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XETA Technologies Inc. (NASDAQ:XETA)

F3Q09 (Qtr End 07/31/09) Earnings Call

August 27, 2009 17:00 pm ET

Executives

Greg Forrest - CEO

Robert Wagner - CFO

Dave Mossberg - IR

Analysts

Larry Hutchin - Adam Paul Asset Management

Operator

Welcome the XETA Technologies third quarter 2009 Earnings Call. (Operator Instructions) It is now my pleasure to introduce your host, Dave Mossberg, Investor Relations for XETA Technologies. Thank you. You may begin.

Dave Mossberg

Thank you, Joe. Before we begin, we will be referring to today's earnings release and a slide presentation, both of which can be downloaded from the Investor Relations page of the company's website at www.xeta.com. We have included a table with a breakdown of our revenue categories for your reference.

This conference call could contain forward-looking statements about XETA Technologies within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are statements that are not historical fact. Such forward-looking statements are based upon current beliefs and expectations of XETA's management and are subject to risks and uncertainties, which could cause actual results to differ from the forward-looking statements. Such risks are more fully disclosed on XETA's filings with the Securities and Exchange Commission.

The information set forth herein should be considered in light of such risks. XETA Technologies does not assume any obligation to update the information contained in this conference call. Throughout today's conference call, we may be referring to both GAAP and non-GAAP financial results, including the term adjusted EBITDA, which is a non-GAAP term. There is a reconciliation of non-GAAP results in the earnings release.

Our speakers today will be Greg Forrest, XETA's CEO and President; and Robert Wagner, the Company's CFO. Greg?

Greg Forrest

Okay. Thanks, Dave. Good afternoon, everyone. Thank you for your interest in XETA Technologies and for joining us on the call today. During the first nine months of the year it has been a challenge to deliver positive year-over-year results. We faced tough top line comparisons with our prior year and difficult economic conditions, resulting in a sharp downturn in our equipment revenues and our first quarterly loss in three-and-a-half years.

Given the reduction in equipment revenue, we adjusted the value of the goodwill associated with our equipment business and reduced our expenses by more than $1 million per year. While we have cut back on spending, we continue to invest in sales, marketing, and operations. We are confident that this is the right time to invest in these areas of our business, given several growth opportunities that have presented themselves.

We made progress ramping several large service contracts and grew our Service business by 8% sequentially from the second quarter. Our Service business is a true differentiator for XETA in the marketplace. Financially speaking, the Service business provides stable recurring revenue, produces higher return on investment, and has continued to outperform the market during the bottom of this economic cycle. As such, we remain strategically focused on growing this part of our business.

In the past 30 days, we have seen a slight improvement in customer activity and have gained momentum in several large projects we have been pursuing. Later in the call, I will give you an update on the progress that we have made.

During the third quarter, we generated $4 million in operating cash flow and exited the quarter with $3 million in cash, and zero drawn on our line of credit. This improved financial condition further strengthens our position, and should help us outperform our peers and grow faster than the market as economic conditions improve.

Now I will turn the call over to Robert Wagner, the Company's CFO, for details on financial results; then I will come back with a progress report on our key growth strategies and discuss our outlook. We will then open the floor for your questions. Robert?

Robert Wagner

Thanks, Greg. Welcome to everybody on the call. Thanks for joining us this afternoon. The continued impacts of economic conditions and tough comparisons to last year's results are reflected throughout our third quarter operating results. These impacts include the impairment charges recorded in the quarter, declines in our Commercial equipment sales, and lower levels of commissions earned from the sale of post-warranty maintenance contracts.

Our results reflect some important successes during the quarter as well, which include continued strong performance of our lodging team, good margins on systems sales and improved cash and AR balances as Greg mentioned. I'll discuss each of these items over the course of the next few minutes.

As discussed in the earnings release and in Greg's comments, we recorded estimated impairment charges against our goodwill and our Oracle ERP system totaling $14 million in the quarter. The impairment charges were non-cash in nature and as such had no impact on our cash flows, cash balances, or access to borrowings under our revolving line of credit.

During the quarter, we experienced a continued decline in revenues in our Commercial equipment reporting unit, due to poor economic conditions and uncertainty regarding Nortel's product line. Additionally, we also experienced a sustained decline in our market capitalization. These factors taken together prompted an interim test for impairment.

We completed step one of the goodwill impairment test under the applicable accounting rules and determined that the carrying value of our Commercial equipment sales reporting unit was greater than its fair value and therefore impairment of goodwill exists. We have estimated the impairment to be between $9 million and $13 million, and impairment charge of $11 million was recorded in the third quarter, representing our best estimate of the probable impairment at this time. The impairment charge will be adjusted if necessary after completing step two of the impairment test in the fourth quarter.

Likewise, we follow the applicable accounting rules regarding the potential impairment of long-lived assets and determine that our investment in the Oracle ERP system is not fully recoverable in the reasonable near-term and its carrying value significantly exceeds its fair value. Accordingly we recorded an estimated impairment charge of $3 million for this asset as of July 31st. This estimate is also subject to revision during the fourth quarter as we refined our analysis of both these impairments.

As noted in the press release, apart from the impairment charges our operating results reflected a non-GAAP loss of $87,000 for the quarter. The key drivers for these results were lower levels of system sales to commercial customers and lower commissions from the sale of Avaya's post-warranty maintenance contracts. Sales of systems to commercial customers were up against very tough comparisons as a result of the Miami-Dade project, which was at its peak in Q3 of last year.

Additionally, macroeconomic conditions and uncertainty around the Nortel product line have created a pause in customer's buying patterns. Consequently our equipment sales to commercial customers were down 52% for the quarter, and 33% for the year-to-date periods.

Despite the difficulty in our Commercial segment, we continue to enjoy a strong year in sales of systems to hospitality customers. Hospitality is typically one of the hardest hit areas of the economy during a recession. This recession has been no exception. And our addition of the Mitel product line and our deep roots into this vertical market allowed us to enjoy 9% growth in the third quarter and 33% growth for the year-to-date period.

The year-to-date revenues include recognition of the largest hospitality order in our 27-year history. So it's been an excellent year for us in this vertical market, especially given the economic conditions.

Another positive is the higher gross margins on equipment sales we've earned in '09. We managed these margins very closely and aggressively pursue manufacture support to help win highly competitive opportunities. We've enjoyed equipment margins of 26% to 28% this year. Our expectations for these margins over the next three years continues to range from 23% to 25% as we stated previously, which reflects the competition of the industry and the commoditization of the hardware we sell which will be offset somewhat by increased sales of higher margin software applications in the future.

Our Service revenues were down 13% for the quarter and 5% for the year. And as the table in the earnings release showed, the decrease is entirely related to a decline in implementation of cabling revenues. Implementation revenues are still very closely tied to equipment sales, so declines in this area were expected.

We continue to work to build the professional services and consulting business that produces predictable service revenue, which are less relied on equipment sales. The recent addition of the Samsung dealer support services which was announced in April is an example of new professional services revenues being generated separately from equipment sales.

This new relationship adds recurring professional fees to our normal mix of equipment related installation revenues. Our cabling revenues have also experienced a decline in '09 much of which relates to the Miami-Dade order last year which included cabling revenue at each school installation.

Our most important revenue stream is our recurring Services revenues, and it was up 2% for the quarter and is flat for the year-to-date period. We've added customers to our base of recurring revenues through recent acquisitions and through new customer relationships.

The impact of these wins has been partially offset by few instances of contract losses or program downsizes in our managed services business. In all cases, these changes were out of our control and reflected divestitures of businesses or strategy changes by end user customers.

Our Services gross margins were down 170 basis points compared to Q3 of last year, but are up 240 basis points in the year-to-date comparisons. The Q3 decline in service margins is solely related to lower margins on our implementation revenues.

As we've discussed on previous calls, our most highly skilled technical resources are in this area and represent a significant fixed cost in our business. The lower level of implementation revenues in Q3 against these fixed costs lowered our overall service margins. The margins earned on our recurring service revenues, cabling revenues were at or above our targets in the Q3 period.

The final key component to our revenues is the other revenue category. Because of strong revenues we enjoyed in this category in fiscal '08, our knowledge of contracts coming up for renewal or refresh, we expected lower revenues in this area for fiscal '09. But as the news release stated, some customers have chosen to defer decisions on contract renewals as they wrestle with more pressing issues in their business.

Moving on to operating expenses, apart from the impairment charges, our operating expenses in Q3 were 27.5% of revenues, up 550 basis points from Q3 of last year. The increase in amortization expense represents 100 basis points of this increase with the remainder primarily being in sales expense.

As the quarter unfolded, it was clear equipment revenues were going to be significantly lower than our expectations. Consequently, we made several adjustments to our cost structure. Some of these adjustments were targeted at specific non-performing areas of our business, and others represented across the board sacrifices made by our entire employee base.

These cost reductions were implemented to varying degrees in late June through the end of the quarter. Our fourth quarter results reflect the full impact of these reductions and they’re reflected in service margins as well as in operating expenses. We set targets on our operating expenses of 18% to 20% of revenues over the next three to five years and while we continue to manage cost carefully, those targets will largely be achieved through revenue expansion.

A few comments about adjusted EBITDA, our adjusted EBITDA in the third quarter was $492,000 or 2.9% of revenues, down from $1.5 million and 6.6% of revenues a year ago. Our year-to-date adjusted EBITDA was $1.9 million or 3.7% of revenues, compared to $3.7 million or 6% of revenues through Q3 of '08.

We believe adjusted EBITDA is a useful non-GAAP financial measure for our company, primarily because of significant non-cash charges in our in our operating statement, including the impairment charges recorded in the third quarter and it was a reconciliation of net income to adjusted EBITDA provided in the release.

Now, I'll close with a few comments about our cash flows and balance sheet issues. Managing our working capital and cash flows has been a priority throughout fiscal '09. Our goals have been to reduce our investment in AR, reduce our borrowings, manage our credit risk and ensure vender continue to be paid on time.

Through the first nine months we generated $7.9 million in positive cash flow from operations. Most of this cash has been generated through collection of receivables which have been reduced by $8.6 million since the beginning of the year. We reduced our DSOs to 61 days at the end of the third quarter, down 21 days since the end of '08.

As I noted on each call this year, we're aggressively pursuing deposits, progress payments and resolution of old AR items. This focus has produced the improvements we saw in our cash flow in the third quarter. To date, the impact of the economy on our bad debt experience has been minimal. We've had a handful of isolated incidents of customers experiencing cash flow problems or difficulties with their lenders.

In each case, we've been able to work out payment arrangements with our customers to resolve the issue and maintain the relationship. We still have work to do to improve the quality of our AR with regard to the level of past due accounts, but overall I'm very pleased with the progress we've made in this area.

We've used the cash flows generated in '09 to fund acquisitions totaling approximately $1.5 million, reduce our borrowings by $2.8 million and fund $631,000 of capital expenditures and in addition build cash reserves of approximately $3 million. We concluded the quarter with total debt outstanding of $1.2 million, which is entirely in the mortgage of our headquarters building. We have a $7.5 million revolver to fund working capital shortfalls.

The credit agreement in place today does expire on September 29th. We've been in discussions with several potential lending partners as well as with our existing lender to establish a new facility. In those discussions, we presented a framework for our long-term credit facilities to support our organic growth and acquisition growth strategies.

Currently tight credit markets and our recent financial performance do not lend themselves to establishment of a significantly expanded facility, but I believe the combination of improving economic conditions, consistent growth in EBITDA and moderate relaxation of credit markets will provide more access to senior debt in the future. In the near term, I'm confident we'll be able to establish a new facility or a renewal of our existing facility to meet working capital needs until conditions improve.

Greg Forrest

Thanks, Robert. During this past quarter, we saw other communication vendors report a 20% to 40% decline in product revenue which are just consistent with the revenue decline we experienced during the quarter. A few vendors have called the bottom in IT spending based upon an uptick in recent activity.

In the past 30 days, we have also seen a slight improvement in customer activity and we gained positive momentum coming out of the quarter. While 30 days does not produce a trend, we are encouraged by the number and size of the opportunities we are currently pursuing.

Our strategy to deal with current economic conditions involves; first, a focus on growing our Services business; second, accelerating our efforts in specific industry verticals that we believe are more resistant to the downturn in spending such as government and education; third, we have continued to invest in sales and marketing infrastructure and we have implemented programs which will improve the efficiency and utilization of our resources while maintaining an ability to deliver high levels of service.

First, I will review the details of our Services strategy. We are building our Service business to make overall results more predictable and less dependent on the fluctuations of systems revenue. Service revenue produces higher margins and tends to be more resistant to economic conditions. Longer-term, our goals to have a revenue mix of 2/3 service, 1/3 systems. Exiting fiscal year '08, our mix was approximately 50/50.

As I mentioned previously, our Services business grew 8% sequentially. We continue to gain momentum adding new customers, penetrating existing accounts, and expanding relationships with wholesale partners. We have been very successful in developing a wholesale service model. In this model, we provide service to end customers on behalf of our partners, which include large manufacturers like Nortel, Siemens and Samsung, network service providers such as Verizon and large system integrators like Lockheed Martin.

Here are some examples of how our wholesale service business has progressed this year and during the third quarter. We signed a five-year, $2 million annual contract earlier this year with Lockheed Martin. Revenues under this contract ramped during the third quarter and this contract is progressing above plan. As a result of our performance, our relationship is expanding with Lockheed Martin.

For example, during the quarter we on-boarded two sizable service projects, each representing an opportunity to exceed the original allowance under the contract. It is important to note that we currently are serving just one of many government agencies Lockheed Martin [Manages]. As the largest IT integrator for the US Government, the revenue opportunities with this partner is several times that of the original contract.

We also signed a three-year, $2 million service contract with Samsung earlier this year, and effectively XETA became the outsourced service department for all of Samsung business communication system dealers in North America. Third quarter was the first full quarter of managing the new Samsung relationship, and in just one quarter the revenue run rate has already grown 10% above contract amount.

Samsung chose XETA for our ability to deploy a nationwide service footprint and to support their dealer channel. This is a key strategic relationship for XETA, and this contract illustrates how we are developing innovative ways to leverage our service competencies to grow and scale our business.

During the third quarter, we also made progress in securing new business with existing wholesale partners, including significant deals with Siemens and Verizon. We also continue to grow our Service business with Nortel by taking share from weaker competitors. We are clearly building momentum with our wholesale services business. Our partners have gained significant trust in our ability to manage and scale with large projects. We expect to continue to gain momentum with these partners and customers in the future.

Now moving on to our equipment sales. As expected, the equipment side of our business has been soft, up 39% from prior year. We face difficult comparisons based upon the large amount of systems we sold to the Miami-Dade school district. Roughly half of the decline was due to Miami-Dade. While bookings were weak during the quarter, we have seen customer activity increase during the last 30 days, and we have had several wins during the quarter which should begin to generate revenue over the next several quarters.

During the third quarter, we had equipment wins with a major Fortune 50 worldwide energy company, a major accounting firm, and a large multi-site call center company. Over the past 18 months, we have built teams dedicated to specific industry verticals, such as government and education that tend to be more resistant to the weakness in IT spending.

We made significant progress during the third quarter with this strategy. It's important to note that we are pursuing much larger opportunities than we have had in the past. These are seven and eight figure deals, similar in size to Miami-Dade.

We have been building our sales funnel with several of these large opportunities. These opportunities tend to have longer sales cycles and can cause system sales to vary significantly from quarter-to-quarter, although we did not generate significant revenue during the quarter, we were able to advance several of these government opportunities that are expected to produce revenue in future periods.

In the education vertical, we have built a practice to pursue federally funded projects throughout the United States. This year, we have been selected as a vendor for six separate school projects in significant transactions, including two during the past quarter. Late in the third quarter, the federal government committed to provide a portion of the funding for these programs and is expected to provide additional funding soon. We expect revenue from these wins to have a more meaningful impact on the next fiscal year.

In addition to federally funded projects, we have won a major procurement contract to serve school districts in multiple states. This contract allows for several million dollars of spending next year and should positively impact results during fiscal 2010.

Our Hospitality vertical which comprises of about 30% of our equipment business has been a bright spot for this year and during the third quarter. As Robert mentioned, despite what has been a very challenging time for the hospitality industry, we have grown our lodging equipment business by 33% during the first nine months and 8% during the third quarter. The Hospitality vertical is expected to face strong headwinds over the next year. Our growth will need to come from our take share initiatives.

We expect to continue to invest in our sales and marketing at an appropriate pace. During the third quarter, we did reduce our operating expenses including targeted sales and marketing resources. However, we continue to maintain a high level of investment in this area, and we believe that sustaining this investment will produce results as economic expansion returns. Here are a couple of examples.

First, we are pursuing larger equipment and services opportunities. Over the past two years, we have announced the largest equipment deal and two of the largest service wins in the company's history. Our performance levels are creating additional opportunities to support our current customers and partners as well as creating opportunities to create net new business. Clearly, we are building momentum with this strategy and as I said earlier, we are pursuing more opportunities of significant size.

Second, larger deals require a longer sales cycle. Sales cycles for larger opportunities can be as long as 12 to 18 months. By maintaining our marketing muscle, we have made progress in building a large pipeline of revenue opportunities. We will be able to generate a fast start and capitalize on these opportunities as conditions improve.

Finally, the downturn in IT spending is providing us a greater opportunity to take market share. There is less competition in the marketplace as weaker competitors find it challenging to finance their businesses. Our wholesale partners are also more willing to outsource as they focus on their core operations.

Now I'll talk a little bit about the changes that we are making to improve efficiencies in our service organization. With the exception of the profitability as Robert mentioned of our implementation services, which are obviously impacted by lower equipment sales, all of our service categories showed improvement in profitability during the third quarter.

Greater utilization and productivity are key drivers to improving profitability in this revenue category. To accomplish this, we have modified our service contracts, focusing on extending the duration of our agreements. On larger contracts, we are securing three to five-year agreements allowing us to improve utilization by better matching resources to revenue.

We are also centralizing some administrative functions in order for our field staff to spend more time working with the customer and less time filling out paperwork. We have also reorganized the field management structure of the services organization. We have empowered employees to make decisions to increase efficiencies and to improve the customer experience.

In addition, we have created selling incentives for our field level personnel who generally are the most customer-facing part of our organization. We are also in process of adding P&L responsibility to field level service managers, which will create a revenue performance expectation in addition to a focus on cost. We are emphasizing an Everyone Sells culture. We expect to see significant improvements in productivity.

We have also added additional resources that will increase the level of business intelligence and maximize the investment we have made in the Oracle ERP system. Not only will these initiatives help drive efficiency, they will also allow us to continue to provide world class service to our customers. For example, we achieved a 99.8% satisfaction rate for the thousands of service tickets we completed with one of our major managed service partners during the quarter.

Before I move to my comments about the outlook for the rest of the year, I'll give you a quick update on the situation with Nortel, one of our major manufacturers and wholesale partners. Nortel announced that it has put its Enterprise business up for sale. Avaya has secured a stalking horse position with this business.

The auction is scheduled to be held September 11th. Regardless of the successful bidder, we are well-positioned to benefit from the conclusion of this sale. Strong channel partners like XETA will be key to the new owner's success, communicating an integration strategy and reassuring Nortel customers that their investment in Nortel technology will continue to be supportive. This will be a market distraction for the acquiring company, and they will be looking for channel partners such as XETA for support.

XETA is uniquely positioned as a vendor with the highest level of certification with both Nortel and Avaya, and can leverage this position during the integration period. Nortel owns about 1/3 of the install base of the voice lines in North America. This installed base represents a significant investment by organizations and is a mission critical part of their operations.

We have been very successful at gaining market share within the installed base and we believe the disruption being caused by this process is creating an attractive opportunity for us to accelerate our growth.

Now for our outlook, we have begun to see signs of increased customer activity over the last 30 days, and our average daily bookings have improved since hitting a multi-year low in June. We expect our system business will continue to face a difficult IT spending environment and difficult comparisons with our prior year.

We have taken appropriate measures to deliver profitability in the fourth quarter and for fiscal 2009. Our service business continues to grow and should help to partially offset anticipated weakness in the equipment side of our business.

For 2010, we are well-positioned financially, operationally and strategically to take market share and outperform our peers. We have reduced our operating expenses by more than $1 million and our profitability should benefit from the shift to higher margin service revenue. We are also gaining momentum with several large equipment and service projects that should provide significant revenue growth for next year.

In closing, we are confident in our ability to manage our business through these uncertainties. We are focusing on things we can control. More specifically, maintaining a strong balance sheet and taking market share. When the economy turns, we believe we will be in an even better position to accelerate our growth and deliver strong profitability and returns to our shareholders. This concludes my comments.

Joe, we're ready for questions.

Question-and-Answer Session

Operator

(Operator Instructions). Our first question is from Larry Hutchin with Adams Hall Asset Management. Please go ahead.

Larry Hutchin - Adam Paul Asset Management

Greg, how many shares has the company repurchased under the repurchase plan that was announced last October?

Greg Forrest

We're in the 25,000 share range since we launched it. It's not a big number, but it's 25,000.

Larry Hutchin - Adam Paul Asset Management

Okay. I think that was about a $950,000 repurchase program. Is that correct?

Greg Forrest

Yes.

Larry Hutchin - Adam Paul Asset Management

Yes. You know, the Board of Directors elected to do one of these things for 1 million shares in October of 2006 and bought no stock or very little stock in fiscal 2007 and the Board of Directors announced approval of this other plan in October of 2008 and you've bought 25,000, as you said, a very insignificant amount of shares.

Maybe I don't know what you paid for it, but maybe 1/10th of the money has been spent. When are they going to figure out this doesn't work? I mean there is too many rules and regulations to follow and buying the stock in the open market given the ill liquidity of XETA, and if the Board of Directors is really serious about repurchasing the stock. Of course this is just strictly my opinion. Perhaps they ought to do a tender offer to give us some degree of liquidity. I can't see that the Board of Directors is anything for the shareholders at all.

Once again, as I've told you many times, I think we ought to be a dark company, XETA being a publicly traded company, we fly way under the radar, it's very expensive to be public, takes a bunch of the CEO's time. If we were dark, the company no longer would have to file 10-K, 8-Ks, only a 10-K would be required. You wouldn't be subject to Sarbanes-Oxley. You wouldn't have to deal with potential investor meetings and you wouldn't have to worry about quarterly performance or annual guidance issues.

The representative of the transfer agent that was at your April shareholders meeting told me straight up that it would cost about $5,000 just to find out exactly how many shareholders you have and I realized the stock is held in a street name under that one nominee kind of clouds the issues, but for $5,000 if the Board of Directors could find out exactly how many shareholders we have instead of guesstimating in the annual report that we have 2,000. I think it would be kind of nice to know, heck, we may be under 300 shareholders right now for all I know.

By remaining a fully reporting publicly trading company I think the Board of Directors is causing the shareholders to spend money that's unnecessary. I think we're just fooling ourselves. XETA is extremely small, back in August of 2007, a little over two years ago, you put forth some pretty aggressive plans and I think you could achieve those plans and it's very possible that the stock would do nothing just because no one cares about it. And we need to recognize that.

I know, you can't use it as a currency in acquisitions, the stock's trading at about a third of revenues. And, you know, the acquisition thing, we've gone through almost a year now of a huge credit crunch and I would think if you're ever going to make any acquisitions, this would be the time. I think acquisitions are probably a mute point. And every time I make an investment, especially in XETA, I've got an exit strategy. And I don't know what the Board of Directors exit strategy is for XETA, but if they don't have one, boy, we got a real problem.

Anyway, those are just opinions. Those aren't really any questions that need to be answered. I'm more concerned about the expiration. This is probably for Robert, the expiration on September 29th of the Bank of Oklahoma arrangement. How are the negotiations going there, Robert?

Robert Wagner

They're good. We create a competitive environment, and as I alluded in my comments, we laid out a framework that we knew was ahead of where the market is today. We want to signal the banks what we were thinking about for the future, and we had a good mix, of course BOK is in the mix. We had a good mix of some of the local players, as well as some national players, and have gotten good feedback. I’ve received one-term [sheet] back so far, which is probably a doable deal the way it is, in terms of more or less an extension of where we are today. So I'm confident we'll get something done. It will be higher priced, but that's where the market is.

Operator

The next question is from [Brian Qualcheck] with Patel Capital Management. Please go ahead.

Brian Qualcheck - Patel Capital Management

Greg, wondering if you could provide a little bit more color. You said something I think is interesting, I would like to kind of drill into that a little bit. Talk a little bit more if you could about the increasing activity that you've seen in the last 30 days, and I think you said it was a continuation of the quarterly trend. So, it sounds like the linearity within the quarter got better and then for the last three days including up until so far August has gotten better. Help us understand a little bit what you're seeing out there?

Greg Forrest

Well, we are seeing both volume and size. So, the number of deals seem to be a little deeper. The quality of the deals seems to be a little bit higher and the value is a little greater. So when I ask for commits by our sales organization, that's the characteristic of these commits now. And again, it's awful early to call some recovery, right? But it's better news than bad news. And it seems to be across multiple industries. As I mentioned earlier, there's energy and professional services and our contact customers, so it seems to be broad.

In addition, it's not only recurring business, but we're getting some net new activity. So, those are all pretty good signs. And this is primarily targeted towards our equipment business, which is in dramatic need of a fairly significant turnaround. And we've had some consistent growth in activity in our Services business. So again, it's awful early to call some recovery internally, but it's more encouraging than discouraging.

Brian Qualcheck - Patel Capital Management

Thanks. Also, you mentioned that or I see and you mentioned that there's been obviously a nice sequential increase in your services. Is that a trend that you would expect to continue, given that we should get a full quarter's benefit of these new contracts?

Greg Forrest

We should and you know, that would be an expectation. Generally this time of the year, seasonality-wise, should be more active. And the nature of that business, the profile of that business is recurring at very good run rates and increase towards the end of the year. So we don't anticipate the significant amount of attrition that we experienced earlier in the year. So we're hopeful.

Brian Qualcheck - Patel Capital Management

Very good, and maybe a little bit on the new government opportunities that you're pursuing. I think you said that you're pursuing a couple or several, even seven to eight figure deals. These are also on the E-rate, kind of education space, or it was separate from education I think. Maybe help me understand what the new government opportunities are.

Greg Forrest

Yeah, we're getting a lot of activity with our new wholesale service partner, Lockheed Martin. As we get more comfortable with that relationship, they get more comfortable with us. Seven figures is not that big of a deal to a Lockheed Martin. So we are seeing more of those. We are seeing direct government deals with our legacy customers. We are also seeing quite a bit of E-Rate activity. This is the E-Rate buying season. Now, with that the E-Rate funding did come later this year. So the cycle in which we start to book that revenue and then actually build the revenue is a little bit later. So we anticipate some booking opportunity in the fourth quarter in, normal rhythms would move to revenue in the first quarter.

Operator

(Operator Instructions) Next question is from [Chad McCarty with Modern Capital]. Please state your question.

Chad McCarty - Modern Capital

Well, without getting up on a soap box too much here, with reference to some of the last caller's comments, as one of the largest shareholder groups we have no interest in seeing the company go dark or private. So I'll just leave that be. I was curious if with all of the events surrounding Nortel, are you guys seeing customers moving away from them? Are you seeing customers express any concern about future support of their equipment?

How is it affecting your sales? How is it affecting your service business? I know you grew your service business at 8%, sales are off, I mean that's just probably largely due to the economy itself but I'm just curious if you could elaborate a little bit more on how the Nortel situation is affecting your business and if there is any more I guess color that you can shed on or maybe the shifts that you're making in your business to compensate for it?

Greg Forrest

Sure. I have personally been on a couple Nortel equipment opportunities, on customer calls and have talked to them about our position with Nortel and tried to create some accuracy in not a comfort level, but just some accuracy and information as to what we’re interested in.

First of all, if you look at why someone would acquire Nortel. They are acquiring Nortel for purposes of market share. So any integration plan is going to target the benefit of the customer which is not owned by Nortel, which is owned by the channel. So Nortel or the acquirer, say, if it's Avaya, needs to make sure that the customer base is comfortable with their go-forwards; how they're going to support the equipment, how are they going to evergreen it, is it going to be some step play?

So, from my perspective and as reflecting some of the customer conversations I've had, they are on the sidelines. They are not making significant buying decisions right now because they do want to wait and see how this thing is going to shake out. But I can tell you, and what I told the customers is that the acquirer is very interested in securing their wallet.

So, they are going to do everything they can to make sure there is ongoing support and a comfort level to make sure that the investment that they had made previously and are about ready to make is supported into some reasonable future period. So that's what we're seeing.

The decline in our systems business is across the Board, but yet from a percentage perspective, the Nortel business line has depreciated faster than Avaya, but yet is also a smaller percentage of our overall equipment revenue. Does that kind of cover what you wanted me to cover?

Chad McCarty - Modern Capital

Yeah, I think so. I also had heard some rumors that Avaya is kind of changing their go-to-market strategy with how they deal with their channel partners. Can you kind of -- are you seeing some changes in the way Avaya approaches the market and…

Greg Forrest

Well, I can give you the conversations we have, and again, we are part of their council, which is I think it's about three, four national partners, we are one of the three, four national partners of a council that I believe that are 15 [partners] deep. So, we are at the table with these guys.

Their message to the channel is that they are moving to a channel-centric organization. So what does that mean? That does not mean that they're taking their direct business and moving it to the channel. What that means is the focus on net new business is primarily driven to the channel. So, their growth will be a greater percentage of a channel-centric model than a direct model.

Have we seen that behavior? I believe we have. But also gets back to who is doing a lot of net new business right now. Not a lot of people. But, you know, I feel confident that they are supporting our initiatives and we have very good support from Avaya. I mean, that was a large success in our Miami-Dade relationship, is the success that we had with the relationship with Avaya. So, we've got a number of accounts that we partner on and they've been true to their message.

Chad McCarty - Modern Capital

Okay. Brian already covered the education sector question I was going to ask, so that's all I had.

Operator

There are no further questions in queue. I'd like to turn the call back over to management for closing remarks.

Greg Forrest

Well, take it Dave.

Dave Mossberg

Thanks, Joe. Thanks everyone for joining us on the call. Feel free to give us a call if you have any questions.

Operator

Thank you. This concludes the teleconference. You may disconnect your lines. Thank you for your participation.

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Source: XETA Technologies Inc. F3Q09 (Qtr End 07/31/09) Earnings Call Transcript

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