The following discussion of the financial condition and results of operations should be read in conjunction with our Consolidated Financial Statements and related Notes included elsewhere in this report. This section also contains forward-looking statements and is subject to the "Disclosure Regarding Forward-Looking Statements" in Part I of this report.

2008 versus 2007 - Results of Operations

Revenues grew 16% for the year ended December 31, 2008 to $47,728,669 from $40,860,461 during the year ended December 31, 2007. This increase is primarily due to our organic growth resulting from increased sales headcount and our increased marketing efforts. In addition, the businesses we acquired subsequent to January 1, 2007 contributed to the year over year increases in revenues and expenses for the year ended December 31, 2008, as follows:

[[Image Removed]]   [[Image Removed]]       [[Image Removed]]     [[Image Removed]]
                           Date of              Additional            Additional
Acquired Business        Acquisition          Contribution to        Contribution
                                                 Revenues             to Expenses
DBA                     March 1, 2007       $         379,050     $         468,038
PS GoLive             November 25, 2008     $         146,856     $         167,855
                                            $         525,906     $         635,893

Costs of revenues increased 11% to $32,936,179 during the year ended December 31, 2008, versus $29,770,639 for the prior year. This increase was primarily attributed to our growth in organic revenue, and also reflected the costs associated with the operations of DBA and PS GoLive. Gross margins in fiscal 2008 increased to 30.7% of revenues from 27.1% in fiscal 2007.

In an effort to grow our revenues, selling and marketing expenses increased by $948,099, or 19%, to $5,835,123 for the year ended December 31, 2008, as compared with $4,887,024 for 2007. We believe the increase in our marketing efforts over the past three years has been instrumental in fueling our organic revenue growth and the improved performance of our acquired companies.

General and administrative expenses for the year ended December 31, 2008, were $8,177,276 as compared with $7,240,060 during 2007, representing an increase of $937,216 or 13%. This increase in general and administrative costs is primarily related to compensation cost including costs related to the PDI disposition and professional fees related to investor relations and other services. Depreciation and amortization expense for the twelve months ended December 31, 2008 increased to $829,901 from $741,708 in 2007. These increases were slightly offset by reductions in stock based compensation and rent expense.

Consolidated Net(Loss)/Income

On a consolidated basis, the increase in operating expenses partly offset the effect of the increases in revenue resulting in an operating gain of $780,091 for the year ended December 31, 2008, as compared to an operating loss of $1,037,262 for the year ended December 31, 2007.

Net interest expense for the year was $1,493,082 compared to $1,824,338 in 2007. The decrease was attributable to a decrease in borrowings in 2008 versus 2007 resulting from the pay down of debt as a result of the PDI transaction. Our interest expense was also lower because of the decrease of the prime rate in 2008 versus 2007.

Our loss from continuing operations before income taxes was $712,991 for the year ended December 31, 2008, as compared to a loss from continuing operations of $2,861,600 for the year ended December 31, 2007.

We recorded an income tax provision of $162,153 for the year ended December 31, 2008, compared to a benefit of $59,758 for 2007.

Loss from the discontinued operations of PDI net of tax was $285,919 for the year ended December 31, 2008 as compared to income from discontinued operation of $365,124 for the year ended December 31, 2007. In addition, we recorded a $1,932,913 gain on the sale of PDI for the year ended December 31, 2008. The Company tax basis exceeds the gain and therefore there is no tax effect. PDI was classified as a discontinued operation in the fourth quarter of 2007 and sold in the first quarter of 2008.

Critical Accounting Policies and Significant Use of Estimates in the Company's Financial Statements

In many cases, the accounting treatment of a particular transaction in conformity with GAAP is specifically dictated, with little or no need for management's judgment in their application. There are also areas in which management's judgment in selecting any available alternative would not produce a materially different result.

However, the preparation of GAAP financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Critical accounting policies are those that require application of management's most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain and may change in subsequent periods.

The following discussion reviews the critical accounting policies and items incorporated in the Company's financial statements that required the use of significant management estimates. The following listing is not intended to be a comprehensive list of all of Zanett's accounting policies. The Company's significant accounting policies are more fully described in Note 2 to the Consolidated Financial Statements.

The Company has identified revenue recognition, stock based compensation, purchase accounting, and the evaluation of the carrying value of goodwill and other intangibles as critical accounting policies of the Company.

Revenue Recognition

The Company earns revenue primarily from IT professional services.

Revenues from contracts for consulting services with fees based on time and materials or cost-plus are recognized as the services are performed and amounts are earned in accordance with SEC Staff Accounting Bulletin No. 101 ("SAB 101"), "Revenue Recognition in Financial Statements," as amended by SAB 104, "Revenue Recognition." We consider revenue to be earned once evidence of an arrangement has been obtained, services are delivered, fees are fixed or determinable, and payment is reasonably assured. Revenues from fixed-fee contracts for professional services are recognized using contract accounting based on the estimated percentage of completion. The percentage of completion for each contract is determined based on the ratio of costs incurred to a current estimate of total project costs since management believes this reflects the extent of contract completion. Changes in estimated costs during the course of a fixed fee contract are reflected in the period in which such facts become known. If such changes indicate that a loss may be realized on a contract, the entire loss is recorded at such time.

On occasion, certain contracts may have substantive customer acceptance provisions. In such cases, revenue is recognized upon receipt of acceptance from the customer.

Out-of-pocket expenses incurred during the performance of professional service contracts are included in costs of revenues and any amounts re-invoiced to customers are included in revenue during the period in which they are incurred.

Unbilled revenue represents revenue for which services have been performed and costs incurred that have not yet been invoiced to the customer.

Stock-Based Compensation

The Company has entered into several transactions involving the issuance of shares of restricted Common Stock and options to purchase shares of restricted Common Stock to independent contractors. The issuance of these securities required management to estimate their value using the Black-Scholes option-pricing model. The Black-Scholes option-pricing model requires management to make certain estimates for values of variables used by the model. Management estimated the values for stock price volatility, the expected life of the

Purchase Accounting

In connection with its acquisitions, the Company allocates the total acquisition costs to all tangible and intangible assets acquired and all liabilities assumed, with the excess purchase price recorded to goodwill. To arrive at the allocation of the total purchase price, management makes certain assumptions in estimating the fair market value of the acquired companies' tangible assets, intangible assets (such as customer lists, and long term contracts) and liabilities.

Evaluating the Carrying Value of Goodwill

Goodwill is evaluated for impairment at least annually and whenever events or circumstances indicate impairment may have occurred. The assessment requires the comparison of the estimated fair value of each of the Company's reporting units to the carrying value of their respective net assets, including allocated goodwill. If the carrying value of the reporting unit exceeds its fair value, the Company must perform a second test to measure the amount of impairment. The second step of the goodwill impairment test compares the implied fair value of reporting unit goodwill with the carrying amount of that goodwill. The Company allocates the fair value of a reporting unit to all of the assets and liabilities of that unit as if the reporting unit had been acquired in a business combination and the fair value of the reporting unit was the price paid to acquire the reporting unit. The excess of the fair value of a reporting unit over the amounts assigned to its assets and liabilities is the implied fair value of goodwill. If the carrying amount of the reporting unit goodwill exceeds the implied fair value of that goodwill, an impairment loss is recognized by the Company in an amount equal to that excess. The estimation of fair values of each reporting unit is based on assumptions and estimates prepared by management which are highly subjective.

Intangibles and Long-Lived Assets

Intangibles and long-lived assets are stated at cost, less accumulated amortization, which is provided for by charges to income on a basis consistent with the utilization of the assets over their useful lives. The carrying value of intangible and long-lived assets is reviewed periodically by the Company for the existence of facts or circumstances that may suggest impairment. If such circumstances exist, the Company estimates the future; undiscounted cash flows associated with the asset, and compare that to the carrying value. If the carrying value exceeds the estimated cash flows, the asset is written down to its estimated fair value. The cost of intangibles is based on the estimated fair values calculated as of the date of acquisition of the related company. Such estimates are based on highly subjective estimates made by management.

Liquidity and Capital Resources

At December 31, 2008 we had cash and cash equivalents of $450,304 representing a decrease of $810,761 from the December 31, 2007 year-end balance of $1,261,065. This decrease was primarily a result of paying down our loan balances.

Cash provided by operating activities was $311,156 for the year ended December 31,2008 compared to cash used in operating activities of $613,290 in 2007. The increase in cash provided by operating activities was primarily due to improvements in our operating results and a decrease in accounts receivable as a result of our revenue growth, offset by a reduction in accounts payable.

Cash provided by investing activities was $6,005,221 for the year ended December 31, 2008 compared to cash used in investing activities of $2,516,486 in 2007. The 2008 inflow primarily reflected net proceeds of $7,848,964 for the PDI acquisition, which was partially offset by the additions to property and equipment of $719,576, cash paid for acquisitions of $397,120 as well as $727,047 of contingent consideration paid in 2008.

Cash used in financing activities for the year ended December 31, 2008 was $7,127,138 versus cash provided of $3,813,659 in 2007. This activity in 2008 included approximately $7,300,000 of loan repayments resulting from the PDI transaction and cash generated from improved operations.

In March 2008 the Company sold the outstanding common stock of PDI for cash to KOR Electronics. This transaction resulted in a cash payment of $8.7 million with a holdback amount of $875,000 that was paid

On December 31, 2006 we entered into a revolving credit facility with LaSalle Bank National Associations ("LaSalle"). The agreement was amended on May 31, 2007 and November 14, 2007. As amended, the available line of credit was based on 80% of eligible accounts receivable up to a maximum of $8 million. The line of credit with LaSalle was further amended on March 18, 2008 at the time of the sale of PDI. The Company paid down $5,700,000 at the time of the amendment.

On January 22, 2009, the Company and ZCS entered into a Fifth Amendment and Modification to Loan and Security Agreement and Other Loan Documents with Bank of America, N.A., as successor-by-merger to LaSalle. The amendment increases the maximum revolving loan limit to $6 million from $5 million and modifies the fixed charge coverage ratio test required by the loan agreement. As amended, the loan agreement requires the borrowers to maintain a fixed charge coverage ratio of not less than 1.25 to 1.0 for the twelve month period ended on December 31, 2008 and each twelve month period ending on the last day of each fiscal quarter thereafter. In addition, the loan agreement also waives the EBITDA covenant for the November 2008 calendar month and terminates the EBITDA covenant as of the date of the amendment. Further, the amendment raises the face amount of the borrowers' eligible accounts receivable from 60% to 80%. At March 24, 2009, the outstanding loan balance was $4,618,780 with available borrowings of $815,102. The loan has an expiration date of December 21, 2009.

[[Image Removed]]                                                [[Image Removed]]
Notes to Related Party                                                  2008
Notes payable to principal shareholder, 11% interest,
quarterly interest payments,                                     $       4,575,000
matures March 15, 2010
Line of credit payable to principal shareholder, 15% interest,
quarterly interest payments,                                             1,027,322
matures March 15, 2010
Notes payable to principal shareholder, 11% interest,
quarterly interest payments,                                               750,000
matures March 15, 2010
Total related party debt                                         $       6,352,322

On March 14, 2006, the Company issued a promissory note in the amount of $500,000 to Bruno Guazzoni with a maturity date of May 31, 2007. On March 15, 2006, the Company issued another promissory note in the amount of $500,000 to Bruno Guazzoni, originally with a maturity date of January 2, 2007, which was extended in the same month to May 31, 2007. Both notes required quarterly cash interest payments at the rate of fifteen percent (15%) per annum, with principal repayable in cash at maturity. Both notes were repaid in full in March 2008 with the proceeds from the PDI disposition.

On December 30, 2005, ZCS issued a promissory note in the amount of $500,000 to Bruno Guazzoni with an original maturity date of January 2, 2007, which was subsequently extended first to May 31, 2007 and then to March 1, 2009. This note required quarterly interest payments at the rate of fifteen percent (15%) per annum, with principal repayable in cash at maturity. This note was repaid in full in March 2008 with the proceeds from the PDI disposition.

On October 1, 2003, PDI issued a promissory note to Emral Holdings Limited in the amount of $1,500,000 with an original maturity date of January 2, 2007, which was subsequently extended first to May 31, 2007 and then to March 1, 2009. This note was repaid in full in March 2008 with the proceeds from the PDI disposition.

On February 21, 2007, ZCS entered into a new, unsecured promissory note in an aggregate principal amount of $750,000, with Bruno Guazzoni. This note has a maturity date of March 15, 2010 (extended from February 21, 2009) and requires quarterly payments of interest at the rate of eleven percent (11%) per annum. Principal is repayable at maturity. The note may be pre-paid without penalty. The proceeds of this note were used to fund the cash portion of consideration paid at closing for the acquisition of the DBA Group.

On March 15, 2007, the Company and our operating subsidiaries replaced four other existing promissory notes that had been issued to Bruno Guazzoni in the aggregate principal amount of $6,575,000 with notes containing identical terms except for the extension of the maturity dates to March 15, 2010. As of December 31, 2008 the aggregate principal amount was $4,575,000.

Management will continue to monitor the Company's cash position carefully and evaluate its future operating cash requirements with respect to its strategy, business objectives and performance. However, due to scheduled debt maturity the Company requires additional capital or other sources of financing in order to meet its commitments. If necessary we will explore other sources of capital, to fund future acquisitions and provide additional working capital. We are also exploring other opportunities that may be available to maximize the Company's value for its stockholders, including strategic transactions. As a result of the extraordinary tightening of the credit and equity markets, it may be difficult for us to secure such additional liquidity sources on favorable terms or at all. If we cannot secure additional funding, we will be unable to finance our acquisition strategy and/or continue our organic growth. Further, due to the recent trading price of our common stock and the possibility of NASDAQ delisting our common stock if we do not regain compliance with minimum listing standards of The NASDAQ Capital Market, completion of a financing could be more difficult and could result in dilution to the ownership interests of existing stockholders.

To further minimize cash outlays, we expect to continue to supplement compensation for both existing and new employees with equity incentives where possible. We believe that this strategy provides the ability to increase stockholder value, as well as utilize cash resources more effectively. To support this strategy, the stockholders of the Company, at its annual meeting in June 2005, approved an amendment to the Zanett, Inc. Incentive Stock Plan ("Stock Plan") that increased the number of equity securities that can be issued under the plan from 1,750,000 shares to 2,500,000 shares. While this increase allows us greater flexibility in its use of stock based compensation, the issuance of equity securities under the Stock Plan may result in dilution to existing stockholders. Moreover, if we are unable to regain compliance with NASDAQ's minimum listing requirements, we will be unable to continue this compensation practice.

The Company's Board of Directors reauthorized a stock repurchase plan effective March 21, 2008 that allows us to repurchase up to 4,000,000 shares of our Common Stock from time to time in open market transactions. Under the Company's previous stock repurchase plan, as of December 31, 2008, we had repurchased 14,915 shares of our Common Stock at a cost of $179,015. None of these shares were repurchased in 2008 or 2007. These shares are reflected as treasury stock on the accompanying Consolidated Balance Sheets.

The Company enters into many contractual and commercial undertakings during the normal course of business. Also, all of our acquisitions were structured with additional contingent purchase price obligations that may be payable if the subsidiaries achieve certain annual performance requirements.

The Company's liquidity could also be impacted by its concentration of credit risk associated with its bank accounts and accounts receivable, as follows:

- We maintain our cash balances and money-market instruments with three separate institutions which we believe are of high credit quality to minimize our exposure. However, these deposits are subject to Federal Deposit Insurance limits.

- We believe that any credit risk associated with our receivables is minimal due to the size and credit worthiness of our customers, which are principally large domestic corporations. However, the uncertainty of the current economic climate affects our level of assurance regarding any of our customers' financial well-being. During 2008, no one customer accounted for more than 7% of revenues. During 2007, one customer accounted for approximately 8% of revenues. At December 31, 2008 and December 31, 2007, the Company did not have a customer account that accounted for over 11% of accounts receivable.

The company has no off-balance sheet arrangements.

Inflation

Inflation has not had a significant impact on our results of operations.

Recent Accounting Pronouncements

Effective January 1, 2008, the Company adopted SFAS No. 157, "Fair Value Measurements". In February 2008, the FASB issued FASB Staff Position No. FAS 157-2, "Effective Date of FASB Statement No. 157", which provides a one year deferral of the effective date of SFAS 157 for non-financial assets and non-financial liabilities, except those that are recognized or disclosed in the financial statements at fair value at least annually. Therefore, the Company has adopted the provisions of SFAS 157 with respect to its financial assets and liabilities only. SFAS 157 defines fair value, establishes a framework for measuring fair value under generally accepted accounting principles and enhances disclosures about fair value measurements. Fair value is defined under SFAS 157 as the exchange price that would be received for and asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Valuation techniques used to measure fair value under SFAS 157 must maximize the use of observable inputs and minimize the use of unobservable inputs. The standard describes a fair value hierarchy based on three levels of inputs, of which the first two are considered observable and the last unobservable, that may be used to measure fair value which are the following:

Level 1 - Quoted prices in active markets for identical assets or liabilities.

Level 2 - Inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets of liabilities.

Level 3 - Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.

The adoption of this Statement did not have a material impact on the Company's consolidated results of operations and financial condition.

In May 2008, the FASB issued Statement No. 162, The Hierarchy of Generally Accepted Accounting Principles ("Statement No. 162"). The statement is intended to improve financial reporting by identifying a consistent hierarchy for selecting accounting principles to be used in preparing financial statements that are presented in conformity with GAAP. Prior to the issuance of Statement No. 162, GAAP hierarchy was defined in the American Institute of Certified Public Accountants ("AICPA") Statement on Auditing Standards (SAS) No. 69, The Meaning of Present Fairly in Conformity With Generally Accepted Accounting Principles. Unlike SAS No. 69, Statement No. 162 is directed to the entity rather than the auditor. Statement No. 162 is effective 60 days following the SEC's approval of the Public Company Accounting Oversight Board Auditing amendments to AU Section 411, The Meaning of Present Fairly in Conformity with Generally Accepted Accounting Principles. Statement No. 162 is not expected to have any material impact on the Company's results of operations, financial condition or liquidity.

In December 2007, the FASB issued Statement of Financial Accounting Standards No. 141R, "Business Combination" (SFAS 141R). This standard establishes principles and requirements for the reporting entity in a business combination, including recognition and measurement in the financial statements of the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree. This statement also establishes disclosure requirements to enable financial statement users to evaluate the nature and financial effects of the business combination. SFAS 141R is effective for fiscal years beginning on or after December 15, 2008. The impact of adopting SFAS 141R will be dependent on the future business combinations that the Company may pursue after its effective date.