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 7, 20096, 2010 are incorporated by reference into Part III, Items 10 through 14 hereof.

CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

This report contains forward-looking statements relating to future events and our future performance and results.  Many of these statements appear in the discussions under the headings “Business,” “Risk Factors,” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” All statements other than those that are purely historical may be forward-looking statements.  Forward-looking statements can generally be identified by words such as “expects,” “anticipates,” “may”, “plans,” “believes,” “intends,” “projects,” “estimates,” and similar words or expressions. Forward-looking statements are not guarantees of performance, but rather reflect our current expectations, estimates, and forecasts about the industry and markets in which we operate, and our assumptions and beliefs based upon information currently available to us.  These statements are subject to risks and uncertainties which are difficult to predict or which we are unable to control, including but not limited to such factors as the condition of the U.S. economic crisiseconomy and its impact on capital spending trends in our markets, the financial condition of our suppliers and changes by them in their distribution strategies and support, our ability to maintain and improve upon current gross profit margins,Nortel’s bankruptcy proceedings, unpredictable revenue levels from quarter to quarter, inconsistent gross profit margins, continuing acceptance and success of the Mitel product and services offering, availability of credit to finance growth, intense competition and industry consolidation, dependence upon a few large wholesale customers in our Managed Services offering, the availability and retention of revenue professionals and certified technicians, and other risks and uncertainties specifically discussed under the heading “Risk Factors” under Part I of this report.  As a result of these risks and uncertainties, actual results may differ materially and adversely from those expressed in forward-looking statements.  Consequently, investors are cautioned to read and consider all forward-looking statements in conjunction with such risk factors and uncertainties.  The Private Securities Litigation Reform Act of 1995 provides a safe-harbor for forward-looking statements made by the Company.

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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 integrator of advanced cutting edge communications technologies.  Our offerings includetechnologies with nationwide sales and service.  XETA provides sales, design, project management, implementation, and maintenance services in support of the products it represents.  The Company sells products produced by several manufacturers including Avaya, Inc. (“Avaya”), Nortel Networks Corporation (“Nortel”), Mitel Corporation (“Mitel”), and Samsung Business Communications Systems (“Samsung”).  In addition, the Company manufactures and markets a comprehensive arrayline of leading edgeproprietary call accounting systems to the hospitality industry.

We market our products and services.  Our market focus includes enterprise-class communications solutions and managed services with particular emphasis on converged communications.  We specialize in assisting our customers as they transition from traditional voice telephony to Internet Protocol (“IP”) telephony and application based communication platforms also referred to as “converged communications”.  Our goal is to reduce our customer’s total communications costs and enable them to serve their customers more efficiently through utilization of an array of advanced communications solutions.  These solutions include contact centers, message management systems, unified communications and integrated multi-media applications.

Our market targets include a variety of companies such as enterprise-class multi-location, mid market and large companies located throughout the United States.  We also market our solutions and services to several vertical markets such as the hospitality, industry, education, the Federal government, and healthcare.

We providedeliver services through our nationwide network of Company-employed design engineers, and service technicians and qualified third party service providers.  Our service delivery is coordinated in our 24-hour, 7-days-per-week contact center, which operates 24-hours per day, 7-days-per-week and is located at our headquarters in Broken Arrow, Oklahoma.

In fiscal 2008, we continued Our contact center and national technical footprint are well-suited to focus on three primary strategies:  acquire, penetrate, and retain targeted customers; expand our wholesale service offerings; and improve alignment with our major business partners.

Our sales efforts targetaddress the communication needs of large, multi-location, national, or super-regional customers.  Our national technical footprint and 24/7/365 contact center are complimentary to the communication needs of these customers.  Additionally, these larger

Large enterprises often have a mixturecombination of manufacturer platforms withinin their communications equipment portfolio andportfolios.  As such our ability to sell and service boththree of the Avaya and Nortel product linesleading communication platforms is an important competitive advantage.  Because of our extensive array of products and services, we enjoy multiple sales opportunities with these customers, includingcustomers.  These include new product sales,equipment installations, implementation of advanced applications, and a varietyvarious service relationships.

An important element of potential service relationships.  Once we establish a relationship with a customer, weour sales strategy is to continually search for opportunities to penetrate deeper into the account by assessing theexpand business relationships with current customers. Our sales teams continually monitor and assess our customer’s communications needs, proposing appropriate technologies to address those needs, establishing or expanding the service relationship, and proposing equipment and service solutions to other divisions or subsidiaries.

We launchedUnder our wholesale service offering in fiscal 2006 and its success has been a key contributor to our growth in recurring revenue.  Under this serviceservices offering, we collaborate with manufacturers, network service providers and systems integrators to provide services to their end-user customers.  In many instances, we provide field resources to carry out on-site service responsibilities.  However, underactivities.  Under a full outsourcing arrangement we may provide a broader range of services.  These services includinginclude call center support, remote technical support, on-site labor and spare parts.  Our entry into the wholesale services marketbusiness initiative has succeeded because we provide excellent service to end-user customers, and our willingnessare willing to create and execute flexible service programs and billing arrangements.  The continued success of this strategicour wholesale services initiative is a vital ingredient tocomponent of our long-term goal of shifting our revenue mix toward more recurring services revenues.

Finally,In April, 2009, we signed a three year services collaboration and dealer agreement with Samsung.  Under the agreement, our professional services team supports Samsung’s North American channel partners and customers. The Samsung delivery team utilizes a “Center of Excellence” model that encourages knowledge sharing and ongoing review of best practices.  The model ensures the highest level of service to dealers and end-users alike.

We strive to align our Company’s sales, marketing, and services programs with those of our manufacturing partners.  As the composition of the market evolves in response to Avaya’s acquisition of Nortel, our cogent and well crafted sales plan is of even greater importance.  We have developed sales and service programs to assist customers in supporting their existing investments or migrating their portfolios to alternative technologies.  Our sales teams will continue to search for market opportunities resulting from the consolidation of Avaya and Nortel.  Uncertainties in the market may also result in acceleration in our acquisitions particularly in the Nortel approach the communications technology market differently and therefore we have assigned separate executive sales management to each manufacturer’s products and services.  Our Avaya sales and marketing efforts focus on partnering with Avaya’s national sales force to sell equipment to large and medium sized enterprises and to sell Avaya implementation and post-warranty maintenance contracts.  Our Nortel initiatives focus on creating relationships with Nortel’s regional sales management to sell equipment and applications.  In addition, we work to deepen our relationships with key decision makers within Nortel’s Global Delivery Services organization to create wholesale service offerings for large Nortel end-users.  Since starting this initiative in late fiscal 2006, we have improved our relationships and penetration with both Nortel and Avaya resulting in a demonstrable increase in equipment and services revenues.partner community.

In early fiscal 2008, we became a dealer for Mitel, selling their communications systems primarily to the lodging market.  Mitel provides us an opportunity to reach a market segment not previously services by us..  We expect to leverage our success in the Mitel product line into the commercial market in fiscal 2009.

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Services

Services revenue is our largest revenue stream.  Due to itsBecause a majority of these revenues are recurring nature and produce generally higher profitability,margins, this portion of our business is of vital importance to our operating results.  Our services product offeringofferings includes nation-wide customer service, project management, professional services, installation, consulting, and structured cabling implementation to support our customers.implementation.  The geographic reach and technical breadth of our services organization are key differentiators between us and our competitors.

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

To our non-hospitality end-users of Nortel equipment, we sell XETA maintenance contracts.  Additionally, we aggressively market our services capabilities to existing and potential wholesale customers.  By providing national coverage at competitive hourly rates, the NSC is a valuable resource to wholesale customers by providing geographic coverage and/or technical capabilities to service their customers directly.  Our largest wholesale customer is Nortel.  Nortel has maintenance contracts with many, “Fortune 1000”-type customers.  Nortel outsources much of the on-site service work for these customers to authorized service providers, such as XETA.  Nortel scores our service quality each quarter and according to Nortel, we enjoy the highest ratings of all their authorized service providers.  Our largest wholesale services opportunities are through potential relationships with the Regional Bell Operating Companies (“RBOCs”).  RBOCs are the largest Nortel dealers in the U.S. and as such have large installed bases of customers with Nortel systems.  Under a wholesale customer agreement, the RBOCs use XETA to service customers out of the RBOCs’ regional service area and/or handle overflow work during peak periods.  Our experience to date is that the sales cycle associated with the wholesale service revenue is lengthy.  We must first become qualified with the targeted wholesale partner such as an RBOC or systems integrator.  Once qualified, we must negotiate a master service agreement with the wholesale partner.  When these are accomplished, we can begin to compete with other qualified service providers to win service programs with end-users.  Because most end-users in this segment of the market are large, super-regional or national enterprises, the contracts tend to also be large and highly competitive, leading to high service level requirements and competitive prices.4

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

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

To our non-hospitality end-users of Nortel equipment, we sell XETA maintenance contracts.  Additionally, we aggressively market our services capabilities to existing and potential wholesale customers.  Our largest wholesale customer is Nortel.  Nortel has maintenance contracts with many “Fortune 1000” customers and outsources much of the on-site service work to authorized service providers, such as XETA.

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

For our distributed products, we 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 our proprietary call accounting products sold to the hospitality industry, we provide a limited one-year parts and labor warranty.

Marketing

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

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

Another important aspect of our marketing effort centers on our relationships with our manufacturers.  As a national dealer, we have certain technical and geographical capabilities that help differentiate us in the marketplace and we aggressively market these capabilities to Avaya, Nortel, and Mitel.  The manufacturers utilize

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Copyrights, Patents Andand Trademarks

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

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

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

The lack of available credit beyond our current credit facility may impair our ability to expandfully execute our business through acquisition.acquisition growth strategies.

BecauseOur growth strategy includes the acquisition of businesses that either increase our market share in traditional voice or converged communications systems or expand our competencies and presence in advanced technologies such as Unified Communications and collaboration applications.  The economic downturn, the cost of entry into these new communications applications businesses, and the acquisition of NES by Avaya has increased the number of potential acquisition opportunities for us.  However, because of the continued uncertainty in the credit markets and the lack of credit available through traditional lending institutions, it may be difficult for us to finance acquisitionsthe acquisition opportunities available with traditional senior debt.  Despite our improved operating results, strong cash flows and low debt, our ability to secure senior debt financing is subject to the same limitations and costs affecting the market as a whole.

We believe that the combination of improved working capital, moderate levels of senior debt, and alternative methods of acquisition financing, such as seller notes and equity, will be sufficient to accomplish our goals for inorganic expansion in fiscal 2009.  However, there  There is no assurance that thesealternative sources of capital will materialize and/or be sufficient to pursue all the acquisition opportunities considered in the best interest of the Company.  As a result we may be unable to pursue certain reasonably priced, synergistic opportunities.

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

Nortel filed a voluntary petition for Chapter 11 bankruptcy protection on January 14, 2009.  At the time of the filing the Company was owed approximately $500,000 in billed accounts receivable and approximately $100,000 in services rendered but not yet billed (“pre-petition claims”).  Nortel was current in its payments to us at the time of their filing.  Based on filings approved by the bankruptcy court which allow Nortel to pay for post-petition business operations, we plan to continue to provide services to Nortel’s end-user customers under our wholesale service relationship which currently produces approximately $3 million in annual revenues. If our pre-petition claims are not collectible either in whole or in large, we could experience material, negative operating results in the near term.  Furthermore, it is impossible to know with certainty what the long term impact of Nortel’s bankruptcy filing will have on our managed services revenues or our Nortel equipment business.  However, our ongoing revenues and future financial results could be materially impaired in the event that Nortel is unable to fund its future operations; end-users elect to abandon their Nortel equipment for other

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products; Nortel implements dramatic changes to its business plan and strategies which negatively impact our relationship with Nortel as a business partner and/or vendor; the U.S. and global economic crisis negatively impacts Nortel’s ability to reorganize successfully; and/or Nortel is unable to continue as debtor in possession or to emerge from bankruptcy.

Telephone service in hotel rooms is now a net cost to most hotels and feature rich voice applications are of modest value in most hospitality locations.  As a result, theThe value of our product and serviceservices offerings to thisthe hospitality market is declining.declining and our repair and maintenance revenues associated with this line of business are under significant pressure.

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

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

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

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

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

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

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

Our manufacturers couldAvaya has announced a significant change in their pricing structure and incentive programs, which may affect our operating results.

We participateAvaya has recently announced significant changes in variousits pricing structure and incentive programs.  According to Avaya these changes, which are being made to simplify its pricing structure and eliminate the need to request special discounts and administer complex incentive programs, with allshould be neutral to profit margins.  Our initial review of these changes contradicts Avaya’s statements regarding the neutrality of these changes on our major manufacturers.  Theprofit margins.  As a large business partner of Avaya we receive substantial discounts off of list price and the payments we receive under theseAvaya’s various incentive programs are material to our operating results.  Our manufacturers could alter We are continuing to evaluate these changes which are scheduled to take effect on February 1, 2010.  Avaya may make additional adjustments to the announced changes before that date and/or discontinue these programs without notice, which couldmay delay the implementation of some or all of the changes as it continues to receive feedback from its business partners.  At this time, no assurance can be given that the pricing and incentive program changes eventually implemented by Avaya will not have a material, adverse effectimpact on our operating results.

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Microsoft Corporation has enteredAvaya’s strategies regarding the UC market, whichprovision of equipment and services to their customers are changing and could result in significant disruption to the current communications market landscape.have a material impact on our operating results.

Microsoft Corporation (“Microsoft”) has announced severalAvaya is repositioning itself as a hardware and software manufacturer providing a wide range of voice communications hardware and applications to its customers.  As part of this strategy, Avaya is segmenting its hardware maintenance and software support.  The new products that will compete directly with existing Avayasoftware support offerings include technical support for specific voice applications and Nortel applications.  Microsoft represents a significant entrant into the converged communications marketupgrade services to ensure customers can access all software patches and may cause a considerable disruption to our strategy of aligning our efforts with Avaya and Nortel.  The timing and qualityupgrades.  Currently, we earn revenues from some of our responsecustomers, particularly hospitality customers, to Microsoft’s entrance intoprovide the market, the quality of Microsoft’s new products and market acceptance of these products may resultservices now being included by Avaya in positive orits new software support offerings.  These changes could have a material, negative impact on our business results.operating results if our revenues or margins are reduced in response to these mandated changes by Avaya.

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

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

The success of our business depends significantly uponon our ability to retainrecruit and recruitretain highly skilled personnel.

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

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

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

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

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

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

We are sellingsell a variety of new, highly complex products that incorporate leading-edge technology, including both hardware and software.  The earlysoftware technology.  Early versions of these products, which we are selling currently, can contain software defects or “bugs” and other defects that can cause the products to not function as intended.  We will be dependent upon Avaya and Nortelour suppliers of these technologies to

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fix these problems as they occur.  Anproblem.   The inability of the manufacturer to quickly 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 and accounting regulations may require a material increase in our operating expenses beginning in fiscal 2010.

We are required to comply with a host of government-mandated corporate governance and accounting regulations, the most significant of which is section 404 of the Sarbanes-Oxley Act of 2002.  Under the current guidelines issued by the Securities and Exchange Commission, our auditors must attest on our report on internal controls over financial reporting beginning in the year ended October 31, 2010.   We believe, based on new guidance provided to small public companies from the Public Companies Accounting Oversight Board and discussions with our external auditors and consultants in this field, that expenditures required to comply with these regulations will not be material to our overall operating results.  However, since we have not been subject to this requirement in the past, we cannot provide assurance that we will not incur significant unexpected costs which could materially impact our operating results.  Additionally,In addition, the Financial Accounting Standards Board (“FASB”) has issued new accounting standards related to fair value and business combination accounting.  These rules require significantly different accounting treatment for some items that are common in business combinations and as such, our financial results could be materially different for future acquisitions.

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

Much of the current growth in our services businessrevenue is coming from a few wholesale service customers as they useusing us as a subcontractor to service many of their high profile end-user customers.  We believe our relationship with these companies is strong and to date our serviceperformance ratings with them have been excellent.  However, our experience to date is that the end-users’ decisions to maintain their service agreements with our wholesale service customers are dependent primarilydepends on cost and other factors which are not underbeyond our control.  Therefore we can provide no assurance that we will not experience sudden declines in our recurring servicemaintenance and repair services revenues due to the loss of large service contracts by our wholesale customers.

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

Hitachi, once one of the leading suppliers of traditional PBX systems to the hospitality market, ceased selling systems forto this market in March 2005.  We have many long-time hospitality customers with significant portfolios of Hitachi systems in their hotels.  Weproperties.  In addition, we have several hundred Hitachi systems under service contracts producinggenerating recurring contract revenues and gross profits for our business.profits.  Over the next sixfour to sevensix years, most of these customers will have to transition their communications systems to new platforms, presentingplatforms.  The transition presents a risk to us that another vendor may be selected to install and service their communications systems.  Our entry intoIn response we have added the Mitel product line is in part a responseto mitigate the impact to our operating results due to Hitachi’s exit offrom the hospitality market.

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

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

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

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

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

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

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

ITEM 1B.               UNRESOLVED STAFF COMMENTS

Not Applicable.

ITEM 2.  PROPERTIES

Our principal executive offices and the NSC are located in a 37,000 square foot, Company-owned, single story building located on a 13-acre tract of land in a suburban business park near Tulsa, Oklahoma.  This facility also houses a warehouse and assembly area.  TheAt October, 31, 2009 the building is located on a 13-acre tract of landwas subject to a mortgage held by Bank of Oklahoma, NA to secure ourNA.  In November 2009, the Company retired the mortgage and entered into a credit facility.facility with a new banking institution.

We have additional leased facilities located near St. Louis, Missouri.  In addition to our primary warehouse and shipping operation, this facility houses sales staff, technical design, professional services and installation support personnel.  Our Seattle branch office is located in leasedWe lease office space for branch offices in Bellevue, Washington, a suburb of Seattle.  This facility housesWashington; Richardson, Texas; and Southborough, Massachusetts.  These facilities primarily house sales and technical personnel.  We also lease other office space throughout the U.S. for sales, consulting, and technical staff.

ITEM 3.  LEGAL PROCEEDINGS

In April 2008, Design Business Communications, Inc., d/b/a/ American Telephone (“AMTEL”) filed a claim withOn November 10, 2009, the American Arbitration Association against us and Hitachi Telecom (USA) Inc. (“HITEL”) alleging a breach of AMTEL’s Authorized Distributorship Agreement with HITEL (“Distributor Agreement”).  We areCompany was named as aan additional defendant in this matter because we acquired HITEL’s PBX business in 2006 and as parta lawsuit originally filed on March 16, 2009 by Pangaia Partners against two of that transaction, agreedPangaia’s former employees who subsequently went to fulfill HITEL’s surviving service obligations to its authorized distributors under their distributor agreements with HITEL.  The AMTEL Distributor Agreement provides that AMTEL may order and HITEL shall provide “spare parts, software and third level technical support as requiredwork for the maintenanceCompany.  The lawsuit was filed in Superior Court of HITEL PRODUCTNew Jersey Law Division, Bergen County.  Pangaia’s claims against the Company are made in relation to a Nortel account to which the employee defendants were assigned when they worked for a period of ten years from the ship datePangaia and which they now service as employees of the HITEL PRODUCT.”Company.  Pangaia’s claims against the Company and the individual defendants include unfair competition, tortuous interference with prospective economic advantage, tortuous interference with contract, misappropriation of trade secrets, conversion and unjust enrichment.  In April 2007, AMTEL placedits original claim against its former employees, Pangaia sought but was denied a $12,000 order with us (aspreliminary injunction to enforce non-competition agreements.  Pangaia now seeks monetary damages against all defendants, but has not alleged a specific dollar amount.  A preliminary investigation indicates the party responsible for fulfilling HITEL’s surviving service obligations) underclaims are without merit and the Distributor Agreement for 48 new telephones,Company expects to mount a product that had been previously discontinued by HITEL.  Because we do not believe that this order falls within the scope of obligations under the Distributor Agreement, we did not fulfill the order and AMTEL filed suit claiming breach of the Distributor Agreement.  AMTEL seeks damages as a result of the alleged breach in the amount of $5 million (for loss of service and spare part revenues; loss of business reputation; loss of customers; and possible claims by AMTEL customers for breach of its service obligations and sales and service warranties).  While HITEL is also contesting AMTEL’s claim, it has notified us that it will seek indemnity against us under the terms of the 2006 purchase and sale agreement between us and HITEL.vigorous defense.

We are vigorously contesting AMTEL’s claim and in November 2008, all three parties to the arbitration signed a settlement agreement pursuant to which we have agreed to deliver to AMTEL a certain number of new phone sets in exchange for an agreed upon payment by AMTEL.  The settlement agreement provides us 120 days from the date of execution of the agreement to deliver the phones to AMTEL, and AMTEL has 30 days from the date of their receipt to pay for the phones.  In accordance with the terms of the settlement agreement, AMTEL has filed a dismissal of the arbitration without prejudice; and within ten days after receiving the phones from us, AMTEL is obligated to file a dismissal of the arbitration proceeding with prejudice.  Our ability to fulfill our obligations under the settlement agreement depends upon the performance of a third party who has agreed to manufacture the discontinued phones.12

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

None.

PART II

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

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

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.

OnIn October 29, 2008 we announced that ourthe Board of Directors had approved a stock repurchase program in which up to $1,000,000 could be used to repurchase our common stockCommon Stock in open market.  The timing and amount of any repurchases will beis based on various factors, including general market conditions, the market price of our common stock,Common Stock, Company-imposed black-out periods during which the Company and its insiders are prohibited from trading in XETA common stock and management’s assessment of our financial position and liquidity.  The announcement also stated that the program couldcan be modified, suspended, extended or terminated by the Company at any time without prior notice.  AsThe program does not have an expiration date.  Since the inception of December 26, 2008 the Company had purchased 13,481 shares at an average cost of $1.86 per share and $25,136 had been spent under the program, we have repurchased a total of 30,796 shares of our common stock for a total cash investment of $58,157.  There was no repurchase activity for the fourth quarter of fiscal 2009.

As of January 6, 2009,4, 2010, there were approximately 164167 shareholders of record.  Since many of the Company’s shareholders hold their shares in “street name,” meaning that their shares are held in the name of their brokerage firms for the account of the individual shareholder, we estimate the actual number of shareholders to be at least over 2,000.

EQUITY COMPENSATION PLAN INFORMATION

(1)    Includes 1,461,7102,252,109 and 266,83338,134 shares available under the 2004 Plan and 2000 Plan, respectively.  The 2004 Plan includes an evergreen feature in which 3% of the total outstanding shares are added to the total shares available for issuance.  The evergreen feature does not apply to incentive stock options.  Consequently, there are 329,656530,000 and 266,83338,134 shares available to be issued as incentive stock options under the 2004 Plan and 2000 Plan, respectively.

(2)    All of these options were granted as part of an initial compensation package to an officer upon his hiring.  These options vested over three years, and are exercisable until June 16, 2009.February 28, 2013.

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ITEM 6.  SELECTED FINANCIAL DATA

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Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements.  Projections of any evaluation of effectiveness to future periods are subject to the risks that controls may become inadequate because of changes in conditions or that the degree of compliance with the policies or procedures may deteriorate.  Our management assessed the effectiveness of our internal control over financial reporting as of September 30, 2008.October 31, 2009.  In making this assessment, our management used criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control-Integrated Framework.  Based on its assessment, our management believes that, as of September 30, 2008,October 31, 2009, our internal control over financial reporting was effective based on those criteria.

This annual report does not include an attestation report of the Company’s independent registered public accounting firm regarding internal control over financial reporting.  Management’s report was not subject to attestation by the Company’s independent registered public accounting firm pursuant to temporary rules of the Securities and Exchange Commission that permit the Company to provide only management’s report in this Annual Report.

ITEM 9B.  OTHER INFORMATION

None.

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PART III

ITEM 10.  DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE

Information required by this Item relating to directors is incorporated by reference to our definitive proxy statement to be filed with the Securities and Exchange Commission (the “Commission”) not later than 120 days after the close of our fiscal year ended October 31, 20082009 (the “Proxy Statement”), under the section “Proposal 1—Election of Directors.”

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

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

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

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

ITEM 11.  EXECUTIVE COMPENSATION

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

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

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

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

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

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

ITEM 14.  PRINCIPAL ACCOUNTING FEES AND SERVICES

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

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