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer o		Accelerated filer o		Non-accelerated filer o		Smaller reporting company þ

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

The aggregate market value of the voting stock held by non-affiliates of the registrant, computed by reference to the Nasdaq closing price on April 30, 2010, the last business day of the registrant’s most recently completed second fiscal quarter, was approximately $32,386,758.

The number of shares outstanding of the registrant’s Common Stock as of December 17, 2010 was 19,730,236.

 

 

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Proxy Statement to be filed with the Securities and Exchange Commission in connection with the Annual Meeting of Shareholders to be held April 5, 2011 are incorporated by reference into Part III, Items 10 through 14 hereof.

CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

This report contains forward-looking statements relating to future events and our future performance and results. Many of these statements appear in the discussions under the headings “Business,” “Risk Factors,” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” All statements other than those that are purely historical may be forward-looking statements. Forward-looking statements can generally be identified by words such as “expects,” “anticipates,” “may”, “plans,” “believes,” “intends,” “projects,” “estimates,” and similar words or expressions. Forward-looking statements are not guarantees of performance, but rather reflect our current expectations, estimates, and forecasts about the industry and markets in which we operate, and our assumptions and beliefs based upon information currently available to us. These statements are subject to risks and uncertainties which are difficult to predict or which we are unable to control, including but not limited to such factors as the successful integration of recently acquired businesses and realization of anticipated synergies and growth opportunities from these transactions, the condition of the U.S. economy and its impact on capital spending trends in our markets, the financial condition of our suppliers and changes by them in their distribution strategies and support, the impact of Nortel’s bankruptcy proceedings on our pre-petition accounts receivable from Nortel and on the market for Nortel products, unpredictable revenue levels from quarter to quarter, inconsistent gross profit margins, continuing acceptance and success of the Mitel product and services offering, availability of credit to finance growth, intense competition and industry consolidation, dependence upon a few large wholesale customers in our Managed Services offering, the availability and retention of revenue professionals and certified technicians, and other risks and uncertainties specifically discussed under the heading “Risk Factors” under Part I of this report. As a result of these risks and uncertainties, actual results may differ materially and adversely from those expressed in forward-looking statements. Consequently, investors are cautioned 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.

PART I

ITEM 1.		BUSINESS

Development and Description of Business

XETA Technologies, Inc. (“XETA”, the “Company”, “we”, “us”, or “our”), an Oklahoma corporation formed in 1981, is a leading provider of advanced communications solutions with nationwide sales and service. We provide a wide variety of applications including voice messaging, wireless voice and data solutions, video applications, contact center solutions, unified communication, and high speed internet access solutions to hospitality and conference center customers. We sell and/or support communications solutions produced by several manufacturers including Avaya, Inc. (“Avaya”), Mitel Corporation (“Mitel”), Samsung Business Communications Systems (“Samsung”), Juniper Networks, Polycom, Microsoft and ShoreTel Corporation (“ShoreTel”).

In fiscal 2010, we implemented a strategy to use our unique market position as a national partner of Avaya and Nortel and our strong balance sheet to pursue acquisitive growth opportunities. As a result of our successful execution of this strategy, we completed three acquisitions in the second half of fiscal 2010 and absorbed the key employees and fixed assets of an additional strategic asset that was abandoned by its previous owner. These acquisitions all address our strategic initiative to advance our business from its historic roots in voice networks and services into the broader unified communications and data networking market, including consultative services. Our acquisition of the assets of Hotel Technologies Solutions, Inc., d/b/a Lorica Solutions (“Lorica”), a privately-held company headquartered in Buffalo, New York, in May, 2010 provided us with a high speed internet access product and service offering and an additional recurring revenue stream in the hospitality vertical market. It also provided us with a platform to resume development of a line of proprietary products to further expand our already strong brand in this market. The acquisition of Pyramid Communications Services, Inc. (“Pyramid”), a privately held company headquartered in Dallas, Texas and the acquisition of the operating assets of Data-Com Telecommunications, Inc. (“Data-Com”), a New Jersey based privately held company, provided us with additional geographic coverage, important new customer relationships, new streams of recurring revenues, and broadened our manufacturer relationships. Finally, we absorbed certain sales and technical employees and a small amount of strategic assets which were being divested by their owner. We have used these assets and personnel to form our new Network Operations Center (“NOC”) and related product offerings around data and voice network monitoring and help desk services. The terms of these purchase agreements are described in Note 16 of the Notes to Consolidated Financial Statements.

We market our products and services to a variety of companies such as enterprise-class multi-location, mid market and large companies located throughout the United States. We also market our solutions and services to several vertical markets such as hospitality, education, Federal government, and healthcare, including a line of proprietary call accounting systems to the hospitality industry.

We provide a wide variety of services to support our customers including professional services such as network architecture and engineering, contact center consulting, wireless solution architecture and information security consulting. We also offer white label solutions deployment, re-badging, traditional MAC services, and maintenance contracts. Beginning in late 2010, we began offering services such as proactive monitoring, remediation and help desk services through our new Network Operations Center (“NOC”).

We deliver our services through a nationwide network of Company-employed design engineers, service technicians and qualified third party service providers. Our service delivery is coordinated in our contact center, which operates 24-hours per day, 7-days-per-week and is located at our headquarters in Broken Arrow, Oklahoma and our NOC is located in Hazelwood, Missouri. Our national technical footprint and 24-hour services are well-suited to address the communication needs of large, multi-location, national, or super-regional customers.

Large enterprises often have a combination of manufacturer platforms in their communications equipment portfolios. As such our ability to sell and service the leading communication platforms is an important competitive advantage. Because of our extensive array of products and services, we enjoy multiple sales opportunities with these customers. These include new equipment installations, implementation of advanced applications, and various service relationships.

An important element of our sales strategy is to continually search for opportunities to expand business relationships with current customers. Our sales teams continually monitor and assess our customer’s communications needs, proposing appropriate technologies to address those needs, establishing or expanding the service relationship, and proposing equipment and service solutions to other divisions or subsidiaries.

Under our wholesale services 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 on-site service activities. Under a full outsourcing arrangement we may provide a broader range of services. These services include call center support, help desk services, remote technical support, on-site labor and spare parts. Our wholesale services business initiative has succeeded because we provide excellent service to end-user customers, and are willing to create and execute flexible service programs and billing arrangements.

We strive to align our Company’s sales, marketing, and services programs with those of our manufacturing partners. As the composition of the market evolves in response to Avaya’s acquisition of Nortel, our cogent and well crafted sales plan is of even greater importance. We have developed sales and service programs to assist customers in supporting their existing investments or migrating their portfolios to alternative technologies. Our sales teams will continue to search for market opportunities resulting from the consolidation of Avaya and Nortel. Uncertainties in the market may also result in acceleration in our acquisitions particularly in the Nortel partner community.

Commercial Systems Sales

We sell communications solutions to the commercial market, school districts, the Federal government, and to the healthcare market. These solutions are designed to maximize the effectiveness of our customers’ communications systems through the use of advanced technologies. By deploying advanced communications technologies and consolidating voice and data traffic on a common infrastructure our customers can reduce their total communications costs. In addition, through the use of integrated applications they can also improve employee productivity. With the adoption of IP telephony by most enterprise level customers, new, advanced applications such as Unified Communications systems and collaboration software are widely available. These advanced applications combine voice, voice mail, presence, instant messaging, and video applications and seamlessly integrates them on the desktop with other data applications such as MS Outlook™.

We sell these systems under dealer agreements with Avaya, Mitel, and Shortel. These manufacturers have significant installed bases in the communications equipment market and are migrating their customers from traditional telephony systems to server based platforms. To support our sales efforts we receive incentive payments from the manufacturers to offset certain product costs, training expenses, and specific sales and marketing expenses. We purchase Avaya products through major distributors and receive additional price incentives from these distributors. These incentive payments are material to our business. We purchase Mitel and Shortel systems directly from the manufacturer from whom we also earn certain discounts and incentive payments. We sell data networking products to the commercial market under non-exclusive dealer agreements with Avaya, Samsung, Juniper Systems, Cisco Systems Inc., and Hewlett-Packard Company. As a result of an acquisition in fiscal 2010, we became a distributor of Samsung Communications Systems, whose systems are sold primarily to small and mid-sized businesses. We support Samsung dealers with new systems and technical support.

Hospitality Products

Communications Systems. We sell communications systems to the hospitality industry through nationwide, non-exclusive dealer agreements with Avaya and Mitel. In addition to most of the features available on commercial systems, the systems sold to hospitality customers include hospitality-specific software, which integrates with nearly all aspects of the property’s operations. We offer a variety of related products such as voice mail systems, analog telephones, uninterruptible power supplies, announcement systems, and others, most of which also have hospitality-specific features. The majority of these additional products are sold in conjunction with the sale of new communications systems and, with the exception of voicemail systems, are purchased from regional and national suppliers.

Proprietary Products. We sell a line of proprietary products to the hospitality industry. The Lorica Room Center (“LRC”) is a converged IP-based managed network which was designed specifically for the lodging industry. We also provide high speed internet access, network monitoring services, and guest help desk services to the hospitality industry. We sell call accounting products under the Virtual XL^Ò and Virtual XL.2™ product names. The “VXL” series is a PC-based system designed to operate on a property’s local or wide area network. If that network is connected to the Internet, the VXL can also be accessed via an Internet connection. The original VXL is a rack-mounted, server-style system and is marketed under the name Virtual XL.2™ (“VXL”). The VXL systems are our latest in a series of call accounting products we have successfully marketed since the Company’s inception. Many of those earlier products remain in operation at customer locations and are under maintenance contracts with us or generate time-and-materials (“T&M”) revenues. These revenues and the related gross profits are material to our business.

Sales of communications systems and products to the hospitality industry represented 5%, 13%, and 10% of total revenues in fiscal 2010, 2009 and 2008, respectively. Marriott International, Host Marriott, and other Marriott-affiliated companies (“Marriott”) represent a single customer relationship for our Company and a major contributor to our hospitality revenues. Revenues earned from sales of hospitality systems sold to Marriott represented 30%, 20%, and 21% of our sales of hospitality systems in fiscal 2010, 2009, and 2008, respectively.

Services

Services revenue is our largest revenue stream. Because a majority of these revenues are recurring and produce generally higher margins, this portion of our business is of vital importance to our operating results. Our services offerings include nation-wide customer service, project management, professional services, installation, consulting, white label managed services, managed network services, help desk services and structured cabling implementation. The geographic reach and technical breadth of our services organization are key differentiators between us and our competitors.

Our services organization includes our National Service Center (“NSC”) located at our headquarters in Broken Arrow, Oklahoma. The NSC supports our commercial and hospitality customers who have purchased maintenance contracts on their systems, our wholesale services offerings, as well as other customers who engage us on hourly time-and-material or per occurrence basis. We employ a network of highly trained technicians who are strategically located in major metropolitan areas and can be dispatched to customer locations or to install new systems. We also employ design and implementation engineers, referred to as our Professional Services Organization (“PSO”), to design voice, data, and converged solutions to meet specific customer requirements. Much of the work done by the PSO is pre-sales design and is often not recovered in revenues. While this activity represents a significant investment, we believe that by hiring the most qualified personnel possible to provide these services we create a competitive advantage.

In late 2010, we opened a NOC in Hazelwood, Missouri to provide a variety of new services including proactive and remedial network monitoring and help desk services. The NSC also has redundant NOC facilities.

For Avaya, Nortel, and Mitel communications systems sold to hospitality customers, we sell XETA maintenance contracts. For our proprietary products, we offer post-warranty service contracts under one-year and multi-year service contracts. The revenues earned from the sale of our maintenance contracts are an important part of our business model as they provide a predictable stream of profitable recurring revenue. We earn a significant portion of our repair and maintenance services revenues from hospitality customers who maintain service contracts on their systems.

To our non-hospitality end-users of Nortel equipment, we sell XETA maintenance contracts. We aggressively market our services capabilities to existing and potential wholesale customers. Our largest wholesale customers are systems integrators and network service providers who have outsourcing contracts with large enterprise and government entities and use us to augment their service capabilities.

For Avaya products sold to non-hospitality customers, we sell Avaya’s post-warranty maintenance contracts, for which we earn a commission. These commissions are recorded as “Other Revenues” in our financial statements and are material to our gross profits and net income.

For our distributed products, we pass on the manufacturer’s limited warranty, which is generally one year in length. Labor costs associated with fulfilling the warranty requirements are generally borne by us. For our proprietary products sold to the hospitality industry, we provide a limited one-year parts and labor warranty.

Marketing

We market our products and services primarily through our direct sales force to a wide variety of customers including large national companies, mid-size companies, hospitality industry, education market, Federal government, and the healthcare industry. Because the technology we sell is typically an application running on an existing data network, the focus is toward data networking decision makers, many of whom are at the executive level of their organization. These executives may have long-standing relationships with their data products and services dealers.

In addition to marketing directly to end-users, we also have a significant sales and marketing effort dedicated to our wholesale services. This area of our business has experienced significant growth in recent years and is a key contributor to our increase in services revenues. Under these offerings we partner with manufacturers, network services companies, and systems integrators to provide a variety of technical and outsourced services to our partners’ end-user customers. We make considerable investments in sales and technical resources to create relationships with current and potential wholesale partners. Once those relationships are established, we jointly market our capabilities with our partners to end-users who have requested bids for new services or are renewing existing contracts.

Another important aspect of our marketing effort centers on our relationships with our manufacturers. Our most important manufacturer relationship is with Avaya, which also includes the legacy Nortel product line. Avaya is rapidly deploying changes to its go to market and channel strategies to more effectively compete as a software and unified communications centric manufacturer. Some of these changes are creating opportunities for us to introduce new products to customers in the form of system upgrades or replacements, reduce our costs associated with complex delivery of technical support and increase our revenues earned from the sale of Avaya maintenance contracts. We are adjusting our marketing strategies to maximize our benefit from Avaya’s changes while also working to minimize the inherent risks associated with such strategy shifts (those risks are discussed in ITEM 1.A “Risk Factors” below).

As a national dealer, we have certain technical and geographical capabilities that help differentiate us in the marketplace and we aggressively market these capabilities to the manufacturers we represent. The manufacturers utilize us in a variety of ways, from fulfilling certain customer orders to handling entire customer relationships. We have carefully positioned ourselves as a leading dealer by achieving the highest level of certification with each manufacturer, building our in-house engineering capabilities, providing nationwide implementation services, and through access to our 24-hour, 7 days-per-week service center.

Our marketing efforts to the hospitality industry rely heavily on our experience and reputation in that industry. Over the course of serving this market for more than 29 years, we have built strong long-term relationships with a wide range of key decision makers responsible for the purchase of hotel communications technology. We have relationships with nearly all hotel chains and major hospitality property management companies. We target our hospitality marketing efforts at strengthening and deepening these relationships.

Competition

Commercial. The market for Commercial communications systems, applications and services has evolved due to the convergence of voice and data networks and the speed at which new applications are being introduced. Our market has always been highly competitive, and all of the manufacturers we represent have extensive dealer networks which include larger organizations with significantly more marketing and financial resources than us. Avaya, in particular has an extensive dealer organization, including the Regional Bell Operating Companies, nationwide dealers similar to us, and smaller regional dealers. In addition, we also face competition from dealers of other communications’ technology manufacturers such as Cisco Systems, Inc. and Alcatel-Lucent. With the addition of data products dealers, particularly Cisco dealers, competition has increased. Many of our new competitors have long-standing relationships with the Information Technology (“IT”) decision makers of our customers, increasing the ferocity of the competition.

Hospitality. We face similar competitive pressures to those discussed above in our hospitality business. However, since the hospitality market is a small niche market, we believe our most effective advantages are the performance and reliability of our proprietary call accounting systems and our high level of service commitment to this niche market.

We assemble the Virtual XL^Ò and Virtual XL.2™ systems, our proprietary call accounting systems, which are sold exclusively to the hospitality industry. The LRC system is assembled by a third party manufacturer. These systems are assembled from an inventory of components, parts and sub-assemblies obtained from various suppliers. These components are purchased from a variety of regional and national distributors at prices that fluctuate based on demand and volumes purchased. Some components, although widely distributed, are manufactured by a single, usually foreign, source and are therefore subject to shortages and price fluctuations if manufacturing is interrupted. We maintain adequate inventories of components to mitigate short-term shortages and believe the ultimate risk of long-term shortages is minimal.

All of the other products we sell are purchased as finished goods from the manufacturers’ distributors.

Employees

We employed 467 and 372 employees at December 1, 2010 and 2009, respectively.

Copyrights, Patents and Trademarks

We own registered United States trademarks on the following names for use in the marketing of our hospitality services and systems: “XETA,” “XPERT,” “XL,” “Virtual XL,” and “Room Center”. All of these trademarks are on the principal register of the United States Patent and Trademark Office.

ITEM 1A.		RISK FACTORS

Our business and prospects are subject to risks and uncertainties. The following items are representative of the risks, uncertainties and assumptions that could affect our business, future performance and the outcome of our forward-looking statements.

Our largest manufacturing partner is implementing a broad range of strategic initiatives some of which could have a material, negative impact on our gross margins.

Avaya has made or announced several changes in their marketing and dealer channel strategy including changes in pricing, mandatory contractual agreements to engage with Avaya technical support and certain limitations on dealers’ service offerings. These changes are potentially disruptive to our business as they require adjustments to our marketing strategies as well as to day-to-day operating interactions with Avaya. Additionally, there is inherent risk to customer relationships when manufacturers adjust their product and service strategies over a rapid timeline. We have already experienced some erosion in our service margins as a result of the changes implemented in 2010 and one of our significant customers has standardized on another of our manufacturer’s platform in reaction to changes implemented by Avaya within the past year. No assurance can be given that the various strategic shifts at Avaya will not cause a material, negative impact to our results of operations.

The acquisition and integration of businesses by the Company may not produce the desired financial and/or operating results.

During fiscal 2010, we completed the acquisition of three businesses in separate transactions. These acquisitions are a part of our stated strategy to take advantage of the current disruption in our market by acquiring assets that increase our market share and establish a presence in the advanced communications applications market segment. Expected synergies and growth often do not materialize as planned. Furthermore, we will continue to devote significant time and effort to improve the probability of success for these investments. However, no assurance can be given that these acquisitions will meet our expectations for revenues and operating results, or that our capital could not have been used more efficiently to improve our financial condition or operating results.

Our business is affected by capital spending. Economic conditions may continue to inhibit capital spending over the next twelve months and beyond.

The U.S. economy is struggling to emerge from a severe recessionary contraction creating continued uncertainty in the outlook for corporate capital spending. Because our business relies on capital spending for technology and equipment, we may continue to experience lumpy demand for our products. This could have a material, negative impact on our operating results and financial condition.

We may experience higher than normal bad debt losses as a result of economic conditions and may experience lower revenues as a result of limiting our extension of credit to customers.

The economic downturn and tight credit markets have resulted in some of our customers experiencing difficulty in paying their obligations to us, particularly obligations related to the purchase of new systems. While we monitor credit reports and payment histories carefully, we cannot eliminate all of the risks associated with the extension of credit. As a result, we may experience higher rates of bad debt in the near future and we may also experience lower revenues as a result of tightening our credit standards.

Our revenue for a particular period is difficult to predict, and a shortfall in revenue can harm our operating results.

Our systems sales, implementation, cabling, and other revenues for a particular quarter are difficult to predict. Our total revenues may decline or grow at a slower rate than in past periods. We have experienced periods during which shipments have exceeded net bookings, or manufacturing issues have delayed shipments, resulting in erratic revenues. The timing of orders, primarily in our systems sales, can also impact our quarter to quarter business and operating results. As a result, our operating results could vary materially from quarter to quarter based on the receipt of orders, and the ultimate recognition of revenue. We set our operating expenses based primarily on forecasted revenues. An unexpected shortfall in revenues could lead to lower than expected operating results if we are unable to quickly reduce these fixed expenses in response to short-term business changes. Any of these factors could have a material adverse impact on our operations and financial results.

The value of our product and services offerings to the hospitality market is declining and our repair and maintenance revenues associated with this line of business are under significant pressure.

Increasing use of cell phones by guests has caused a rapid decline in hotels’ revenues and gross profits earned from long distance and other telephone-related fees. This development has severely reduced the importance of PBX and call accounting systems in hotels. Additionally, many of the new voice applications have limited value in the hospitality market. As a result, there is not a compelling financial reason or guest-driven need to replace existing equipment. The primary uses of guest room phones are to access hotel amenities such as the front desk or room service or to call other guests. Additionally, guest room phones are necessary to satisfy laws mandating access to 911 services in all guest rooms. Manufacturers who enjoy a significant share of the installed base of systems in the hospitality market are in competition with startup firms to develop low cost, shared, network dial tone that will meet the needs of hotel properties at prices that will produce a sufficient return on their investment. While we are carefully monitoring these developments, there is no assurance that hotel’s spending on PBX and call accounting systems and associated maintenance services will not drop dramatically resulting in a material, negative impact on our operating results.

Success in our overall strategy, a key component of which is to focus on the marketing of advanced communications products and applications and related services, may be difficult or even prevented by a variety of factors.

Expansion of our net profit margins and increasing our shareholders’ return on investment over the long term is highly dependent upon our ability to become a leader in the sale, implementation, and ongoing maintenance of advanced communications products and applications. Because of their sophistication and complex integration with both network and desktop software applications, including Microsoft Office products such as Outlook, these products are expected to earn higher margins than our current products. To succeed in these dynamic markets, we must continue to: train our sales employees on the capabilities and technical specifications of these new technologies; train our services technicians to support these products and applications; develop relationships with new types of qualified service providers to supplement our internal capabilities; and develop new relationships with different disciplines, and at higher management levels, within our customers’ organizations.

We cannot predict whether: (i) the demand for advanced communications products, applications, and services, including IP telephony systems and UC, will grow as fast as anticipated; (ii) other new technologies may cause the market to evolve in a manner different than we expect; or (iii) technologies developed by manufacturers that we do not represent may become more accepted as the industry standard.

Finally, we cannot predict the impact of economic conditions on the adoption of these technologies. We believe that most customers will likely limit their capital investments to those with anticipated paybacks of one year or less until it is clearer that an economic recovery is underway and competitive pressures begin to drive technology decision-making again. While UC and other collaboration-oriented voice applications are predicted to enhance user productivity and improve the security of certain intra-company communications, the return rate on these investments is yet unproven, therefore customers may choose to delay investment.

We may experience severe declines in our services revenues from the loss of a major wholesale services customer.

Our wholesale services revenues are generated from a few large customers who contract with us to provide a variety of services for specific end-user customers. Typically, the end-user customer is a large corporation as well. Our experience to date in these arrangements indicates that we may experience severe reductions in service revenues in the event that either the end-user or our customer selects a different service provider or changes their operating strategy regarding the delivery of these services. The loss of one of our wholesale managed service customers could have a sudden, material, adverse effect on our operating results.

Nortel’s Chapter 11 Bankruptcy filing and subsequent sale of its enterprise solution business to Avaya may negatively impact our financial condition.

Nortel filed a voluntary petition for Chapter 11 bankruptcy protection on January 14, 2009. On July 12, 2010, Nortel filed its plan of reorganization which was essentially a plan of liquidation. We are owed approximately $717,000 in pre-petition accounts receivable less approximately $116,000 in approved offsets for amounts we owed to Nortel at the time of the filing. Nortel’s July 12, 2010 filing classifies our claim as a Class 3 “General Unsecured” claim. As such, our claim will be impaired and any distribution made by Nortel to Class 3 unsecured creditors will be shared among such creditors on a pro-rata basis. We do not know the extent to which this receivable will be impaired but it is apparent we will not collect the full amount. If this claim is not collectible in large part, we could experience material, negative operating results in the near term.

We face intense competition fueled by rapid changes in the technologies and markets in which we operate.

The market for our products and services is highly competitive and subject to rapidly changing technologies. As the industry continues to evolve and new technologies and products are introduced, new participants enter the market and existing competitors search for ways to strengthen their positions and expand their offerings. There is a developing trend toward consolidation, which could result in the creation of stronger competitors better able to compete as a sole-source vendor for customers. While we believe that through our transformation and expansion during the last few years, we are well positioned to compete effectively in the marketplace; our failure to maintain or enhance this position could adversely affect our business and results of operations.

The success of our business depends on our ability to recruit and retain highly skilled personnel.

Our ability to attract, train, motivate and retain highly skilled and qualified technical and sales personnel is critical to our success. Competition for such employees in the rapidly changing communications industry is fierce. As we have transformed our company into an integrator of advanced communications solutions we have invested heavily in the hiring and training of personnel to sell and service our portfolio of products and services. If we are unable to retain our skilled employees or to hire additional qualified personnel when needed, it could adversely impact our ability to implement our strategies.

The technology we sell is highly complex and changes rapidly, increasing our reliance upon the manufacturers for technical assistance and increasing the risk that our inventories on hand will become obsolete.

The communications equipment we sell is highly complex and requires significant technical resources to design, install, and maintain. This complexity may require us to rely heavily upon the manufacturers’ technical staff to support the installation and maintenance of communications systems. This reliance may result in lower services revenue or lower profit margins earned on our services revenue. In addition to their complexity, the systems are evolving rapidly as product enhancements are introduced by the manufacturers. These rapid changes present risks that our inventory on hand will become obsolete, resulting in the need to reduce sales margins to sell the equipment or in direct write-offs in the value of the equipment. Any of these results would be detrimental to our profitability.

The loss of our highest level dealer certifications with any of our manufacturers could negatively impact our ability to differentiate our products and services in the market and could negatively impact our operating results.

We hold the highest level of dealer certifications with Avaya and Mitel. These certifications are based on technical and sales capabilities and purchasing volumes and are reviewed annually. We emphasize the fact that we are one of the few providers in our market to have the highest certification level with each manufacturer and we believe that this is a significant differentiator with some customers who have two or more of the manufacturers’ products in their installed base. Additionally, as a result of these certifications we receive enhanced manufacturer incentive payments which are material to our operating results. While we expect to maintain the technical capabilities, sales skill sets, and purchasing volumes to secure our certifications, a downgrade could have a material impact on our reputation in the market and negatively impact our operating results.

The introduction of new products could result in reduced revenues, reduced gross margins, reduced customer satisfaction, and longer collection periods.

We sell a variety of highly complex products that incorporate leading-edge hardware and software technology. Early versions of these products, which we are selling currently, can contain software defects or “bugs” that can cause the products to not function as intended. We will be dependent upon our suppliers of these technologies to fix these problems. The inability of the manufacturer to quickly correct these problems could result in damage to our reputation, reduced revenues, reduced customer satisfaction, delays in payments from customers for products purchased, and potential liabilities.

A significant portion of our expected growth in services revenues is dependent upon our relationship with a few wholesale customers.

Much of the growth in our services revenue is coming from a few wholesale service customers using us as a subcontractor to service many of their high profile end-user customers. We believe our relationship with these companies is strong and our performance ratings have been excellent. However, our experience is that end-users’ decisions to maintain their service agreements with our wholesale service customers depends on factors which are beyond our control. Therefore we can provide no assurance that we will not experience sudden declines in our maintenance and repair services revenues due to the loss of large contracts by our wholesale customers.

Hitachi’s decision to cease manufacturing communications systems for the hospitality market has caused some uncertainty with respect to our future relationship with our Hitachi installed base of hospitality customers.

Hitachi, once one of the leading suppliers of traditional PBX systems to the hospitality market, ceased selling systems to this market in March 2005. We have many long-time hospitality customers with significant portfolios of Hitachi systems in their properties. In addition, we have several hundred Hitachi systems under service contracts generating recurring contract revenues and gross profits. Over the next four to six years, most of these customers will have to transition their communications systems to new platforms. The transition presents a risk to us that another vendor may be selected to install and service their communications systems. In response we have added the Mitel product line to mitigate the impact to our operating results due to Hitachi’s exit from the hospitality market.

While Hitachi’s exit created some uncertainty in our relationship with existing customers, we believe our relationship with our Hitachi customers is strong. Consequently, we believe that in most instances we will be in a favorable position to supply a new system to our customers when they decide to replace their Hitachi system. Additionally, during the third quarter of fiscal 2006 we acquired the remaining assets and liabilities of Hitachi’s U.S. hospitality market. Included in the acquired assets was a substantial inventory of new and refurbished parts and equipment enabling us to serve our Hitachi customers. Despite these mitigating factors, no assurance can be given that Hitachi’s exit from this market will not negatively impact our financial results in the future.

We are connecting our products to our customer’s computer networks and integrating these products to other customer-owned software applications such as the Microsoft Office Suite. In most cases, we are integrating our products to mission-critical networks and systems such as contact centers owned by the customer. Problems with the implementation of these products could cause operational disruption, loss of revenues and gross profits for our customers.

IP-based products and advanced voice applications are typically connected to our customers’ existing local and wide area networks. While we believe the risk of our products disrupting other traffic or affecting performance of these networks is low, such problems could occur. Such an event could cause significant disruption to our customers’ operations, including loss of revenue, or the inability to access critical services such as 911 emergency services. In turn, these disruptions could result in reduced customer satisfaction, delays in payments from customers for products and services purchased, damage to our reputation, and potential liabilities.

We expect our gross margins to vary over time.

Our gross margins are affected by a variety of factors, including changes in customer and product mix, increased price competition, changes in vendor incentive programs, and changes in shipment volume. We expect these factors to cause our gross margins to be inconsistent in quarter-to-quarter and year-to-year comparisons.

If our dealer agreements with the original equipment manufacturers are terminated prematurely or unexpectedly, our business could be adversely affected.

We sell communications systems under dealer agreements with various manufacturers such as Avaya, Mitel and Shortel. We are a major dealer for many manufacturers and we consider our relationship with them to be good. Nevertheless, if our strategic relationship with our manufacturers were to be terminated prematurely or unexpectedly, our operating results would be adversely impacted. Furthermore, these agreements require that we meet certain volume commitments to earn the pricing incentives provided in the dealer agreements. Failure to meet these requirements could have material adverse consequences on our gross margins and overall operating results.

We are dependent upon a few suppliers.

Our growth and ability to meet customer demand depends in part on our capability to obtain timely deliveries of products from suppliers. Avaya utilizes a two-tier distribution model whereby a few third-party companies (super distributors) distribute their products to their dealer communities. The limited amount of distribution available for these product lines increases our risk of interruptions in the supply of these products.

We may incur goodwill and other asset impairments in the event our business was to suffer a severe decline.

We are required to evaluate the fair value of each of our reporting units annually to determine if the fair value is less than the carrying value of those reporting units. If we determine that is the case, then an impairment loss will be recorded in our statement of operations. In fiscal year 2010, after completing the annual impairment test, management determined that the fair value of each reporting unit was greater than our carrying value and therefore no impairment had occurred. In fiscal year 2009, management determined that the goodwill associated with our commercial equipment sales reporting unit was impaired and we recorded an impairment charge of $14.8 million. We could experience further deterioration in this area of our business or other areas of our business, which might result in additional impairment of our remaining goodwill balances. Additional impairment charges could have a material adverse effect on our financial condition and results of operations.

Our stock price may continue to be volatile.

Historically, our stock is not widely followed by investment analysts and is subject to price and trading volume volatility. This volatility is sometimes tied to overall market conditions and may or may not reflect our financial performance. It is likely that this volatility will continue.

Our business is subject to the risks of tornadoes and other natural catastrophic events and to interruptions caused by man-made problems such as computer viruses or terrorism.

Our corporate headquarters and NSC are located in northeastern Oklahoma, a region known as “tornado alley”. The region is also frequently the victim of significant ice storms. A significant natural disaster, such as a tornado or prolonged ice storm could have a material adverse impact on our business, operating results, and financial condition. In addition, despite our implementation of network security measures, our servers are vulnerable to computer viruses, hacking, and similar disruptions from unauthorized tampering of our computer systems. Any such event could also cause a similar material adverse impact. In addition, acts of war or terrorism could have a material adverse impact on our business, operating results and financial condition. The continued threat of terrorism and associated security and military response, or any future acts of terrorism may further disrupt the national economy and create additional uncertainties. To the extent that such disruptions or uncertainties might result in delays or cancellations of customer orders, or impact the assembly or shipment of our products, business, operating results and financial condition could be materially and adversely affected.

We may be subject to infringement claims and litigation, which could cause us to incur significant expenses or prevent us from selling certain products and services.

Third parties, including customers, may assert claims or initiate legal action against our manufacturers, suppliers, customers or us, alleging that the products we sell infringe on another’s proprietary rights. Regardless of merit, such claims can be time-consuming, expensive, and/or require us to enter into costly license agreements. In some instances, a successful claim could prevent us from selling a particular product or service. We have not conducted patent searches on the third party-products we distribute to independently determine if they infringe on another party’s proprietary rights. Nor would it be practical or cost-effective for us to do so. Rather, we rely on infringement indemnities provided by the equipment manufacturers. However, because these indemnities are not absolute and in some instances have limits of coverage, no assurance can be given that in the event of a claim our indemnification by the equipment manufacturer will be adequate to hold us harmless, or that we are entitled to indemnification by the equipment manufacturer.

If any infringement or other intellectual property claim is brought against us, and succeeds, whether it is based on a third-party’s equipment that we distribute or on our own proprietary products, our business, operating results and financial condition could be materially and adversely affected.

We are subject to a variety of other general risks and uncertainties inherent in doing business.

In addition to the specific factors discussed above, we are subject to risks that are inherent to doing business. These include growth rates, general economic and political conditions, customer satisfaction with the quality of our services, costs of obtaining insurance, unexpected death of key employees, changes in employment laws and regulations, changes in tax laws and regulations, and other events that can impact revenues and the cost of doing business.

ITEM 2.		PROPERTIES

Our principal executive offices and the NSC are located in a 37,000 square foot, Company-owned, single story building located on a 13-acre tract of land in a suburban business park near Tulsa, Oklahoma. This facility also houses a warehouse and assembly area.

We have additional leased facilities located in Hazelwood, Missouri. In addition to our primary warehouse and shipping operation, this facility houses sales staff, technical design, professional services and installation support personnel. We lease office space for branch offices in Richardson, Texas; Flanders, New Jersey; Carrolton, Texas; and Southborough, Massachusetts. These facilities primarily house sales and technical personnel. We also lease other office space throughout the U.S. for sales, consulting, and technical staff.

ITEM 3.		LEGAL PROCEEDINGS

None.

PART II

ITEM 5.		MARKET FOR THE REGISTRANT’S COMMON STOCK AND RELATED STOCKHOLDER MATTERS

Our common stock is traded on the Nasdaq Global Market under the symbol “XETA.” The following table sets forth, for the periods indicated, the high and low sales prices of our common stock as reported on the Nasdaq National Market.

		2010								2009
Quarter Ended:		High				Low				High				Low
January 31		$	3.15			$	2.27			$	2.21			$	1.25
April 30		$	3.99			$	2.85			$	2.05			$	1.06
July 31		$	3.95			$	3.05			$	3.00			$	1.66
October 31		$	3.64			$	2.60			$	2.98			$	2.05

We have never paid cash dividends on our common stock. Payment of cash dividends is dependent upon our earnings, capital requirements, overall financial condition and other factors deemed relevant by the Board of Directors. Currently, we are prohibited by our credit facility from paying cash dividends.

In 2008 the Board of Directors approved a stock repurchase program in which up to $1 million could be used to repurchase our common stock in open market. During fiscal year 2009, we repurchased a total of 30,796 shares of our common stock for a total cash investment of $58,157. There was no repurchase activity during fiscal 2010 and the program was withdrawn by the Board of Directors.

As of November 16, 2010, there were approximately 170 shareholders of record of our common stock. We believe that the number of beneficial owners of our common stock who hold in street name is in excess of 1,500.

EQUITY COMPENSATION PLAN INFORMATION

										Number of securities
										remaining available for
										future issuance under
		Number of securities to be				Weighted-average				equity compensation
		issued upon exercise of				exercise price of				plans (excluding
		outstanding options,				outstanding options,				securities reflected in
		warrants and rights				warrants and rights				column (a))
Plan Category		(a)				(b)				(c)
Equity compensation plans approved by security holders			527,284			$	2.93				2,489,207	(1)
Warrants issued in acquisition			150,000				3.77				0
Equity compensation plans not approved by security holders			240,000	(2)		$	7.43				0
Total			917,284			$	4.24				2,489,207

ITEM 7.		MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Overview

In fiscal 2010, we implemented a strategy to use our unique market position and strong balance sheet to pursue acquisitive growth opportunities. As a result of our successful execution of this strategy, we completed three acquisitions in the second half of fiscal 2010 and absorbed the key employees and fixed assets of an additional strategic asset that was abandoned by its previous owner. These successes plus organic revenue growth of 12% enabled us to record $85.7 million in revenues in fiscal 2010, up 20% from fiscal 2009.

The acquisitions completed in fiscal 2010 all address our strategic initiative to advance our business from its historic roots in voice networks and services into the broader unified communications and data networking market, including consulting services. Our acquisition of the assets of Hotel Technologies Solutions, Inc., d/b/a Lorica Solutions (“Lorica”), a privately-held company headquartered in Buffalo, New York, in May, 2010 provided us with a high speed internet access product and service offering and a help desk service offering in the hospitality vertical market. It also provided us with a platform to resume development of a line of proprietary products to further expand our already strong brand in this market. The acquisition of Pyramid Communications Services, Inc. (“Pyramid”), a privately held company headquartered in Dallas, Texas and the acquisition of the operating assets of Data-Com Telecommunications, Inc. (“Data-Com”), a New Jersey based privately held company, provided us with additional geographic coverage, important new customer relationships, new streams of recurring revenues, and broadened our manufacturer relationships. Finally, we absorbed certain sales and technical employees and a small amount of strategic assets which were being abandoned by their owner. We have used these assets and personnel to form our new Network Operations Center (“NOC”) and related product offerings around data and voice network monitoring and help desk services. The terms of these purchase agreements are described in Note 16 of the Notes to Consolidated Financial Statements.

The discussion that follows provides more details regarding the factors and trends that affected our financial results, liquidity, and capital resources in fiscal 2010 when compared to the previous year.

Results of Operations

FISCAL YEAR 2010 COMPARED TO FISCAL YEAR 2009.

Revenues for fiscal 2010 were $85.7 million compared to $71.6 million in fiscal 2009, a 20% increase. Net income for fiscal 2010 was $1.4 million compared to a net loss of $10.3 million in fiscal 2009, which included $14.8 million ($9.0 million after-tax) in impairment charges against our Goodwill and $3.0 million ($1.8 million after-tax) in impairment charges against our ERP system. Without these one-time charges, our net income in fiscal 2009 would have been $505,000. Discussed below are the major revenue, gross margin, and operating expense items that affected our financial results during fiscal 2010.

Services Revenues. Revenues earned from our services business were $51.3 million in fiscal 2010 compared to $41.1 million in fiscal 2009, a 25% increase. This increase reflects a 21% or $6.1 million increase in maintenance and repair revenues, a 37% or $3.5 million increase in implementation revenues, and a 23% or $611,000 increase in structured cabling revenues.

The increase in our maintenance and repair services business, which include revenues earned from maintenance contracts and time-and-materials (“T&M”) charges reflects the continued success of our wholesale services programs as well as the addition to our base of maintenance customers associated with the purchase of Lorica, Pyramid and Data-Com. We aggressively market our national service footprint and multi-product line technical capabilities to existing and potential wholesale service partners such as network service providers, and large voice and data integrators. Under these offerings we partner with manufacturers, network services companies, and systems integrators to provide a variety of technical services to our partners’ end-user customers. Typically in these relationships, we are filling gaps in geographic or technical competence for our wholesale partner. Our national service footprint and strong technical capabilities make us an attractive partner to these large organizations who have won large outsourcing contracts with end-users. We have invested heavily in sales and technical resources to create relationships with current and potential wholesale partners. Once those relationships are established, we jointly market our capabilities with our partners to end-users who have requested bids for new services or are renewing existing contracts. The wholesale services segment is a highly competitive market and because of their size and prominence end-users can demand both favorable pricing and high service levels. In most cases, our service performance is measured monthly, quarterly and/or annually by our partner. To date, our service ratings have been excellent. However, our experience indicates that end-users expect excellent service ratings, and pricing drives most purchase decisions. As a result, we have limited influence in contract negotiations between our wholesale partners and end-users. This is a key difference between the direct and wholesale services offerings. We expect growth in our wholesale services business to include large contract wins that are partially offset by the occasional loss of a large wholesale services contract.

Our implementation revenues reflect an increase in revenues from our Professional Services Organization (“PSO”) and relatively flat installation revenues. We attribute this to increasing demand for more complex communications systems requiring significant fee-generating design and engineering services. Additionally, we continue to build the capabilities and breadth of our PSO organization to enable us to provide more high value products and services to our customers, particularly advanced communications applications such as unified communications solutions and video conferencing as well as data networking assessment, design, and monitoring. In the near term, Implementation revenues will continue to be closely aligned with the sale of new systems. From a long term perspective, however, as we broaden our product and service offerings and as customers displace conventional communications platforms and adopt more complex systems, we anticipate growth in this area of our business through the fee-based utilization of our highly skilled technical resources.

Our structured cabling revenues increased 23% in fiscal 2010. The increase is primarily from a new wholesale service program added late in fiscal 2009.

Systems Sales. Sales of systems were $34.0 million in fiscal 2010 compared to $30.1 million in fiscal 2009, a 13% increase. Sales of systems to commercial customers were $29.9 million in fiscal 2010, a 42% increase compared to fiscal 2009. Sales of systems to hospitality customers were $4.2 million in fiscal 2010, a 54% decrease compared to the prior year.

Sales of systems to commercial customers reflect a $2.6 million increase with one of our major customers in the education vertical market. While orders for systems to other commercial customers are above last year’s pace, systems revenues continue to reflect the general unpredictable nature of this segment of our business and reluctance on the part of some customers to make significant new investments in technology.

Our hospitality sector experienced a delayed reaction to the deep recession in 2009. Because of spending momentum and new construction and major renovation projects already committed in 2009, we enjoyed a strong year in sales of new systems to this market. In 2010, capital spending in hospitality was severely curtailed resulting in the steep reduction in our sales of systems in this market segment. While no assurance can be given, we are expecting an improvement in this area of our business in fiscal 2011.

Other Revenues. Other revenues were $360,000 in fiscal 2010 compared to $396,000 in fiscal 2009. Other revenues consist of commissions earned on the sale of Avaya maintenance contracts. The decrease in other revenues is attributable to a decrease in the sales of Avaya post-warranty maintenance contracts. Under our dealer agreement with Avaya, we are paid a commission on sales of their maintenance contracts to the Avaya customer base. The commission value on the sale of a maintenance contract is based on the size and length of the contract and the underlying equipment covered under the agreement. 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.

Gross Margins. Gross margins were 27.4% in fiscal 2010 compared to 27.2% in fiscal 2009.

The gross margins earned on services revenues were 30.9% in fiscal 2010 compared to 31.1% in fiscal 2009. Our service margins declined in the fourth quarter due to the short-term impact of the start-up of our network operations center and general inefficiencies from integrating newly acquired operations into our existing systems and processes. We expect steady improvement of these issues throughout fiscal 2011 and integration efforts continue. Overall, our service margins have been expanding reflecting an increase in recurring service revenues combined with improved cost controls, improved utilization of variable labor through the use of third party Quality Service Partners, and improved utilization of our professional services personnel for consulting and fee-based engagements. Despite the additional costs associated with our new businesses, our services margins were within our target range of 30%-35%.

Gross margins on systems sales were 26.4% in fiscal 2010 compared to 26.6% in fiscal 2009. These margins are slightly higher than our expectations of 23%-25% and reflect our continued focus on systems sales margins through controls around contract acceptance and margin reviews. We work closely with our manufacturers and distributors to maximize vendor support through rebate, promotion, and competitive discount programs. These discounts and incentives are material to our gross margins. The Systems sales market is highly competitive and downward pressure on margins is a constant in this segment of our business. We believe the techniques and disciplines we employ around contract acceptance and margin reviews will enable us to maintain our gross margins on systems sales. However, we can give no assurance regarding possible changes in our vendor support programs or other market factors that could either increase or lower margins.

A final component to our gross margins is the margins earned on other revenues. These include costs incurred to market and administer the Avaya post-warranty maintenance contracts that we sell and our corporate cost of goods sold expenses. While we earn a commission on the sale of Avaya post-warranty maintenance contracts which has no direct cost of goods sold, we incur costs in marketing and administration of these contracts before submitting them to Avaya. Corporate cost of goods sold represents the cost of our material logistics, warehousing, advance replacement of service spare parts, and purchasing functions. Corporate cost of goods sold was 1.7% of revenues in fiscal 2010 compared to 2.0% of revenues in fiscal 2009.

Operating Expenses. Operating expenses were $21.3 million or 24.9% of revenues in fiscal 2010 compared to $36.4 million, including $17.8 million in impairment charges, or 50.8% of revenues in fiscal 2009. Excluding the impairment charges, operating expenses were 25.9% of revenues in fiscal 2009. The modest improvement in operating expenses as a percent of revenues was realized despite an increase of over $500,000 in investment in IT related activities and $617,000 in non-recurring expenses for professional fees and other costs related to recently completed and new corporate development activities. Integration expenses included professional fees such as legal, tax and valuation services, finder’s fees, consulting fees paid to outside contractors for integration and due diligence services, and travel costs directly associated with integration activities. Additionally, vendor support payments earned in fiscal 2010 were approximately $670,000 lower than in fiscal 2009 due to additional payments received in 2009 to assist in the transition of Nortel to Avaya and the on-boarding of new manufacturer relationships such as Mitel. These support payments are not directly associated with specific transactions, but are to assist in the marketing of the manufacturer’s products and the promotion of their brand. As a result, these payments are recorded as offsets to our operating expenses.

Interest Expense and Other Income. Interest expense consists primarily of interest paid or accrued on our credit facility. Interest expense was $36,000 in fiscal 2010 compared to $100,000 in fiscal 2009. This reduction reflects both lower interest rates and lower average borrowing during the year. Net other income in fiscal 2010 was approximately $139,000 compared to net other income of approximately $28,000 in fiscal 2009. Most of this increase was the result of a note agreement with a customer which generated interest and late fee income in fiscal 2010. This note was paid in full by the customer in early fiscal 2011.

Income Tax Expense. We have recorded a combined Federal and state tax provision of approximately 39.0% in fiscal 2010 and 39.2% in fiscal 2009. This rate reflects the effective Federal tax rate plus the estimated composite state income tax rate.

Operating Margins. Our net income as a percent of revenues in fiscal 2010 was 1.6%. In fiscal 2009, excluding the impact of the non-cash impairment charges, net income as a percentage of revenues was 0.7%. This increase reflects a 108 basis point improvement in operating expenses as percent of revenues, a 22 basis point increase in other income, and a 16 basis point improvement in gross profit margin (all on a pre-tax basis). We believe operating margins can be improved to the 4% to 6% range through continued expansion of our more predictable and recurring revenue streams, better use of technology, and improved management of sales resources.

FISCAL YEAR 2009 COMPARED TO FISCAL YEAR 2008.

Revenues for fiscal 2009 were $71.6 million compared to $84.3 million in fiscal 2008, a 15% decrease. The net loss for fiscal 2009 was $10.3 million compared to net income of $2.1 million in fiscal 2008. Discussed below are the major revenue, gross margin, and operating expense items that affected our financial results during fiscal 2009.

Services Revenues. Revenues earned from our services business were $41.1 million in fiscal 2009 compared to $43.5 million in fiscal 2008, a 6% decrease. This decline reflected a 1% or $228,000 decrease in maintenance and repair revenues, a 15% or $1.6 million decrease in implementation revenues, and a 17% or $538,000 decrease in structured cabling revenues.

The decreases in our maintenance and repair services business consisted of relatively flat contract maintenance revenues and a decrease in T&M revenues of 5%. The decrease in our implementation revenues in fiscal 2009 reflected the difficult comparison to fiscal 2008 which provided over $3 million in implementation revenues associated with the Miami-Dade County Public School’s (“M-DCPS”) orders. Our structured cabling revenues decreased 17% in fiscal 2009. This decline was a difficult comparison to our structured cabling revenues in fiscal 2008 due to the significant contribution to these revenues by the M-DCPS orders during fiscal 2008.

Systems Sales. Sales of systems were $30.1 million in fiscal 2009 compared to $38.9 million in fiscal 2008, a 23% decrease. Sales of systems to commercial customers were $21.1 million in fiscal 2009, a 30% decrease compared to fiscal 2008. Sales of systems to hospitality customers were $9.0 million in fiscal 2009, a 5% increase compared to fiscal 2008.

The decrease in sales of systems to commercial customers was primarily attributable to the completion of the M-DCPS contract which produced $1.7 million in equipment revenues during fiscal 2009 compared to $9.4 million during fiscal 2008. Additionally, macro-economic conditions and uncertainty around the Nortel bankruptcy dampened capital spending on technology.

The increased sales of systems to hospitality customers in fiscal 2009 reflected our continued success in this relatively mature niche market despite considerable economic challenges in the hospitality segment and the successful execution of our strategy to expand into the Mitel product offering.

Other Revenues. Other revenues were $396,000 in fiscal 2009 compared to $1.9 million in fiscal 2008. The decrease in other revenues was attributable to a decrease in the sales of Avaya post-warranty maintenance contracts.

Gross Margins. Gross margins were 27.2% in fiscal 2009 compared to 26.4% in fiscal 2008.

The gross margins earned on services revenues were 31.1% in fiscal 2009 compared to 28.3% in fiscal 2008. Gross margins earned on Services revenues reflected mixed results between improved margins earned on maintenance and repair services and structured cabling, which were offset by lower margins on implementations. Gross margins on systems sales were 26.6% in fiscal 2009 compared to 26.2% in fiscal 2008.

A final component to our gross margins was the margins earned on other revenues. (See discussion of gross margins on other revenues in the caption “Gross Margins” under “FISCAL YEAR 2010 COMPARED TO FISCAL YEAR 2009” above for an explanation of composition of these margins). Corporate cost of goods sold was 2.0% of revenues in fiscal 2009 compared to 1.8% of revenues in fiscal 2008.

Operating Expenses. Operating expenses, which included $17.8 million in impairment charges, were $36.4 million or 50.8% of revenues in fiscal 2009 compared to $18.6 million or 22.0% of revenues in fiscal 2008. Excluding the impairment charges, operating expenses were 25.9% of revenues in fiscal 2009. The increase in operating expenses included a $17.8 million impairment charge, a bad debt provision of $350,000 in specific response to the Nortel bankruptcy filing, increased legal fees to support litigation and board governance activities, increased amortization of our ERP system and increased amortization of intangible assets associated with recent acquisitions of service contracts and customer lists.

Interest Expense and Other Income. Interest expense was $100,000 in fiscal 2009 compared to $334,000 in fiscal 2008 reflecting both lower interest rates and lower average borrowing during the year. The cash cycle on the M-DCPS project was extremely long and forced us to borrow heavily on our revolving line of credit in fiscal 2008 to meet working capital needs. Net other income in fiscal 2009 was approximately $28,000 compared to net other income of approximately $24,000 in fiscal 2008.

Income Tax Expense. We recorded a combined Federal and state tax provision of approximately 39.2% in fiscal 2009 and fiscal 2008. This rate reflected the effective Federal tax rate plus the estimated composite state income tax rate.

Operating Margins. Our net loss as a percent of revenues in fiscal 2009 was a negative 14.4%. Excluding the impact of the non-cash impairment charges in fiscal 2009, our net income as a percentage of revenues was 0.7% compared to net income as a percent of revenues of 2.4% in fiscal 2008.

Liquidity and Capital Resources

At October 31, 2010 our working capital was $7.5 million compared to $11.5 million at October 31, 2009. We used our beginning cash balance of $4.7 million, cash generated from operations of $4.3 million, short-term borrowings from our line of credit, subordinated notes, and equity to fund our acquisitions and capital expenditures during the year.

To purchase the net operating assets of Lorica, the net operating assets of Data-Com and the stock of Pyramid we paid $6.3 million in cash from existing cash balances and short-term borrowings on our line of credit. In addition, we issued $675,000 in subordinated notes to the previous owners of Pyramid as part of the consideration in that transaction. The notes are payable in 8 quarterly installments and carry a 3% interest rate. Finally, we issued 397,898 shares of common stock valued at $1.5 million and 150,000 warrants to purchase common stock at $3.77 to the previous owners of Lorica. The warrants have a term of 5 years from the May 21, 2010 closing date and were valued at $279,000.

We acquired capital assets of $1.3 million which were primarily supporting normal replacement cycles of technology infrastructure and support of newly acquired operating assets. We also retired $1.1 million in previously issued term debt as part of the establishment of a new credit facility in early fiscal 2010.

At October 31, 2010, our cash balance was $1.0 million and we owed $1.8 million outstanding balance on our line of credit. In accordance with the collateral base defined in the credit facility, $6.7 million was available for borrowing on the facility at the end of the year. At October 31, 2010, we were in compliance with the covenants of the credit facility and on November 5, 2010 we renewed our loan agreement for a one year term on substantially the same terms and conditions.

In addition to the current available capacity under our working capital line of credit, we believe our current assets support additional short-term borrowing capacity and our real estate holdings support an additional $3.0 to $3.5 million in term debt. Additionally, we may have access to a variety of capital sources such as private placements of subordinated debt, and public or private sales of equity.

We have a variety of financing tools at our disposal to fund acquisitions. We believe our cash balances, expected free cash flows from operations, and available borrowing capacity will be our primary sources of capital. However, we also expect to employ financial tools such as subordinated seller notes, earn-out agreements, indemnity hold-backs, and occasionally restricted stock and/or warrants. The level to which we employ these various methods, particularly the use of our equity, will depend upon a multitude of factors which are unique to each negotiation.

Recent Accounting Pronouncements

See Notes to Consolidated Financial Statements, Note 1: Business and Summary of Significant Accounting Policies for a discussion of the impact of new accounting standards on the Company’s consolidated financial statements.

Application of Critical Accounting Policies

Our financial statements are prepared based on the application of generally accepted accounting principles in the U.S. These accounting principles require us to exercise considerable judgment about future events that affect the amounts reported throughout our financial statements. Actual events could unfold quite differently than our judgments predicted. Therefore, the estimates and assumptions inherent in the financial statements included in this report could be materially different once actual events unfold. We believe the following policies may involve a higher degree of judgment and complexity in their application and represent critical accounting policies used in the preparation of our financial statements. If different assumptions or estimates were used, our financial statements could be materially different from those included in this report.

Revenue Recognition. We recognize revenues from equipment sales based on shipment of the equipment, which is generally easily determined. Revenues from implementation and service activities are recognized based upon completion of the activity, which sometimes requires judgment on our part. Revenues from maintenance contracts are recognized ratably over the term of the underlying contract.

Collectability of Accounts Receivable. We must make judgments about the collectability of our accounts receivable to be able to present them at their net realizable value on the balance sheet. To do this, we carefully analyze the aging of our customer accounts, try to understand why accounts have not been paid, and review historical bad debt problems. From this analysis, we record an estimated allowance for receivables that we believe will ultimately become uncollectible. We actively manage our accounts receivable to minimize our credit risks and believe that our current allowance for doubtful accounts is fairly stated.

Realizability of Inventory Values. We make judgments about the ultimate realizability of our inventory in order to record our inventory at its lower of cost or market. These judgments involve reviewing current demand for our products in comparison to present inventory levels and reviewing inventory costs compared to current market values. We maintain a significant inventory of used and refurbished parts for which these assessments require a high degree of judgment.

Goodwill and Other Long-lived Assets. We have a significant amount of goodwill on our balance sheet resulting from acquisitions made between fiscal years 2000 and 2010. The Company accounts for goodwill under the provisions of Accounting Standards Codification (“ASC”) 350, “Intangibles — Goodwill and Other”. Goodwill recorded as a part of a business combination is not amortized, but instead is subject to at least an annual assessment for impairment by applying a fair-value-based test. The test for goodwill impairment is a two-step analysis process. The first step of the analysis is to determine if a potential impairment exists for a reporting unit by comparing the fair value of the unit with the carrying value of the unit. The goodwill of the reporting unit is not considered to have a potential impairment if the fair value of a reporting unit exceeds its carrying amount and the second step of the impairment test is not necessary. If the carrying amount of a reporting unit exceeds the fair value of the unit, the second step is performed to determine if goodwill is impaired and to measure the amount, if any, of impairment loss to recognize. The second step of the analysis compares the implied fair value of goodwill with the carrying amount of goodwill. The implied fair value of goodwill is determined by allocating all the assets and liabilities, including any unrecognized intangible assets, to the reporting unit. If the implied fair value of goodwill exceeds the carrying amount, then goodwill is not considered impaired. If the carrying amount of goodwill exceeds the implied fair value, goodwill is considered impaired and an impairment loss is recognized in an amount equal to the excess of the carrying amount over the implied fair value.

We conducted these impairment tests on August 1 for fiscal year 2010. We engaged an independent valuation consultant to assist in the valuation of the commercial systems sales and services reporting units. The Company used a combination of evaluations to estimate the fair value of its reporting units, including the following: a) an income approach by which forecasted future cash flows are discounted to present value; b) a market approach by which comparable companies values are compared to the applicable reporting unit’s values; and c) a market approach by which the Company’s own market capitalization is applied to the applicable reporting unit. This examination also requires a great amount of subjectivity and assumptions. Based on the work performed, we determined that the fair value of each reporting unit was greater than its carrying value and therefore no impairment had occurred.

For fiscal 2009 the Company conducted an interim test for impairment as of July 31, 2009. The Company engaged a consultant to assist in the valuation and based on the results of this work, the Company determined that the carrying value of the commercial systems sales reporting unit was impaired, and the services reporting unit was not impaired. The Company recorded an impairment charge of $14.8 million against its commercial systems sales reporting unit.

We have recorded property, equipment, and capitalized software costs at historical cost less accumulated depreciation or amortization. The determination of useful economic lives and whether or not these assets are impaired involves significant judgment. In accordance with ASC 360, “Impairment or Disposal of Long-Lived Assets”, an impairment loss on long-lived assets used in operations is recorded when events and circumstances indicate that the carrying amount of the asset may not be recoverable. During fiscal year 2010, it was determined that no impairment had occurred. In fiscal 2009, an impairment charge of $3.0 million was recorded to reduce the carrying value of certain identifiable assets related to our ERP platform. We estimated that the full cost of the system could not be reasonably recovered based on near-term projected financial results. The impairment charge reduced the carrying value of this asset to the mid-point of our estimate of the replacement cost of an ERP system that would be adequate for the Company’s current and near-term operating needs.

Accruals for Contractual Obligations and Contingent Liabilities. On products assembled or installed by us, we have varying degrees of warranty obligations. We use historical trends and make other judgments to estimate our liability for such obligations. We also must record estimated liabilities for many forms of Federal, state, and local taxes. Our ultimate liability for these taxes depends upon a number of factors, including the interpretation of statutes and the mix of our taxable income between higher and lower taxing jurisdictions. In the normal course of business, we can be a party to threatened or actual litigation. In such cases, we evaluate our potential liability, if any, and determine if an estimate of that liability should be recorded in our financial statements. Estimating both the probability of our liability and the potential amount of the liability are highly subjective exercises and are evaluated frequently as the underlying circumstances change.

ITEM 8.		FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The financial information required by this Item is incorporated by reference to the financial statements listed in Items 15(a)(1) and 15(a)(2), which financial statements appear at Pages F-1 through F-21 at the end of this Report.

ITEM 9.		CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

None.

ITEM 9A.		CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

We carried out, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, an evaluation of 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”)) as of the end of our fiscal year ended October 31, 2010. Based upon our evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures are effective to ensure that information required to be disclosed in reports that we file or submit under the Exchange Act are recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission (“Commission”) rules and forms.

Changes in Internal Controls

There were no significant changes in our internal controls or in other factors that could significantly affect these controls subsequent to the date of their evaluation. There were no significant deficiencies or material weaknesses, and therefore, there were no corrective actions taken.

Management Report on Internal Control over Financial Reporting

Our management is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is defined in Rules 13a-15(f) and 15d-15(f) promulgated under the Securities Exchange Act of 1934, as amended, as a process designed by, or under the supervision of, a company’s principal executive and principal financial officers and effected by a company’s board, management and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with GAAP and includes those policies and procedures that:

•

Pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of a company;

•

Provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with GAAP, and that receipts and expenditures of a company are being made only in accordance with authorizations of management and directors of a company; and

•

Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of a company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Projections of any evaluation of effectiveness to future periods are subject to the risks that controls may become inadequate because of changes in conditions or that the degree of compliance with the policies or procedures may deteriorate. Our management assessed the effectiveness of our internal control over financial reporting as of October 31, 2010. In making this assessment, our management used criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control-Integrated Framework. Based on its assessment, our management believes that, as of October 31, 2010, our internal control over financial reporting was effective based on those criteria.

We acquired the assets of Lorica in May, 2010 and the assets of DataCom in September, 2010. Additionally, we acquired 100% of the capital stock of Pyramid in August, 2010 (the “Acquired Companies”). We have excluded the Acquired Companies from our annual assessment of and conclusion on the effectiveness of internal control over financial reporting. The Acquired Companies accounted for 9 percent of our total assets as of October 31, 2010 and approximately 7 percent of our consolidated revenues for the year ended October 31, 2010.

ITEM 9B.		OTHER INFORMATION

None.

PART III

ITEM 10.		DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE

Information required by this Item relating to directors is incorporated by reference to our definitive proxy statement to be filed with the Securities and Exchange Commission (the “Commission”) not later than 120 days after the close of our fiscal year ended October 31, 2010 (the “Proxy Statement”), under the section “Proposal 1—Election of Directors.”

Information relating to executive officers required by this Item is incorporated by reference to the Proxy Statement under the section “Executive Officers.”

Other information required by this Item is incorporated by reference to the Proxy Statement under the section “Section 16(a) Beneficial Ownership Reporting Compliance,” and to the discussions “Code of Ethics,” “Nominating Committee” and “Audit Committee” under the section “Corporate Governance.”

We have adopted a financial code of ethics that applies to our CEO, CFO, controller, principal accounting officer and any other employee performing similar functions. This financial code of ethics is posted on our website. The Internet address for our website is www.xeta.com, and the financial code of ethics may be found on the Investor Relations page under “Governance.”

We will satisfy the disclosure requirement under Item 5.05 of Form 8-K regarding any amendment to, or waiver from, a provision of this code of ethics by posting such information on our website, at the address and location specified above.

ITEM 11.		EXECUTIVE COMPENSATION

Information required by this Item is incorporated by reference to the Proxy Statement under the sections “Executive Compensation” and “Director Compensation,” and to the discussion “Compensation Committee Interlocks” under the section “Corporate Governance”.

ITEM 12.		SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

Information relating to Equity Compensation Plans required by this Item is included in Part II of this Report in the table entitled “Equity Compensation Plan Information” under the caption “Market for the Registrant’s Common Stock and Related Stockholder Matters.”

Other information required by this Item is incorporated by reference to the Proxy Statement under the section “Security Ownership of Certain Beneficial Owners and Management.”

ITEM 13.		CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE

Information required by this Item is incorporated by reference to the Proxy Statement under the section “Certain Relationships and Related Transaction” and to the discussion “Director Independence” under the section “Corporate Governance.”

ITEM 14.		PRINCIPAL ACCOUNTING FEES AND SERVICES

Information required by this Item is incorporated by reference to the discussion in the Proxy Statement “Fees and Independence” under the section “Proposal 2—Independent Public Accountants.”

PART IV

ITEM 15.		EXHIBITS AND FINANCIAL STATEMENT SCHEDULES.

The following documents are filed as a part of this report:

(a)(1) Financial Statements — The following financial statements are included with this report:

		Page
Report of Independent Registered Public Accounting Firm			F-1
Consolidated Financial Statements
Consolidated Balance Sheets — October 31, 2010 and 2009			F-2
Consolidated Statements of Operations — For the Years Ended October 31, 2010, 2009 and 2008			F-3
Consolidated Statement of Shareholders’ Equity — For the Years Ended October 31, 2010, 2009 and 2008			F-4
Consolidated Statements of Cash Flows — For the Years Ended October 31, 2010, 2009 and 2008			F-5
Notes to Consolidated Financial Statements			F-6

No.				Description
	2.1	*		Asset Purchase Agreement dated August 23, 2010 between XETA Technologies, Inc. as Purchaser, Data-Com Telecommunications Inc. as Seller, and Seller Principal.
				PORTIONS OF THIS EXHIBIT HAVE BEEN OMITTED PURSUANT TO A CONFIDENTIAL TREATMENT REQUEST. SUCH PORTIONS HAVE BEEN FILED SEPARATELY WITH THE COMMISSION WITH THE REGISTRANT’S APPLICATION FOR CONFIDENTIAL TREATMENT.
	2.2			Stock Purchase Agreement dated July 9, 2010 by and among XETA Technologies, Inc. as Purchaser, Pyramid Communications Services Inc., and Pyramid’s six individual shareholders as Sellers (incorporated by reference to Exhibit 2.2 to XETA’s Quarterly Report on Form 10-Q for the quarter ended July 31, 2010).
	2.3			Asset Purchase Agreement dated May 10, 2010 between XETA Technologies, Inc. as Purchaser, Hotel Technology Solutions, Inc. as Seller, and Seller Principals (incorporated by reference to Exhibit 2.1 to XETA’s Quarterly Report on Form 10-Q for the quarter ended July 31, 2010).
	3	(i)		Restated Certificate of Incorporation (incorporated by reference to Exhibit 3(i) to XETA’s Annual Report on Form 10-K for the year ended October 31, 2004).
	3	(ii)		Amended and Restated Bylaws as adopted January 23, 2008 (incorporated by reference to Exhibit 3(ii) to XETA’s Quarterly Report on Form 10-Q for the quarter ended January 31, 2008).
	10.1	*†		XETA Technologies, Inc. Executive Change in Control Severance Plan
	10.2	†		XETA Technologies, Inc. 2004 Omnibus Stock Incentive Plan as amended and restated December 18, 2008 (the “2004 Omnibus Plan”) (incorporated by reference to Exhibit 10.1 to XETA’s Annual Report on Form 10-K for the fiscal year ended October 31, 2008).

No.				Description
	10.3	†		Form of Restricted Stock Award Agreement under the 2004 Omnibus Plan (incorporated by reference to Exhibit 10.2 to XETA’s Annual Report on Form 10-K for the fiscal year ended October 31, 2009).
	10.4	†		Form of Stock Option Award Agreement under the 2004 Omnibus Plan (incorporated by reference to Exhibit 99(d)(4) to XETA’s SC TO-I filed September 17, 2009).
	10.5	†		XETA Technologies 2000 Stock Option Plan as amended and restated December 30, 2008 (the “2000 Plan”) (incorporated by reference to Exhibit 10.5 to XETA’s Annual Report on Form 10-K for the fiscal year ended October 31, 2008).
	10.6	†		Form of Stock Purchase Option Agreement under the 2000 Plan (incorporated by reference to Exhibit 99(d)(2) to XETA’s SC TO-I filed September 17, 2009).
	10.7			Avaya Inc. Reseller Master Terms and Conditions effective as of August 6, 2003 between Avaya Inc. and XETA Technologies, Inc. (incorporated by reference to Exhibit 10.6 to XETA’s Annual Report on Form 10-K for the fiscal year ended October 31, 2003).
	10.8			Mitel authorized PARTNER Agreement dated September 28, 2007 between Mitel Networks Inc. and XETA Technologies, Inc. (incorporated by reference to Exhibit 10.8 to XETA’s Annual Report on Form 10-K for the fiscal year ended October 31, 2009).
	10.9	*		North America Reseller Agreement Acknowledgement dated September 27, 2010 between XETA Technologies, Inc. and ShoreTel, Inc.
	10.10	*		Reseller Agreement Addendum dated September 28, 2010 between XETA Technologies, Inc. and ShoreTel, Inc.
				PORTIONS OF THIS EXHIBIT HAVE BEEN OMITTED PURSUANT TO A CONFIDENTIAL TREATMENT REQUEST. SUCH PORTIONS HAVE BEEN FILED SEPARATELY WITH THE COMMISSION WITH THE REGISTRANT’S APPLICATION FOR CONFIDENTIAL TREATMENT.
	10.11			First Amendment to Loan Agreement between Commerce Bank, N.A. and XETA Technologies, Inc. dated November 5, 2010 (incorporated by reference to Exhibit 10.1 to XETA’s Current Report on Form 8-K filed November 10, 2010).
	10.12			Loan Agreement between Commerce Bank and XETA Technologies, Inc. dated November 6, 2009 (incorporated by reference to Exhibit 10.1 to XETA’s Current Report on Form 8-K filed November 12, 2009).
	10.13			Promissory Note payable to Commerce Bank for $8,500,000 dated November 6, 2009 (incorporated by reference to Exhibit 10.2 to XETA’s Current Report on Form 8-K filed November 12, 2009).
	21	*		Subsidiaries of XETA Technologies, Inc.
	23.1	*		Consent of HoganTaylor LLP.
	31.1	*		Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
	31.2	*		Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
	32.1	*		Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
	32.2	*		Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) 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.
January 21, 2011		By:		/s/ Greg D. Forrest   Greg D. Forrest, Chief Executive Officer

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.

January 21, 2011		/s/ Greg D. Forrest   Greg D. Forrest, Chief Executive Officer and President
January 21, 2011		/s/ Robert B. Wagner   Robert B. Wagner, Chief Financial Officer and Executive Director of Operations
January 18, 2011		/s/ Donald T. Duke   Donald T. Duke, Director
January 18, 2011		/s/ Ronald L. Siegenthaler   Ronald L. Siegenthaler, Director
January 18, 2011		/s/ S. Lee Crawley   S. Lee Crawley, Director

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Shareholders of

XETA Technologies, Inc.

We have audited the accompanying consolidated balance sheets of XETA Technologies, Inc. and subsidiaries as of October 31, 2010 and 2009, and the related consolidated statements of operations, shareholders’ equity and cash flows for each of the three years in the period ended October 31, 2010. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of XETA Technologies, Inc. and subsidiaries as of October 31, 2010 and 2009, and the results of their operations and their cash flows for each of the three years in the period ended October 31, 2010, in conformity with U.S. generally accepted accounting principles.

/s/ HOGANTAYLOR LLP

Tulsa, Oklahoma
January 24, 2011

XETA TECHNOLOGIES, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

		October 31, 2010				October 31, 2009
ASSETS
Current assets:
Cash and cash equivalents		$	1,003,180			$	4,731,926
Current portion of net investment in sales-type leases and other receivables			996,148				470,025
Trade accounts receivable, net			17,805,992				13,832,452
Inventories, net			6,715,076				5,036,198
Deferred tax asset			1,168,544				1,136,351
Prepaid taxes			69,980				39,784
Prepaid expenses and other assets			2,402,111				2,057,514
Total current assets			30,161,031				27,304,250
Noncurrent assets:
Goodwill			17,783,911				12,031,975
Intangible assets, net			3,161,791				570,740
Net investment in sales-type leases and other receivables, less current portion above			326,454				335,413
Property, plant & equipment, net			6,931,927				6,825,916
Deferred tax asset			—				739,216
Total noncurrent assets			28,204,083				20,503,260
Total assets		$	58,365,114			$	47,807,510
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
Current portion of long-term debt		$	337,500			$	1,183,475
Revolving line of credit			1,756,361				—
Accounts payable			10,031,900				5,785,225
Current portion of obligations under capital lease			122,401				154,072
Current unearned services revenue			6,529,330				5,194,601
Accrued liabilities			3,883,303				3,444,396
Total current liabilities			22,660,795				15,761,769
Noncurrent liabilities:
Long-term debt, less current portion above			255,315				—
Accrued long-term liability			144,100				144,100
Long-term portion of obligations under capital lease			—				106,076
Noncurrent unearned services revenue			48,629				36,691
Noncurrent deferred tax liability			12,417				—
Total noncurrent liabilities			460,461				286,867
Contingencies
Shareholders’ equity:
Preferred stock; $.10 par value; 50,000 shares authorized, 0 issued			—				—
Common stock; $.001 par value; 50,000,000 shares authorized, 11,654,071 issued at October 31, 2010 and 11,256,193 issued at October 31, 2009			11,653				11,255
Paid-in capital			15,662,689				13,704,460
Retained earnings			21,596,383				20,223,169
Less treasury stock, at cost (923,835 shares at October 31, 2010 and 993,763 shares at October 31, 2009)			(2,026,867	)			(2,180,010	)
Total shareholders’ equity			35,243,858				31,758,874
Total liabilities and shareholders’ equity		$	58,365,114			$	47,807,510

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

XETA TECHNOLOGIES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

		For the Years
		Ended October 31,
		2010				2009				2008
Systems sales		$	34,014,571			$	30,095,844			$	38,900,301
Services			51,304,187				41,080,689				43,483,939
Other revenues			359,525				395,878				1,936,639
Net sales and services revenues			85,678,283				71,572,411				84,320,879
Cost of systems sales			25,023,057				22,079,858				28,719,969
Services costs			35,450,671				28,291,495				31,178,401
Cost of other revenues & corporate COGS			1,751,244				1,720,115				2,166,374
Total cost of sales and services			62,224,972				52,091,468				62,064,744
Gross profit			23,453,311				19,480,943				22,256,135
Operating expenses
Selling, general and administrative			20,436,520				17,370,765				17,547,088
Amortization			868,054				1,201,176				1,018,186
Impairment of goodwill & other assets			—				17,800,000				—
Total operating expenses			21,304,574				36,371,941				18,565,274
Income (loss) from operations			2,148,737				(16,890,998	)			3,690,861
Interest expense			(36,452	)			(99,657	)			(334,072	)
Interest and other income			138,929				28,110				23,645
Net interest and other income (expense)			102,477				(71,547	)			(310,427	)
Income (loss) before provision (benefit) for income taxes			2,251,214				(16,962,545	)			3,380,434
Provision (benefit) for income taxes			878,000				(6,646,000	)			1,324,000
Net income (loss)		$	1,373,214			$	(10,316,545	)		$	2,056,434
Earnings (loss) per share
Basic		$	0.13			$	(1.01	)		$	0.20
Diluted		$	0.13			$	(1.01	)		$	0.20
Weighted average shares outstanding			10,402,261				10,223,626				10,249,671
Weighted average equivalent shares			10,478,377				10,223,626				10,249,671

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

XETA TECHNOLOGIES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY

		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 from treasury			—				—				(16,905	)			37,191				(37,191	)			—				—
Tax benefit of stock options			—				—				—				—				4,032				—				4,032
Stock based compensation			—				—				—				—				247,050				—				247,050
Net Income			—				—				—				—				—				2,056,434				2,056,434
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, at cost			—				—				30,796				(58,157	)			—				—				(58,157	)
Issuance of restricted common stock from treasury			—				—				(38,916	)			85,615				(85,615	)			—				—
Stock based compensation			—				—				—				—				296,680				—				296,680
Net loss			—				—				—				—				—				(10,316,545	)			(10,316,545	)
Balance- October 31, 2009			11,256,193			$	11,255				993,763			$	(2,180,010	)		$	13,704,460			$	20,223,169			$	31,758,874
Issuance of restricted common stock from treasury (net of 10,950 forfeited shares)			—				—				(69,928	)			153,143				(153,143	)			—				—
Issuance of common stock			397,878				398				—				—				1,499,602				—				1,500,000
Issuance of warrants			—				—				—				—				279,000				—				279,000
Stock-based compensation			—				—				—				—				332,770				—				332,770
Net income			—				—				—				—				—				1,373,214				1,373,214
Balance- October 31, 2010			11,654,071			$	11,653				923,835			$	(2,026,867	)		$	15,662,689			$	21,596,383			$	35,243,858

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

XETA TECHNOLOGIES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

		For the Years
		Ended October 31,
		2010				2009				2008
Cash flows from operating activities:
Net income (loss)		$	1,373,214			$	(10,316,545	)		$	2,056,434
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Depreciation			1,249,761				1,026,069				744,003
Amortization			868,054				1,201,174				1,018,189
Impairment of goodwill & other assets			—				17,800,000				—
Stock-based compensation			302,467				283,909				247,050
Loss on sale of assets			—				3,764				425
Provision for returns & doubtful accounts receivable			63,226				460,000				22,924
Provision for excess and obsolete inventory			102,000				102,000				102,000
Deferred taxes			815,466				(6,776,757	)			1,300,716
Change in assets and liabilities:
(Increase) decrease in net investment in sales-type leases & other receivables			(517,164	)			(89,400	)			170,273
(Increase) decrease in trade accounts receivable			(1,321,905	)			6,114,067				(3,748,230	)
(Increase) decrease in inventories			(566,609	)			343,114				(962,714	)
Increase in prepaid expenses and other assets			(183,239	)			(325,375	)			(1,092,627	)
(Increase) decrease in prepaid taxes			(30,196	)			24,809				(44,856	)
Increase (decrease) in accounts payable			2,079,034				(956,376	)			1,021,231
Increase in unearned revenue			209,993				1,517,735				925,638
Decrease in accrued liabilities			(192,121	)			(398,628	)			(88,289	)
Total adjustments			2,878,767				20,330,105				(384,267	)
Net cash provided by operating activities			4,251,981				10,013,560				1,672,167
Cash flows from investing activities:
Additions to property, plant & equipment			(1,345,332	)			(895,848	)			(1,294,415	)
Proceeds from sale of assets			—				5,064				—
Acquisitions, net of cash acquired			(6,319,665	)			(802,887	)			—
Investment in capitalized service contracts			—				(750,000	)			(353,481	)
Net cash used in investing activities			(7,664,997	)			(2,443,671	)			(1,647,896	)
Cash flows from financing activities:
Principal payments on debt			(1,355,815	)			(171,090	)			(171,088	)
Net proceeds (payments) on revolving line of credit			1,201,829				(2,524,130	)			(234,530	)
Payments on capital lease obligations			(161,744	)			(148,225	)			(48,147	)
Payments to acquire treasury stock			—				(58,157	)			—
Exercise of stock options			—				—				90,215
Net cash used in financing activities			(315,730	)			(2,901,602	)			(363,550	)
Net (decrease) increase in cash and cash equivalents			(3,728,746	)			4,668,287				(339,279	)
Cash and cash equivalents, beginning of period			4,731,926				63,639				402,918
Cash and cash equivalents, end of period		$	1,003,180			$	4,731,926			$	63,639
Supplemental disclosure of cash flow information:
Cash paid during the period for interest		$	37,351			$	101,276			$	346,045
Cash paid during the period for income taxes		$	49,332			$	110,210			$	68,108
Non-cash investing and financing activity:
Non-collateralized obligation to purchase service contracts		$	—			$	—			$	750,000
Capital lease obligations incurred		$	—			$	—			$	456,520
Issuance of common stock for acquisition		$	1,500,000			$	—			$	—
Issuance of warrants for acquisition		$	279,000			$	—			$	—
Issuance and assumption of debt and line of credit for acquisition		$	1,319,687

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

XETA TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE YEARS ENDED OCTOBER 31, 2010

1. BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:

Business

XETA Technologies, Inc. (“XETA” or the “Company”) is a leading integrator of advanced communications solutions with nationwide sales and service. XETA provides a wide variety of applications including voice messaging, wireless voice and data solutions, video applications, contact center solutions, unified communication, and high speed internet access solutions to hospitality and conference center customers. The Company sells and/or supports communications solutions produced by several manufacturers including Avaya, Inc. (“Avaya”), Mitel Corporation (“Mitel”), Samsung Business Communications Systems (“Samsung”), Juniper Networks, Polycom, Microsoft and ShoreTel Corporation (“ShoreTel”). The Company also manufactures and markets a line of proprietary call accounting systems to the hospitality industry. Through its recent acquisition of the assets of Hotel Technology Solutions, Inc. (“Lorica”) the Company provides high speed internet access, network monitoring services, and guest help desk services to the hospitality industry. The Company also manufactures and markets a line of proprietary call accounting systems to the hospitality industry. XETA is an Oklahoma corporation.

Pyramid Communication Services, Inc. is a wholly-owned subsidiary of XETA purchased on August 2, 2010. Xetacom, Inc. is a wholly-owned dormant subsidiary of the Company.

Cash and Cash Equivalents

Cash and cash equivalents consist of money-market accounts and commercial bank accounts.

Fair Value of Financial Instruments

The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate the value:

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

Based upon the borrowing rates currently available to the Company for bank loans with similar terms and average maturities, the fair value of the long-term debt approximates the carrying value.

Revenue Recognition

The Company earns revenues from the sale and installation of communications systems, the sale of maintenance contracts, and the sale of services on a time-and-materials (“T&M”) basis. The Company typically sells communications systems under single contracts to provide the equipment and the implementation services; however, the installation and any associated professional services and project management services are priced independently from the equipment based on the market price for those services. The installation of the systems sold by the Company can be outsourced to a third party either by the Company under a subcontractor arrangement or by the customer under arrangements in which vendors bid separately for the provision of the equipment from the installation and related services. Accounting Standards Codification (“ASC”) 605-25, “Revenue Recognition — Multiple-Element Arrangements”, addresses certain aspects of accounting by a vendor for arrangements with multiple revenue-generating elements, such as those including products with installation. Revenue is recognized for each element of the transaction based on its relative fair value. The revenue associated with each delivered element should be recognized separately if it has stand-alone value to the customer, there is evidence of the fair value of the undelivered element, the delivery or performance of the undelivered element is considered probable and performance is substantially under the Company’s control and is not essential to the functionality of the delivered element. Under these guidelines, the Company recognizes systems sales revenue upon shipment of the equipment and implementation services revenues upon completion of the installation of the system. Services revenues earned from maintenance contracts are recognized ratably over the term of the underlying contract on a straight-line basis. Revenues earned from services provided on a T&M basis are recognized as those services are provided. The Company recognizes revenue from sales-type leases as discussed below under the caption “Lease Accounting.” Revenues are reported net of applicable sales and use tax imposed on the related transaction.

Shipping and Handling Fees

Freight billed to customers is included in net sales and service revenues in the consolidated statements of operations, while freight billed by vendors is included in cost of sales in the consolidated statements of operations.

Accounting for Manufacturer Incentives

The Company receives various forms of incentive payments, rebates, and negotiated price discounts from the manufacturers of the products sold. Rebates and negotiated price discounts directly related to specific customer sales are recorded as a reduction in the cost of goods sold on those systems sales. Rebates and other incentives designed to offset marketing expenses and certain growth initiatives supported by the manufacturer are recorded as contra expense to the related expenditure. All incentive payments are recorded when earned under the specific rules of the incentive plan.

Lease Accounting

A small portion (less than 1%) of the Company’s revenues has been generated using sales-type leases. The Company sells some of its call accounting systems to the hospitality industry under sales-type leases to be paid over three, four and five-year periods. Because the present value (computed at the rate implicit in the lease) of the minimum payments under these sales-type leases equals or exceeds 90 percent of the fair market value of the systems and/or the length of the lease exceeds 75 percent of the estimated economic life of the equipment, the Company recognizes the net effect of these transactions as a sale.

The Company records interest income from its sales-type lease receivables. Interest income from a sales-type lease represents that portion of the aggregate payments to be received over the life of the lease that exceeds the present value of such payments using a discount factor equal to the rate implicit in the underlying lease.

Accounts Receivable

Accounts receivable are recorded at amounts billed to customers less an allowance for doubtful accounts. Management monitors the payment status of all customer balances and considers an account to be delinquent once it has aged sixty days past the due date. The allowance for doubtful accounts is adjusted based on management’s assessment of collection trends, aging of customer balances, and any specific disputes. For the year ended October 31, 2010, the Company recorded bad debt expense of $63,226. For the year ended October 31, 2009, the Company recorded bad debt expense of $460,000 which included $350,000 provided for potential uncollectible amounts associated with Nortel’s bankruptcy filing. This matter is discussed more fully in Note 2. The Company recorded bad debt expense of $22,924 for the year ended October 31, 2008.

Property, Plant & Equipment

The Company capitalizes the cost of all significant property, plant and equipment additions including equipment manufactured by the Company and installed at customer locations under certain system service agreements. Depreciation is computed over the estimated useful life of the asset or the terms of the lease for leasehold improvements, whichever is shorter, on a straight-line basis. When assets are retired or sold, the cost of the assets and the related accumulated depreciation is removed from the accounts and any resulting gain or loss is included in other income. Maintenance and repair costs are expensed as incurred. 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 did not capitalize any interest costs in fiscal years 2010, 2009 or 2008.

Software Development Costs

External direct costs of software development, payroll and payroll-related costs for time spent on the project by employees directly associated with the development, and interest costs incurred during the development after the “preliminary project stage” has been completed are capitalized. At October 31, 2010 the capitalized value of our developed ERP software was $3.5 million and other capitalized software was $100,000.

In the third fiscal quarter of fiscal 2009, management determined that its ERP system and the related investment were over-adequate for its current and near-term operating needs. The ERP system was originally purchased in 2001 during a period of hyper-growth and the Company expected to be significantly larger within three-to-five years. Those growth expectations did not materialize. Furthermore, the economic downturn represented a setback in the Company’s growth curve. As a result, management determined that it was likely the investment in the ERP system would not be realized within a reasonable time-frame and was therefore impaired. At the time of the impairment charge, the net book value of the Company’s ERP investment was $6.5 million. The Company used various outside sources and its current vendor to estimate the replacement cost of an ERP system that would be adequate for the Company’s current and near-term operating needs. This research yielded an estimated replacement cost of $3.5 million and an impairment charge of $3.0 million was recorded in the third fiscal quarter of the year.

The Company has segregated the cost of the developed software into four groups with estimated useful lives of three, five, seven and ten years. Amortization costs of $522,000, $931,000, and $906,000 were recognized in fiscal years 2010, 2009 and 2008, respectively.

Stock-Based Compensation Plans

The Company applies the provisions of ASC 718, “Compensation — Stock Compensation”, which requires companies to measure all employee stock-based compensation awards using a fair value method and recognize compensation cost in its financial statements. The Company recognizes the fair value of stock-based compensation awards as selling, general and administrative expense in the consolidated statements of operations on a straight-line basis over the vesting period. We recognized compensation expense of $302,000, $284,000, and $247,000 for the fiscal years 2010, 2009, and 2008, respectively.

Income Taxes

Income tax expense is based on pretax income. Deferred income taxes are computed using the asset-liability method in accordance with ASC 740, “Income Taxes”, and are provided on all temporary differences between the financial basis and the tax basis of the Company’s assets and liabilities. The Company accounts for any uncertain tax positions, including issues related to the recognition and measurement of those tax positions, in accordance with the tax position guidance in ASC 740. Generally, the Company is no longer subject to income tax examinations by the U.S. federal, state or local tax authorities for years before 2008.

Unearned Revenue and Warranty

For proprietary systems sold, the Company typically provides a one-year warranty from the date of installation of the system. The Company defers a portion of each system sale to be recognized as service revenue during the warranty period. The amount deferred is generally equal to the sales price of a maintenance contract for the type of system under warranty and the length of the warranty period. The Company also records deposits received on sales orders and prepayments for maintenance contracts as unearned revenues.

Most of the systems sold by the Company are manufactured by third parties. In these instances the Company passes on the manufacturers’ warranties to its customers and therefore does not maintain a warranty reserve for this equipment. The Company maintains a small reserve for occasional labor costs associated with fulfilling warranty requests from customers.

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.

Segment Information

The Company has three reportable segments: services, commercial system sales, and hospitality system sales. Services revenues represent revenues earned from installing and maintaining systems for customers in both the commercial and hospitality segments. The Company defines commercial system sales as sales to the 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. Company management evaluates a segment’s performance based upon gross margins. Assets are not allocated to the segments. Sales to customers located outside of the U.S. are immaterial.

The following is a tabulation of business segment information for 2010, 2009 and 2008:

						Commercial				Hospitality
		Services				System				System				Other
		Revenues				Sales				Sales				Revenue				Total
2010
Sales		$	51,304,187			$	29,859,523			$	4,155,048			$	359,525			$	85,678,283
Cost of sales			35,450,671				22,114,348				2,908,709				1,751,244				62,224,972
Gross profit		$	15,853,516			$	7,745,175			$	1,246,339			$	(1,391,719	)		$	23,453,311
2009
Sales		$	41,080,689			$	21,062,073			$	9,033,771			$	395,878			$	71,572,411
Cost of sales			28,291,495				15,675,673				6,404,185				1,720,115				52,091,468
Gross profit		$	12,789,194			$	5,386,400			$	2,629,586			$	(1,324,237	)		$	19,480,943
2008
Sales		$	43,483,939			$	30,266,493			$	8,633,808			$	1,936,639			$	84,320,879
Cost of sales			31,178,401				22,536,512				6,183,457				2,166,374				62,064,744
Gross profit		$	12,305,538			$	7,729,981			$	2,450,351			$	(229,735	)		$	22,256,135

Recently Issued Accounting Pronouncements

In December 2010 the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2010-28, “Intangibles — Goodwill and Other (Topic 350): When to Perform Step 2 of the Goodwill Impairment Test for Reporting Units with Zero or Negative Carrying Amounts”. ASU 2010-28 modifies Step 1 of the goodwill impairment test for reporting units with zero or negative carrying amounts by requiring an entity to perform Step 2 of the goodwill impairment test if it is more likely than not that a goodwill impairment exists. This update will be effective for fiscal years beginning after December 15, 2010. The adoption of this guidance is not expected to have an impact on the Company’s consolidated financial statements.

In July 2010 the FASB issued ASU 2010-20, “Receivables (Topic 310): Disclosure about the Credit Quality of Financing Receivables and the Allowance for Credit Losses”. ASU 2010-20 requires disclosures designed to enhance transparency regarding credit losses and the credit quality of loan and lease receivables. Disclosures include an evaluation of the nature of credit risk inherent in the entity’s financing receivables; how the risk is analyzed to arrive at the allowance for credit losses and the changes and reasons for changes in the allowance for credit losses. Under this guidance, the allowance for credit losses and fair value are to be disclosed by portfolio segment. ASU 2010-20 will be effective for fiscal years beginning on or after December 31, 2010. The adoption of this guidance is not expected to have an impact on the Company’s consolidated financial statements.

In November 2009 the Company adopted ASC 805, “Business Combinations”. Under ASC 805, 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 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 Company began applying the guidance to business combinations in fiscal 2010.

In November 2009 the Company adopted ASC 350 “Intangibles — Goodwill and Other”. The guidance amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of intangible assets. The intent of the guidance is to improve the consistency between the useful life of a recognized intangible asset under the accounting standards and the period of the expected cash flows used to measure the fair value of the asset. The Company began applying the guidance to intangible assets acquired in fiscal 2010.

In October 2009 the FASB issued ASU 2009-13, “Revenue Recognition — Multiple-Deliverable Revenue Arrangements”. The guidance in ASU 2009-13 amends the criteria for separating consideration in multiple-deliverable arrangements. The guidance eliminates the estimated fair value approach for revenue allocation between the separate units of accounting and replaces it with a sales-based approach referred so as the relative-selling-price method. ASU 2009-13 expands required disclosures related to a company’s multiple-deliverable revenue arrangements. ASU 2009-13 is effective prospectively for fiscal years beginning on or after June 15, 2010. The Company is currently assessing the impact that adoption will have on required disclosures, its financial position and results of operations.

Other accounting standards that have been issued or proposed that do not require adoption until a future date are not expected to have a material impact on our consolidated financial statements upon adoption.

Goodwill

Goodwill recorded as a part of a business combination is not amortized, but instead is subject to at least an annual assessment for impairment by applying a fair-value-based test. The test for goodwill impairment is a two-step analysis process. The first step of the analysis is to determine if a potential impairment exists for a reporting unit by comparing the fair value of the unit with the carrying value of the unit. The goodwill of the reporting unit is not considered to have a potential impairment if the fair value of a reporting unit exceeds its carrying amount in which case the second step of the impairment test is not necessary. If the carrying amount of a reporting unit exceeds the fair value of the unit impairment is indicated and the second step is performed to measure the amount, if any, of impairment loss to recognize. The second step of the analysis compares the implied fair value of goodwill with the carrying amount of goodwill. The implied fair value of goodwill is determined by allocating all the assets and liabilities, including any unrecognized intangible assets, to the reporting unit. If the implied fair value of goodwill exceeds the carrying amount, then goodwill is not considered impaired. If the carrying amount of goodwill exceeds the implied fair value, goodwill is considered impaired and an impairment loss is recognized in an amount equal to the excess of the carrying amount over the implied fair value.

Fiscal 2010. We conducted these impairment tests on August 1 for fiscal year 2010. We engaged an independent valuation consultant to assist in the valuation of the commercial systems sales and services reporting units. The Company used a combination of evaluations to estimate the fair value of its reporting units, including the following: a) an income approach by which forecasted future cash flows are discounted to present value; b) a market approach by which comparable companies values are compared to the applicable reporting unit’s values; and c) a market approach by which the Company’s own market capitalization is applied to the applicable reporting unit. The impairment test also requires a great amount of subjectivity and assumptions. Based on the work performed, we determined that the fair value of our reporting units was greater than the carrying values and therefore no impairment had occurred.

Fiscal 2009. Macro-economic conditions negatively impacted our commercial systems business beginning in the first quarter of fiscal 2009. Those conditions worsened significantly in the third fiscal quarter. Also, uncertainty regarding the ultimate disposition of the Nortel product line grew as Nortel began divesting its assets, including assets which are strategic to the Company’s operations. Finally, the Company’s sustained decline in market capitalization continued, reflecting market uncertainty regarding the value of the Company’s operations. This combination of factors prompted the Company to conduct an interim test for impairment as of July 31, 2009. The Company engaged a consultant to assist in the valuation of the commercial systems sales and services reporting units. The Company used a combination of evaluations to estimate the fair value of its reporting units, including the following: a) an income approach by which forecasted future cash flows are discounted to present value; b) a market approach by which comparable companies values are compared to the applicable reporting unit’s values; and c) a market approach by which the Company’s own market capitalization is applied to the applicable reporting unit. Based on the results of this work, the Company determined that the carrying value of the commercial systems sales reporting unit was impaired, and the services reporting unit was not impaired. The Company recorded an impairment charge of $11 million against its commercial systems sales reporting unit as an initial estimate at the end of the third quarter. The Company completed its evaluation of the fair value of this reporting unit including performing the step II analysis required by ASC 350 during the fourth quarter and increased the total goodwill impairment charge to $14.8 million.

The tax basis goodwill associated with the acquisition of U.S. Technologies, Inc. (which occurred November 30, 1999) exceeded the goodwill recorded on the financial statements by $1,462,000. The Company is reducing the carrying value of goodwill recorded on the financial statements each accounting period to record the tax benefit realized due to the excess of tax-deductible goodwill over the reported amount of goodwill, which resulted from a difference in the valuation dates used for common stock given in the acquisition. Accrued income taxes and deferred tax liabilities are being reduced as well. The Company reduced the carrying value of goodwill by $55,576 for the impact of the basis difference for both the years ended October 31, 2010 and 2009.

The changes in the carrying value of goodwill for fiscal 2010 and 2009 are as follows:

		Commercial								Hospitality
		Systems								Systems
		Sales				Services				Sales				Other				Total
Balance, November 1, 2008			17,962,263				8,645,946				—				217,289			$	26,825,498
Goodwill acquired			37,232				24,821				—				—				62,053
Amortization of book versus tax basis difference			(41,680	)			(13,340	)			—				(556	)			(55,576	)
Impairment of Goodwill			(14,800,000	)			—				—				—				(14,800,000	)
Balance, October 31, 2009			3,157,815				8,657,427				—				216,733				12,031,975
Goodwill acquired			2,309,349				2,934,496				563,667				—				5,807,512
Amortization of book versus tax basis difference			(41,680	)			(13,340	)			—				(556	)			(55,576	)
Balance, October 31, 2010		$	5,425,484			$	11,578,583			$	563,667			$	216,177			$	17,783,911

Other Intangible Assets

As of October 31, 2010

As of October 31, 2009

Gross

Gross

Carrying

Accumulated

Carrying

Accumulated

Amount

Amortization

Amount

Amortization

Acquired customer lists and other

$

4,010,353

$

848,562

$

1,076,352

$

505,612

Amortization expense of intangible assets was $342,949, $270,155 and $112,501 for the years ended October 31, 2010, 2009 and 2008, respectively. The estimated amortization expense of intangible assets is $663,000, $614,000, $524,000, $440,000 and $440,000 for fiscal years ended October 31, 2011, 2012, 2013, 2014 and 2015, respectively.

2. ACCOUNTS RECEIVABLE:

Trade accounts receivable consist of the following at October 31:

		2010				2009
Trade accounts receivables		$	18,352,519			$	14,393,681
Less- reserve for doubtful accounts			546,527				561,229
Trade receivables, net		$	17,805,992			$	13,832,452

Adjustments to the reserve for doubtful accounts consist of the following at October 31:

		2010				2009				2008
Balance, beginning of period		$	561,229			$	192,880			$	175,844
Provision for doubtful accounts			63,226				460,000				22,924
Net write-offs			(77,728	)			(91,651	)			(5,888	)
Balance, end of period		$	546,727			$	561,229			$	192,880

On January 14, 2009, Nortel Networks Corporation filed for bankruptcy protection in the United States Bankruptcy Court for the District of Delaware. Subsequent to the filing the administrators of the bankruptcy adopted a business disposal strategy. Under the strategy, the administrators segmented Nortel into three primary business units: Virtual Service Switches, CDMA businesses and Enterprise Solutions. We conducted all of our Nortel business through the Enterprise Solutions unit which was purchased by Avaya in December 2009.

Nortel owes XETA approximately $700,000 in pre-petition accounts receivable. On July 17, 2009 the bankruptcy court granted XETA’s request for offset of $116,000 in charges owed to Nortel at the time of the filing. In fiscal year 2009, the Company recorded $350,000 as a reserve against possible Nortel bad debts. Nortel filed its plan of reorganization on July 12, 2010 (the “Nortel Plan”). XETA’s claim is classified as a Class 3 claim, “General Unsecured Claims”. The Nortel Plan states that priority non-tax claims and secured claims will be paid in full, but that Class 3 claims will be impaired. No indication or estimate is given as to the potential extent of the impairment. According to the Nortel Plan, XETA and other Class 3 claimants will receive a pro rata share of the assets of Nortel at the time the Nortel Plan goes into affect but the Administrator has provided no guidance as to an expected payout level. Based on the information presently available, the Company can make no further determination regarding the adequacy of its reserve in this matter. The Company will continue to carefully follow developments associated with the bankruptcy case and will assert its legal rights and defenses as appropriate.

3. INVENTORIES:

Inventories are stated at the lower of weighted-average cost or market and consist of the following components at October 31:

		2010				2009
Finished goods and spare parts		$	7,785,951			$	5,977,703
Less- reserve for excess and obsolete inventories			1,070,875				941,505
Total inventories, net		$	6,715,076			$	5,036,198

Adjustments to the reserve for excess and obsolete inventories consist of the following:

		2010				2009				2008
Balance, beginning of period		$	941,505			$	848,265			$	771,653
Provision for excess and obsolete inventories			102,000				102,000				102,000
Adjustments to inventories			27,370				(8,760	)			(25,388	)
Balance, end of period		$	1,070,875			$	941,505			$	848,265

Adjustments to inventories in 2010, 2009 and 2008 included write-offs of obsolete inventory and adjustments to certain inventory values to lower of cost or market.

4. PROPERTY, PLANT AND EQUIPMENT:

Property, plant and equipment consist of the following at October 31:

		Estimated
		Useful Lives		2010				2009
Building and building improvements		3-20		$	3,379,059			$	3,253,693
Data processing and computer field equipment		1-7			4,438,556				3,248,126
Software development costs, work-in-process		N/A			272,097				197,097
Software development costs of components placed into service		3-10			2,731,310				2,697,806
Hardware		3-5			643,635				643,635
Land		—			611,582				611,582
Office furniture		5-7			880,635				779,588
Auto		5			710,608				537,300
Other		3-7			156,131				149,484
Total property, plant and equipment					13,823,613				12,118,311
Less- accumulated depreciation and amortization					(6,891,686	)			(5,292,395	)
Total property, plant and equipment, net				$	6,931,927			$	6,825,916

Amortization expense of software placed in service was approximately $522,000, $931,000 and $906,000 for the years ended October 31, 2010, 2009 and 2008, respectively. Estimated amortization expense of software currently placed in service is approximately $549,000 annually for fiscal years 2011 through 2015, respectively.

5. ACCRUED LIABILITIES:

Current accrued liabilities consist of the following at October 31:

		2010				2009
Vacation		$	1,007,448			$	792,958
Commissions			747,810				789,184
Contingent payment			156,249				85,916
Bonuses			490,546				283,467
Sales taxes			9,184				71,072
Payroll			336,820				187,066
Interest			7,408				8,308
Other			1,127,838				1,226,425
Total current accrued liabilities		$	3,883,303			$	3,444,396

6. UNEARNED SERVICES REVENUE:

Unearned services revenue consists of the following at October 31:

		2010				2009
Service contracts		$	3,396,495			$	2,465,485
Warranty service			2,181,846				1,158,102
Customer deposits			909,235				1,529,260
Other			41,754				41,754
Total current unearned services revenue			6,529,330				5,194,601
Noncurrent unearned services revenue			48,629				36,691
Total unearned services revenue		$	6,577,959			$	5,231,292

7. INCOME TAXES:

The income tax provision for the years ended October 31, 2010, 2009, and 2008, consists of the following:

		2010				2009				2008
Current provision — Federal		$	—			$	—			$	28,034
Current provision — State			85,000				80,000				23,161
Deferred provision (benefit)			793,000				(6,726,000	)			1,272,805
Total provision (benefit)		$	878,000			$	(6,646,000	)		$	1,324,000

The reconciliation of the statutory income tax rate to the effective income tax rate is as follows:

		Year Ended
		October 31,
		2010				2009				2008
Statutory rate			34	%			34	%			34	%
State income taxes, net of Federal benefit			5	%			5	%			5	%
Effective rate			39	%			39	%			39	%

The tax effect of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities as of October 31 are presented below:

		2010				2009
Deferred tax assets:
Net operating loss carry forward		$	1,036,830			$	1,183,015
Currently nondeductible reserves			691,577				569,871
Accrued liabilities			516,501				566,305
Prepaid service contracts			34,704				40,651
Stock based compensation expense			374,384				255,816
Other			47,950				51,302
Total deferred tax asset			2,701,946				2,666,960
Deferred tax liabilities:
Intangible assets			773,822				68,483
Depreciation			766,097				701,034
Tax income to be recognized on sales-type lease contracts			5,900				21,876
Total deferred tax liability			1,545,819				791,393
Net deferred tax asset		$	1,156,127			$	1,875,567