Preliminary Note Regarding Forward-Looking Statements

In the following discussion, we make forward-looking statements concerning future performance, events and results. Other than purely historical statements, all others are likely forward-looking. Forward-looking statements generally include words such as "expects," "anticipates," "may," "plans," "believes," "intends," "projects," "estimates," "targets," "should" and similar expressions. Such statements reflect our perspective on the industry and markets in which we operate. Any statements containing estimates and forecasts are not guarantees of performance, but rather, our assumptions and beliefs based upon information currently available to us. These statements are subject to risks and uncertainties that are difficult to predict or beyond our control. Examples of these risks include: the condition of U.S. economy and its impact on capital spending; reduced availability of credit; the Nortel Networks bankruptcy filing; the financial condition of our suppliers and changes in their distribution strategies and support; our ability to maintain and improve current gross profit margins; unpredictable quarter to quarter revenues; continuing market success of the Mitel product and services offerings; intense competition; industry consolidation; our dependence upon a few large wholesale customers in our Managed Services offering; and our ability to attract and retain talented sales, operational and technical personnel. These and other risks and uncertainties are discussed under the heading "Risk Factors" under Part I of the Company's Form 10-K for the fiscal year ended October 31, 2008 (filed with the Commission on January 23, 2009), and in updates to such risk factors set forth in Item 1A of Part II of our quarterly reports during fiscal 2009. Because of these risks and uncertainties, actual results may differ materially and adversely from those expressed in forward-looking statements. Consequently, we caution investors to read and consider all forward-looking statements in conjunction with such risk factors and uncertainties. The Private Securities Litigation Reform Act of 1995 provides a safe-harbor for forward-looking statements made by the Company.

Overview

Strategy.

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

In addition to these strategies, senior management initiated an internal program to improve operational methods and practices to produce leverage in our operating results, particularly in our selling, general, and administrative expenses. The purpose of this effort is to identify internal opportunities to reduce costs. These efforts are ongoing, and include development of new and refined processes; organize back office activities for improved labor utilization; use internal systems and technologies to automate routine activities; and review workforce utilization to ensure appropriate staffing composition.

In April 2009 XETA purchased the assets of Summatis Communications, LLC ("Summatis") located in Southboro, MA. Summatis provides communications solutions, integration and maintenance services primarily targeted at the Nortel product line. The acquisition strengthens our presence in the northeastern U.S. and adds to our Nortel competencies. While the acquisition is not material to our financial position or results of operations, it represents an incremental step in our overall acquisitions strategy.

On January 14, 2009 Nortel Networks Corporation filed for bankruptcy protection in the United States Bankruptcy Court for the District of Delaware. Nortel is one of our major suppliers and represents a significant portion of our business. As such this filing is of considerable concern. At the time of filing this form 10-Q, our post-petition relationship with Nortel continues without interruption. However, management recognizes the potential impact of Nortel's filing on the Company's financial performance (see Item 1A. "Risk Factors" below). Nortel owes XETA approximately $685,000 in pre-petition accounts receivable. To date, Nortel has not filed its reorganization plan. This limits our ability to assess the probability of recovering pre-petition amounts due. As of April 30, 2009, we have recorded $350,000 as a

reserve against possible bad debts. We are following developments in the bankruptcy case and will assert our legal rights and defenses as appropriate.

Operating Summary.

In the second quarter of fiscal 2009, we earned net income of $183,000 on revenues of $17.8 million compared to net income of $371,000 on revenues of $20.8 million in the second quarter of last year. For the first six months of fiscal 2009, we earned $186,000 in net income on revenues of $36.3 million compared to net income of $760,000 on revenues of $38.8 million. These results reflect the challenging macroeconomic conditions and their influence primarily on our commercial systems sales. We discuss this and other contributing factors in more detail under "Results of Operations" below.

Financial Position Summary.

Since October 31, 2008, our financial condition has improved as evidenced by the generation of positive cash flows from operations. We discuss these and other financial items in more detail under "Financial Condition" below.

The following discussion presents additional information regarding our financial condition and results of operations for the three- and six-month periods ended April 30, 2009 and 2008 and should be considered in conjunction with our above comments as well as the "Risk Factors" section below.

Financial Condition

Our financial condition improved during the first two fiscal quarters of 2009 as our working capital grew by 8.6% to $10.2 million. In addition we generated $3.70 million in cash flows from operations. These cash flows included earnings and non-cash charges of $1.88 million; a decrease in accounts receivable of $5.40 million; a decrease in inventory of $323,000; and an increase in deferred tax liabilities of $193,000. These increases were partially offset by a decrease in accounts payable of $1.80 million; a decrease in accrued liabilities of $815,000; and other changes in working capital items, which netted a decrease in cash of $1.48 million. Non-cash charges included depreciation of $454,000; amortization of $657,000; stock-based compensation of $145,000; a loss on the sale of assets of $4,000; a provision for doubtful accounts receivable of $380,000; and a provision for obsolete inventory of $51,000.

We used these positive cash flows to reduce borrowings on our working capital line of credit by $1.765 million: to make asset purchases of capitalized hospitality service contracts as well as certain net assets of Summatis, together totaling $1.452 million; reduce our mortgage balance through scheduled principal payments by $86,000; fund other financing and investing activities of $129,000; and acquire capital assets of $329,000. The acquisition of capital assets included $179,000 spent as part of normal replacement of our Information Technology infrastructure and headquarters facility improvements. The remaining $150,000 was spent on our Oracle implementation.

At April 30, 2009, the balance on our working capital revolver was $759,000, with $6.7 million additional borrowings available. We believe that this capacity is sufficient to support our operating requirements for the foreseeable future. The working capital revolver and the mortgage on our headquarters facility are scheduled to mature on September 30, 2009. We expect to renew these instruments prior to their expiration. Given current credit market conditions, it is likely that such renewals could result in higher borrowing costs and/or reduced availability for unsecured borrowings. In addition to the available capacity under our working capital line of credit, we believe we may have access to a variety of capital sources such as bank debt, private placements of subordinated debt, and public or private sales of equity.

Results of Operations

In the second quarter of fiscal 2009, revenues decreased $3.1 million or 15% compared to the second quarter 2008, and net income decreased $188,000 or 51%. In the first six months of the year, revenues decreased $2.4 million or 6% and earnings declined $575,000 or 76%. These results reflect lower sales of commercial systems and lower levels of commissions earned from the sale of Avaya post-warranty maintenance contracts.. The year-to-date results were also impacted by the $350,000 bad debt provision in response to Nortel's bankruptcy filing. The narrative below provides further explanation of these results.

Systems Sales.

In the second quarter of fiscal 2009, systems sales decreased approximately $2.5 million or 24% compared to the same period last year. This decrease includes a $3.5 million or 40% decrease in sales of systems to commercial customers and a $1.0 million or 68% increase in sales of systems to hospitality customers. Year-to-date systems sales decreased $1.6 million or 9% compared to last year. This decrease includes a decrease in sales of systems to commercial customers of $3.2 million or 22% and an increase in sales of systems to hospitality customers of $1.6 million or 51%. The decrease in system sales to commercial customers reflects difficult comparisons related to the revenues earned from the Miami-Dade County Public School's ("M-DCPS") project. Additionally macroeconomic conditions and Nortel's bankruptcy impacted our sales efforts.

Throughout fiscal 2008, we enjoyed strong commercial systems sales, installation revenues, and cabling revenues generated by the series of orders received from M-DCPS. In total, these orders generated over $10 million in revenues for the Company during the year. We have not received a similar order during fiscal 2009, making comparisons to last year's results more difficult. Customers continue to reduce capital spending in response to recessionary conditions, and access to credit remains problematic. As these conditions have intensified, customers have limited their capital spending to necessity purchases and investments with clear, rapid returns. Finally, uncertainty around the Nortel bankruptcy continues to dampen demand for equipment in this product line.

The quarterly and year to date growth in sales of systems to hospitality customers, particularly during a challenging hospitality market, reflects our continued success in this niche market. Results support our strategy to expand our product offering to Mitel products which has provided us with the opportunity to work with hotel chains and property management companies that have previously standardized on the Mitel product line. While we anticipate continued success in the hospitality market, given economic conditions, we expect downward pressure on revenues in this segment. As such revenues may be at or less than historical levels in the last half of the fiscal year.

Services Revenues.

Services revenues consist of the following:



                            For the Three Months Ended       For the Six Months Ended
                                    April 30,                       April 30,
                               2009             2008           2009            2008
Contract & T&M            $    7,050,000    $  7,028,000   $  14,026,000   $ 14,236,000
Implementation                 2,271,000       2,344,000       4,457,000      4,386,000
Cabling                          520,000         762,000       1,352,000      1,237,000
Total Services revenues   $    9,841,000    $ 10,134,000   $  19,835,000   $ 19,859,000

Contract and time-and-materials (T&M) revenues increased 0.3% and decreased 2%, respectively in the second quarter and year-to-date periods. This year-to-date performance reflects relatively flat revenues in our wholesale services programs and a modest decline in T&M service revenues. We believe T&M revenues were influenced by general economic conditions as customers reduced spending on non-critical services. We continue to aggressively market our national service footprint and multi-product line technical capabilities to end-users, network service providers, and large integrators of voice and data technologies. In the second quarter, we secured new service programs with Marriott International and Lockheed Martin Corporation. Additionally, we acquired customer relationships from Summatis. We expect these new programs and relationships to positively impact our Contract & T&M revenues in the third fiscal quarter.

Implementation revenues decreased 3% and increased 2%, respectively in the second fiscal quarter and year-to-date periods. These results were achieved despite significant deceases in commercial systems sales, traditionally the primary driver of these revenues. We attribute year-to-date performance to increasing demand for more complex communications systems. These projects require significant fee-generating design and engineering services provided by our Professional Services Organization ("PSO"). Long term as customers displace conventional communications platforms and adopt more complex systems, we anticipate growth in this area of our business through the fee-based utilization of these highly skilled technical resources.

Cabling revenues decreased 32% and increased 9%, respectively in the second fiscal quarter and year-to-date periods. The second quarter decline in cabling revenues is primarily associated with the difficult comparisons to fiscal 2008 which were helped significantly by the M-DCPS orders as discussed above. Generally, we are pleased with the beneficial year-to-date growth in cabling revenues and continue to market our national structured cabling capabilities.

Gross Margins.

The table below presents the gross margins earned on our primary revenue
streams:



                                For the Three      For the Six
                                 Months Ended      Months Ended
                                  April 30,         April 30,
Gross Margins                   2009      2008     2009     2008
Services revenues                31.2 %    25.0 %   30.7 %  25.8 %
Systems sales                    25.4 %    26.6 %   25.8 %  25.9 %
Other revenues                   40.2 %    79.1 %  -24.5 %  84.6 %
Corporate cost of goods sold     -2.0 %    -1.9 %   -2.0 %  -2.0 %
Total                            26.7 %    24.9 %   26.3 %  25.2 %

Gross margins earned on Services revenues reflect improved cost controls and on-boarding the new Samsung service program. In addition during the period we experienced improved utilization of our PSO consulting and design resources on fee-based engagements. Expanding these billable consulting services for these high-value resources is an important aspect of our services strategy.

Gross margins on systems sales in the second quarter and the year-to-date periods are above our target of 23% to 25% for systems revenues. We continue to receive considerable pricing support from our manufactures in the form of project-specific discounts and incentive rebates. These incentives are material to our gross margins and we work diligently to maximize this support; however, no assurance can be given that future support will continue at historical levels.

The final component of our gross margins is the margins earned on other revenues and our corporate cost of goods sold. We earn the majority of other revenues from the sale of Avaya maintenance contracts on which we earn either a commission or gross profit. We have no continuing service obligation associated with these revenues and gross profits. In the first half of fiscal 2009 we experienced a dramatic drop in other revenues as compared to the same period last year. Some decline in this segment was expected as we benefitted from accelerated customer decisions throughout 2008. In 2008 many customers accelerated their purchases or renewals of Avaya service contracts in anticipation of manufacturer price increases for these services. This is an unpredictable revenue stream that depends on the expiration dates of existing contracts, installation dates of new systems, the customer type as defined by Avaya, and the number of years that customers contract for services. While no assurance can be given, we expect sales of Avaya service contracts to return to pre fiscal 2008 levels. Other revenues may also include sales and cost of goods sold on equipment or services sold outside our normal provisioning processes. These revenues vary in both sales volume and gross margins earned. Corporate cost of goods sold represents our material logistics and purchasing functions that support all of our revenue segments.

Operating Expenses.

Our total operating expenses decreased $102,000 or 2% in the second quarter of fiscal 2009 compared to the second quarter of fiscal 2008. Operating expenses were 24.9% of revenues in the second quarter compared to 21.7% in the second quarter last year. Operating expenses increased $811,000 or 10% for the first half of fiscal 2009 compared to the same period a year ago. Operating expenses were 25.3% of revenues in the first half of fiscal 2009 compared to 21.6% last year. The growth in operating expenses in the first half of fiscal 2009 reflects the following factors:

†          A significant bad debt provision in response to the Nortel bankruptcy
filing

†          Increased legal fees to support litigation and board governance
activities

†          Increased amortization of: the Oracle platform in association with

The growth of operating expenses as a percentage of revenues is concerning, however; we deemed it tactically appropriate, given our strong cash flows, to support operating expenses above our targets in the near term. This tactic positions us to take advantage of improving economic conditions in subsequent quarters. In the longer term we continue to target operating expenses of 18% to 20% of revenues over the next two to four years as we realize economies of scale.

Interest Expense and Other Income.

Net interest and other expense was $25,000 in the second quarter of fiscal 2009 compared to $59,000 in net other expense in the second quarter of fiscal 2008. Net interest and other expense was $43,000 for the six-month period ended April 30, 2009 compared to $144,000 in net other expense in the same period last year. This decrease reflects both lower interest rates and a reduction in borrowings.

Tax Provision.

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