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 including those identified in the "Risk Factors" section of the Company's Annual Report on Form 10-K for the year ended December 31, 2008. 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. Our overarching mission is to provide custom solutions that exceed client expectations, are delivered on time and within budget, and achieve superior results.

Results of Operations

Three months ended June 30, 2009 versus three months ended June 30, 2008

In the quarter ended June 30, 2009, we generated revenues of $10,932,731, a decrease of 8% from the $11,856,734 generated in the same quarter of 2008. This decrease in revenue can be attributed primarily to the weakening of the economy and decreased demand in the IT industry.

As a consequence of the decrease in revenue in the three months ended June 30, 2009 compared to the same period in 2008, costs of revenues decreased 9% from the comparable prior year period.

Despite the competition for new customers in the commercial solutions marketplace, we decreased our selling and marketing expense by 3% to $1,436,937 for the quarter ended June 30, 2009, as compared with $1,477,740 during the quarter ended June 30, 2008. This decrease in costs is related to a reduction in commission and other various marketing expenses in the second quarter of 2009, as part of our overall cost-containment efforts.

General and administrative expenses for the quarter ended June 30, 2009 were $1,921,374 as compared to $1,752,340 in the same quarter in 2008, representing an increase of $169,034, or 10%. This increase is the result of additional headcount as well as additional amortization expense related to acquisitions.

Net interest expense for the quarter ended June 30, 2009 was $315,113 as compared to $346,123 for the same quarter in 2008. This reduction in interest expense is a result of the repayment of debt from the proceeds of the PDI transaction and income from our continuing operations.

In the three months ended June 30, 2009 we recorded no income tax provision compared to $17,834 for the same three month period in 2008.

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 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.

As a result of the above, for the quarter ended June 30, 2009, we reported a net loss of $249,163 compared to a net gain from continuing operations of $26,331 for the quarter ended June 30, 2008.

Six months ended June 30, 2009 versus 2008

Our revenues were $21,892,585 for the six months ended June 30, 2009 versus revenues of $24,237,826 for the six months ended June 30, 2008, a decrease of 10%. This decrease in revenue can be attributed primarily to the weakening of the economy and decreased demand in the IT industry, coupled with increased competition for customers. As a result, primarily, of this decrease in revenues, costs of revenues also decreased by 10%. Selling and marketing expenses increased 5%, from $2,806,783 in the six months ended June 30, 2008 to $3,055,711 for the first six months of 2009. This increase can be attributed to the increase in bad debt expense which has been partially offset by the decline in commission and marketing expenses.

General and administrative expenses for the first six months of 2009 were $3,807,902 as compared to $4,184,249 in the first six months of 2008, representing a decrease of $376,347, or 9%. This decrease is a result of one-time expenses incurred in 2008 at the corporate level, related to the sale of PDI, offset in part by the increase in headcount in the second quarter.

For the reasons discussed above, our operating loss in the first six months of 2009 was $127,634 compared to our operating gain of $492,650 in the comparable prior year period.

Net interest expense decreased $150,959, or 19%, to $642,602 for the six months ended June 30, 2009 from $793,561 for the same period in 2008. This is a result of the repayment of debt with a portion of the proceeds from the PDI transaction and cash flow from continuing operations.

In the first six months of 2009, we recorded an income tax provision of $34,136 versus a provision of $59,776 in the same quarter last year.

In addition, we recorded an $887,500 gain on the sale of PDI in the six months ended June 30, 2009.

Loss from the discontinued operations of PDI net of tax was $285,919 for the six months ended June 30, 2008. We recorded a $1,932,913 gain on the sale of PDI for the same period in 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 2008 and sold in the first quarter of 2009.

As a result of the above, for the six months ended June 30, 2009, we reported net income of $83,128 compared to net income of $1,286,307 for the six months ended June 30, 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 six 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 June 30, 2009 we had cash and cash equivalents of $499,145, representing an increase of $48,841 from the December 31, 2008 year-end balance of $450,304.

Cash used in operating activities was $1,105,752 for the six months ended June 30, 2009 compared to cash provided by operating activities of $105,707 for the same period last year. Cash used in operating activities in the first half of 2009 was primarily due to our operating results offset by the gain on the sale of PDI and an increased provision for doubtful accounts. We also had a decrease in accrued expenses resulting from the PDI transaction, an increase in unbilled revenue due to certain long term projects and an increase in accounts receivable, offset in part by an increase in accounts payable.

Cash provided by investing activities was $366,170 for the six months ended June 30, 2009 compared to $7,239,991 of cash provided for the corresponding period in 2008. The 2009 inflow primarily reflected net proceeds of $720,833 for the PDI acquisition (compared to $7,946,297 in the 2008 period), offset by additions to property and equipment of $132,680 as well as $221,983 of contingent consideration paid in 2009.

Cash provided by financing activities for the six months ended June 30, 2009 was $788,423 versus $8,224,164 of cash used for the same period in 2008. This activity in 2009 included approximately $780,000 of draws on our line of credit with Bank of America for working capital and capital expenditures. In 2008, we repaid approximately $8.5 million of bank and related party indebtedness with a portion of the proceeds of the PDI transaction.

The PDI transaction provided the Company with a cash payment of $8.7 million with a holdback amount of $887,500 that was paid on March 17, 2009. The Company believes that the existing working capital is more than sufficient to cover its day to day needs.

On December 21, 2006 we entered into a revolving credit facility with LaSalle Bank National Association (to which Bank of America is successor-by-merger). The secured facility provides the Company with up to $8,000,000, with availability calculated using a borrowing-base formula consisting of 80% of eligible accounts receivable. Borrowings under the credit facility bear interest at prime or LIBOR plus 2.5%. The loan agreement has been amended from time to time, including the fifth amendment entered into on January 22, 2009.

As amended, the terms of the credit facility require the Company to comply with a minimum fixed charge coverage ratio of 1.25 to 1.0 and a maximum senior debt ratio of 2.5 to 1.0. The Company was in compliance with these covenants as of June 30, 2009. Prior to the January 2009 amendment, the Company was also required to meet a minimum EBITDA target.

As of June 30, 2009, the Company had borrowings under this revolving line of credit of $5,016,145, and available borrowings of $455,784. The line of credit has a maturity date of December 21, 2009.

With a portion of the proceeds from the sale of PDI, the Company repaid $5,700,000 of the outstanding borrowings under the Bank of America credit facility. In addition, the Company also used a portion of the proceeds to repay promissory notes owing to Bruno Guazzoni. The notes repaid consisted of two notes issued by the Company each in aggregate principal amount of $500,000 and bearing interest at 15% per annum and a note issued by ZCS in an aggregate principal amount of $500,000 and bearing interest at 15% per annum. The proceeds were also used to repay a promissory note owing by PDI to Emral Holdings Limited in the amount of $1.5 million.

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 2%. This line is available for working capital requirements and is unrestricted. The line has a maturity date of March 15, 2010. As of June 30, 2009 this line has an outstanding balance of $1,027,322.

On February 21, 2007, ZCS entered into an 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 11% per annum. Principal is due at maturity. The note may be pre-paid without penalty. The proceeds of this note were used to fund the cash portion of the 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 11% per annum. Principal is due 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, 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 June 30, 2009, we have repurchased a total of 14,915 shares of common stock. These shares are reflected as treasury stock on the balance sheet. For the six month period ended June 30, 2009 and 2008 no shares were repurchased.

Recent Accounting Pronouncements

See Note 11 to the Condensed 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.