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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

FORM 10-Q

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

For the quarterly period ended July 31, 2010

OR

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

Commission File Number 0-16231

XETA Technologies, Inc.

(Exact name of registrant as specified in its charter)

918-664-8200

(Registrant’s telephone number, including area code)

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

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

Indicate by check mark whether the registrant 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).   Yes o No x

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company (as defined by Rule 12b-2 of the Exchange Act).

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

As of August 23, 2010 there were 10,699,186 shares of the registrant’s common stock, par value $0.001, outstanding.

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INDEX

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XETA TECHNOLOGIES, INC. AND SUBSIDIARY

CONSOLIDATED BALANCE SHEETS

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

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XETA TECHNOLOGIES, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF OPERATIONS

(UNAUDITED)

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

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XETA TECHNOLOGIES, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY

(UNAUDITED)

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

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XETA TECHNOLOGIES, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

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

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XETA TECHNOLOGIES, INC. AND SUBSIDIARY

Notes to Consolidated Financial Statements

July 31, 2010

(Unaudited)

1.  BASIS OF PRESENTATION:

XETA Technologies, Inc. (“XETA”, the “Company”, “we”, “us”, or “our”), an Oklahoma corporation formed in 1981, is a leading integrator of advanced communications technologies with nationwide sales and service.  XETA provides sales, design, project management, implementation, and maintenance services in support of the products it represents.  The Company sells and/or supports products produced by several manufacturers including Avaya, Inc. (“Avaya”), Mitel Corporation (“Mitel”), and Samsung Business Communications Systems (“Samsung”).  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.

The Company prepared the accompanying unaudited consolidated financial statements pursuant to the rules and regulations of the Securities and Exchange Commission (the “Commission”).  Certain information and footnote disclosures normally included in annual financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to those rules and regulations.  The Company believes that the disclosures are reasonably adequate to ensure the information is not misleading.  Management suggests that these condensed financial statements be read in conjunction with the consolidated financial statements and the notes thereto made a part of the Company’s Annual Report on Form 10-K.  The Company filed the 10-K as Commission File No. 0-16231, with the Commission on January 8, 2010.  Management believes that the financial statements contain the necessary adjustments for a fair statement of the results for the interim periods presented.  All adjustments were of a normal recurring nature.  The results of operations for the interim period are not necessarily indicative of the results for the entire fiscal year.

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.

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 in the Company’s Form 10-K described above.  Company management evaluates a segment’s performance based on gross margins.  Assets are not allocated to the segments.  Sales outside of the U.S. are immaterial.

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The following is a tabulation of business segment information for the three months ended July 31, 2010 and 2009:

The following is a tabulation of business segment information for the nine months ended July 31, 2010 and 2009:

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.  Compensation expense was recognized in the statements of operations as follows:

Use of Estimates

The preparation of the financial statements conforms to the accounting principles generally accepted in the U.S., and requires management to make estimates and assumptions affecting the reported amounts of assets and liabilities: 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 may differ from these estimates.

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New Accounting Pronouncements

In July 2010 the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“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 February 2010 the FASB issued ASU 2010-09, “Subsequent Events: Amendments to Certain Recognition and Disclosure Requirements”.  The guidance in ASU 2010-09 removes the requirement for SEC filers to disclose the date through which subsequent events have been evaluated.  The adoption of this update did not have a material impact on the Company’s financial position or results of operations.

In November 2009 the Company adopted Accounting Standards Codification (“ASC”) 810, “Consolidation”.  ASC 810 changes the accounting and reporting for minority interests, which are now recharacterized as non-controlling interests and classified as a component of equity.   The Company does not have any minority interests; therefore the adoption of this statement did not 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.

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2.  ACCOUNTS RECEIVABLE:

Trade accounts receivable consist of the following:

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.

On December 18, 2009, Avaya completed the purchase of Nortel’s Enterprise Solutions business unit.  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.  The next significant action in this matter is expected to be Nortel’s filing of a Disclosure Statement in mid-September providing more information regarding Nortel’s assets and potentially an estimate of payouts to Class 3 creditors.  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 average cost or market and consist of the following:

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4.  PROPERTY, PLANT AND EQUIPMENT:

Property, plant and equipment consist of the following:

5.  INCOME TAXES:

The tax provision reflects the effective Federal tax rate plus the composite state income tax rates adjusted for states that require minimum tax payments even if tax losses are incurred.  Generally, we expect our tax provision rate to be approximately 40%.

6.  CREDIT AGREEMENTS:

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

At July 31, 2010, the Company did not have an outstanding balance on the revolving line of credit.  The Company had approximately $8.5 million available under the revolving line of credit at July 31, 2010.  The advance rates are defined in the agreement, but are generally at the rate of 75% on qualified trade accounts receivable and 50% of qualified inventories and real estate, subject to a maximum of $2.0 million each.  Long term debt consisted of the following:

Interest on all outstanding debt under the credit facility accrues at the greater of either the London Interbank Offered Rate (“LIBOR”) (0.305% at July 31, 2010) plus 3.0% or 4.5%.  The credit facility contains several financial covenants common in such agreements including tangible net worth requirements, limitations on the amount of funded debt to annual earnings before interest, taxes, depreciation and amortization, limitations on cash dividends, and debt service coverage requirements.  At July 31, 2010 the Company was in compliance with the covenants of the credit facility.

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7.  EARNINGS PER SHARE:

The Company computes basic earnings per common share by dividing net income by the weighted average number of shares of common stock outstanding during the reporting periods.  Dividing net income by the weighted average number of shares of common stock and dilutive potential common stock outstanding during the reporting periods computes diluted earnings per common share.  A reconciliation of net income and weighted average shares used in computing basic and diluted earnings per share is as follows:

Options to purchase 712,450 shares of common stock at an average exercise price of $5.82 and 1,269,900 shares of common stock at an average exercise price of $6.42 were not included in the computation of diluted earnings per share for the three months ended July 31, 2010 and 2009, respectively, because inclusion of these options would be antidilutive.  Options to purchase 834,595 shares of common stock at an average exercise price of $5.23 and 1,269,900 shares of common stock at an average exercise price of $6.42 were not included in the computation of diluted earnings per share for the nine months ended July 31, 2010 and 2009, respectively, because inclusion of these options would be antidilutive.

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8.  CONTINGENCIES:

In addition to potential losses related to Nortel’s pre-petition receivables, the Company may be subject to preference payment claims asserted by Nortel.  It is routine in bankruptcy proceedings for the debtor in possession or bankruptcy trustee to assert a statutory “preference claim” to seek to recover payments made by the bankrupt entity to creditors during the 90-day period immediately preceding the filing of the bankruptcy petition.  This period is known as the “preference period”.  Although the debtor is entitled to make a claim based solely upon when the payments were made, the payments are not recoverable if they were made in the debtor’s ordinary course of dealings with the creditor.  Nortel has filed a schedule showing approximately $1.6 million in payments made to the Company during the preference period.  To date Nortel has not asserted a preference claim against the Company.  However, if a preference claim is brought, the Company believes it has good defenses to any such potential claim against it, including that the subject payments were made in the ordinary course of the Company’s business dealings with Nortel.  These defenses must be argued on each individual Company invoice paid during the preference period.  The Company is unable at this time to determine the extent, if any, of any material loss that might occur if a claim to recover preference payments is asserted.  Therefore, no provision for loss has been made beyond the amount discussed above related to unpaid invoices at the time of the bankruptcy filing.

9.  CAPITAL LEASES:

During 2008 the Company leased software licenses under an agreement that is classified as a capital lease. The book value of the licenses is included in the balance sheet as property, plant and equipment and was $139,492 at July 31, 2010.  Accumulated amortization of the leased licenses at July 31, 2010 was $317,028.  Amortization under the capital lease is included in depreciation expense.  The future minimum lease payments required under the capital lease and the present value of the net minimum lease payments as of July 31, 2010, are as follows:

10.  ACQUISITIONS: