10-K

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-K

x	ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
	For the fiscal year ended October 31, 2005
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)

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

Registrant’s telephone number including area 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 x

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 x

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 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 an accelerated filer (as defined in Rule 12b-2 of the Act).

Yes o No x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).

Yes o No x

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 29, 2005, the last business day of the registrant’s most recently completed second fiscal quarter, was approximately $23,966,520.

The number of shares outstanding of the registrant’s Common Stock as of December 22, 2005 was 10,178,237.

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 4, 2006 are incorporated by reference into Part III, Items 10 through 14 hereof. 

FORWARD-LOOKING STATEMENTS

     In the discussions under the headings “Business,” “Risk Factors,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and elsewhere in this report, we make forward-looking statements regarding future events and our future performance and results.  These and other 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.  Forward-looking statements can generally be identified by words such as “expects,” “anticipates,” “may”, “plans,” “believes,” “intends,” “projects,” “estimates,” and similar words or expressions.  These statements are subject to risks and uncertainties which are difficult to predict or which we are unable to control, including but not limited to such factors as customer demand for advanced communications products, capital spending trends within our market, the financial condition of our suppliers and changes by them in their distribution strategies and support, technological changes, product mix, the ability to attract and retain highly skilled personnel, competition 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.

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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 enterprise-class communications solutions.  We specialize in providing these solutions to multi-location mid-size and large companies throughout the United States.  In addition to selling products to customers, we derive a significant portion of our revenues and gross profits from services provided to our customers.  These services include the installation and maintenance of the systems we sell as well as peripheral products and other voice and/or data networking equipment in use at customer locations.  We provide these services through our nationwide network of Company-employed design engineers and service technicians as well as our 24-hour, 7-days-per-week call center located in our headquarters building in Broken Arrow, Oklahoma.

     Previous to 1999, our business was focused entirely in the vertical market of hospitality customers.  In 1999 we expanded our business into the general commercial market through the acquisition of St. Louis-based U.S. Technologies Systems, Inc. (“USTI”).  Three smaller acquisitions were consummated in fiscal 2000 to expand our geographic and technical capabilities further.  Our initial expansion into the general commercial market was based on the sale and installation of Avaya, Inc., (“Avaya”) products, a product line we have represented since 1998.  In 2003 we added the Nortel Networks Corporation (“Nortel”) product line to our product mix.  To expand our presence in the Nortel market, in 2004 we purchased the assets of Bluejack Systems, LLC (“Bluejack”), a Seattle-based dealer of Nortel products. Both Avaya and Nortel have well-respected products and have transitioned their product lines into server-based systems that work effectively in converged voice and data environments.  All of these products are distributed under nationwide, non-exclusive dealer agreements we have with the manufacturers.  We purchase these products from large distributors who provide additional pricing and volume incentives.

     In fiscal 2005, we continued to pursue our strategy of investing in sales and technical capabilities to expand our Nortel and Avaya revenues.  In fiscal 2004 we began rebalancing our sales and technical forces to be able to effectively represent both product lines in the marketplace.  Significant investments were made over the course of the last two fiscal years to hire sales and technical talent with previous Nortel experience, while at the same time improving the productivity of our existing Avaya-focused sales force.  As a result of our investments in staff and training, we maintain the highest available levels of certifications from both manufacturers and are one of the few dealers in our industry who do so. 

     We have also been aggressively expanding our managed services business by marketing our service capabilities to large Nortel customers and to large, national Nortel service providers such as Regional Bell Operating Companies (“RBOCs”), and to Nortel itself.  For example, under an arrangement with an RBOC, the RBOC would possess a customer relationship in the form of a maintenance contract or a time and materials (“T&M”) contract.  To fulfill on its service obligations, the RBOC will engage XETA on a T&M basis as a third-party service provider.  Typically, we are called to take care of service obligations in coverage areas where the RBOC does not have a physical presence or when a uniform nation-wide implementation process is needed to roll out a system upgrade.  During fiscal 2005 we increased our managed services revenues approximately 37% through these types of arrangements and we expect substantial additional growth in this area in fiscal 2006.

     In fiscal 2005 services revenues increased $1.7 million or 7% and our other revenues increased $826,000 or 83%.  These increases were offset by a decrease in our systems revenues of $3.4 million or 11%.  Overall, our total revenues declined $824,000 or 1%.  Our overall gross margins were unchanged at 24.2% in fiscal 2005.  However, investments in our sales force, reduced incentive payments from manufacturers, and increased amortization charges related to our Oracle implementation project combined to reduce our fiscal 2005 pre-tax operating income to $815,000 compared to $2.6 million in fiscal 2004. 

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     In July, 2005 the Company’s Board of Directors appointed Greg Forrest as our President and Chief Operating Officer.  Mr. Forrest was the owner of Bluejack and served as a Director of Sales over the Company’s Seattle branch office until his appointment as an executive officer.  Jack Ingram, the Company’s previous President, remains as Chairman and CEO of the Company.

Commercial Systems Sales

     We sell a broad range of communications solutions for the general commercial market, including government agencies.  These products include:  IP telephony, unified messaging, and contact management systems.  We sell these systems under dealer agreements with Avaya and Nortel.  Both of these manufacturers hold significant portions of the communications equipment market and have migrated their customer bases from traditional telephony systems to the new IP-based technology platform.  We have been an Avaya dealer since 1998 and a Nortel dealer since 2003.  We receive incentive payments from both manufacturers which offset certain product costs as well as certain sales and marketing expenses.  We purchase these products through major distributors and receive additional price incentives from these distributors.  These incentive payments are material to our business.  We also sell data networking products to the commercial market under non-exclusive dealer agreements with Avaya, Nortel, Cisco Systems Inc., and Hewlett-Packard Company.

     Sales of systems to Commercial customers were $21.4 million in fiscal 2005 compared to $25.9 million and $21.3 million in 2004 and 2003, respectively.  These sales represented 37%, 44%, and 40% of total revenues during fiscal years 2005, 2004, and 2003, respectively. 

Hospitality Products

     Communications Systems.  We sell communications systems to the hospitality industry through nationwide, non-exclusive dealer agreements with Avaya and  Nortel.  In addition to most of the features available on the commercial systems above, the systems sold to hospitality customers are equipped with hospitality-specific software, which integrates with nearly all aspects of the hotel’s operations.  We also 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 lodging-specific software features.  Most of these additional products are sold in conjunction with the sale of new communications systems and, with the exception of voice mail systems, are purchased from regional and national suppliers. 

     Call Accounting Products.  We market a line of proprietary call accounting products under the Virtual XL^® and Virtual XL^2™(“VXL”) names.   Introduced in 1998, the VXL is a PC-based system designed to operate on a hotel’s local or wide area network, and if that network is connected to the Internet, the VXL can also be accessed via an Internet connection.  The original VXL was upgraded to a rack-mounted, server-style system in 2004 and is marketed under the name Virtual XL^2™.  The VXL systems are our latest technology 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 T&M revenues for us.  These revenues and the related gross profits are material to our business.

     Sales of communications systems and products to the hospitality industry represented 11%, 9% and 12% of total revenues in fiscal 2005, 2004 and 2003, respectively.  Marriott International, Host Marriott, and other Marriott-affiliated companies (“Marriott”) represent a single customer relationship for our Company and are a major customer to our hospitality business.  Revenues earned from sales of hospitality systems sold to Marriott represented 52%, 38%, and 30% of our sales of Hospitality systems in fiscal 2005, 2004, and 2003, respectively.

Services

     We provide nation-wide customer service, project management, professional services, installation and consulting to support our customers.  Our services organization is one of the key differentiators between our competitors and us.  The purchase price of our systems typically includes charges for professional services, project management activities, and installation costs, all of which are reflected as services revenues in our financial statements. 

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     Our services organization includes our National Service Center (“NSC”) housed at our headquarters in Broken Arrow, Oklahoma.  The NSC supports our managed services customers who have purchased maintenance contracts on their systems, as well as other customers who contract with us on a T&M basis.  We employ a network of highly trained technicians who are strategically located in major metropolitan areas and can be dispatched by the NSC to support our customers in the field or to install new systems.  We also employ design engineers (the Professional Services Organization (“PSO”)) to design voice, data, and converged networks to meet specific customer applications.  Much of the work done by the PSO represents pre-sales work and is often not recovered in revenues, representing a significant investment.  We believe, however, that by hiring the most qualified personnel possible and keeping their talents in-house, we have built a competitive advantage in the marketplace.

     In 2005 we began to aggressively market our managed services capabilities to large, national customers, RBOCs and other large Nortel dealers.  By providing national coverage at competitive hourly rates, the NSC is a valuable resource to many of these larger organizations who do not have sufficient technical or geographic coverage to service their internal or external customers directly.  These services relationships currently fall into three categories:  large Nortel end-users, RBOCs, and Nortel itself.  Many large Nortel end-users have sophisticated in-house capabilities at their headquarters location, but choose to outsource the services provided to other locations in their networks.  Under our managed services program, the NSC is being used in these instances to assist with T&M services and to assist in national roll-outs of system upgrades.  RBOCs are the largest Nortel dealers in the U.S. and as such have large installed bases of customers with Nortel systems.  Similar to large end-users, the RBOCs use the NSC to service customers out of the RBOCs regional service area and/or handle overflow work during peak periods.  Finally, Nortel has maintenance contracts with many large, “Fortune 1000”-type customers.  Nortel outsources much of the on-site service work for these customers to its dealer network.  Late in 2005 the NSC began doing T&M work for Nortel under these circumstances.  Management believes that these relationships will produce significant revenues and gross profits in fiscal 2006.

     For our distributed products, we typically 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 Avaya products that we have sold to non-hospitality customers, we pursue the sale of Avaya’s post-warranty maintenance contracts, for which we earn a commission.  For systems sold to hospitality customers, we sell our own maintenance agreements.  For proprietary call accounting products sold to the hospitality industry, we provide our customers with a limited one-year warranty covering parts and labor.  Subsequent to the expiration of the warranty, we offer after-market service contracts to our hospitality customers under one-year and multi-year service contracts.  The revenues earned from the sale of 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 recurring service revenues from hospitality customers who maintain service contracts on their systems.

     Services revenues represented 49%, 45%, and 44% of total revenues for fiscal years 2005, 2004 and 2003, respectively.  Marriott is a significant customer and Services revenues earned from Marriott represented 15%, 15%, and 16% of total Services revenues for fiscal years, 2005, 2004, and 2003, respectively.

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, government agencies, and the hospitality industry.  In addition to our direct marketing effort to customers, a significant aspect of our marketing effort centers on our relationships with Avaya and Nortel.  As a national dealer for both manufacturers, we have certain technical and geographical capabilities that help differentiate us in the marketplace.  We aggressively market these capabilities to Avaya and Nortel.  Both 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 for both manufacturers by building our in-house engineering capabilities, providing nationwide implementation services, and through access to our 24-hour, 7 days-per-week service center.

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     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 20 years, we have built strong long-term relationships with a wide range of personnel (corporate hotel chain personnel, property management officials, industry consultants, hotel owners, and on-site financial and/or operating officers) that are the key decision makers for the purchase of hotel telecommunications equipment.  We have relationships with nearly all hotel chains and major hospitality property management companies.  These relationships are key to our past and future success and our hospitality marketing efforts are targeted at strengthening and deepening those relationships rather than the more broad promotional efforts sometimes employed in our marketing efforts to the commercial sector. 

Backlog

     At December 1, 2005 our backlog of orders for systems sales was $2.2 million compared to $1.7 million at the same time last year.  We expect this entire backlog to ship and be recognized as revenue by October 31, 2006.

Competition

     Commercial.  The market for communications systems, applications and services is highly competitive and subject to rapid technological change.  Both Avaya and Nortel have extensive dealer organizations, including nationwide dealers like us, and smaller regionally-focused dealers.  In addition to other Avaya and Nortel dealers, we also face competition from dealers of other large communications equipment suppliers, including Cisco Systems, Inc., Siemens Aktiengesellschaft, Alcatel S.A. and NEC Corporation, as well as from a number of other companies, some of which focus on particular segments of the market such as customer relationship management.

     Hospitality.  We sell Avaya and Nortel communications systems to the hospitality market, and as such face similar competitive pressures to those discussed above under “Commercial” competition.  However, since the hospitality market is a small niche market, we believe our most effective competitive strengths are the performance and reliability of our proprietary hospitality systems and our high level of service commitment to this niche market.  While we believe that our reputation and nationwide presence contribute significantly to our success in the hospitality market, there can be no assurance given that we will be able to continue to expand our market share in the future.

Manufacturing

     We assemble the Virtual XL^® and Virtual XL^2™ systems, our proprietary call accounting systems sold exclusively to the hospitality industry.  These systems comprise less than 2% of our total revenues.  We assemble these systems 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. 

     We use outside contractors to assemble our proprietary printed circuit boards that are part of our proprietary call accounting systems.  The components and blank circuit boards are purchased, inventoried, and supplied to the outside contractors for assembly and quality-control testing.  We perform various quality-control procedures, including powering up completed systems and allowing them to “burn in” before being assembled into a final unit for a specific customer location, and performing final testing prior to shipment.

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

Employees

     We employed 314 and 324 employees at December 31, 2005 and 2004, respectively.  There were no part-time employees.

Copyrights, Patents And Trademarks

     We recognize that our reputation for quality products and services gives value to our hospitality products and service offerings names.  Therefore, we place high importance upon protecting such names by obtaining registered trademarks where practicable and appropriate.  We own registered United States trademarks on the following names for use in the marketing of our services and systems: “XETA,” “XPERT,” “XL,” “Virtual XL,” and “XTRAMILE”.  All of these trademarks are registered on the principal register of the United States Patent and Trademark Office.

ITEM 1A.  RISK FACTORS

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

A key component of our strategy is our focus on the marketing of advanced communications products and applications and related services, including IP telephony systems, and this strategy may not be successful.

     Our operating results may be adversely affected if the market opportunity for advanced communications products, applications and services, including IP telephony systems, does not develop in the ways that we anticipate. Because this market opportunity is in its early stages, we cannot predict whether the demand for advanced communications products, applications, and services, including IP telephony systems, will grow as fast as we anticipate; new technologies may cause the market to evolve in a manner different than we expect; technologies developed by manufacturers that we do not represent may become more accepted or the standard in our industry; or we may fail to achieve a leadership or profitable position as these market opportunities develop.

We are investing significant resources to add Nortel products and services to our product line and our efforts may not produce satisfactory results. 

     To extend our market reach and reduce our reliance on Avaya, we added the Nortel product line to our business in 2003.  Since then, we have invested significant financial resources in the hiring and training of personnel to sell, design, install and maintain Nortel products.  To maximize the potential ramp-up of this business, we have purposely sacrificed short-term profitability by increasing selling expenses and services cost of goods sold.  These investments may not produce the revenues and gross profits that we expect.

The financial condition of Nortel is uncertain and actions they may take could hurt our operating results.

     In recent years, Nortel has endured severe financial difficulties, made significant senior management changes, and until recently, was unable to file its SEC reports in a timely manner.  Recent developments indicate that these financial and accounting difficulties may be subsiding.  However, should these problems persist, there can be no assurance given that Nortel will not take actions to preserve its short-term financial condition which could be detrimental to our operating results or financial condition. 

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Revenues and gross profits earned by hotels from guest calls continue to decline, which may result in hotels canceling their call accounting maintenance agreements with us.

     Primarily because of the increasing use of cell phones by guests, hotels have experienced a rapid decline in their revenues and gross profits earned from long distance and other telephone-related fees.  This development has severely reduced the importance of call accounting systems in hotels and as a result, many of our customers are considering reducing or eliminating their call accounting maintenance contracts with us.  In fiscal 2005 we earned $4.0 million in revenues associated with these maintenance contracts.  The loss of or reduction in these revenues could materially and negatively impact our operating results. 

The success of our business depends significantly upon our ability to retain and recruit 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 telecommunications industry is fierce and will likely intensify as the US economy improves.  As we have transformed our company into an integrated communications solutions provider, we have invested heavily in the hiring and training of personnel to sell and service our new products and service offerings.  If we are unable to retain our skilled employees or to hire additional qualified personnel as needed, it could adversely impact our ability to implement our strategies efficiently and effectively.

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 systems.  This reliance may result in lower service revenues or lower profit margins earned on our service revenues.  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.

Our business is directly affected by capital spending trends in the United States and, in particular, market conditions for telecommunications and networking equipment and services.  

     Our business is directly affected by capital spending on technology equipment in the U.S.  In periods of slow macro economic growth, companies tend to improve their profitability through cost reductions and reduced capital spending.  Our business is directly and negatively impacted by such actions. 

Avaya frequently changes the incentive programs offered to its business partners.  Such changes had a detrimental effect on our financial results for the last three years and could do so again in the future.

     Avaya, like many major manufacturers, provides various financial incentive programs to support increasing the market share, promotion, and sale of its products.  We receive substantial rebates through these incentive programs to offset both costs of goods sold and sales and marketing expenses.  We also receive commissions from Avaya to sell its maintenance contracts.  These amounts are material to our operating results.  Avaya announces changes to these programs at least annually, and in recent years those changes have had a negative impact on the incentive payments we have received.  We expect Avaya to continue to change its rebate programs to encourage its dealers to target certain customer segments, typically small to mid-sized firms, and to avoid certain other customer sets such as large, national customers, which Avaya prefers to serve with its direct sales force.  We expect our business model to be at odds with some of the goals of these incentive programs and, therefore, we expect to continue to experience difficulty in maintaining the level of incentive payments which we enjoyed in prior years. 

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

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

Compliance with new corporate governance regulations may require a material increase in our operating expenses. 

     We are required to comply with a host of new government-mandated corporate governance and accounting regulations, the most significant of which is section 404 of the Sarbanes-Oxley Act of 2002.  Our compliance with section 404 must be complete by our fiscal year ending October 31, 2007.  At the present time, there is not sufficient information available to determine the significance of the cost of complying with these regulations, except that most estimates available suggest that the fees paid to outside auditors and other accounting professionals will at least double their pre-compliance levels.  However, there are abundant examples in the marketplace of much larger increases in compliance costs and at the present time we cannot predict whether our costs will be material to our overall operating expenses.

Hitachi has ceased manufacturing communications systems for the hospitality market, which 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 for this market in March 2005, but has committed to maintaining an adequate supply of parts for its installed systems for the next ten years.  We have many long-time hospitality customers with significant portfolios of Hitachi systems in their hotels.  We have several hundred Hitachi systems under service contract producing recurring contract revenues and gross profits for our business.  Over the next ten years, all of these customers will have to transition their communications systems to new platforms presenting a risk to us that another vendor will be selected.  While this risk also presents us with an opportunity to sell new systems to our existing Hitachi customers, no assurance can be given that Hitachi’s decision will not negatively impact our financial results in the future. 

We are connecting our products to our customers’ computer networks and problems with the implementation of these products could cause disruption to our customers’ entire operations.

     Unlike traditional stand-alone voice systems, our new IP-based products typically are connected to our customers’ existing local and wide area networks.  While we believe the risk of our products disrupting other traffic or operations on these networks is low, such problems could occur, which could cause significant disruption to our customers’ operations.  These disruptions, in turn, could result in reduced customer satisfaction, delays in payments from customers for products purchased, damage to our reputation, and potential liabilities. 

We expect our gross margins to vary over time.

     Our gross margins are impacted 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 as we make 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 Avaya and Nortel.  We are a major dealer for both manufacturers and consider our relationship with both to be good.  Nevertheless, if our strategic relationship with these 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 structure provided in the dealer agreements.  Failure to meet these requirements could cause material adverse consequences to our gross margins and overall operating results. 

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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.  Both Avaya and Nortel utilize a two-tier distribution model in which a few third-party companies (super distributors) distribute their products to their respective dealer communities.  In the case of one such distributor, they distribute both Avaya and Nortel products.  The limited amount of distribution available for each of these product lines increases our risk of interruptions in the supply of products in the future. 

We are faced with intense competition and rapidly changing technologies in the industry and market in which we operate.

     The market for our products and services is highly competitive and subject to rapidly changing technologies.  As the industry itself evolves and new technologies and products are introduced into the marketplace, new participants enter the market and existing competitors seek to strengthen their positions and expand their product/service offerings.  There has been a trend toward industry consolidation, which can lead to the creation of stronger competitors who may be better able to compete as a sole-source vendor for customers.  While we believe that through the 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.

We might have to record a significant goodwill impairment loss in the event our business was to suffer a severe decline.

     Under SFAS 142, we are required to evaluate the fair value of each of our reporting units annually and determine if the fair value is less than the carrying value of those reporting units, and if so, an impairment loss is recorded in our statement of operations.  The determination of fair value is a highly subjective exercise and can produce significantly different results based on the assumptions used and methodologies employed.  It is likely that if our financial results were to decline substantially and if macroeconomic conditions eroded, we would have to record a non-cash impairment loss in our statement of operations.

If our business grows significantly over the next three years, the successful completion of our Oracle implementation project will be critical to our ability to effectively and efficiently operate our business in the future; implementation of the system will significantly increase our amortization expense.

     Once our business exceeds $100 million in revenues, it will be increasingly important that we have the necessary information to make informed decisions and implement those decisions quickly and effectively.  We have been working on a major upgrade to our technology infrastructure and information systems to consolidate our critical legacy systems from four down to one.  Due to constraints that we have imposed on capital spending, we have purposely slowed down the development of this system.  Furthermore, at our current revenue and activity levels, conversion to this new system is not critical to our near-term success.  However, we believe it is prudent to proceed with the conversion while our revenues are at these lower levels in anticipation of future growth, which we believe will require upgraded and consolidated technology infrastructure.  While we are taking great care to properly plan this implementation and to test the solution fully prior to the conversion, there can be no guarantees given that the conversion will not disrupt our operations.  We recognized $348,000 in amortization expense in fiscal 2005 reflecting the fact that certain functions of the system are available for use, and are being used.  When fully implemented, we estimate that this annual amortization expense will increase to $1.1 million per year.  Although a non-cash charge, this expense will have a material, negative impact on the operating results of the Company.

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Our stock price may continue to be volatile.

     Historically, our stock is not widely followed by investment analysts and is subject to price and volume trading 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 manmade problems such as computer viruses or terrorism.

     Our corporate headquarters and NSC are located in northeastern Oklahoma, a region known to be part of “tornado alley”.  A significant natural disaster, such as a tornado, 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 material adverse impact on our business, operating results, and financial condition.  In addition, acts of war or acts of terrorism could have a material adverse impact on our business, operating results, and financial condition.  The continued threat of terrorism and heightened security and military response to this threat, or any future acts of terrorism, may cause further disruption to our economy and create further uncertainties.  To the extent that such disruptions or uncertainties result in delays or cancellations of customer orders or the assembly or shipment of our products, our 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 the merit of a claim, these types of 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 whether they infringe upon another’s proprietary rights; nor would it be practical or cost-effective for us to do so.  Rather, we rely on infringement indemnities given to us by the manufacturers of the equipment we distribute.   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 an infringement claim, our indemnification by the equipment manufacturer will be adequate to hold us harmless or that we will even be entitled to indemnification by the equipment manufacturer. 

     If any infringement or other intellectual property claim is brought against us and is successful, whether it is based upon a third-party manufacturer’s equipment that we distribute or upon 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 certain risks that are inherent in doing business, such as general industry and market conditions and growth rates, general economic and political conditions, 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 1B.     UNRESOLVED STAFF COMMENTS

     Not Applicable.

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ITEM 2.  PROPERTIES

     Our principal executive offices and the NSC are located in a 37,000 square foot, Company-owned, single story building located in a suburban business park near Tulsa, Oklahoma.  This facility also houses a warehouse and assembly area.  The building is located on a 13-acre tract of land.  The property is subject to a mortgage held by Bank of Oklahoma, NA to secure our credit facility.

     Our commercial channel shipping operations are primarily located in a leased facility near St. Louis, Missouri.  In addition to the warehouse, this facility houses sales staff, technical design, professional services, and installation support personnel.   Our Seattle branch office is located in leased office space in Bellevue, Washington, a suburb of Seattle.  This facility houses sales and technical personnel. 

     We also lease other office space throughout the U.S. for sales, consulting, and technical staff and have informal office arrangements with our regional technicians to allow for some storage of spare parts inventory.

ITEM 3.  LEGAL PROCEEDINGS 

     Since 1994, we have been monitoring numerous patent infringement lawsuits filed by Phonometrics, Inc., a Florida company, against certain telecommunications equipment manufacturers and hotels who use such equipment.  While we were never named as a defendant in any of these cases, several of our call accounting customers were named defendants and notified us that they would seek indemnification under the terms of their contracts with us. Because there were other equipment vendors implicated along with us in the cases filed against our customers, we have never assumed the outright defense of our customers in any of these actions.  In October 1998, all of the cases filed against the hotels were dismissed by the court for failure to state a claim.  Phonometrics appealed these rulings over the course of several years but lost on the merits.  A final order dismissing the cases with prejudice was entered in November 2002, and the defendant hotels have been awarded attorney fees and costs, and in some cases sanctions, against both Phonometrics and/or its legal counsel.  Phonometrics continues to dispute the amount of fees awarded in some cases, and this issue continues to be litigated by Phonometrics.   Appeals by Phonometrics on the award of attorneys fees and sanctions are currently pending in the United States Court of Appeals for the Federal Circuit. 

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

     None.

EXECUTIVE OFFICERS OF THE REGISTRANT

     Our executive officers are set forth below.  There is no family relationship between any of the named persons.

Name and Age	Positions With Company
Jack R. Ingram	Chairman of the Board and Chief Executive Officer
Age 62
Greg D. Forrest	President and Chief Operating Officer
Age 44
Robert B. Wagner	Chief Financial Officer, Secretary,  and Treasurer
Age 44
Larry N. Patterson	Executive Director of Operations
Age 49

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     Mr. Ingram has been our Chief Executive Officer since July 1990.  He also served as our President from July 1990 until August 1999 and from June 2001 until July 2005.  He has been a Director since March 1989.  Mr. Ingram’s business experience prior to joining XETA was concentrated in the oil and gas industry. Mr. Ingram holds a Bachelor of Science Degree in Petroleum Engineering from the University of Tulsa.

     Mr. Forrest has been our President and Chief Operating Officer since July 2005.  Previously, he was a Director of Sales over our Seattle branch sales and service operations.  Mr. Forrest joined XETA in August, 2004 upon the acquisition of Bluejack, of which he was the founder, owner, and CEO.  Prior to founding Bluejack, Mr. Forrest founded and operated several fast-growing companies in the telecommunications, clothing and commercial interior industries, including Bluejack Systems, LLC.  He attended the University of Washington.

     Mr. Wagner joined us in July 1988 as Chief Accounting Officer and became our Chief Financial Officer in March 1989.  He was a member of the Board of Directors from March 1996 until April 2004.  Mr. Wagner is a Certified Public Accountant licensed in Oklahoma and received his Bachelor of Science Degree in Accounting from Oklahoma State University.

     Mr. Patterson joined us in March 2000 and serves as Executive Director of Operations.  Prior to his employment with us, Mr. Patterson worked for Exxon Corporation and held various executive positions in Europe, Asia and Latin America with Exxon Company, International.  He is a member of the American Management Association and is active in Organizational Development, Leadership Development and Investment Management activities.  Mr. Patterson received his Bachelor of Science Degree in Engineering from Oklahoma State University.

PART II

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

     Our common stock is traded on the Nasdaq National 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.

	2005				2004
	High		Low		High		Low
Quarter Ending:
January 31	$	3.74	$	2.76	$	6.47	$	5.40
April 30		3.98		2.90		7.12		5.40
July 31		3.60		2.70		5.57		4.00
October 31		2.89		2.07		4.27		3.38

     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. 

     As of December 29, 2005, the latest practicable date for which such information is available, we had 177 shareholders of record, and approximately 3,668 shareholders who hold their stock in brokerage accounts. 

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EQUITY COMPENSATION PLAN INFORMATION

Plan Category	Number or securities to be issued upon exercise of outstanding options, warrants and rights (a)			Weighted-average exercise price of outstanding options, warrants and rights (b)		Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a)) (c)
Equity compensation plans approved by security holders		538,172		$	7.64		773,233
Equity compensation plans not approved by security holders		620,000	(1)	$	6.44		0
Total		1,158,272		$	7.00		773,233

(1) All of these options were granted as part of an initial compensation package to several different officers upon their hiring.  These options generally vested or were earned over periods ranging from one to three years, and are exercisable for a period of ten years from the date of grant or date earned.

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ITEM 6.  SELECTED FINANCIAL DATA 

For the Year Ending October 31,	2005		2004		2003			2002		2001
	(Amounts in thousands, except per share data)
Results of Operations
Systems sales	$	27,943	$	31,341	$	27,550		$	27,852	$	52,028
Services		28,241		26,493		23,339			25,390		33,105
Other revenues		1,819		993		1,792			498		921
Net Sales and Services Revenues		58,003		58,827		52,681			53,740		86,054
Cost of equipment sales		20,978		23,914		19,622			21,384		36,261
Services costs		20,919		19,120		16,548			18,803		23,616
Cost of other revenues & corporate COGS		2,073		1,530		2,193			1,956		2,759
Total Cost of Sales		43,970		44,564		38,363			42,143		62,636
Gross Profit		14,033		14,263		14,318			11,597		23,418
Operating expenses		13,275		11,652		11,210			10,459		16,069
Income from operations		758		2,611		3,108			1,138		7,349
Interest and other income (expense)		57		32		(545	)		309		(1,623	)
Income before taxes		815		2,643		2,563			1,447		5,726
Provisions for taxes		321		1,035		1,005			569		2,245
Net Income	$	494	$	1,608	$	1,558		$	878	$	3,481
Earnings per share – Basic	$	0.05	$	0.16	$	0.16		$	0.09	$	0.38
Earnings per share – Diluted	$	0.05	$	0.16	$	0.16		$	0.09	$	0.36
Weighted Average Common Shares Outstanding		10,087		10,009		9,828			9,375		9,061
Weighted Average Common Share Equivalents		10,117		10,157		9,999			9,866		9,698
As of October 31,	2005		2004		2003			2002		2001
Balance Sheet Data:
Working capital	$	5,480	$	4,465	$	4,204		$	8,580	$	11,214
Total assets		57,019		53,556		50,673			59,384		67,285
Long term debt, less current portion		1,697		2,820		4,030			11,565		14,853
Shareholders’ equity		37,098		36,304		34,611			32,521		31,197

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

Overview

     In fiscal 2005 we continued our strategies of rebalancing our sales efforts to support both the Avaya and Nortel product lines and to expand our services business.  To execute this strategy, we continued to invest heavily in our sales department and technical forces.  Over the past two years, we have increased our sales expenses to hire new personnel with experience selling Nortel products and to increase sales management to provide more accountability for revenue production.  Similarly, in the services area we have acquired more technical expertise to support our Nortel service initiatives and to support certain geographical areas.  These investments have been made with our long-term future in mind as we believe that it is important to quickly establish ourselves as a leading provider of enterprise-class communications solutions while this market continues to develop.  These investments, coupled with flat revenues, reduced vendor incentives, and increased amortization and support costs associated with our technology infrastructure, produced lower income from operations in fiscal 2005.  However, we believe we are on the right course to produce above-market, sustainable and profitable revenue growth in the future.

     In July 2005 Greg Forrest was named President and Chief Operating Officer of the Company.  Jack Ingram remains Chairman and Chief Executive Officer.  Since Mr. Forrest’s appointment, the Company has focused heavily on revenue growth by establishing new structures and processes to support our existing sales organization and enable organic growth.  Additionally, we have focused on selling services.  This initiative, which is part of our “managed services” line of business, began to produce revenues in the fourth fiscal quarter and will continue to be a major emphasis in fiscal 2006.  As part of the Managed Services initiative, we have begun to earn services revenues from major Nortel customers who need a nationwide vendor to provide on-site assistance for non-telephony communications, networking, and other technology related projects.  By positioning the Company as on-site “hands and eyes” for these large customers, we are able to expand the range of services we can perform for them beyond telephony.  Typically, these additional services, such as checking or upgrading security systems, fax machines, and networking components are performed at the direction of the customer’s in-house technical experts and may not require specific technical education beyond a basic understanding of wiring and technology.

     We continue to be very optimistic about our long-term prospects.  IP-based communications systems continue to gain market acceptance, the market for software applications to run on these systems is rapidly developing, and we believe we are well positioned in this market to be successful.  In addition to selling products and related software applications, we believe our services business will continue to grow more rapidly than will our systems sales.  We believe the initiatives discussed above represent substantial opportunities for new services growth independent of the growth in services that naturally follows from sales of systems to customers.

     The discussion that follows provides more details regarding the factors and trends which affected our financial results, liquidity, and capital resources in fiscal 2005 when compared to the previous year. 

Results of Operations

Year ending October 31, 2005 compared to October 31, 2004. 

     Net revenues for fiscal 2005 were $58.0 million compared to $58.8 million in fiscal 2004, a 1% decrease.  Net income for fiscal 2005 was $0.494 million compared to $1.6 million in fiscal 2004.  Discussed below are the major revenue, gross margin, and operating expense items that affected our financial results during fiscal 2005.

     Systems Sales.  Sales of systems and equipment were $27.9 million in fiscal 2005 compared to $31.3 million in fiscal 2004.  These results include sales of systems to Commercial customers of $21.4 million in fiscal 2005 compared to $25.9 million in fiscal 2004 and sales of systems to Hospitality customers of $6.6 million in fiscal 2005 compared to $5.0 million in fiscal 2004.  The decline in sales of systems to Commercial customers reflects the fewer number of large projects we received in fiscal 2005 compared to the prior year.  Most of these larger projects were

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recognized as revenues in the first quarter of fiscal 2004 and 70% of the decline in systems sales to Commercial customers occurred in that quarter.  In the fourth quarter of the fiscal year, our systems sales to Commercial customers had recovered to fourth quarter fiscal 2004 levels, reflecting both improved sales of Avaya systems and increased traction in our Nortel systems sales initiatives.  The 24% improvement in year-over-year sales of systems to Lodging customers reflects improved financial conditions in that vertical market and significantly increased new construction activity by our largest customer in that segment.

     Based upon the improvements we began to see in the fourth fiscal quarter, we believe that our sales of Nortel systems will continue to improve in fiscal 2006.  Also, at the end of fiscal 2005 we expanded our Avaya sales force to resume expansion of that product line as well. 

     Services.  Revenues earned from service related activities were $28.2 million in fiscal 2005 compared to $26.5 million in fiscal 2004.  This increase consisted of increases in revenues from services provided by both the NSC and our installation department.  The revenues earned by the NSC reflect higher sales of T&M services as discussed above, as well as higher revenues earned from cabling services sold during the year.  As part of our acquisition of Bluejack in fiscal 2004, we launched a national cabling initiative to increase the market awareness of our capabilities in this area.  These efforts were very successful and increases in cabling revenues represented approximately 28% of the total increase in services revenues in fiscal 2005.  The other major component of our NSC revenues is our maintenance contract base.  Revenues earned from maintenance contracts represented approximately 52% of total Services revenues and was relatively unchanged from the previous year.

     Despite experiencing lower sales of systems during fiscal 2005, our installation services revenues were flat during the year.  This was due to an installation contract we received at the beginning of the fiscal year to install a series of systems for the Metropolitan Transit Authority of Atlanta (“MARTA”) and due to improved sales of systems to lodging customers.  Under the MARTA contract, we were engaged as a subcontractor to perform a series of installations of equipment upgrades to the MARTA communications network and provide training at the various upgrade locations.  The majority of the services revenues from the MARTA project were recorded during the second quarter.  There were no equipment revenues recorded by us under this contract as another dealer won that portion of the MARTA contract.  As such, the MARTA contract represents an example of how we are positioning the services segment of our business to be less dependent on systems sales revenues to generate revenue growth.  We believe that there is a substantial market available to earn revenues from installation related activities unrelated to sales of systems to our customers.  Most of these installation opportunities would likely be Nortel related products. 

     Gross Margins.  Gross margins were 24.2% in fiscal 2005 and in fiscal 2004. 

     Gross margins on systems sales were 24.9% in fiscal 2005 compared to 23.7% in fiscal 2004.  This 1.2 point increase in gross margins on systems sales was achieved through careful focus and controls around contract acceptance and margin reviews and a mix of fewer large, low-margin projects.  These factors more than offset the continued tightening of cost of goods sold rebate programs by our major vendors, primarily Avaya.  In fiscal 2004 these programs, in which we receive rebates against our cost of goods sold for selling specific products, represented 3.6 points of margin improvement on systems sales.  In fiscal 2005, these rebates represented only 1.9 points of margin enhancement, a 47% decrease.  We believe that despite a highly competitive market, we can hold our gross margins on systems sales relatively stable, subject to various mix factors.  However, we can give no assurance regarding possible changes in the cost of goods sold rebate programs that could either improve or further erode our margins.

     The gross margins earned on services revenues were 25.9% in fiscal 2005 compared to 27.8% in fiscal 2004.  This decrease reflects (i) our continued investment in hiring and training technical personnel for our Nortel initiative, (ii) higher materials costs to support our installed base of customers under maintenance contracts, and (iii) a higher usage of third-party service providers to support some of our managed services initiative.  We are continuing to build up our technical competencies to install and support the products we sell.  This includes hiring some new technical personnel; replacing some existing personnel with higher-priced certified staff; and additional training of existing staff.  In addition to selling the Nortel product line, we also are working to become more

17

proficient in contact management, unified messaging, and networking applications.  We are also continuing to evaluate the geographic locations of our technical staff and have made reductions in some areas to be able to hire new or additional technical staff in other areas.  In most of those instances, we hire experienced and certified technicians which has led to a slightly higher cost structure.  Additionally, our materials costs were higher to support equipment under customer service contracts in fiscal 2005 than in previous years.  In particular, in the fourth fiscal quarter of 2005 we experienced a string of equipment failures which were covered under our maintenance contracts.  We have no reason to believe this trend will continue into the future.  Finally, we service most of our customer locations through the use of XETA-employed service technicians.  However, to serve remote locations and to maintain an efficient cost structure, we also utilize third-party technical vendors to perform some services for us on a subcontractor basis.  These costs were higher than expected and our service management is reviewing our procedures and staffing plans to more effectively manage the balance between internal and external labor requirements in fiscal 2006.  As a result of growth initiatives in the services area and more effective use of internal personnel, we expect services gross margins to improve in fiscal 2006.

     A final component to our gross margins is the margins earned on other revenues and our corporate cost of goods sold expenses.  Other revenues represent commissions earned on the sale of manufacturer service contracts and sales and cost of goods sold on equipment outside our normal provisioning processes.  Corporate cost of goods sold represents the cost of our material logistics and purchasing functions.  Corporate cost of goods sold declined 1% in fiscal 2005 compared to fiscal 2004. 

     Operating Expenses.  Operating expenses were $13.3 million or 23% of revenues in fiscal 2005 compared to $11.7 million or 20% of revenues in fiscal 2004.  This increase in operating expenses includes:  our investment in sales resources to support the Nortel product line initiative of approximately $600,000, increased corporate expenses of approximately $250,000 related to increases in insurance costs, auditing and legal expenses, and the addition and relocation of a senior executive, reduced marketing incentive payments from our major vendors of $343,000, and increased expenses related to our Oracle implementation project of $455,000.  Most of the increase in the Oracle upgrade project represented an increase in non-cash amortization expense of $348,000. 

     Interest and Other Income.  Interest expense consists of interest paid or accrued on our credit facility.  Interest expense declined in fiscal 2005 by approximately $117,000, reflecting lower average debt levels in fiscal 2005.  Also, during fiscal 2005, we capitalized interest costs of approximately $204,000 related to our Oracle implementation project compared to approximately $187,000 in fiscal 2004.  During fiscal 2005, we reduced our term debt by $1.2 million through cash on hand and funds generated from operations.

     Net other income in fiscal 2005 was approximately $171,000 compared to net other income of approximately $263,000 last year.  The primary reason for the change in other income and expense relates to a $100,000 reversal of a legal contingency in 2004.  There was no such unusual item of that magnitude in the current year and the legal matter in question was settled in 2005 for the amount remaining in the accrual.

     Tax Expense.  We have recorded a combined federal and state tax provision of approximately 39% in all years presented.  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 2005 was 0.8% compared to 2.7% in 2004.  This decrease reflects slightly lower revenues and the increases in operating expenses discussed above.  Our current business model targets an operating margin of 4%.  However, we will have to realize sustained growth in our revenues, both commercial systems revenues and service revenues, and improve the gross margins in our services business to reach this target.

Year ending October 31, 2004 compared to October 31, 2003. 

     Net revenues for fiscal 2004 were $58.8 million compared to $52.7 million in fiscal 2003, a 12% increase.  Net income for fiscal 2004 was $1.6 million compared to $1.6 million in fiscal 2003.  Discussed below are the major revenue, gross margin, and operating expense items that affected our financial results during fiscal 2004.

18

     Systems Sales.  Sales of systems and equipment were $31.3 million in fiscal 2004 compared to $27.5 million in fiscal 2003, a 14% increase.  These results reflect improved market conditions (while the overall U.S. economy showed signs of improvement, we continued to see mixed results as technology spending, especially on communications equipment, remained sluggish), and the addition of the Nortel product line in fiscal 2004.  Market acceptance of IP-based telephony and related technologies improved during the year and nearly all new systems sold were either hybrid or IP-based systems. 

     Installation and Service Revenues.  Revenues earned from installation and service related activities were $26.5 million for fiscal 2004, a 14% increase over fiscal 2003.  All of our major service revenue streams showed increases in fiscal 2004 over fiscal 2003.  These increases included increases in installation and consulting revenues that were driven by increases in systems sales and increases in revenues from maintenance contracts and services that were driven primarily by the addition of the Nortel product line. 

     The 14% increase in systems sales in fiscal 2004 resulted in improved installation, project management and programming revenues, all of which were directly associated with new systems sales.  Our revenues earned from maintenance contracts increased 9% overall, but were mainly fueled by a 132% increase in revenues earned from service contracts with commercial (non-lodging) customers.  This increase was directly related to the addition of the Nortel product line to our business.  We also enjoyed a 27% increase in revenues earned from move, add, and change (MAC) and T&M service activities.  A portion of these revenues were earned from customers who did not have service contracts, but called us regularly for services.  The remaining portion of MAC and T&M revenues were earned from customers who did have service contracts with us, but needed non-covered services performed. 

     Gross Margins.  Gross margins were 24.2% in fiscal 2004 compared to 27.2% in fiscal 2003.  While we experienced a decline in gross margins on both systems sales and services, most of the decline in gross margins, 5.1 percentage points, was related to the gross margins on systems sales. 

     Gross margins on systems sales were 23.7% in fiscal 2004 compared to 28.8% in fiscal 2003.  The gross margins we earned on systems sales were volatile and were affected by several factors including: 1) product mix; 2) sales to some customers who had pre-negotiated contracts with Avaya, which resulted in lower margins for us; and, 3) variety and changes in our suppliers and manufacturers’ financial incentives to their distributors.  Approximately 2.0 percentage points of the gross margin decline was expected as a result of dropping our exclusive representation of Avaya products to the commercial sector and adding the Nortel product line.  The decrease in gross margins earned on systems sales occurred mostly during our first fiscal quarter and then was relatively stable the remainder of the year.

     The gross margins earned on installation and service revenues were 27.8% in fiscal 2004 compared to 29.1% in fiscal 2003.  This decrease was directly related to the cost of starting up our service offering for the Nortel product line. 

     A final component to our gross margins--the margins earned on other revenues and our corporate cost of goods sold expenses--declined 7% in fiscal 2004 compared to fiscal 2003, reflecting management’s continued focus on containment of administrative costs. 

     Operating Expenses.  Operating expenses were $11.7 million or 19.8% of revenues in fiscal 2004 compared to $11.2 million or 21.3% of revenues in fiscal 2003.  The decrease in operating expenses as a percent of sales reflects continued focus on controlling administrative costs and an increase in the sales and marketing incentive payments received from manufacturers.

     Interest and Other Income.  Interest expense declined in fiscal 2004 by approximately $243,000, reflecting lower average debt levels in fiscal 2004.  Also, during fiscal 2004 we capitalized interest costs of approximately $187,000 related to our Oracle implementation project compared to approximately $337,000 in fiscal 2003.  During fiscal 2004, we reduced our term debt by $1.2 million through cash on hand and funds generated from operations.

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     Net other income in fiscal 2004 was approximately $263,000 compared to net other expense of approximately $71,000 in fiscal 2003.  The primary reason for the change in other income and expense related to the accrual of a contingent liability in 2003 and the partial reversal of that contingency in 2004 as more facts about the matter became available. 

     Tax Expense.  We recorded a combined federal and state tax provision of approximately 39% in all years presented.  This rate reflected 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 2004 was 2.7% compared to 3.0% in 2003.  This decrease reflected lower gross margins earned in fiscal 2004.

Liquidity and Capital Resources

     Our financial condition improved during fiscal 2005 as our working capital grew by 23%, our total assets grew by 6%, and our term debt was reduced by 30%.  These improvements were the result of the $1.5 million in cash flows generated by operations.  These cash flows included cash from earnings and non-cash charges such as depreciation and amortization of $1.5 million.  Other changes in our working capital accounts netted to zero, but included increases in accounts receivable and inventories of $2.1 million and $1.0 million, respectively, both reflecting the growth in our revenues during the last quarter of the fiscal year.  These changes were offset by a $2.4 million increase in accounts payable during the year, also reflecting the increased purchasing activity in the fourth fiscal quarter.  We used these cash flows to fund capital expenditures of $793,000 and to reduce debt by $640,000.  Approximately one-half of our capital expenditures were focused on supporting our Nortel growth initiatives such as acquiring vans for our new branch model operations and acquiring and upgrading computer hardware to support growth in personnel.  The remaining capital expenditures were made to support our Oracle implementation project.  At October 31, 2005 we had capitalized $7.7 million in this project.  We have segregated the cost of this asset into four groups with estimated useful lives of three, five, seven and ten years.  In fiscal 2005 we began amortizing the cost of those portions of the system that were ready for use.  Our operating results for fiscal 2005 include $348,000 in amortization expense related to the project.

     At October 31, 2005 the balance on our working capital revolver was $4.39 million, leaving $3.11 million available for additional borrowings.  We believe that this available capacity is sufficient for our operating needs for the foreseeable future.  The revolver is scheduled to expire on September 28, 2006, however we expect to renew it for another 12-month period prior to its expiration.  At October 31, 2005, we were in compliance with the covenants of our debt agreements and we consider our relationship with our bank to be good.  In addition to the available capacity under our working capital line of credit, we believe we have access to a variety of capital sources such as additional bank debt, private placements of subordinated debt, and public or private sales of additional equity.  However, there are currently no plans to issue such securities. 

     The table below presents our contractual obligations at October 31, 2005 as well as payment obligations over the next five fiscal years:

			Payments due by period
Contractual Obligations	Total		Less than 1 year		2 – 3 years		4 – 5 years		More than 5 years
Long-term debt	$	3,034,822	$	1,141,729	$	483,839	$	1,409,254	$	—
Operating leases		814,028		252,885		413,820		147,323		—
Total	$	3,848,850	$	3,171,619	$	413,820	$	147,323	$	—

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Recent Accounting Pronouncements

     On December 16, 2004, the Financial Accounting Standards Board (“FASB”) issued FASB Statement No. 153, “Exchanges of Nonmonetary Assets - An Amendment of APB Opinion No. 29” (“SFAS No. 153”). This new standard is the result of a broader effort by the FASB to improve financial reporting by eliminating differences between generally accepted accounting principles (“GAAP”) in the US and GAAP developed by the International Accounting Standards Board (IASB). As part of this effort, the FASB and the IASB identified opportunities to improve financial reporting by eliminating certain narrow differences between their existing accounting standards. SFAS No. 153 amends Accounting Principles Board (“APB”) Opinion No. 29, “Accounting for Nonmonetary Transactions,” (“APB No. 29”) that was issued in 1973. The amendments made by SFAS No. 153 are based on the principle that exchanges of nonmonetary assets should be measured based on the fair value of the assets exchanged. Further, the amendments eliminate the narrow exception for nonmonetary exchanges of similar productive assets and replace it with a broader exception for exchanges of nonmonetary assets that do not have “commercial substance.” Previously, APB 29 required that the accounting for an exchange of a productive asset for a similar productive asset or an equivalent interest in the same or similar productive asset should be based on the recorded amount of the asset relinquished. The Company adopted SFAS No. 153 in the third quarter of fiscal 2005.  There was no impact to the Company’s operating results or financial condition as a result of the adoption of the standard.

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 significant judgment about future events that affect the amounts reported throughout our financial statements.  Actual events could unfold quite differently than our previous judgments had predicted.  Therefore, the estimates and assumptions inherent in the financial statements included in this report could be materially different once those actual events are known.  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 sales of equipment based on shipment of the equipment, which is generally easily determined.  Revenues from installation and service activities are recognized based upon completion of the activity and customer acceptance, which sometimes requires judgment on our part.  Revenues from maintenance contracts are recognized ratably over the term of the underlying contract.

     Collectibility of Accounts Receivable.  We must make judgments about the collectibility 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 the acquisitions made in fiscal 2000, 2001, and 2004.  We conduct an annual goodwill impairment review on November 1 of each year for the previous year just ended October 31 to determine the fair value of our reporting units.  In fiscal years 2005 and 2004, we engaged an independent valuation consultant to assist us in this review.  In order to make this assessment each year, we prepared a long-term forecast of the operating results and cash flows associated with the major reporting units of our business.  We prepared this forecast to determine the net discounted cash flows associated with each of these units. The value of the discounted cash flows, less bank debt, was then compared to the book value of each of those units.  There is a great deal of judgment involved in making this assessment, including the growth rates of our various business lines, gross margins, operating margins, discount rates,

21

and the capital expenditures needed to support the projected growth in revenues.  In those years in which a valuation consultant was engaged to assist in this evaluation, additional data regarding competitors and market valuations was also examined.  This examination also requires a great amount of subjectivity and assumptions.  Based on the work performed, we determined that the fair value was greater than our carrying value and therefore no impairment had occurred. 

     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.

     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 addition, from time-to-time we are a party to threatened litigation or actual litigation in the normal course of business.  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 7A.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 

     Market risks relating to our operations result primarily from changes in interest rates.  We did not use derivative financial instruments for speculative or trading purposes during the 2005 fiscal year.

     Interest Rate Risk.   We are subject to the risk of fluctuation in interest rates in the normal course of business due to our utilization of variable debt.  Our credit facility bears interest at a floating rate at either the London Interbank Offered Rate (“LIBOR”) (4.09% at October 31, 2005) plus 1.25 to 2.75% depending on the Company’s funded debt to cash flow ratio or the bank’s prime rate (6.75% at October 31, 2005) less 0.0% to 1.125% also depending on the Company’s funded debt to cash flow ratio.  In an effort to manage the risk associated with variable interest rates, in November 2001 we entered into an interest rate swap to hedge the variability of cash flows associated with variable rate interest payments on amortizing notional amounts of $10.0 million.  The swap agreement expired on November 3, 2004 and was not renewed.  The “pay fixed rates” under the swap agreement was 3.32%.  The “receive floating rates” for the swap agreement was “1-month” LIBOR, resetting monthly.  A hypothetical 10% increase in interest rates would have increased our interest expense by approximately $11,000 in fiscal 2005 and would not have had a material impact on our financial position or cash flows. 

22

PART II

ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

Index to Financial Statements		Page
Reports of Independent Registered Public Accounting Firms		F-1
Consolidated Financial Statements
	Consolidated Balance Sheets - October 31, 2005 and 2004	F-3
	Consolidated Statements of Operations - For the Years Ended October 31, 2005, 2004 and 2003	F-4
	Consolidated Statements of Shareholders’ Equity - For the Years Ended October 31, 2005, 2004 and 2003	F-5
	Consolidated Statements of Cash Flows - For the Years Ended October 31, 2005, 2004 and 2003	F-6
Notes to Consolidated Financial Statements		F-7

23

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Shareholders of
Xeta Technologies, Inc.

We have audited the consolidated balance sheet of Xeta Technologies, Inc. (an Oklahoma Corporation) and subsidiary as of October 31, 2005, and the related consolidated statements of operations, shareholders’ equity and cash flows for the year then ended.  Our responsibility is to express an opinion on these financial statements based on our audit.

We conducted our audit 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 audit 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 includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements.  An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation.  We believe that our audit provides 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 subsidiary as of October 31, 2005, and the results of their operations and their cash flows for the year then ended, in conformity with U.S. generally accepted accounting principles. 

/s/ TULLIUS TAYLOR SARTAIN & SARTAIN LLP

December 16, 2005

F-1

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

Board of Directors and
Shareholders of XETA Technologies, Inc.

We have audited the accompanying consolidated balance sheet of XETA Technologies, Inc. (an Oklahoma corporation) and subsidiary as of October 31, 2004, and the related consolidated statements of operations, shareholders’ equity and cash flows for each of the two years in the period ended October 31, 2004.  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 subsidiary as of October 31, 2004, and the results of their operations and their cash flows for each of the two years in the period ended October 31, 2004 in conformity with accounting principles generally accepted in the United States of America.

/s/ Grant Thornton LLP

Oklahoma City, Oklahoma

December 10, 2004

F-2

XETA TECHNOLOGIES, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS

	October 31, 2005			October 31, 2004
ASSETS
Current assets:
Cash and cash equivalents	$	176,688		$	141,054
Current portion of net investment in sales-type leases and other receivables		533,114			439,026
Trade accounts receivable, net		11,634,030			9,529,377
Inventories, net		5,650,027			4,844,702
Deferred tax asset, net		727,222			880,605
Prepaid taxes		888,842			6,868
Prepaid expenses and other assets		139,525			230,293
Total current assets		19,749,448			16,071,925
Noncurrent assets:
Goodwill		26,476,245			26,196,806
Intangible assets, net		179,709			217,542
Net investment in sales-type leases, less current portion above		167,399			296,865
Property, plant & equipment, net		10,411,329			10,726,855
Other assets		34,411			46,358
Total noncurrent assets		37,269,093			37,484,426
Total assets	$	57,018,541		$	53,556,351
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
Current portion of long-term debt	$	1,123,582		$	1,209,645
Revolving line of credit		4,394,727			3,850,282
Lease payable		5,303			8,897
Accounts payable		4,847,799			2,452,480
Current unearned services revenue		1,505,609			1,558,510
Accrued liabilities		2,392,846			2,522,343
Other liabilities		—			4,986
Total current liabilities		14,269,866			11,607,143
Noncurrent liabilities:
Long-term debt, less current portion above		1,697,039			2,820,357
Accrued long-term liability		144,100			144,100
Noncurrent unearned services revenue		64,895			140,172
Noncurrent deferred tax liability, net		3,744,704			2,540,559
Total noncurrent liabilities		5,650,738			5,645,188
Contingencies
Shareholders’ equity:
Preferred stock; $.10 par value; 50,000 shares authorized, 0 issued		—			—
Common stock; $.001 par value; 50,000,000 shares authorized, 11,197,025 and 11,031,575 issued at October 31, 2005 and October 31, 2004, respectively		11,197			11,031
Paid-in capital		12,999,074			12,695,224
Retained earnings		26,332,325			25,837,870
Accumulated other comprehensive income		—			4,554
Less treasury stock, at cost (1,018,788 shares at October 31, 2005 and October 31, 2004)		(2,244,659	)		(2,244,659	)
Total shareholders’ equity		37,097,937			36,304,020
Total liabilities and shareholders’ equity	$	57,018,541		$	53,556,351

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

F-3

XETA TECHNOLOGIES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS

	For the Years Ended October 31,
	2005			2004			2003
Systems sales	$	27,942,695		$	31,341,190		$	27,549,876
Services		28,241,316			26,492,810			23,338,915
Other revenues		1,819,241			993,431			1,792,512
Net sales and services revenues		58,003,252			58,827,431			52,681,303
Cost of equipment sales		20,978,447			23,914,329			19,621,591
Services costs		20,918,581			19,120,486			16,548,392
Cost of other revenues & corporate COGS		2,072,931			1,529,938			2,192,967
Total cost of sales		43,969,959			44,564,753			38,362,950
Gross profit		14,033,293			14,262,678			14,318,353
Operating expenses
Selling, general and administrative		12,889,802			11,569,185			11,030,671
Amortization		385,591			82,485			180,000
Total operating expenses		13,275,393			11,651,670			11,210,671
Income from operations		757,900			2,611,008			3,107,682
Interest expense		(113,523	)		(230,819	)		(473,979	)
Interest and other income (expense)		171,078			262,861			(71,139	)
Total interest and other income (expense)		57,555			32,042			(545,118	)
Income before provision for income taxes		815,455			2,643,050			2,562,564
Provision for income taxes		321,000			1,035,000			1,005,000
Net income	$	494,455		$	1,608,050		$	1,557,564
Earnings per share
Basic	$	0.05		$	0.16		$	0.16
Diluted	$	0.05		$	0.16		$	0.16
Weighted average shares outstanding		10,087,279			10,008,507			9,827,884
Weighted average equivalent shares		10,116,694			10,157,372			9,998,670

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

F-4

XETA TECHNOLOGIES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
FOR THE YEARS ENDED OCTOBER 31, 2005, 2004 AND 2003

												Accumulated Other Comprehensive Income (Loss)
	Common Stock				Treasury Stock
										Paid-in Capital					Retained Earnings
	Shares Issued		Par Value		Shares		Amount										Total
Balance-October 31, 2002		10,721,740	$	10,721		1,018,788	$	(2,244,659	)	$	12,193,029	$	(110,353	)	$	22,672,256	$	32,520,994
Stock options exercised $.001 par value		300,000		300		—		—			74,700		—			—		75,000
Tax benefit of stock options		—		—		—		—			413,952		—			—		413,952
Components of comprehensive income:
Net income		—		—		—		—			—		—			1,557,564		1,557,564
Unrealized gain on hedge, net of tax of $28,050		—		—		—		—			—		43,507			—		43,507
Total comprehensive income																		1,601,071
Balance-October 31, 2003		11,021,740		11,021		1,018,788		(2,244,659	)		12,681,681		(66,846	)		24,229,820		34,611,017
Stock options exercised $.001 par value		9,835		10		—		—			9,535		—			—		9,545
Tax benefit of stock options		—		—		—		—			4,008		—			—		4,008
Components of comprehensive income:
Net income		—		—		—		—			—		—			1,608,050		1,608,050
Unrealized gain on hedge, net of tax of $46,034		—		—		—		—			—		71,400			—		71,400
Total comprehensive income																		1,679,450
Balance- October 31, 2004		11,031,575		11,031		1,018,788		(2,244,659	)		12,695,224		4,554			25,837,870		36,304,020
Stock options exercised $.001 par value		65,450		66		—		—			24,950		—			—		25,016
Restricted shares issued $.001 par value		100,000		100		—		—			278,900		—			—		279,000
Components of comprehensive income:
Net income		—		—		—		—			—		—			494,455		494,455
Unrealized loss on hedge		—		—		—		—			—		(4,554	)		—		(4,554	)
Total comprehensive income																		489,901
Balance- October 31, 2005		11,197,025	$	11,197		1,018,788	$	(2,244,659	)	$	12,999,074	$	—		$	26,332,325	$	37,097,937

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

F-5

XETA TECHNOLOGIES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS

	For the Years Ended October 31,
	2005			2004			2003
Cash flows from operating activities:
Net income	$	494,455		$	1,608,050		$	1,557,564
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
Depreciation		710,435			822,300			971,499
Amortization		385,591			82,485			180,000
(Gain) loss on sale of assets		(5,819	)		2,465			48,521
Ineffectiveness of cash flow hedge		(12,476	)		12,473			—
Provision (reversal) for returns & doubtful accounts receivable		15,263			—			(45,907	)
Provision for excess and obsolete inventory		242,730			—			280,431
Change in assets and liabilities, net of acquisitions:
Decrease in net investment in sales-type leases & other receivables		35,378			663,164			135,311
(Increase) decrease in trade account receivables		(2,119,916	)		(3,405,570	)		3,963,230
(Increase) decrease in inventories		(1,048,055	)		959,786			1,906,448
(Increase) decrease in deferred tax asset		153,383			5,147			(293,109	)
(Increase) decrease in prepaid expenses and other assets		102,715			172,357			(99,146	)
(Increase) decrease in prepaid taxes		(881,974	)		(6,868	)		1,195,539
Increase (decrease) in accounts payable		2,395,319			(1,810,728	)		(2,190,257	)
Decrease in unearned revenue		(128,178	)		(357,693	)		(462,367	)
Increase (decrease) in accrued taxes		38,216			(19,918	)		96,352
Increase (decrease) in accrued liabilities and lease payable		(133,091	)		286,669			(260,861	)
Increase in deferred tax liability		1,224,441			542,319			1,190,155
Total adjustments		973,962			(2,051,612	)		6,615,839
Net cash provided by (used in) operating activities		1,468,417			(443,562	)		8,173,403
Cash flows from investing activities:
Acquisitions, net of cash acquired		(56,015	)		(597,791	)		—
Additions to property, plant & equipment		(743,009	)		(1,059,623	)		(1,031,696	)
Proceeds from sale of assets		6,161			19,542			2,568
Net cash used in investing activities		(792,863	)		(1,637,872	)		(1,029,128	)
Cash flows from financing activities:
Proceeds from issuance of debt		—			—			1,125
Proceeds from draws on revolving line of credit		23,290,889			30,111,338			16,083,009
Principal payments on debt		(1,209,381	)		(1,209,384	)		(9,615,089	)
Payments on revolving line of credit		(22,746,444	)		(26,980,129	)		(15,363,936	)
Exercise of stock options		25,016			9,545			75,000
Net cash (used in) provided by financing activities		(639,920	)		1,931,370			(8,819,891	)
Net increase (decrease) in cash and cash equivalents		35,634			(150,064	)		(1,675,616	)
Cash and cash equivalents, beginning of year		141,054			291,118			1,966,734
Cash and cash equivalents, end of year	$	176,688		$	141,054		$	291,118
Supplemental disclosure of cash flow information:
Cash paid during the period for interest, net of amount capitalized of $204,125 in 2005, $187,092 in 2004 and $337,200 in 2003	$	124,250		$	180,366		$	446,786
Cash paid during the period for income taxes	$	41,511		$	525,881		$	132,011
Non-cash financing activities - Issuance of restricted stock	$	279,000		$	—		$	—

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

F-6

XETA TECHNOLOGIES, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE YEARS ENDED OCTOBER 31, 2005

1.     BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:

Business

XETA Technologies, Inc. (“XETA” or the “Company”) is a leading provider of enterprise class communications solutions with sales and service locations nationwide, serving business clients in sales, consulting, engineering, project management, installation, and service support.  The Company sells products that are manufactured by a variety of manufacturers including Avaya Inc. (“Avaya”) Nortel Networks Corporation (“Nortel”), and Spectralink Corporation.  In addition, the Company provides XETA-manufactured call accounting systems to the hospitality industry.  XETA is an Oklahoma corporation.

During fiscal 2003 U.S. Technologies Systems, Inc. (“USTI”) was merged into XETA for tax purposes.  There was no impact on the Company’s financial statements.  Formerly, USTI was a wholly-owned subsidiary of XETA, which was purchased on November 30, 1999 as part of the Company’s expansion into the commercial market.  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 installation 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.  Emerging Issues Task Force (“EITF”) Issue  No. 00-21 “Revenue Arrangements with Multiple Deliverables” (“EITF 00-21”) addresses certain aspects of accounting by a vendor for arrangements with multiple revenue-generating elements, such as those including products with installation.  Under EITF 00-21, 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 installation services revenues upon completion of the installation of the system. 

F-7

Service 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.” 

Shipping and Handling Fees

In accordance with Emerging Issues Task Force Issue 00-10, “Accounting for Shipping and Handling Fees and Costs,” 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 they sell.  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.  Incentive payments that are based on purchasing certain product lines exclusively from one manufacturer (“loyalty rebates”) are also recorded as a reduction in systems cost of goods sold.  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.

Interest and other income is primarily the recognition of interest income on the Company’s sales-type lease receivables and income earned on short-term cash investments.  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, agings of customer balances, and any specific disputes.  The Company recorded bad debt expense of $15,263 and $0 for the years ended October 31, 2005 and 2004, respectively, and recorded a reversal of the provision for doubtful accounts of $45,907 for the year ended October 31, 2003.

Property, Plant and 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 capitalized $204,000, $187,000, and $337,000 in interest costs in fiscal years 2005, 2004 and 2003, respectively.

F-8

Research and Development and Capitalization of Software Production Costs

In the past, the Company developed proprietary telecommunications products targeted at the hospitality industry.  The Company capitalized software production costs related to the product upon the establishment of technological feasibility in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 86, “Accounting for Costs of Computer Software to be Sold, Leased or Otherwise Marketed,” (“SFAS No. 86”).  Amortization is provided on a product-by-product basis based upon the estimated useful life of the software (generally seven years).  All other research and development costs (including those related to software for which technological feasibility has not been established) are expensed as incurred.  Since the Company’s expansion into the general commercial market in fiscal 1999, the Company has ceased research and development of new products for the hospitality market.

Software Development Costs

The Company applies the provisions of Statement of Position (“SOP”) 98-1, “Accounting for the Cost of Computer Software Developed or Obtained for Internal Use” (“SOP 98-1”).  Under SOP 98-1 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, as provided under the provisions of SFAS No. 34, “Capitalization of Interest Costs,” should be capitalized after the “preliminary project stage” has been completed.  Accordingly, the Company capitalized $7.7 million and $7.3 million related to the software development as of October 31, 2005 and 2004, respectively.  The Company has segregated the cost of the developed software into four groups with estimated useful lives of three, five, seven and ten years.  Beginning in fiscal 2005, the Company began implementing the developed software in its business and the operating results for fiscal 2005 include $348,000 in amortization costs calculated based on the estimated useful lives of those functions of the software which are ready for their intended use.

Derivative Instruments and Hedging Activities

The Company applies the provisions of SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” as amended.  SFAS No. 133 requires companies to recognize all derivative instruments as either assets or liabilities in the consolidated balance sheets at fair value. 

Stock-based Compensation Plans

The Company accounts for its stock-based awards granted to officers, directors and key employees using Accounting Principles Board Opinion (“APB”) No. 25, “Accounting for Stock Issued to Employees”.  Options under these plans are granted at fair market value on the date of grant and thus no compensation cost has been recorded in the consolidated financial statements.  Accordingly, the Company follows fixed plan accounting. XETA applies the disclosure only provisions of SFAS No. 123, “Accounting for Stock-Based Compensation”.

In December 2002 the Financial Accounting Standards Board (FASB) issued SFAS No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure – an amendment of SFAS No. 123” (SFAS No. 148).  This statement provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation.  It also amends the disclosure requirements of SFAS No.123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results.  Until its adoption of SFAS No. 123 (Revised 2004), “Share-Based Payments,” a revision of FASB Statement 123 (“SFAS No. 123R”) as described below, the Company accounted for stock-based employee compensation under the intrinsic value method, an alternative to the fair value method allowed by SFAS No. 123.  Under this alternative method, the Company was only required to disclose the impact of issued stock options, as set forth below, as if the expense had been recorded in the consolidated financial statements. 

F-9

	For the Year Ended October 31,
	2005		2004			2003
Pro Forma Disclosures:
NET INCOME:
As reported	$	494,455	$	1,608,050		$	1,557,564
Add (deduct): Total stock-based employee compensation recovered (expensed) determined under fair value based method for all awards, net of related tax effects		1,203		(103,583	)		(388,628	)
Pro forma	$	495,658	$	1,504,467		$	1,168,936
EARNINGS PER SHARE:
As reported – Basic	$	0.05	$	0.16		$	0.16
As reported – Diluted	$	0.05	$	0.16		$	0.16
Pro forma – Basic	$	0.05	$	0.15		$	0.12
Pro forma – Diluted	$	0.05	$	0.15		$	0.12

The fair value of the options granted was estimated at the date of grant using the Modified Black-Scholes European pricing model with the following assumptions: risk free interest rate (3.42% to 5.78%), dividend yield (0.00%), expected volatility (80.50% to 86.64%), and expected life (6 years).

In December 2004 the FASB issued SFAS No. 123R.  This new statement supersedes APB Opinion No. 25, “Accounting for Stock Issued to Employees,” and its related implementation guidance. The statement focuses primarily on accounting for transactions in which an entity obtains employee services in share-based payment transactions. SFAS No. 123R requires a public entity to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award (with limited exceptions). That cost will be recognized over the period during which an employee is required to provide service in exchange for the award. This statement is effective as of the beginning of the first annual reporting period that begins after June 15, 2005 and the Company adopted the standard on November 1, 2005.  Because option-holders are fully vested in all outstanding options at the present time, adoption of the new standard did not have a material impact on the Company’s consolidated financial position or results of operations. 

Income Taxes

Income tax expense is based on pretax income.  Deferred income taxes are computed using the asset-liability method in accordance with SFAS No. 109, “Accounting for Income Taxes,” and are provided on all temporary differences between the financial basis and the tax basis of the Company’s assets and liabilities.

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 manufacturer’s 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.

F-10

Segment Information

The Company has three reportable segments:  commercial system sales, lodging system sales and services.  The Company defines commercial system sales as sales to the non-hospitality industry.  Services represent revenues earned from installing and maintaining systems for customers in both the commercial and hospitality segments.

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 2005, 2004, and 2003:

	Commercial System Sales		Lodging System Sales		Services		Other Revenue			Total
2005
Sales	$	21,364,393	$	6,578,302	$	28,241,316	$	1,819,241		$	58,003,252
Cost of sales		16,349,218		4,629,229		20,918,581		2,072,931			43,969,959
Gross profit		5,015,175		1,949,073		7,322,735		(253,690	)		14,033,293
2004
Sales	$	25,897,343	$	5,443,847	$	26,492,810	$	993,431		$	58,827,431
Cost of sales		20,180,498		3,733,831		19,120,486		1,529,938			44,564,753
Gross profit		5,716,845		1,710,016		7,372,324		(536,507	)		14,262,678
2003
Sales	$	21,304,223	$	6,245,653	$	23,338,915	$	1,792,512		$	52,681,303
Cost of sales		15,279,565		4,342,026		16,548,392		2,192,967			38,362,950
Gross profit		6,024,658		1,903,627		6,790,523		(400,455	)		14,318,353

Recently Issued Accounting Pronouncements

          On December 16, 2004 the FASB issued FASB Statement No. 153, “Exchanges of Nonmonetary Assets - An Amendment of APB Opinion No. 29” (“SFAS No. 153”). This new standard is the result of a broader effort by the FASB to improve financial reporting by eliminating differences between generally accepted accounting principles (“GAAP”) in the United States and GAAP developed by the International Accounting Standards Board (IASB). As part of this effort, the FASB and the IASB identified opportunities to improve financial reporting by eliminating certain narrow differences between their existing accounting standards. SFAS No. 153 amends APB No. 29, Accounting for Nonmonetary Transactions, that was issued in 1973. The amendments made by SFAS No. 153 are based on the principle that exchanges of nonmonetary assets should be measured based on the fair value of the assets exchanged. Further, the amendments eliminate the narrow exception for nonmonetary exchanges of similar productive assets and replace it with a broader exception for exchanges of nonmonetary assets that do not have “commercial substance.” Previously, APB No. 29 required that the accounting for an exchange of a productive asset for a similar productive asset or an equivalent interest in the same or similar productive asset should be based on the recorded amount of the asset relinquished. The Company adopted SFAS No. 153 in the third quarter of fiscal 2005.  There was no impact to the Company’s operating results or financial condition as a result of the adoption of the standard.

F-11

Acquisitions

On August 1, 2004, the Company acquired substantially all of the assets and liabilities of Bluejack Systems, LLC (Bluejack), a  Seattle, Washington based Nortel dealer.  The Company’s consolidated financial statements include the results of Bluejack’s operations since the date of the acquisition.  The acquisition was made as part of the Company’s entry into the Nortel market and to establish a branch office in Seattle, a significant metropolitan area not previously served by the Company.  Under the terms of the purchase agreement, the Company paid the owner of Bluejack $569,987.  The Company recorded the acquisition according to the provisions of SFAS No. 141, “Business Combinations” (SFAS No. 141).  Under SFAS No. 141, the acquired assets and liabilities were recorded on the Company’s books at their fair value.  Included in the assets acquired was the customer list of Bluejack.  The Company determined that the estimated fair value of the customer list was $227,000 and this amount was set up as a separate intangible asset on the Company’s consolidated balance sheet.  This asset will be amortized over its expected useful life of 6 years.  The remaining $498,000 difference between the cash paid and fair value of the net assets acquired plus approximately $27,000 in direct costs of the acquisition were recorded as goodwill.  For tax purposes, the Company has recorded $1,088,000 in goodwill and other intangible assets, which will be deductible over 15 years on a straight-line basis.  Certain other pro forma disclosures required by SFAS No. 141 have been omitted because they were not material to the Company’s consolidated financial statements.

Under the terms of the purchase agreement, the former owner of Bluejack was to receive additional purchase consideration over five years based upon the financial contribution, as defined, of the Seattle branch office.  In July, 2005, the Company negotiated a purchase of this earn-out.  Under the terms of the buyout, the former owner was paid $50,000 in cash and 100,000 shares of restricted stock.  The restricted stock carries restrictions against transfer for two years as to 50,000 shares, three years as to 25,000 shares and four years as to 25,000 shares.  As a result of these payments, the Company recorded  additional goodwill of $329,000 in the third quarter of fiscal 2005. 

Goodwill

The Company adopted SFAS No. 142, “Goodwill and Other Intangible Assets” on November 1, 2001.  Under SFAS No. 142, 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.  Such impairment tests have been performed by management on November 1, 2005, 2004, and 2003 for the previous year just ended October 31. The results of these assessments have indicated that no impairment has existed in the value of recorded goodwill.  Therefore, no impairment loss has been recognized. 

The goodwill for tax purposes associated with the acquisition of USTI exceeded the goodwill recorded on the financial statements by $1,462,000.  The Company is reducing the carrying value of goodwill each accounting period to record the tax benefit realized due to the excess of tax-deductible goodwill over the reported amount of goodwill, resulting 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, 2005 and 2004. 

The changes in the carrying value of goodwill for fiscal 2005 and 2004 are as follows:

	Commercial Systems Sales			Services			Other			Total
Balance, November 1, 2003	$	17,566,586		$	7,961,744		$	198,556		$	25,726,886
Amortization of book versus tax basis difference		(41,682	)		(13,338	)		(556	)		(55,576	)
Goodwill acquired		368,898			143,460			13,138			525,496
Balance, October 31, 2004		17,893,802			8,091,866			211,138			26,196,806
Amortization of book versus tax basis difference		(41,680	)		(13,340	)		(556	)		(55,576	)
Goodwill acquired		235,181			91,459			8,375			335,015
Balance, October 31, 2005	$	18,087,303		$	8,169,985		$	218,957		$	26,476,245

F-12

Other Intangible Assets

	As of October 31, 2005				As of October 31, 2004
	Gross Carrying Amount		Accumulated Amortization		Gross Carrying Amount		Accumulated Amortization
Amortized intangible assets:
Software production costs	$	1,291,021	$	1,291,021	$	1,291,021	$	1,291,021
Other		402,710		223,001		402,710		185,168
Total amortized intangible assets	$	1,693,731	$	1,514,022	$	1,693,731	$	1,476,189

Aggregate amortization expense of intangible assets was $37,833, $124,105, and $220,525 for the years ended October 31, 2005, 2004, and 2003, respectively, which includes $0, $41,620, and $40,525 recorded as interest expense in the consolidated statements of operations for the years ended October 31, 2005, 2004, and 2003, respectively.  The estimated aggregate amortization expense of intangible assets for each of the next five fiscal years is $37,833.

2.  ACCOUNTS RECEIVABLE:

Trade accounts receivable consist of the following at October 31:

	2005		2004
Trade receivables	$	11,932,173	$	9,847,984
Less- reserve for doubtful accounts		298,143		318,607
Net trade receivables	$	11,634,030	$	9,529,377

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

	2005			2004			2003
Balance, beginning of period	$	318,607		$	335,541		$	345,516
Provision (reversal) for doubtful accounts		15,263			—			(45,907	)
Net (write-offs) recoveries		(35,727	)		(16,934	)		35,932
Balance, end of period	$	298,143		$	318,607		$	335,541

3.  INVENTORIES:

Inventories are stated at the lower of cost (first-in, first-out or weighted-average) or market and consist of the following components at October 31:

	2005		2004
Raw materials	$	358,646	$	395,539
Finished goods and spare parts		5,831,560		5,320,972
		6,190,206		5,716,511
Less- reserve for excess and obsolete inventories		540,179		871,809
Total inventories, net	$	5,650,027	$	4,844,702

F-13

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

	2005			2004			2003
Balance, beginning of period	$	871,809		$	1,182,380		$	786,619
Provision for excess and obsolete inventories		242,730			—			280,431
Adjustments to inventories		(574,360	)		(310,571	)		115,330
Balance, end of period	$	540,179		$	871,809		$	1,182,380

Adjustments to inventories in 2005, 2004 and 2003 included write-offs of obsolete inventory, corrections of vendor invoices, and adjustments to reduce certain items 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		2005			2004
Building		20	$	2,397,954		$	2,397,954
Data processing and computer field equipment		3-10		4,720,698			4,587,485
Software development costs, work-in-process		N/A		5,410,558			7,280,461
Software development costs of components placed into service		3-10		1,695,370			—
Hardware		3-5		589,905			—
Land		—		611,582			611,582
Office furniture		5		1,114,073			1,110,729
Auto		5		384,278			237,176
Other		3-7		549,613			546,253
Total property, plant and equipment				17,474,031			16,771,640
Less- accumulated depreciation				(7,062,702	)		(6,044,785	)
Total property, plant and equipment, net			$	10,411,329		$	10,726,855

5.  ACCRUED LIABILITIES:

Accrued liabilities consist of the following at October 31:

	2005		2004
Commissions	$	597,811	$	618,291
Interest		23,246		21,494
Payroll		554,506		520,397
Bonuses		242,917		306,981
Vacation		580,922		504,585
Other		393,444		550,595
Total current		2,392,846		2,522,343
Accrued long-term liability		144,100		144,100
Total accrued liabilities	$	2,536,946	$	2,666,443

F-14

6.  UNEARNED SERVICES REVENUE:

Unearned service revenue consists of the following at October 31:

	2005		2004
Service contracts	$	737,618	$	845,550
Warranty service		299,618		320,193
Customer deposits		272,871		229,772
Systems shipped but not installed		153,748		115,413
Other		41,754		47,582
Total current unearned revenue		1,505,609		1,558,510
Noncurrent unearned services revenue		64,895		140,172
Total unearned revenue	$	1,570,504	$	1,698,682

7.  INCOME TAXES:

The income tax provision for the years ending October 31, 2005, 2004, and 2003, consists of the following:

	2005			2004		2003
Current provision (benefit) – federal	$	(725,730	)	$	266,490	$	484,930
Current provision (benefit) – state		(95,930	)		67,700		97,590
Deferred provision		1,142,660			700,810		422,480
Total provision	$	321,000		$	1,035,000	$	1,005,000

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

	Year Ended October 31,
	2005			2004			2003
Statutory rate		34	%		34	%		34	%
State income taxes, net of federal benefit		5	%		5	%		5	%
Effective rate		39	%		39	%		39	%

F-15

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:

	2005			2004
Deferred tax assets:
Currently nondeductible reserves	$	238,379		$	351,059
Accrued liabilities		300,255			393,760
Prepaid service contracts		111,771			163,333
Unamortized cost of service contracts		87,972			6,842
Other		—			80,240
Total deferred tax assets		738,377			995,234
Deferred tax liabilities:
Intangible assets		2,992,299			2,300,008
Depreciation and sale of assets		734,394			343,726
Tax income to be recognized on sales-type lease contracts		29,166			8,518
Other		—			2,936
Total deferred tax liabilities		3,755,859			2,655,188
Net deferred tax liability	$	(3,017,482	)	$	(1,659,954	)

8.  CREDIT AGREEMENTS:

The Company’s credit facility consists of a revolving credit and term loan agreement with a commercial bank.  This agreement contains three separate notes:  a term loan maturing on September 30, 2006, a mortgage agreement maturing on September 30, 2009 and amortizing based on an 11 year life, and a $7.5 million revolving credit agreement to finance growth in working capital.  The revolving line of credit is collateralized by trade accounts receivable and inventories.  At October 31, 2005 and 2004, the Company had approximately $4.395 million and $3.850 million, respectively, outstanding on the revolving line of credit.  The weighted average interest rate on amounts outstanding under the line of credit during fiscal years 2005 and 2004 was 5.06% and 3.31%, respectively. The Company had approximately $3.1 million available under the revolving line of credit at October 31, 2005.  Advance rates are defined in the agreement, but are generall y at the rate of 80% on qualified trade accounts receivable and 40% of qualified inventories.  The revolving line of credit matures on September 28, 2009.  At October 31, long-term debt consisted of the following:

	October 31,
	2005		2004
Term loan, payable in monthly installments of $86,524, due September 30, 2006 collateralized by all assets of the Company	$	952,459	$	1,990,750
Real estate term note, payable in monthly installments of $14,257, plus a final payment of $1,198,061 on September 30, 2009, collateralized by a first mortgage on the Company’s building		1,868,162		2,039,252
		2,820,621		4,030,002
Less-current maturities		1,123,582		1,209,645
	$	1,697,039	$	2,820,357

Maturities of long-term debt for each of the years ended October 31, are as follows:

2006	$	1,123,549
2007		171,090
2008		171,090
2009		1,354,892

F-16

Interest on all outstanding debt under the credit facility accrues at either a) the London Interbank Offered Rate (“LIBOR”) (which was 4.09% at October 31, 2005) plus 1.25% to 2.75% depending on the Company’s funded debt to cash flow ratio, or b) the bank’s prime rate (which was 6.75% at October 31, 2005) minus 0% to minus 1.125% also depending on the Company’s funded debt to cash flow ratio.  At October 31, 2005, the Company was paying 6.375% on the revolving line of credit borrowings, 5.864% on the term loan and 5.614% on the mortgage note.  The credit facility contains several financial covenants common in such agreements including tangible net worth requirements, limitations on the amount of funded debt to annual earnings before interest, taxes, depreciation and amortization, limitations on capital spending, and debt service coverage requirements.  At October 31, 2005, the Company was either in compliance with the covenants of the credit facility or had received the appropriate waivers from its bank.

9.  DERIVATIVES AND RISK MANAGEMENT:

At October 31, 2004, the Company had an outstanding interest rate swap (“Swap”) in a notional amount of $4.2 million which expired in November 2004.  Under the Swap contract, the Company paid a fixed interest rate of 3.32% and received a variable interest payment based on one-month LIBOR rates.  SFAS No. 133, as amended, governs the accounting for derivative instruments such as Swaps.  Under the provisions of SFAS No. 133, as long as the interest rate hedge is “effective”, as defined in the standard, the Company’s Swap is accounted for by recognizing an asset or liability at fair value with the offsetting entry to other comprehensive income or loss in Company’s stockholders’ equity section.  Accordingly, the Company recorded a current liability and accumulated other comprehensive income of $4,554 at October 31, 2004, and recorded $12,473 of ineffectiveness during the year ended October 31, 2004, which is included in interest expense in the consolidated statement of operations.  No material ineffective portion of the interest rate swap existed for 2003. 

10.  STOCK-BASED INCENTIVE AWARDS:

In fiscal 2004, the Company’s stockholders approved the “2004 Omnibus Stock Incentive Plan” (“2004 Plan”) for officers, directors and employees.  The 2004 Plan authorizes the grant of up to 600,000 shares of common stock and includes an evergreen feature so that such number will automatically increase on November 1 of each year during the term of the 2004 Plan by three percent of the total number of outstanding shares of common stock outstanding on the previous October 31.  Awards available for issuance under the 2004 Plan include nonqualified and incentive stock options, restricted stock, and other stock-based incentive awards such as stock appreciation rights or phantom stock.  The 2004 Plan is administered by the Compensation Committee of the Board of Directors.  There have been no awards granted under the 2004 Plan.

In fiscal 2000 the Company’s shareholders approved a stock option plan (“2000 Plan”) for officers, directors and key employees.  The 2000 Plan replaced the previous 1988 Plan, which had expired.  Under the 2000 Plan, the Board of Directors, or a committee thereof, determine the option price, not to be less than fair market value at the date of grant, number of options granted, and the vesting period.  Although there are exceptions, generally options that have been granted under the 2000 Plan expire ten years from the date of grant, have three-year cliff-vesting, and are incentive stock options as defined under the applicable Internal Revenue Service tax rules. Options granted under the previous 1988 Plan generally vested 33 1/3% per year after a one-year waiting period.  The following table summarizes information concerning options outstanding under the 2000 and 1988 Plans including the related transactions for the fiscal years ended October 31, 2003, 2004, and 2005:

F-17

	Number			Weighted Average Exercise Price		Weighted Average Fair Value of Options Granted
Balance, October 31, 2002		674,740		$	7.66
Granted		5,000		$	3.00	$	1.26
Forfeited		(56,440	)	$	7.78
Balance, October 31, 2003		623,300		$	7.61
Granted		1,500		$	6.35	$	5.36
Exercised		(9,835	)	$	0.97
Forfeited		(56,793	)	$	7.96
Balance, October 31, 2004		558,172		$	7.69
Forfeited		(19,900	)	$	9.03
Balance, October 31, 2005		538,272		$	7.64
Exercisable at October 31, 2005		538,272		$	7.64
Exercisable at October 31, 2004		330,772		$	10.46
Exercisable at October 31, 2003		310,123		$	10.55

The Company has also granted options outside the 1988 Plan, 2000 Plan, and 2004 Plan to certain officers and directors.  These options generally expire ten years from the date of grant and are exercisable over the period stated in each option.  The following table summarizes information concerning options outstanding under various Officer and Director Plans including the related transactions for the fiscal years ended October 31, 2003, 2004, and 2005:

	Number			Weighted Average Exercise Price
Balance, October 31, 2003 and 2004		685,400		$	5.86
Exercised		(65,400	)		0.38
Balance, October 31, 2005		620,000		$	6.44
Exercisable at October 31, 2005		620,000		$	6.44
Exercisable at October 31, 2004		685,400		$	5.86
Exercisable at October 31, 2003		685,400		$	5.86

The following is a summary of stock options outstanding as of October 31, 2005:

	Options Outstanding						Options Exercisable
Range of Exercise Prices	Number Outstanding at October 31, 2005		Weighted Average Exercise Price		Weighted Average Remaining Contractual Life (Years)		Number Exercisable at October 31, 2005		Weighted Average Exercise Price
$1.64-1.82		36,504	$	1.64		0.27		36,504	$	1.64
$3.63-5.79		339,268	$	4.04		5.09		339,268	$	4.04
$5.81		580,000	$	5.81		3.63		580,000	$	5.81
$5.85-12.00		32,150	$	9.90		4.92		32,150	$	9.90
$15.53		40,000	$	15.53		4.25		40,000	$	15.53
$18.13		130,350	$	18.13		4.47		130,350	$	18.13

F-18

11.  EARNINGS PER SHARE:

All basic earnings per common share were computed by dividing net income by the weighted average number of shares of common stock outstanding during the reporting period.  A reconciliation of net income and weighted average shares used in computing basic and diluted earnings per share is as follows:

	For the Year Ended October 31, 2005
	Income (Numerator)		Shares (Denominator)		Per Share Amount
Basic EPS
Net income	$	494,455		10,087,279	$	0.05
Dilutive effect of stock options				29,415
Diluted EPS
Net income	$	494,455		10,116,694	$	0.05

	For the Year Ended October 31, 2004
	Income (Numerator)		Shares (Denominator)		Per Share Amount
Basic EPS
Net income	$	1,608,050		10,008,507	$	0.16
Dilutive effect of stock options				148,865
Diluted EPS
Net income	$	1,608,050		10,157,372	$	0.16

	For the Year Ended October 31, 2003
	Income (Numerator)		Shares (Denominator)		Per Share Amount
Basic EPS
Net income	$	1,557,564		9,827,884	$	0.16
Dilutive effect of stock options				170,786
Diluted EPS
Net income	$	1,557,564		9,998,670	$	0.16

For the years ended October 31, 2005, 2004, and 2003, respectively, stock options for 1,121,668 shares at an average exercise price of $7.17, 843,017 shares at an average exercise price of $8.40, and 1,193,628 shares at an average exercise price of $7.22, were excluded from the calculation of earnings per share because they were antidilutive. 

F-19

12.   FINANCING RECEIVABLES:

A small portion of the Company’s systems sales are made under sales-type lease agreements with the end-users of the equipment.  These receivables are secured by the cash flows under the leases and the equipment installed at the customers’ premises.  Minimum future annual payments to be received under various leases are as follows for years ending October 31:

	Sales-Type Lease Payments Receivable
2006	$	312,413
2007		123,731
2008		38,687
		474,831
Less-imputed interest		60,869
Present value of minimum payments	$	413,962

13.  MAJOR CUSTOMERS, SUPPLIERS AND CONCENTRATIONS OF CREDIT RISK:

Marriott International, Host Marriott, and other affiliated companies (“Marriott”) represent a single customer relationship for our Company and are a major customer.  Revenues earned from Marriott represented 13%, 10%, and 11% of our total revenues in fiscal 2005, 2004, and 2003, respectively.

The Company extends credit to its customers in the normal course of business, including under its sales-type lease program. As a result, the Company is subject to changes in the economic and regulatory environments or other conditions, which in turn may impact the Company’s overall credit risk.  However, the Company sells to a wide variety of customers and, except for its hospitality customers, does not focus its sales and marketing efforts on any particular industry.  Management considers the Company’s credit risk to be satisfactorily diversified and believes that the allowance for doubtful accounts is adequate to absorb estimated losses at October 31, 2005.

The majority of the Company’s systems sales are derived from sales of equipment designed and marketed by Avaya or Nortel.  As such, the Company is subject to the risks associated with these companies’ financial condition, ability to continue to develop and market leading-edge technology systems, and the soundness of their long-term product strategies.  Both Avaya and Nortel have outsourced their manufacturing operations to single, separate manufacturers.  Thus, the Company is subject to certain additional risks such as those that might be caused if the manufacturers incur financial difficulties or if man-made or natural disasters impact their manufacturing facilities.  The Company purchases most of its Avaya and Nortel products from two distributors who have common ownership.  Avaya has one other distributor that could quickly supply the Company’s business.  Nortel products can be purchased from several distributors and the Company makes frequent purchases from those other distributors.  The Company believes that both its Avaya and Nortel purchases could be quickly converted to the other available distributors without a material disruption to its business.

14.  EMPLOYMENT AGREEMENTS:

The Company has two incentive compensation plans: one for sales professionals and sales management and one for all other employees.  The bonus plan for sales personnel is based on either gross profit generated or a percentage of their “contribution”, defined as the gross profit generated less their direct and allocated sales expenses.  The Company paid $309,424, $239,200 and $224,907 during 2005, 2004 and 2003, respectively, under the sales professionals’ bonus plan.  The Employee Bonus Plan (“EBP”) provides an annual incentive compensation opportunity for senior executives and other employees designated by senior management and the Board of Directors as key employees.  The purpose of the EBP is to provide an incentive for senior executives to reach Company-wide targeted financial objectives and to reward key employees for leadership and excellent performance.  Those targeted results were not fully achieved in fiscal 2005, 2004 and 2003, however, the Company elected to pay partial bonuses of approximately $150,000, $240,000 and $240,000, respectively.

F-20

15.  CONTINGENCIES:

Lease Commitments

Future minimum commitments under non-cancelable operating leases for office space and equipment are approximately $253,000, $212,000, $202,000, $92,000 and $55,000 in fiscal years 2006 through 2010, respectively.

Litigation

On June 15, 2005 the Company settled litigation with Software & Information Industry Association (“SIIA”).  In 2003, SIIA, an association of software publishers, claimed that XETA had violated the Copyright Act, 17 U.S.C. § 501, et seq. by allegedly using unlicensed software in XETA’s business.  In the settlement agreement reached with SIIA and eleven of its members, none of the parties admitted liability for any claims or causes of action, all pending matters were dismissed, and XETA made a $50,000 payment to the SIIA Copyright Protection Fund.  XETA does not believe that it has any material liability to any SIIA member who was not a party to the settlement agreement and no such member has made any claim against the Company.  The settlement of this matter did not have a material impact on XETA’s results of operations or financial position.

Since 1994, the Company has been monitoring numerous patent infringement lawsuits filed by Phonometrics, Inc., a Florida company, against certain telecommunications equipment manufacturers and hotels who use such equipment.  While the Company was never named as a defendant in any of these cases, several of the Company’s call accounting customers were named defendants and notified the Company that they would seek indemnification under the terms of their contracts. Because there were other equipment vendors implicated along with the Company in the cases filed against the Company’s customers, the Company never assumed the outright defense of the customers in any of these actions.  In October 1998, all of the cases filed against the hotels were dismissed by the court for failure to state a claim.  After years of appeals by Phonometrics, all of which were lost on the merits, a final order dismissing the cases with prejudice was entered in November 2002, and the defendant hotels have been awarded attorney fees and costs, and in some cases sanctions, against Phonometrics and/or its legal counsel.  Phonometrics continues to dispute the amount of fees awarded in some cases, and this issue continues to be litigated by Phonometrics in the United States Court of Appeals for the Federal Circuit. 

16.  RETIREMENT PLAN:

The Company has a 401(k) retirement plan (“Plan”).  In addition to employee contributions, the Company makes discretionary matching and profit sharing contributions to the Plan based on percentages set by the Board of Directors.  Contributions made by the Company to the Plan were approximately $547,000, $508,000 and $457,000 for the years ending October 31, 2005, 2004, and 2003, respectively.

F-21

17.  SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED):

The following quarterly financial data has been prepared from the financial records of the Company without an audit, and reflects all adjustments, which in the opinion of management were of a normal, recurring nature and necessary for a fair presentation of the results of operations for the interim periods presented.

	For the Fiscal Year Ended October 31, 2005
	Quarter Ended
	January 31, 2005		April 30, 2005		July 31, 2005		October 31, 2005
	(in thousands, except per share data)
Net sales	$	13,915	$	14,204	$	13,522	$	16,362
Gross profit		3,265		3,662		3,389		3,717
Operating income		17		286		122		333
Net income		78		164		64		188
Basic EPS	$	0.01	$	0.02	$	0.01	$	0.02
Diluted EPS	$	0.01	$	0.02	$	0.01	$	0.02

	For the Fiscal Year Ended October 31, 2004
	Quarter Ended
	January 31, 2004		April 30, 2004		July 31, 2004		October 31, 2004
	(in thousands, except per share data)
Net sales	$	16,929	$	13,189	$	13,890	$	14,819
Gross profit		3,955		3,275		3,361		3,671
Operating income		954		595		607		455
Net income		562		410		371		265
Basic EPS	$	0.06	$	0.04	$	0.04	$	0.02
Diluted EPS	$	0.06	$	0.04	$	0.04	$	0.02

	For the Fiscal Year Ended October 31, 2003
	Quarter Ended
	January 31, 2003		April 30, 2003		July 31, 2003		October 31, 2003
	(in thousands, except per share data)
Net sales	$	15,431	$	11,765	$	12,910	$	12,575
Gross profit		3,919		3,436		3,561		3,402
Operating income		937		637		742		792
Net income		491		313		376		378
Basic EPS	$	0.05	$	0.03	$	0.04	$	0.04
Diluted EPS	$	0.05	$	0.03	$	0.04	$	0.04

F-22

ITEM 9A.  CONTROLS AND PROCEDURES.

          Evaluation of Disclosure Controls and Procedures.  Based on their evaluation as of the end of fiscal year ending October 31, 2005, our principal executive officer and principal financial officer have concluded that our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) are effective to 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 rules and forms.

          On August 24, 2005, we issued a press release regarding our financial results for the third quarter ending July 31, 2005 and the nine months then ending.  On September 16, 2005 we discovered that we had failed to timely file a Form 8-K with the Securities and Exchange Commission disclosing that this release had been issued.  We promptly made the appropriate Form 8-K filing on the same day as the discovery of the error.  We have consulted with legal counsel regarding the appropriate corrective actions to take to ensure that such filings are made on time in the future.  As a result of these discussions, it was determined that a more effective calendaring system with backup was necessary, and it was agreed that the Chief Financial Officer’s assistant, the investor relations coordinator, and our legal counsel would calendar a reminder both just before and just after our scheduled earnings release dates to ensure, to the extent possible, that filings would be made promptly.

          Changes in Internal Controls.  There were no changes in our internal controls over financial reporting during the fourth fiscal quarter of fiscal 2005 that materially affected or are reasonably likely to materially affect our internal control over financial reporting.  There were no significant deficiencies or material weaknesses, and therefore, there were no corrective actions taken.

25

PART III

ITEM 10.  DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

     Information relating to Directors required by this Item is incorporated by reference to the section captioned “Election of Directors” in our Proxy Statement to be filed with the Securities and Exchange Commission (the “Commission”) in connection with our Annual Meeting of Shareholders to be held April 4, 2006.

     Information relating to the Audit Committee of the Board of Directors required by this Item is incorporated by reference to the section captioned “Board of Directors and Committees” under the subsection “Committees” in our Proxy Statement to be filed with the Commission in connection with our Annual Meeting of Shareholders to be held April 4, 2006.

     Information relating to executive officers required by this Item is included in Part I of this Report under the caption “Executive Officers of the Registrant”.

     Other information required by this Item is incorporated by reference to the sections captioned “Section 16(a) Beneficial Ownership Reporting Compliance” and “Corporate Governance—Code of Ethics” in our Proxy Statement to be filed with the Commission in connection with our Annual Meeting of Shareholders to be held April 4, 2006.

ITEM 11.  EXECUTIVE COMPENSATION

     Information required by this Item is incorporated by reference to the sections captioned “Executive Compensation and Related Information,” “Compensation Committee Report” and “Stock Performance Graph,” and to the subsections entitled “Director Compensation” and “Compensation Committee Interlocks and Insider Participation” under the section captioned “Board of Directors and Committees,” in our Proxy Statement to be filed with the Commission in connection with our Annual Meeting of Shareholders to be held April 4, 2006. 

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 section captioned “Market for the Registrant’s Common Stock and Related Stockholder Matters.”

     Other  information required by this Item is incorporated by reference to the section captioned “Security Ownership of Certain Beneficial Owners and Management” in our Proxy Statement to be filed with the Commission in connection with our Annual Meeting of Shareholders to be held April 4, 2006. 

ITEM 13.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

     Information required by this Item is incorporated by reference to the section captioned “Related Transactions” in our Proxy Statement to be filed with the Commission in connection with our Annual Meeting of Shareholders to be held April 4, 2006.

ITEM 14.  PRINCIPAL ACCOUNTING FEES AND SERVICES

     Information required by this Item is incorporated by reference to the section captioned “Independent Public Accountants” under the subheading “Fees and Independence” in our Proxy Statement to be filed with the Commission in connection with our Annual Meeting of Shareholders to be held April 4, 2006.

26

PART IV

ITEM 15.  EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.

(a)	The following documents are filed as a part of this report:
(1)	Financial Statements - See Index to Financial Statements at Page 23 of this Form 10-K.
(2)	Financial Statement Schedule - None.
(3)	Exhibits – The following exhibits are included with this report or incorporated herein by reference:

No.	Description
2.0*	Agreement dated July 8, 2005 between XETA Technologies, Inc., Bluejack Systems, LLC and Greg Forrest
2.1	Asset Purchase Agreement dated August 1, 2004 between XETA Technologies, Inc. and Bluejack Systems, LLC. (incorporated by reference to Exhibit 2.1 to XETA’s Annual Report on Form 10-K for the year ended October 31, 2004).
2.2	Bill of Sale, Assignment and Assumption Agreement dated August 1, 2004 between XETA Technologies, Inc. and Bluejack Systems, LLC. (incorporated by reference to Exhibit 2.2 to XETA’s Annual Report on Form 10-K for the year ended October 31, 2004).
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 (incorporated by reference to Exhibit 3(ii)(a) to XETA’s Quarterly Report on Form 10-Q for the quarter ended April 30, 2001).
10.1†	XETA Technologies, Inc. 2004 Omnibus Stock Incentive Plan (incorporated by reference to Exhibit 10.1 to XETA’s Annual Report on Form 10-K for the year ended October 31, 2004).
10. 2†	Stock Purchase Option dated February 1, 2000 granted to Larry N. Patterson (incorporated by reference to Exhibit 10.9 to XETA’s Quarterly Report on Form 10-Q for the quarter ended April 30, 2000).
10. 3†	XETA Technologies 2000 Stock Option Plan (incorporated by reference to Exhibit 10.11 to XETA’s Quarterly Report on Form 10-Q for the quarter ended April 30, 2000).
10. 4†	Stock Purchase Option dated August 11, 2000 granted to Larry N. Patterson (incorporated by reference to Exhibit 10.14 to XETA’s Annual  Report on Form 10-K for the fiscal year ended October 31, 2000).
10.5	HCX 5000/HCX 5000i® Authorized Distributor Agreement dated January 1, 2004 between Hitachi Telecom (USA), Inc. and XETA Corporation (Incorporated by reference to Exhibit 10 to XETA’s Quarterly Report on Form 10-Q for the quarter ended July 31, 2005).
	PORTIONS OF THIS EXHIBIT HAVE BEEN OMITTED PURSUANT TO A REQUEST FOR CONFIDENTIAL TREATMENT.  SUCH PORTIONS HAVE BEEN FILED SEPARATELY WITH THE COMISSION WITH THE APPLICATION FOR CONFIDENTIAL TREATMENT.
10.6	Nortel Networks Premium Partner U. S. Agreement effective June 25, 2003 between Nortel Networks, Inc. and XETA Technologies, Inc.  (incorporated by reference to Exhibit 10.1 to XETA’s Quarterly Report on Form 10-Q for the quarter ended July 31, 2003).

27

10.7	Avaya Inc. Reseller Master Terms and Conditions effective as of August 6, 2003 between Avaya Inc. and XETA Technologies, Inc., including Reseller Product Group Attachment for Enterprise Communication and Internetworking Solutions Product, Reseller Product Group Attachment: Octel®Products, and Addendum for GSA Schedule Contract Sales to the Federal Government (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	Revolving Credit and Term Loan Agreement dated as of October 1, 2003 between XETA Technologies, Inc. and Bank of Oklahoma, N.A. (“BOK”) (incorporated by reference to Exhibit 10.7 to XETA’s Annual Report on Form 10-K for the fiscal year ended October 31, 2003).
10.9	Mortgage, Assignment of Leases and Rents, Security Agreement and Financing Statement dated October 1, 2003 granted to BOK (incorporated by reference to Exhibit 10.8 to XETA’s Annual Report on Form 10-K for the fiscal year ended October 31, 2003).
10.10	Promissory Note ($2,238,333.48 payable to BOK) dated October 1, 2003(incorporated by reference to Exhibit 10.9 to XETA’s Annual Report on Form 10-K for the fiscal year ended October 31, 2003).
10.11	Promissory Note ($3,374,734.33 payable to BOK) dated October 1, 2003 (incorporated by reference to Exhibit 10.11 to XETA’s Annual Report on Form 10-K for the fiscal year ended October 31, 2003).
10.12*	Promissory Note ($7,500,000 payable to BOK) dated September 30, 2005.
10.13*	Second Amendment to Revolving Credit and Term Loan Agreement dated September 30, 2005 between Xeta Technologies, Inc. and Bank of Oklahoma, N.A.
10.14	Security Agreement dated October 1, 2003 granted to BOK  (incorporated by reference to Exhibit 10.12 to XETA’s Annual Report on Form 10-K for the fiscal year ended October 31, 2003).
21*	Subsidiaries of XETA Technologies, Inc.
23.1*	Consent of Tullius, Taylor, Sartain & Sartain LLP.
23.2*	Consent of Grant Thornton 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.

*  Indicates Exhibits filed with this Report.

†  Indicates management contract or compensatory plan or arrangement.

(b)	We filed the following Reports on Form 8-K during the last quarter of the fiscal year covered by this report:
	1.  August 24, 2005—Item 2.02—Earnings Release for 3rd Quarter.
	2.  November 2, 2005—Item 8.01—Nortel “Elite Advantage Partner” Status Achieved.
	3,  November 30, 2005—Item 2.02—Earnings Release for 4th Quarter.

28

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.
December 29, 2005	By:	/s/  Jack R. Ingram
		Jack R. Ingram, 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.

December 29, 2005	/s/  Jack R. Ingram
	Jack R. Ingram, Chief Executive Officer, and Director
December 29, 2005	/s/  Greg D. Forrest
	Greg Forrest, President, and Chief Operating Officer
December 29, 2005	/s/  Robert B. Wagner
	Robert B. Wagner, Chief Financial Officer
December 29, 2005	/s/  Donald T. Duke
	Donald T. Duke, Director
December 29, 2005	/s/  Ronald L. Siegenthaler
	Ronald L. Siegenthaler, Director

29

INDEX TO EXHIBITS

No.	Description
2.0*	Agreement dated July 8, 2005 between XETA Technologies, Inc., Bluejack Systems, LLC and Greg Forrest.
2.1	Asset Purchase Agreement dated August 1, 2004 between XETA Technologies, Inc. and Bluejack Systems, LLC (incorporated by reference to Exhibit 2.1 to XETA’s Annual Report on Form 10-K for the year ended October 31, 2004).
2.2	Bill of Sale, Assignment and Assumption Agreement dated August 1, 2004 between XETA Technologies, Inc. and Bluejack Systems, LLC (incorporated by reference to Exhibit 2.2 to XETA’s Annual Report on Form 10-K for the year ended October 31, 2004).
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 (incorporated by reference to Exhibit 3(ii)(a) to XETA’s Quarterly Report on Form 10-Q for the quarter ended April 30, 2001).
10.1†	XETA Technologies, Inc. 2004 Omnibus Stock Incentive Plan (incorporated by reference to Exhibit 10.1 to XETA’s Annual Report on Form 10-K for the year ended October 31, 2004).
10. 2†	Stock Purchase Option dated February 1, 2000 granted to Larry N. Patterson (incorporated by reference to Exhibit 10.9 to XETA’s Quarterly Report on Form 10-Q for the quarter ended April 30, 2000).
10. 3†	XETA Technologies 2000 Stock Option Plan (incorporated by reference to Exhibit 10.11 to XETA’s Quarterly Report on Form 10-Q for the quarter ended April 30, 2000).
10. 4†	Stock Purchase Option dated August 11, 2000 granted to Larry N. Patterson (incorporated by reference to Exhibit 10.14 to XETA’s Annual  Report on Form 10-K for the fiscal year ended October 31, 2000).
10.5	HCX 5000/HCX 5000i® Authorized Distributor Agreement dated January 1, 2004 between Hitachi Telecom (USA), Inc. and XETA Technologies (incorporated by reference to Exhibit 10 to XETA’s Quarterly Report on Form 10-Q for the quarter ended July 31, 2005).
	PORTIONS OF THIS EXHIBIT HAVE BEEN OMITTED PURSUANT TO A REQUEST FOR CONFIDENTIAL TREATMENT.  SUCH PORTIONS HAVE BEEN FILED SEPARATELY WITH THE COMISSION WITH THE APPLICATION FOR CONFIDENTIAL TREATMENT.
10.6	Nortel Networks Premium Partner U. S. Agreement effective June 25, 2003 between Nortel Networks, Inc. and XETA Technologies, Inc.  (incorporated by reference to Exhibit 10.1 to XETA’s Quarterly Report on Form 10-Q for the quarter ended July 31, 2003).
10.7	Avaya Inc. Reseller Master Terms and Conditions effective as of August 6, 2003 between Avaya Inc. and XETA Technologies, Inc., including Reseller Product Group Attachment for Enterprise Communication and Internetworking Solutions Product, Reseller Product Group Attachment: Octel®Products, and Addendum for GSA Schedule Contract Sales to the Federal Government (incorporated by reference to Exhibit 10.6 to XETA’s Annual Report on Form 10-K for the fiscal year ended October 31, 2003).

30

10.8	Revolving Credit and Term Loan Agreement dated as of October 1, 2003 between XETA Technologies, Inc. and Bank of Oklahoma, N.A. (“BOK”) (incorporated by reference to Exhibit 10.7 to XETA’s Annual Report on Form 10-K for the fiscal year ended October 31, 2003).
10.9	Mortgage, Assignment of Leases and Rents, Security Agreement and Financing Statement dated October 1, 2003 granted to BOK (incorporated by reference to Exhibit 10.8 to XETA’s Annual Report on Form 10-K for the fiscal year ended October 31, 2003).
10.10	Promissory Note ($2,238,333.48 payable to BOK) dated October 1, 2003(incorporated by reference to Exhibit 10.9 to XETA’s Annual Report on Form 10-K for the fiscal year ended October 31, 2003).
10.11	Promissory Note ($3,374,734.33 payable to BOK) dated October 1, 2003 (incorporated by reference to Exhibit 10.11 to XETA’s Annual Report on Form 10-K for the fiscal year ended October 31, 2003).
10.12*	Promissory Note ($7,500,000 payable to BOK) dated September 30, 2005.
10.13*	Second Amendment to Revolving Credit and Term Loan Agreement dated September 30, 2005 between Xeta Technologies, Inc. and Bank of Oklahoma, N.A.
10.14	Security Agreement dated October 1, 2003 granted to BOK  (incorporated by reference to Exhibit 10.12 to XETA’s Annual Report on Form 10-K for the fiscal year ended October 31, 2003).
21*	Subsidiaries of XETA Technologies, Inc.
23.1*	Consent of Tullius, Taylor, Sartain & Sartain LLP.
23.2*	Consent of Grant Thornton 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.

*  Filed herewith.

†  Indicates management contract or compensatory plan or arrangement.

31

EX-2.0

Exhibit 2.0

AGREEMENT

          THIS AGREEMENT (this “Agreement”) is entered into as of the 8th day of July, 2005, by and among XETA TECHNOLOGIES, INC., an Oklahoma corporation (“XETA”), BLUEJACK SYSTEMS, L.L.C., a Washington limited liability company (“Bluejack”), and GREG FORREST (“Forrest”).

Recitals:

          A.          XETA, Bluejack and Forrest are parties to an Asset Purchase Agreement dated effective as of August 1, 2004 (“Purchase Agreement”).

          B.          Capitalized terms used and not otherwise defined herein have the meanings assigned to them in the Purchase Agreement.

          C.          Pursuant to the Purchase Agreement, Bluejack is entitled to receive, in addition to the Cash Portion of the Purchase Price received at Closing, a five-year Earnout (as more particularly described in the Purchase Agreement).

          D.          Bluejack and Forrest are willing to relinquish the right to payment of the Earnout (and any portion thereof) in consideration of XETA’s agreement to the terms of this Agreement.

Terms and Conditions

          In consideration of the foregoing premises, and for other good and valuable consideration the receipt and sufficiency of which are hereby acknowledged, the parties hereby agree as follows:

          1.          Bluejack and Forrest agree to relinquish all right to payment of the Earnout.

          2.          XETA agrees to pay to Bluejack the sum of Fifty Thousand ($50,000) dollars and to issue to Bluejack One Hundred Thousand (100,000) shares of restricted common stock of XETA (the “Restricted Shares”), which shares shall be restricted against transfer and may not be sold, pledged or otherwise transferred by Bluejack during the restriction period (the “Restricted Period”), which shall be as follows:

                       50,000 of the Restricted Shares will be restricted until the 2^nd anniversary of the Issue Date;

                       25,000 of the Restricted Shares will be restricted until the 3^rd anniversary of the Issue Date;

                       25,000 of the Restricted Shares will be restricted until the 4^th anniversary of the Issue Date.

          3.          Bluejack acknowledges and understands that (i) the Restricted Shares are also “restricted securities” as that term is defined under Rule 144 of the Securities Act of 1933, as amended, and that as a result thereof, Bluejack cannot sell, transfer or otherwise distribute the Restricted Shares after expiration of the Restricted Period unless an exemption from registration is available, or unless the Restricted Shares are registered which XETA currently has no plans to do and is not obligated to do; and (ii) the restricted nature of the Restricted Shares will be noted on the books of XETA and on any certificate issued to Bluejack representing the Restricted Shares.  Bluejack represents and warrants to XETA that (i) it is acquiring the Restricted Shares for investment purposes only and not with a view to or for the resale or distribution thereof;   (ii) it has no need for liquidity in the Restricted Shares and is able to bear the economic risks of this investment for an indefinite period of time; and (iii) in making the decision to accept the Restricted Shares hereunder, Bluejack has (x) made such independent investigation of XETA as it has deemed necessary; (y) had access to and received and reviewed all information it has deemed relevant to its investment decision (including without limitation, annual, quarterly and other reports filed by XETA with the Securities and Exchange Commission and press releases issued by XETA); and (z) had the opportunity to ask questions of and receive answers from XETA officers and management. 

          4.          Bluejack and Forrest hereby (a) release and discharge XETA, and its present and former employees, affiliates, directors, officers, representatives, agents, shareholders, successors and assigns (“Releasees”) from any and all claims, charges, demands, rights, liabilities and causes of action of any kind, whether now existing or hereafter arising, matured or unmatured, liquidated or unliquidated, absolute or contingent, with respect to, or arising out of, the Purchase Agreement, (b) release and waive any claim and/or right to demand or receive further consideration or payment of any kind from XETA or any Releasee in connection with or pursuant to the Purchase Agreement; and (c) agree not to file or pursue any claim, charge or proceeding of any kind in any agency or court against XETA or any Releasee with respect to any matter concerning the Purchase Agreement. 

          5.          XETA hereby releases and discharges Bluejack and Forrest from any and all claims, charges, demands, rights, liabilities and causes of action of any kind, whether now existing or hereafter arising with respect to, or arising out of, the Purchase Agreement; provided, however, that this paragraph shall exclude and shall not be deemed to release, impair or limit the obligations of Forrest to XETA arising under or in connection with the Non-Competition Agreement dated August 1, 2004, entered into by them in connection with the Purchase Agreement, or XETA’s rights and remedies thereunder.  

          6.          This Agreement shall be governed by the laws of the State of Oklahoma applicable to contracts made and wholly performed therein. 

          IN WITNESS WHEREOF, the undersigned have duly executed and delivered this Agreement as of the day and year first written above.

XETA TECHNOLOGIES, INC.,		BLUEJACK SYSTEMS, L.L.C.,
an Oklahoma corporation		a Washington limited liability company
By	/s/ Jack R. Ingram	By	/s/ Greg Forrest
	Jack R. Ingram, Chairman		Greg Forrest, Sole Member
	and Chief Executive Officer
			/s/ Greg Forrest
			Greg Forrest, individually

2

EX-10.12

Exhibit 10.12

PROMISSORY NOTE

$7,500,000	September 30, 2005
	Tulsa, Oklahoma

          FOR VALUE RECEIVED, the undersigned, XETA TECHNOLOGIES, INC., an Oklahoma corporation (“Maker”), promises to pay to the order of BANK OF OKLAHOMA, N.A. (“Lender”), at its offices in Tulsa, Oklahoma, the principal sum of Seven Million Five Hundred Thousand and No/100 Dollars ($7,500,000) or, if less, the aggregate sum of advances made by Lender to Maker under the Revolving Credit and Term Loan Agreement dated October 1, 2003 (as amended, the “Credit Agreement”) between Maker and Lender, payable as follows (all capitalized terms used but not defined herein shall have the meanings given in the Credit Agreement):

a.	Principal. Principal shall be payable on September 28, 2006.
b.	Interest. Interest shall be payable on the first day of each month, commencing the 1st day of October, 2005, and at maturity. Interest shall accrue on the principal balance outstanding hereunder and on any past due interest hereunder at a rate at all times equal to the Note Rate (defined below).

          “Note Rate” shall mean a rate at all times equal to the Adjusted Prime Rate or the Adjusted LIBOR Rate, as elected by Maker pursuant to a properly made Interest Rate Election (defined below); provided, that at the end of any applicable Interest Period (defined below), the Note Rate shall revert to the Adjusted Prime Rate unless a new Interest Rate Election has been properly made by Maker. The Adjusted Prime Rate and the Adjusted LIBOR Rate shall be calculated, on any date of determination thereof, as follows:

Funded Debt to Cash Flow	Adjusted LIBOR Rate	Adjusted Prime Rate
Greater than or equal to 2.50 to 1	LIBOR Rate plus 2.50%	Prime Rate minus .375%
Greater than or equal to 2.0 to 1 but less than 2.5 to 1	LIBOR Rate plus 2.00%	Prime Rate minus .375%
Greater than or equal to 1.50 to 1 but less than 2.0 to 1	LIBOR Rate plus 1.75%	Prime Rate minus .875%
Greater than or equal to 1.0 to 1 but less than 1.5 to 1	LIBOR Rate plus 1.50%	Prime Rate minus 1.125%
Less than 1.0 to 1	LIBOR Rate plus 1.25%	Prime Rate minus 1.125%

The Adjusted LIBOR Rate and Adjusted Prime Rate shall be recalculated on not less than a quarterly basis, on the date on which the Lender is in receipt of Maker’s most recent financial statements (and, in the case of the year-end financial statements, audit report) for the fiscal quarter then ended (“Pricing Date”). From the date of this Agreement to the first recalculation, the Adjusted LIBOR Rate shall be set at the LIBOR Rate plus 2.00 percent (2.00%), and the Adjusted Prime Rate shall be set at the Prime Rate minus .375 percent (-.375%). The Note Rate shall be established based on the ratio of Funded Debt to Cash Flow for the most recently completed fiscal quarter and the Note Rate established on a Pricing Date shall remain in effect until the next Pricing Date.

If the Maker has not delivered its financial statements by the date such financial statements (and, in the case of the year-end financial statements, audit report) are required to be delivered under the Credit Agreement, until such financial statements and audit report are delivered, the Note Rate shall be the Prime Rate minus three hundred seventy-five thousandths of one percent (0.375%). If the Maker subsequently delivers such financial statements before the next Pricing Date, the Note Rate established by such late delivered financial statements shall take effect from the date of delivery until the next Pricing Date, In all other circumstances, the Note Rate established by such financial statements shall be in effect from the Pricing Date that occurs immediately after the end of the fiscal quarter covered by such financial statements until the next Pricing Date. Each determination of the Note Rate made by the Lender in accordance with the foregoing shall be conclusive and binding on the Maker and the Lender if reasonably determined. Any change in the Note Rate resulting from a change in the Prime Rate shall be effective as of the opening of business on the day on which such change in the Prime Rate becomes effective.

          “Funded Debt” (for purposes of this Note) shall mean all interest bearing debt.

          “Cash Flow” (for purposes of this Note) shall mean EBITDA less Cash Taxes.

          “Interest Rate Election” means written notice from Maker to Lender no earlier than twenty (20) days and no later than five (5) days prior to the contemplated effective date, substantially in form and content as set forth on Exhibit “A” hereto, whereby Maker may elect from time to time that interest shall accrue hereunder at the Adjusted Prime Rate or the Adjusted LIBOR Rate.

          “LIBOR Rate” means the London Interbank Offered Rate composite rate per annum for U.S. Dollars for the applicable Interest Period which appears on the LIBOR 01 page of the Reuters information service on the day the Interest Rate Election is received by Lender.  The LIBOR Rate shall remain fixed during the applicable Interest Period.

          “Interest Period” shall mean a period of time equal to the lesser of: (i) at the election of the Maker, thirty (30), sixty (60), or ninety (90) days; or (ii) the number of days between the contemplated effective date specified by the Maker in the applicable Interest Rate Election and the maturity date hereunder.

          “Prime Rate” shall mean a fluctuating interest rate per annum as in effect from time to time, which interest rate per annum shall at all times be equal to the rate of interest announced publicly from time to time (whether or not charged in each instance), by JP Morgan Chase Bank, at New York, New York (“Rate Bank”), as its base rate or general reference rate. Each change in the Prime Rate (or any component thereof) shall become effective hereunder without notice to Maker (which notice is hereby expressly waived by Maker), on the effective date of each such change. Should the Rate Bank abolish or abandon the practice of announcing or publishing a Prime Rate, then the Prime Rate used during the remaining term of this Note shall be that interest rate or other general reference rate then in effect at the Rate Bank which, from time to time, in the reasonable judgment of Bank, most effectively approximates the initial definition of the “Prime Rate.” Maker acknowledges that Lender may, from time to time, extend credit to other borrowers at rates of interest varying from, and having no relationship to, the Prime Rate. The rate of interest payable upon the indebtedness evidenced by this Note shall not, however, at any time exceed the maximum rate of interest permitted under the laws of the State of Oklahoma for loans of the type and character evidenced by this Note.

          If any payment shall be due on a Saturday or Sunday or upon any other day on which state or national banks in the State of Oklahoma are closed for business by virtue of a legal holiday for such banks, such payment shall be due and payable on the next succeeding banking day and interest shall accrue to such day. All interest due hereon shall be computed on the actual number of days elapsed (365 or 366) based upon a 360-day year.

          All payments under this Note shall be made in legal tender of the United States of America or in other immediately available funds at Lender’s office described above, and no credit shall be given for any payment received by check, draft or other instrument or item until such time as the holder hereof shall have received credit therefor from the holder’s collecting agent or, in the event no collecting agent is used, from the bank or other financial institution upon which said check, draft or other instrument or item is drawn.

          From time to time the maturity date of this Note may be extended or this Note may be renewed, in whole or in part, or a new note of different form may be substituted for this Note and/or the rate of interest may be changed, or changes may be made in consideration of loan extensions, and the holder, from time to time, may waive or surrender, either in whole or in part, any rights, guarantees,  security interests or liens given for the benefit of the holder in connection herewith; but no such occurrences shall in any manner affect, limit, modify or otherwise impair any rights, guarantees or security of the holder not specifically waived, released or surrendered in writing, nor shall any maker, guarantor, endorser or any person who is or might be liable hereon, either primarily or contingently, be released from such liability by reason of the occurrence of any such event. The holder hereof, from time to time, shall have the unlimited right to release any person who might be liable hereon; and such release shall not affect or discharge the liability of any other person who is or might be liable hereon.

          If any payment required by this Note to be made is not made when due, or if any default occurs  under any loan agreement or under the provisions of any mortgage, security agreement, assignment, pledge or other document or agreement which provides security for the indebtedness evidenced by this Note, the holder hereof may, at its option, without notice or demand, declare this Note in default and all indebtedness due and owing hereunder immediately due and payable. Interest from the date of default on such principal balance and on any past due interest hereunder shall accrue at the rate of five percent (5%) per annum above the nondefault interest rate accruing hereunder. The Maker and any endorsers, guarantors and sureties hereby severally waive protest, presentment, demand, and notice of protest and nonpayment in case this Note or any payment due hereunder is not paid when due; and they agree to any renewal, extension, acceleration, postponement of the time of payment, substitution, exchange or release of collateral and to the release of any party or person primarily or contingently liable without prejudice to the holder and without notice to the Maker or any endorser, guarantor or surety. Maker and any guarantor, endorser, surety or any other person who is or may become liable hereon will, on demand, pay all costs of collection, including reasonable attorney fees of the holder hereof in attempting to enforce payment of this Note and reasonable attorney fees for defending the validity of any document securing this Note as a valid first and prior lien.

          Upon the occurrence of any default hereunder, Lender shall have the right, immediately and without further action by it, to set off against this Note all money owed by Lender in any capacity to the Maker or any guarantor, endorser or other person who is or might be liable for payment hereof, whether or not due, and also to set off against all other liabilities of Maker to Lender all money owed by Lender in any capacity to Maker; and Lender shall be deemed to have exercised such right of setoff and to have made a charge against such money immediately upon the occurrence of such default even though such charge is made or entered into the books of Lender subsequently thereto.

          The holder of this Note may collect a late charge not to exceed an amount equal to five percent (5%) of the amount of any payment which is not paid within ten (10) days from the due date thereof, for the purposes of covering the extra expenses involved in handling delinquent payments. This late charge provision shall not be applicable in the event the holder hereof, at its option, elects to receive interest at the increased rate as provided hereunder in the event of default.

          This Note is given for an actual loan of money for business purposes and not for personal, agricultural or residential purposes, and is executed and delivered in the State of Oklahoma and shall be governed by and construed in accordance with the laws of the State of Oklahoma.

          This Note constitutes an extension and renewal of the $7,500,000 Revolving Line Note dated June 7, 2004, from Maker to Lender.

XETA TECHNOLOGIES, INC.
By	/s/ Robert B. Wagner
	Robert B. Wagner, Chief Financial Officer

EXHIBIT “A”

(Interest Rate Election Notice)

Bank of Oklahoma, N.A.
P.O. Box 2300
Tulsa, Oklahoma 74192-2300
Attn:     Mr. Stephen R. Wright, Senior Vice President

Re: Revolving Credit and Term Loan Agreement (“Loan Agreement”) dated October 1, 2003, between XETA TECHNOLOGIES, INC. (“Borrowers”) and BANK OF OKLAHOMA, N.A. — Interest Rate Election

Ladies and Gentlemen:

          Please be advised that no Initial Default or Matured Default exists under the Loan Agreement, and the Borrower hereby provides the following interest rate election:

          A.          Revolving Line. (Insert applicable information as to the (i) Adjusted Prime Rate or (ii) Adjusted LIBOR Rate, including requested interest rate period) 30-day LIBOR

          B.          Term Loan. (Insert applicable information as to the (i) Adjusted Prime Rate or (ii) Adjusted LIBOR Rate, including requested interest rate period) 30-day LIBOR

          C.          Real Estate Loan. (Insert applicable information as to the (i) Adjusted Prime Rate or (ii) Adjusted LIBOR Rate, including requested interest rate period) 30-day LIBOR

	“Borrower”
	XETA TECHNOLOGIES, INC., an Oklahoma corporation
	By	/s/ Robert B. Wagner
		Robert B. Wagner, Chief Financial Officer
Date Received by Bank of Oklahoma: __________________________

EX-10.13

Exhibit 10.13

SECOND AMENDMENT TO REVOLVING CREDIT
AND TERM LOAN AGREEMENT

          This Second Amendment to Revolving Credit and Term Loan Agreement is dated as of September 30, 2005, between XETA TECHNOLOGIES, INC., an Oklahoma corporation (“Borrower”), and BANK OF OKLAHOMA, N.A (“Bank”).

RECITALS

          A.          Reference is made to the Revolving Credit and Term Loan Agreement dated as of October 1, 2003 and amended June 7, 2004 (as amended “Credit Agreement”) between Borrower and Bank, pursuant to which currently exists: (i) a term loan in the amount of $3,374,734.33, with a current outstanding principal balance of $1,125,507.76 (“Term Loan”), (ii) a real estate loan in the amount of $2,238,333.48, with a current outstanding principal balance of $1,896,677.26 (“Real Estate Loan”), and (iii) a revolving line of credit in the amount of $7,500,000 (“Revolving Line”). Terms used herein shall have the meanings ascribed them in the Credit Agreement unless otherwise defined herein.

          B.          Borrower has requested that Bank extend the commitment of the Revolving Line to September 28, 2006; and Bank has agreed to accommodate such request, subject to the terms and conditions set forth below.

AGREEMENT

          For valuable consideration received, it is agreed as follows:

          1.          AMENDMENTS TO THE CREDIT AGREEMENT. The Credit Agreement is hereby amended as follows:

            1.1.         Section 1.18 (Debt Service Coverage Ratio) is hereby amended to evidence that the term “EBITDA” is hereby deleted and replaced with the term “EBIDA”.

            1.2.          A new Section 1.20(a) is hereby added, as follows:

                           “1.20(a) ‘EBIDA’ shall mean net income plus (i) interest expense, (ii) depreciation, depletion, obsolescence, amortization of property, and tax amortization of goodwill (tax effected), (iii) capitalized lease expense, all determined in accordance with generally accepted accounting principles, consistently applied, and for a particular period, except for the tax amortization of goodwill which shall be determined in accordance with Internal Revenue Service regulations and presented on the Company’s previously filed federal tax return.”

            1.3.         Section 1.20 (EBITDA) is hereby deleted and replaced with the following:

                           “1.20(b) EBITDA’ shall mean EBIDA plus tax expense determined in accordance with generally accepted accounting principles, consistently applied, and for a particular period.”

            1.4.         The Revolving Line Note, attached to the Credit Agreement as Schedule “1.49” is hereby replaced by the $7,500,000 Promissory Note in form and content as set forth on Schedule “1.1” attached hereto (“Renewal Note”).

            1.5.         Section 1.53 (Termination Date) is hereby amended to reflect that the date “September 28, 2005” shall now mean and read “September 28, 2006”.

            1.6.         Section 6.8.2 (Annual Financial Statements) is hereby deleted and replaced with the following:

                           “6.8.2. Annual Financial Statements. As soon as available and in any event within (a) ninety (90) days after the end of each fiscal year of Borrower, commencing with the fiscal year ending October 31, 2005, a copy of its Form 10K that has been or will be filed with the Securities and Exchange Commission, and (b) as soon as available and in any event within one hundred twenty (120) days of year end, a copy of Borrower’s federal tax returns (including all schedules and K-1s).”

2.          CONDITIONS PRECEDENT. Borrower shall deliver to Bank at or before closing:

            2.1.         This Amendment and all schedules hereto;

            2.2.         the Renewal Note; and

            2.3.         Any other instruments, documents or agreements reasonably requested by Bank in connection herewith.

          3.          Borrower Ratification. Borrower hereby ratifies and confirms the Credit Agreement, Security Agreement and all other instruments, documents and agreements executed by Borrower in connection with the Credit Agreement, and acknowledges and agrees that they remain in full force and effect, binding and enforceable against the Borrower in accordance with their terms.

          4.          Representations. Borrower represents and warrants that (i) no Event of Default exists under the Credit Agreement or any instruments, documents or agreements executed by Borrower in connection therewith (collectively, the “Loan Documents”), and (ii) all representations and warranties made in the Loan Documents remain true and correct as of the date hereof. Borrower further represents and warrants that all authority documents delivered to Bank in connection with the Credit Agreement remain in full force and effect and have not been modified or changed whatsoever.

          5.          Governing Law and Binding Effect. This document shall be governed by and construed in accordance with the laws of the State of Oklahoma, and shall inure to the benefit of and be binding upon the parties hereto, their successors and assigns.

          6.          USA Patriot Act Notification. IMPORTANT INFORMATION ABOUT PROCEDURES FOR OPENING A NEW ACCOUNT. To help the government fight the funding of terrorism and money laundering activities, Federal law requires all financial institutions to obtain, verify, and record information that identifies each person or entity that opens an account, including any deposit account, treasury management account, loan, other extension of credit, or other financial services product. What this means for Borrower: When Borrower opens an account, if Borrower is an individual, Lender will ask for Borrower’s name, taxpayer identification number, residential address, date of birth, and other information that will allow Lender to identify Borrower, and, if Borrower is not an individual, Lender will ask for Borrower’s name, taxpayer identification number, business address, and other information that will allow Lender to identify Borrower. Lender may also ask, if Borrower is an individual, to see Borrower’s driver’s license or other identifying documents, and, if Borrower is not an individual, to see Borrower’s legal organizational documents or other identifying documents.

          7.          No Change. Except as expressly amended hereby, the Credit Agreement, and all instruments, documents and agreements executed and/or delivered by Borrower to Bank in connection therewith, shall remain in full force and effect and unchanged.

          8.           Costs, Expenses and Fees. Borrower agrees to pay all costs, expenses and fees incurred by Bank or otherwise in connection herewith, including, without limitation, all reasonable attorney fees, costs and expenses of Riggs, Abney, Neal, Turpen, Orbison & Lewis.

          9.            Multiple Counterparts. This Amendment may be executed in multiple counterparts.

          IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be executed by their respective officers thereunto duly authorized, as of the date first above written.

“Borrower”
XETA TECHNOLOGIES, INC.
By	/s/ Robert B. Wagner
	Robert B. Wagner, Chief Financial Officer
“Bank”
BANK OF OKLAHOMA, NA
By	/s/ Stephen R. Wright
	Stephen R. Wright, Senior Vice President

EX-21

EXHIBIT 21

Subsidiaries of the Company

XETAPLAN, Inc., an Oklahoma corporation

EX-23.1

Exhibit 23.1

Consent of Independent Registered Public Accounting Firm

We consent to the incorporation by reference in Registration Statements No. 33-62173, 333-44544 and 333-116745 on Form S-8 of Xeta Technologies, Inc. of our report dated December 16, 2005 relating to our audit of the consolidated financial statements, which appear in the Annual Report on Form 10-K of Xeta Technologies, Inc. for the year ended October 31, 2005.

/s/ TULLIUS TAYLOR SARTAIN & SARTAIN LLP

Tulsa, Oklahoma

December 29, 2005

EX-23.2

Exhibit 23.2

CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

We have issued our report dated December 10, 2004 on the consolidated balance sheet of XETA Technologies, Inc. as of October 31, 2004, and the related consolidated statements of operations, shareholders’ equity and cash flows for each of the two years in the period ended October 31, 2004, accompanying the consolidated financial statements included in the Annual Report of Xeta Technologies, Inc. on Form 10-K for the year ended October 31, 2005. We hereby consent to the incorporation by reference of said report in the Registration Statements of  Xeta Technologies, Inc. on Forms S-8 (File No. 033-62173, File No. 333-44544, and File No. 333-116745).

/s/ GRANT THORNTON LLP

Oklahoma City, Oklahoma

December 29, 2005

EX-31.1

Exhibit 31.1

PRINCIPAL EXECUTIVE OFFICER CERTIFICATION
Under Rule 13a-14 (a) / 15d-14 (a)

I, Jack R. Ingram, certify that:

1.          I have reviewed this annual report on Form 10-K of XETA Technologies, Inc;

2.          Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;

3.          Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;

4.          The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and we have:

a)          designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;

b)          evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

c)          disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s fourth fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5.          The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent functions):

a)          all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

b)          any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Dated:  December 22, 2005

/s/ Jack R. Ingram

Jack R. Ingram

Chief Executive Officer

EX-31.2

Exhibit 31.2

PRINCIPAL FINANCIAL OFFICER CERTIFICATION
Under Rule 13a-14 (a) / 15d-14 (a)

I, Robert B. Wagner, certify that:

1.          I have reviewed this annual report on Form 10-K of XETA Technologies, Inc;

2.          Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;

3.          Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;

4.          The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and we have:

(a)          designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;

(b)          evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

(c)          disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s fourth fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting.

5.          The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent function):

(a)          all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

(b)          any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Dated:  December 22, 2005

/s/ Robert B. Wagner

Robert B. Wagner

Chief Financial Officer

EX-32.1

Exhibit 32.1

CERTIFICATION PURSUANT TO
18 U.S.C. Section 1350
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with the Annual Report of XETA Technologies, Inc. (the “Company”) on Form 10-K for the fiscal year ended October 31, 2005, as filed with the Securities and Exchange Commission (the “Report”), I, Jack R. Ingram, Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:

(1)	The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and
(2)	The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

/s/ Jack R. Ingram

Jack R. Ingram

Chief Executive Officer

December 22, 2005

EX-32.2

Exhibit 32.2

CERTIFICATION PURSUANT TO
18 U.S.C. Section 1350
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with the Annual Report of XETA Technologies, Inc. (the “Company”) on Form 10-K for the fiscal year ended October 31, 2005, as filed with the Securities and Exchange Commission (the “Report”), I, Robert B. Wagner, Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:

(1)	The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and
(2)	The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

/s/ Robert B. Wagner

Robert B. Wagner

Chief Financial Officer

December 22, 2005