Summary of ZANETT INC - Yahoo! Finance

Item 2 - Management's Discussion and Analysis of Financial Condition and Results of Operations

This report contains certain forward-looking statements and information relating to Zanett and its wholly-owned subsidiaries that are based on assumptions made by management and on information currently available. When used in this report, the words "anticipate", "believe", "estimate", "expect", "intend", "plan" and similar expressions, as they relate to the Company or its management, are intended to identify forward-looking statements. These statements reflect management's current view of the Company concerning future events and are subject to certain risks, uncertainties and assumptions, including among many others: a further or prolonged general economic downturn; a further or prolonged downturn in the securities markets; federal or state laws or regulations having an adverse effect on the Company; and other risks and uncertainties. Please see Item 1A of the Company's Form 10-K for the year ended December 31, 2008 for a discussion of important risk factors that relate to the forward looking statements in this report. Should any of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results may vary materially from those described in this report as anticipated, estimated or expected.

The following discussion should be read in conjunction with Zanett's audited Consolidated Financial Statements and related Notes thereto included in its Annual Report on Form 10-K for the year ended December 31, 2008, as amended, as filed with the Securities and Exchange Commission.

Overview

Zanett is an information technology ("IT") company that provides customized, mission-critical IT solutions to Fortune 500 corporations and mid-market companies. Its overarching mission is to provide custom solutions that exceed client expectations, are delivered on time and within budget, and achieve superior results.

Three months ended March 31, 2009 versus 2008

In the first quarter ended March 31, 2009, we generated revenues of $10,959,853, a decrease of 11.48% over the $12,381,092 generated in the first quarter of 2008. This decrease in revenue was attributable primarily to the continued weakening of the economy and decreased demand in the IT industry.

As a consequence of the decrease in revenue in the first quarter of 2009 compared to the first quarter of 2008 costs of revenues decreased 10.21% as compared to the prior year period.

Our selling and marketing expense was $1,618,774 for the quarter ended March 31, 2009, as compared with $1,329,042 during the quarter ended March 31, 2008. This change resulted from an increase in bad debt expense for the quarter ended March 31, 2009 of $336,669 compared to the same period in 2008, primarily relating to accounts receivable for two customers that filed for protection under Chapter 11 of the United States Bankruptcy Code. In addition to the increase in bad debt we continue to invest in our marketing activities; this investment rose slightly in the first quarter of 2009 compared to the first quarter of 2008.

General and administrative expenses for the first quarter of 2009 were $1,886,528 as compared to $2,431,909 in the first quarter of 2008, representing a decrease of $545,381, or 22%. This decrease results from the absence in 2009 of one time expenses incurred in 2008 related to the sale of PDI. Without these one time charges, general and administrative expenses for 2009 and 2008 remained level in the first quarter of 2009 compared to the first quarter of 2008.

For the reasons discussed above, our operating loss in the first quarter of 2009 was $193,585, compared to our operating income of $102,362 in the comparable prior year period.

Net interest expense decreased $119,950, or 27%, to $327,488 in the quarter ended March 31, 2009 from $447,438 in the quarter ended March 31, 2008. This resulted from a decrease in working capital borrowings and a decrease in other borrowings that were repaid with the proceeds from to the PDI transactions.

On a consolidated basis, the effect of the increases and decreases in revenue and the components of operating expenses discussed above resulted in a loss from continuing operations of $555,209 for the quarter ended March 31, 2009 compared to a loss from continuing operations of $387,018 for the comparable period last year. This greater loss from continuing operations for the period was due largely to the decrease in revenue which was partially offset by a decrease in general and administrative costs.

In the first quarter of 2009, we recorded an income tax provision of $34,136 versus a provision of $41,942 in the same quarter last year.

We account for income taxes in accordance with SFAS No. 109, "Accounting for Income Taxes" ("SFAS 109"). Under SFAS 109, deferred tax assets and liabilities are determined based on differences between the financial reporting and tax basis of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. A valuation allowance is provided when it is more likely than not that some portion or all of the deferred tax assets will not be realized. In determining the need for a valuation allowance, management reviews both positive and negative evidence pursuant to the requirements of SFAS 109, including current and historical results of operations, future income projections and the overall prospects of the our business. Based upon management's assessment of all available evidence, we have provided valuation allowances to offset our deferred tax assets due to the significant uncertainties related to our ability to generate future taxable income.

In addition we recorded a $887,500 gain on the sale of PDI in the quarter ended March 31, 2009.

Loss from the discontinued operations of PDI net of tax was $285,919 for the three months ended March 31, 2008. In addition, we recorded a $1,932,913 gain on the sale of PDI in the quarter ended March 31, 2008. The Company's 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.

As a result of the above, for the quarter ended March 31, 2009, we reported net income of $332,291 compared to net income of $1,259,976 for the quarter ended March 31, 2008.

Summary of Critical Accounting Policies; Significant Judgments and Estimates

There were no changes to our critical accounting policies, which are described in our Annual Report on Form 10-K for the year ended December 31, 2008, during the first three months of 2009. Items incorporated in the Company's financial statements that required the significant use of management estimates include the allowance for doubtful accounts, revenue recognition, stock based compensation, purchase accounting and the evaluation of the carrying value of goodwill.

Liquidity and Capital Resources

At March 31, 2009 we had cash and cash equivalents of $52,971, representing a decrease of $397,333 from the December 31, 2008 year-end balance of $450,304.

Cash used in operating activities was $933,323 for the three months ended March 31, 2009 compared to cash used in operating activities of $800,311 for the same period last year. The cash used in operating activity of $933,323 for the three months ended March 31, 2009 was primarily due to an increase in accounts receivable, which was partially offset by a increase in accounts payable and accrued expenses.

Cash provided by investing activities was $540,834 for the quarter ended March 31, 2009 compared to cash provided of $7,558,379 for the corresponding period in 2008. The 2008 inflow primarily reflected proceeds of $8,092,758 for the PDI acquisition. In 2009 we received net cash from the sale of PDI of $720,833 and had additions to property and equipment of $128,070 as well as $72,644 of contingent consideration paid in 2009.

Cash used in financing activities for the three months ended March 31, 2009 was $4,844 versus $7,922,427 for the same period in 2008. This difference results from the March 2008 repayment of approximately $8,000,000 of loans with the proceeds from the PDI disposition.

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 March 17, 2009. With the proceeds from this transaction, the Company repaid in full promissory notes in an aggregate principal amount of $3,000,000 owing to Bruno Guazzoni (described below) and approximately $5,000,000 of short term debt. The Company believes that the existing working capital is more than sufficient to cover its day to day needs.

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 $1.7 million. The loan has an expiration date of December 21, 2009.

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.

In addition to the notes that were repaid, the Company has a line of credit agreement with Bruno Guazzoni in the amount of $3,000,000. The interest rate on the line of credit is prime plus two percent [2%]. This line is available for working capital requirements and is unrestricted. The line has a maturity date of March 15, 2010. As of March 31, 2009 this line has an outstanding balance of $1,027,322.

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, 2009, ZCS replaced two promissory notes, one for $1,500,000 and the other for $3,075,000, both entered into on December 30, 2005 with Bruno Guazzoni, with a combined promissory note for $4,575,000 having a maturity date of March 15, 2010. This new note requires quarterly payments of interest at the rate of eleven percent (11%) per annum. Principal is repayable at maturity. The note may be prepaid without penalty.

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. At this time the Company is in discussions to refinance both the related party and Bank of America debts. At this time the Company is in discussion to refinance both the related party and Bank of America debts both of which are due within one year and are classified as current liabilities. However, there can be no assurances that we will be able to refinance these debts or if we are able to refinance them under what terms.

To minimize cash outlays, we have compensated employees with equity incentives where possible. We believe this strategy provides us with the ability to increase stockholder value as well as utilize cash resources more effectively. The issuance of equity securities under the stock plan may, however, result in dilution to existing stockholders and this compensation practice will have to be discontinued if the Company is unable to regain compliance with NASDAQ's minimum listing requirements.

Our Board of Directors also reauthorized a stock repurchase plan effective March 21, 2008 that allows us to repurchase up to 4,000,000 shares of the our common stock from time to time in open market transactions. As a result of the plan, through March 31, 2009, we have repurchased a total of 14,915 shares of common stock. These shares are reflected as treasury stock on the balance sheet. In the quarters ended March 31, 2009 and 2008 no shares were repurchased.

Recent Accounting Pronouncements

See Note 11 to the Condensed Consolidated Financial Statements included elsewhere in this report for a full description of recent accounting pronouncements, including the expected dates of adoption and estimated effects on our consolidated financial statements, which is incorporated herein by reference.