UNITED
STATES





SECURITIES
AND EXCHANGE COMMISSION





Washington,
D.C. 20549







FORM
10-K








x  ANNUAL
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934





For the
Fiscal Year Ended: December 31, 2009





OR





 ̈  TRANSITION
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934





For the
transition period from  _______  to _______





Commission
File Number: 1-32589





ZANETT,
INC.





(Exact
name of registrant as specified in its Charter)





Delaware
              
              56-4389547(State
      or Other Jurisdiction of
              
              (I.R.S.
      EmployerIncorporation
      or Organization)
              
              Identification
      No.)





635 Madison Avenue, 15th Floor, New York,
      NY
                
                10022(Address
      of principal executive offices)
                
                (Zip Code)





(212)583-0300








(Registrant's
telephone number, including area code)










Securities
registered under to Section 12(g) of the Act:





Common
Stock, par value $0.001


(Title of
Class)





Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined in
Rule 405 of the Securities Act.  Yes  ̈  No x





Indicate
by check mark if the registrant is not required to file reports pursuant to
Section 13 or Section 15(d) of the
Act.  Yes  ̈  No x





Indicate
by check mark whether the registrant: (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days.  Yes x  No  ̈





Indicate
by check mark whether the registrant has submitted electronically and posted on
its corporate Web site, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding
12 months (or for such shorter period that the registrant was required to submit
and post such files).  Yes  ̈  No  ̈





Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K is not contained herein, and will not be contained, to the best
of registrant’s knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. x





Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company. See
the definitions of “large accelerated filer,” “accelerated filer” and “smaller
reporting company” in Rule 12b-2 of the Exchange Act.


Large
accelerated filer  ̈  Accelerated
filer  ̈  Non-accelerated
filer  ̈  Smaller
reporting company x





Indicate
by check mark whether the registrant is a shell company as defined in Rule 12b-2
of the Exchange Act.  Yes  ̈  No x





The
aggregate market value of the voting and non-voting common equity held by
non-affiliates as of June 30, 2009 was $3,752,974 based on the closing price of
the Registrant's common stock on such date of $.43 as reported by the Nasdaq
Capital Market.





There
were 8,738,833 shares of common stock outstanding as of March 26,
2010.





DOCUMENTS
INCORPORATED BY REFERENCE





Certain
information contained in Part III of this Annual Report on Form 10-K will be
incorporated by reference from the definitive proxy statement for the 2010
Annual Meeting of Shareholders (the “2010 Proxy Statement”).







ZANETT,
INC.


ANNUAL
REPORT ON FORM 10-K


FOR THE
FISCAL YEAR ENDED


DECEMBER
31, 2009





TABLE OF
CONTENTS





PAGEPART
      IItem
      1.
                      
                      Business
                      
                      4Item
      1A.
                      
                      Risk
      Factors
                      
                      9Item
      2.
                      
                      Properties
                      
                      18Item
      3.
                      
                      Legal
      Proceedings
                      
                      18Item
      4.
                      
                      Reserved
                      
                      18PART
      IIItem
      5.
                      
                      Market
      for Registrant’s Common Equity and Related Stockholder
    Matters
                      
                      18Item
      7.
                      
                      Management's
      Discussion and Analysis of Financial Condition and Results of
      Operations
                      
                      20Item
      8.
                      
                      Financial
      Statements and Supplemental Data
                      
                      28Item
      9.
                      
                      Changes
      in and Disagreements with Accountants on Accounting and Financial
      Disclosure
                      
                      28Item 9A(T).
                      
                      Controls
      and Procedures
                      
                      29Item
      9B.
                      
                      Other
      Information
                      
                      30PART
      IIIItem
      10.
                      
                      Directors
      and Corporate Governance
                      
                      31Item
      11.
                      
                      Executive
      Compensation
                      
                      31Item
      12.
                      
                      Security
      Ownership of Certain Beneficial Owners and Management and Related
      Stockholder Matters
                      
                      31Item
      13.
                      
                      Certain
      Relationships and Related Transactions, and Director
      Independence
                      
                      31Item
      14.
                      
                      Principal
      Accounting Fees and Services
                      
                      32Item
      15.
                      
                      Exhibits,
      Financial Statement Schedules
                      
                      32


2





PART
I





As used
herein, "Zanett" and the "Company" refer to Zanett Inc. and its wholly-owned,
consolidated subsidiaries: Zanett Commercial Solutions, Inc., and, where the
discussion relates to a time before its disposition, Paragon Dynamics, Inc., and the wholly-owned subsidiaries of Zanett
Commercial Solutions, Inc., Data Road, Inc. and PS GoLive,
LLC.





Disclosure
Regarding Forward-Looking Statements





This
Annual Report on Form 10-K includes forward-looking statements within the
meaning of Section 27A of the Securities Act of 1933, as amended, and Section
21E of the Securities Exchange Act of 1934, as amended. These forward-looking
statements are subject to known and unknown risks, uncertainties and assumptions
about Zanett, its subsidiaries and its affiliate companies that may cause the
Company’s actual results, levels of activity, performance or achievements to be
materially different from any future results, levels of activity, performance or
achievements expressed or implied by such forward-looking statements. In some
cases, forward-looking statements can be identified by terminology such as
"may," "should," "could," "would," "expect," "plan," "anticipate," "believe,"
"estimate," "continue," or the negative of such terms or other similar
expressions. All forward-looking statements in this Report are based on
information available to the Company as of the date this Report is filed with
the Securities and Exchange Commission (the "SEC"), and the Company assumes no
obligation to update any such forward-looking statements. Factors that could
cause actual results to differ materially from those expressed or implied by
such forward-looking statements include, but are not limited to, those factors
listed at "Item 1A. Risk Factors.” The Company undertakes no obligation to
release publicly the results of any future revisions it may make to
forward-looking statements to reflect events or circumstances after the date
hereof or to reflect the occurrence of unanticipated events.


3


Item
1.  Business





Overview




Zanett is
an information technology ("IT") company that provides customized IT solutions
to Fortune 500 corporations and mid-market companies.  Until the
disposition of Paragon Dynamics, Inc. (“PDI”), (as described below), the Company
also provided such solutions to classified government agencies. Our overarching
mission is to provide custom solutions that exceed client expectations, are
delivered on time and within budget, and achieve superior results.




The
Company’s strategy consists of both expanding existing operations and growing by
acquisition.




To grow
our existing operations, the Company seeks to obtain the benefit of leveraged
marketing and solutions delivery through cross-selling, joint-marketing and
resource-sharing.  The Company also seeks to achieve economies of
scale by providing centralized back-office functions to contain costs while
enhancing our ability to serve clients.




To grow
by acquisition, the Company utilizes a highly selective search methodology to
identify and acquire specialized, profitable IT companies with outstanding
management and professional staffs, exceptional performance records, and superb
client relationships that complement our existing solutions sets and practices.
As the Company adds new entrants to our existing solutions we seek to preserve
the unique relationships we have with our clients and our core skill sets while
expanding the solutions we can provide.




The
Company’s principal executive offices are located at 635 Madison Avenue, 15th
Floor, New York, NY 10022.  The Company’s telephone number is
(212)583-0300.




Growth-by-Acquisition




From the
Company’s formation in the fall of 2000 through December 31, 2009, nine
operating companies have been acquired, two of which were disposed of
subsequently. We did not make any acquisitions or dispositions in
2009.




On
December 7, 2001 the Company acquired Back Bay Technologies, Inc. (“BBT”), based
in Needham, Massachusetts. BBT is a technology consulting firm providing
strategic planning, analysis, business case development, vendor selection,
systems architecture, systems integration, full life cycle application
development and post-production support services.




On May
31, 2002, the Company acquired Brandywine Computer Group, Inc. (“BCG”), based in
West Chester, Ohio. BCG provides technology consulting services associated with
the implementation of enterprise resource planning (“ERP”), supply chain
management and customer relationship management (“CRM”) systems.




On
January 31, 2003, the Company acquired PDI, based in Denver, Colorado. PDI
specializes in providing advanced software and satellite engineering services
with domain area expertise on government and aerospace satellite and IT
infrastructure contracts. As described below, in March 2008, we sold the
outstanding common stock of PDI for cash to KOR Electronics. PDI was treated as
a discontinued operation as of December 31, 2007 because the decision was
reached in the fourth quarter of 2007 to exit the government IT engineering
business that is PDI's principal business activity. In December 2007, the
Company entered into a letter of intent to sell PDI to KOR Electronics, which
sale was completed on March 18, 2008.


4


On December 4, 2003, the Company acquired DeltaData,
Inc. (dba Delta Communications Group), based in Alisa Viejo,
California.  Following the acquisition, DeltaData, Inc. changed its
name to Delta Communications Group, Inc. ("Delta").  Delta was a voice
and data communications network integrator that sold IT hardware, peripheral
equipment and telecommunications lines for voice and data communications
networks and provided related IT security, design and implementation
solutions.  On March 7, 2006, we disposed of Delta by exchanging the
outstanding common stock of Delta for the former owner of Delta's equity
holdings of the Company.




On April
23, 2004, BCG acquired INRANGE Global Consulting, a professional services
business unit of Computer Network Technology Corporation (“CNT”). INRANGE Global
Consulting, a long-time PeopleSoft partner, is a leading consulting and
technology services consultancy that provides high-value business solutions to
corporate and government clients across the Midwest. After the acquisition, BCG
and INRANGE Global Consulting combined their professional service businesses and
operate under the name INRANGE Consulting Corporation (“ICC”). ICC has principal
offices in Indianapolis, Indiana and West Chester, Ohio.




On March
1, 2005, the Company acquired Whitbread Technology Partners, Inc. (“Whitbread”),
based in Stoneham, Massachusetts. Whitbread is an award-winning IT consulting
firm specializing in the deployment of Oracle ERP systems for corporate and
government clients in the Northeastern U.S.




On
December 30, 2005, BBT, ICC and Whitbread merged with and into another of our
wholly-owned subsidiaries, Zanett Commercial Solutions, Inc.
(“ZCS”).  This consolidation of our commercial practices into one
accounting and legal entity was designed to help us achieve back office
economies of scale and increase our ability to leverage marketing and
professional resources across this segment.




On May 1,
2006, ZCS completed the acquisition of all of the issued and outstanding capital
stock of Data Road, Inc. ("Data Road"). The Company acquired Data Road in order
to broaden our services and solutions portfolio, further our national expansion
and add a substantial roster of blue-chip companies to our client base. Founded
in 2001, Data Road is a dedicated Oracle services company that specializes in
managed services and remote hosting. Based in Jacksonville, Florida, Data Road
provides managed services and consulting services throughout the United
States.




On March
6, 2007, ZCS completed an acquisition of all the issued and outstanding capital
stock of the DBA Group, LLC. (“DBA”).  Based in Alpharetta, Georgia,
DBA provides database managed services.  The Company acquired DBA
Group, LLC in order to broaden its expertise in database
administration.  DBA Group was merged
into ZCS in connection with the acquisition.




On
November 25, 2008, ZCS completed an acquisition of PS GoLive, LLC (“PS GoLive”).
Based in North Palm Beach, FL, PS GoLive provides upper-end services for
Oracle’s PeopleSoft Enterprise products and business processes. The Company
acquired PS GoLive, LLC in order to further its commitment to develop
world-class Oracle/PeopleSoft capabilities.




The
Company continues to seek successful, growing IT solutions companies to
incorporate into our business model.




Organic
Growth




The
Company employs a multi-dimensional organic growth strategy that seeks to
provide new solutions to existing customers, current solutions to new customers,
and new solutions to new customers.  The Company believes all three of
these approaches are dependent on three elements:


5


·
            forming
      deep, trusted relationships between our professional staff and customer
      management;


·
            constantly
      broadening the solution and skill sets at our disposal;
  and


·
            unburdening
      professional staff from those day-to-day operational activities that do
      not directly relate to solutions
delivery.





While the
Company provides discrete solutions to specific problems when needed, we seek to
achieve what we refer to as “consultant of record” or “COR Status” with our
customers.  COR Status means customers come to rely on us for
continuing advice and help with their most mission critical, “core business”
challenges.  By acquiring new companies from time to time, we believe
our business model enhances these trusted relationships with our current
customers by providing fresh infusions of talent, skill sets, partnership
relationships and experience, all of which can be utilized to help our customers
and strengthen our relationships.




We
believe our business model further enhances organic growth by centralizing such
back office functions as financial reporting, legal review, and certain aspects
of human resource and IT infrastructure.  This centralization allows
our professional staff to focus on their core business skill sets and seek to
achieve the highest possible standards of service quality for our
customers.





Customers





The
Company’s customers consist primarily of small to large businesses needing IT
solutions, such as strategy and systems architecture consulting, business
application development, systems implementation and integration, systems
engineering and technical assistance and IT communications hardware and
peripheral equipment. Prior to the disposition of PDI, the Company’s customers
also included U.S. government agencies.





Currently,
the Company is dependent on a limited number of customers for a substantial
portion of its revenues. During 2009, our largest customer, Reynolds Consumer Products Company, accounted for approximately 10% of revenues.
During 2008, a different customer accounted for approximately 7% of
revenues.





To lessen
its dependence on any one particular service line, customer or group of
customers, the Company continually seeks to expand its customer base through
organic growth as well as additional acquisitions.  See “Item
1A.:  Risk Factors – Termination of a contract by a significant
customer and/or cancellation with short notice, or failure by us to attract new
customers and replace customers not renewing their contracts, could reduce our
revenue and profitability and adversely affect our financial condition” and
“Risk Factors – An unexpected shortfall in revenues in relation to our expenses,
or significant bad debt experience, could materially and adversely affect our
business.”




Competition





The
Company faces significant competition in its individual markets. The Company
believes competition will continue to grow from new entrants to the market, as
well as from existing participants, such as software vendors expanding their
sales into consulting, integration and implementation services.





The
Company believes that, in general, competition in the IT solutions market is
based upon the following factors:





*
            Speed
      of response to customer
requests


6


*
            Flexibility
      and willingness to adapt to customer
needs


*
            Responsiveness
      to customer demands


*
            Number
      and availability of qualified consultants, engineers and
      programmers


*
            Project
      management capability


*
            Technical
      expertise


*
            Size
      and reputation


*
            Brand
      recognition and geographic presence


*
            Price





The
Company competes with numerous large companies that have substantially greater
market presence and financial, technical, marketing and other resources than the
Company has, such as Accenture, Cap Gemini, Ernst & Young, IBM Global
Services, Keane, KForce and MPS Group.  These competitors include (i)
large information technology consulting and service providers and application
software firms; (ii) international, national, regional and commercial Internet
service providers ("ISPs") who have consulting services divisions; (iii)
established on-line services companies; (iv) computer hardware, software and
other technology companies; (v) application service providers and (vi) major
accounting and consulting firms. Many of the Company's competitors have expanded
their service offerings over the past several years and increased their focus on
e-Business and the IT professional services markets, thus increasing the number
of organizations that are providing solutions similar to those offered by the
Company.





As a
result of continued competition, the Company encounters pricing pressure, which
in turn results in reductions in the average selling price of its solutions. We
may not be able to offset the effects of any such price reductions through
increases in the number of customer engagements, higher revenue from enhanced
services, cost reductions or otherwise. In addition, the Company believes that
continuing consolidation in the business and IT solutions market could result in
increased price pressure and other competition in the industry.





There is
also a high degree of competition among companies seeking to acquire interests
in IT services companies such as those the Company targets for
acquisition.  A large number of established and, in some cases,
well-financed entities, including large IT consulting companies, systems
integrators and venture capital firms, are active in acquiring interests in
companies that the Company may also find to be desirable acquisition candidates.
Many of these entities have significantly greater financial resources, technical
expertise and managerial capabilities than the Company. Consequently, the
Company may be at a competitive disadvantage in negotiating and executing
possible acquisitions of these entities. Although entrepreneur-founders of
privately held IT solutions companies, including those suffering as a result of
the volatile economic climate of recent years and those facing potential
bankruptcy restructuring or liquidation, may place greater emphasis on the ease
of access to capital than on obtaining the management skills and networking
services that the Company can provide, management believes that Zanett offers
unique and attractive benefits, including the ability of the founders and
management to preserve their business culture and identity while leveraging the
strengths of the Company's existing practices. Nonetheless, this kind of
competition could limit the Company’s growth-by-acquisition strategy as the
number of target companies decreases.





See “Item
1A.:  Risk Factors – The IT services industry is highly competitive,
and we may not be able to compete effectively” for additional discussions of
matters that could affect its ability to compete in its
markets.


7





Employees





As of
December 31, 2009, the Company had 204 full-time employees, as compared with 211
full-time employees as of December 31, 2008.  None of its employees
are currently covered by collective bargaining agreements and the Company
considers relations with its employees to be good.





Executive
Officers of Zanett





Our
executive officers, their ages and positions are set forth below:





Name
                  
                  Age
                  
                  Title
                  
                  SinceClaudio
      M. Guazzoni
                  
                  47
                  
                  Chairman,
      Chief Executive Officer and Director
                  
                  2000Dennis
      Harkins
                  
                  47
                  
                  President
      and Chief Financial Officer
                  
                  2006Chuck
      Deskins
                  
                  48
                  
                  President
      ZCS
                  
                  2006





Officers
of the Company serve at the pleasure of the Board of Directors.





Claudio
M. Guazzoni – Mr. Guazzoni was named Chief Executive Officer of Zanett, Inc.
in February 2006, after serving as
President of Zanett, Inc. since he co-founded the Company in 2000. Prior to such
time, he had co-founded The Zanett Securities Corporation in 1993, of which he
is still President. At Zanett Securities Corporation, Mr. Guazzoni was
instrumental in the success and initial public offering of a number of young
technology companies, including YouthStream Media, Inc., Robotic Vision Systems,
Inc., SmartServ Online, and FiberNet Telecom Group. His previous work in mergers
and acquisitions for Salomon Brothers and past experience as a fund manager
responsible for managing portfolios aggregating in excess of $1.4 billion
provides Zanett with expertise in international finance and deal
structuring.





Dennis
Harkins – Mr. Harkins was named Presidentof Zanett on March 21, 2008 and has served as
Chief Financial Officer of Zanett since
June 2006. Previous to joiningZanett in June 2006, Mr.Harkins was
Director of Sales and Planning for almost ten years at MSC Industrial
Supply(“MSC”), a $1.3 billion direct
marketing firm dealing with various industrial products in the United States; in
this position he was responsible for the budget and forecast for over 100
branches with operating expenses of over $250 million. Earlier in his
tenurewith MSC he was the Director of IT
Business Development where he managed over 80 IT professionals with a budget of
over $20 million. He started at MSC in 1996 as the Director of Accounting where
he oversaw the accounting, accounts payable and accounts receivable areas. Prior
to MSC, Mr. Harkins was the Controller for Arbor Property Trust and Real Estate
Investment Trust with headquarters in Conshohocken, Pennsylvania.





Chuck
Deskins – Mr. Deskins became the President of Zanett Commercial Solutions (ZCS)
in February, 2006 and is responsible for the day-to-day operations, organic
expansion, and the integration and assimilation of acquired businesses. Prior to
ZCS, Mr. Deskins served as President, SPX Valley Forge(“SPX”) from 2003 to 2005, overseeing global
operations in North America, Italy, France, Germany, and the UK. During his
tenure at SPX, Deskins led the integration of two accretive acquisitions, one in
North America, and one in Europe, while leading the organization to record
revenue growth. Prior to joining SPX,Mr.
Deskins served as General Manager, GE
Capital, and other senior leadership positions at
GE Capital including Area GM, ARC; and Director, CHC. As President of
Pinnacle Computer Resources, Mr. Deskins won recognition as a successful
entrepreneur, guiding the business from start-up to $32 million in revenue in 4
years.


8





Item 1A.
Risk Factors





You
should carefully consider and evaluate all of the information in this annual
report on Form 10-K and the documents incorporated by reference into this
report, including the risk factors listed below.  Any of these risks
could materially and adversely affect our business, financial condition and
operating results, and could cause our actual results to differ materially from
our plans, projections, or other forward-looking statements included in “Item
7.  Management’s Discussion and Analysis of Financial Condition and
Results of Operations” below and elsewhere in this Report on Form 10-K and in
our other public filings.  The occurrence of one or more of these
risks could also materially and adversely affect the price of our common
stock.





We
require additional financing to sustain our operations, andthere is substantial doubt about our ability to
continue as a going concern.




During
the year ended December 31, 2009, we incurred a net loss from continuing
operations of $3,211,921 and had net cash used in operations of
$428,549.  As of December 31, 2009, we had an excess of current
liabilities compared to current assets of $10.6 million.




Our
current financing source is our $6 million
revolving credit facility with Bank of America, N.A. (as successor-by-merger to
LaSalle Bank National Association).  Asof
March 24, 2010, the outstanding loan balance was $4,350,090 with available
borrowings of $668,562.  The credit facility matures on June 21,
2010.As of December 31, 2009,
we alsohada $3 million line of creditheld by Rockport Investments, Ltd., which it purchased
on February 28, 2010 from Bruno Guazzoni, the uncle of our Chief
Executive Officer and the owner of approximately 27.8% of our outstanding common stock as of March
26, 2010.  In addition to the line of
credit, as of the end of fiscal 2009, we also had outstanding promissory
notes in an aggregate principal amount of $5.325
million originally issued to Bruno Guazzoni, which were sold by him to Rockport
Investments, Ltd. on February 28, 2010.  On March 31, 2010, we
exchanged the debt held by Rockport Investments, Ltd. for a new note convertible
into shares of our common stock at any time after stockholder approval of the
transaction at the option of the noteholder (provided, however, that without
stockholder approval of the transaction, the note may not be converted into more
than 19.99% of the common stock outstanding before the issuance of the
convertible note).  The note has a principal amount of $7,131,983,
bears interest at a rate of 7.95% per annum, payable quarterly in arrears, and
matures on March 31, 2015.  The conversion rate is initially equal to
the closing bid price immediately preceding the closing
date.  Rockport may, at its option, reset the conversion price once
per calendar year to the greater of (a) the average of the closing sales price
of the Company’s common stock during the preceding 20 consecutive trading day
period and (b) $0.10.  The conversion price is also subject to
adjustment in the event of dilutive issuances by the Company or the Company’s
issuance of options, warrants of other rights to purchase the Company’s common
stock or convertible securities (subject to certain exceptions, including the
grant of options to purchase common stock to employees, officers, directors or
consultants of the Company).  In addition, Rockport has the right to
vote on all matters to which holders of our common stock are entitled to vote,
on an as-converted basis using the closing bid price immediately preceding the
closing date as the conversion rate, although this voting right does not become
effective until our stockholders approve the terms of the convertible note that
provide for the potential issuance of more than 19.99% of our common stock (on a
pre-transaction basis) upon conversion of the convertible note by Rockport and
grant this voting power to the noteholder.  Pursuant to the terms of
the convertible note, effective upon such stockholder approval, Rockport would
have the right to vote approximately 28% of our common stock; however, Rockport
has entered into a voting agreement with our Chief Executive Officer, Claudio
Guazzoni, pursuant to which it has appointed Mr. Guazzoni as its proxy to vote
on Rockport’s behalf in all matters to which stockholders are entitled to vote
beginning upon such stockholder approval and continuing for the life of the
note.  See “Management's Discussion and Analysis of Financial
Condition and Results of Operations – Liquidity and Capital Resources” and Note
22 to our Consolidated Financial Statements included in this Annual Report on
Form 10-K.


9


The loss
from continuing operations, working capital deficit and current maturity dates
of our outstanding debt and available borrowings raise substantial doubt about
our ability to continue as a going
concern.





The
Company is currently negotiating the refinancing or replacementof its credit facility or is otherwise looking to secure additional funding,
though there can be no assurances that such financing will be obtainedon satisfactory terms or at all.  If we are
not able to refinance or replace this debt, we may not be able to continue our
operations.  The accompanying consolidated financial statements
do not include any adjustments relating to the recoverability of the carrying
amount of recorded assets or the amount of liabilities that might result should
the Company be unable to continue as a going concern.





Current
economic conditions and reduced information technology spending may adversely
impact our business.




Our
business depends on the overall demand for information technology and on the
economic health of our current and prospective customers.  The
purchase of our services may be discretionary and may require our customers to
make significant commitments of capital.  During the current economic
downturn, business spending on information technology has
decreased.  Continued weak economic conditions, or a reduction in
information technology spending even if economic conditions improve, could
adversely affect our financial position, results of operations and cash flow,
particularly through reduced contracts for service and lower prices for our
services, difficulty in the collection of our accounts receivable and lower
recoverability of assets.




We
may experience difficulties in scaling our operations to react to economic
pressures in the U.S.





In order
to continue to increase sales and marketing efforts, to expand and enhance the
solutions and services we are able to offer to current and future customers and
to fund potential acquisitions, we will require additional capital that may not
be available on terms acceptable to us, or at all. As a consequence, we will be
required to raise additional capital through public or private equity or debt
financings, collaborative relationships, bank facilities or other arrangements
with corporate partners or from other sources, all of which have contracted
sharply in the last two years. Any additional equity financing is expected to be
dilutive to stockholders, and debt financing, if available, may involve
restrictive covenants and increased interest costs. We have financed our
operations to date primarily through private sales of equity securities, and
loans from related parties and business associates. In addition, if unforeseen
difficulties arise in the course of these capital-raising or other aspects of
our business, we may be required to spend funds in an amount greater than
anticipated. Such additional capital may not be available on terms acceptable to
us, or at all. Our inability to obtain sufficient funds may require us to delay,
scale back or eliminate some or all of our expansion programs or to limit the
marketing of our services. Any such disruption could require us to take measures
to conserve cash until the markets stabilize or until alternative credit
arrangements or other funding for our business needs can be
arranged.  Such measures could include deferring capital expenditures
and reducing or eliminating future discretionary uses of cash.  We
also continue to explore other ways to maximize the value of the Company for its
stockholders.


10





The
Company has not achieved profitability in each reporting period and may incur
net losses in future quarters.




The
Company has a history of operating losses, including a loss from continuing
operations of approximately $3,211,921 for the year ended December 31, 2009 and
a loss from continuing operations of approximately $875,144 for the year ended
December 31, 2008. We may incur additional operating losses in the future.
Operating expenses may increase as we seek to grow our business through
acquisition and as our existing business expands. Even if we achieve consistent
profitability, we may be unable to generate sufficient cash flow from operations
or be able to raise capital in sufficient amounts to enable us to continue to
expand our business. An inability to sustain profitability may also result in an
impairment loss in the value of our long-lived assets, principally goodwill,
property and equipment, and other tangible and intangible assets. If we are
unable to generate sufficient cash flow from operations or raise capital in
sufficient amounts, our business will be materially and adversely
affected.




Termination
of a contract by a significant customer and/or cancellation with short notice,
or failure by us to attract new customers and replace customers not renewing
their contracts, could reduce our revenue and profitability and adversely affect
our financial condition.




For the
year ended December 31, 2009, our largest customer, Reynolds Consumer Products Company, accounted for approximately 10% of revenues.
Non-renewal or termination of contracts with a significant customer could have a
material adverse effect on our business. A large portion of our revenues were
derived from professional services that are generally non-recurring in nature.
There can be no assurance that we will obtain additional contracts for projects
similar in scope to those previously obtained from our principal customers or
any other customer, that we will be able to retain existing customers or attract
new customers or that we will not remain largely dependent on a limited customer
base, which may continue to account for a substantial portion of our revenues.
In addition, we may be subject to delays in customer funding; non-renewal;
delay, termination, reduction or modification of contracts in the event of
changes in customer policies or as a result of budgetary constraints; and
increased or unexpected costs resulting in losses under fixed-fee
contracts.




Our
success in meeting growth targets is dependent on our ability to maintain
existing clients and to continually attract and retain new customers to replace
customers who have not renewed their contracts. Achieving significant market
acceptance requires substantial effort and expenditures on our part to create
awareness of our services.




An
unexpected shortfall in revenues in relation to our expenses, or significant bad
debt experience, could materially and adversely affect our
business.




Revenues
are difficult to forecast. We may increase our corporate overhead expenses as
we integrate past and future acquisitions
and we build an infrastructure to implement our strategy.  Meanwhile,
our business units may increase their operating expenses for sales, marketing
and technical personnel to sell, provide and support their products and
services. Additionally, at any given point in time, and especially in the
current challenging economic climate, we may have significant accounts
receivable balances with customers that expose us to credit risks.  If
we have an unexpected shortfall in revenues in relation to our expenses, or
significant bad debt experience, our business could be materially and adversely
affected.


11


IT
services are subject to uncertain demand due to emerging and evolving markets
and technology.




The
markets for some of our services are changing rapidly and evolving and,
therefore, the ultimate level of demand for our services is subject to a high
degree of uncertainty. Any significant decline in demand for programming and
applications development and IT consulting services could materially adversely
affect our business and prospects.




Significant
technological changes could render our existing products and services obsolete.
To be successful, we must adapt to this rapidly changing market by continually
improving the responsiveness, functionality and features of our products and
services to meet customers' needs. If we are unable to respond to technological
advances and conform to emerging industry standards in a cost-effective and
timely manner, our business could be materially and adversely
affected.




The
IT services industry is highly competitive, and we may not be able to compete
effectively.




Competition
for our IT solutions is significant, and we expect that competition will
continue to intensify due to the low barriers to entry. We may not have the
financial resources, technical expertise, sales and marketing or support
capabilities to successfully meet this competition. If we are unable to compete
successfully against our competitors, our business will be adversely affected.
We compete against numerous large companies that have substantially greater
market presence, longer operating histories, more significant customer bases,
and financial, technical, facilities, marketing, capital and other resources
than we have.




Our
competitors include national, regional and local IT consulting service
providers, software development firms and major accounting and consulting firms
such as Accenture, Cap Gemini, Ernst & Young, IBM Global Services, Keane,
KForce and MPS Group.




In
addition, we also encounter competition from numerous other businesses that
provide one or more similar goods or services, including numerous resellers of
Internet-related hardware and software and web-site development
companies.




Our
competitors may respond more quickly than us to new or emerging technologies and
changes in customer requirements. Our competitors may also devote greater
resources than we can to the development, promotion and sale of their products
and services. They may develop products and services that are superior to or
have greater market acceptance than ours. Competitors may also engage in more
extensive research and development, undertake more extensive marketing
campaigns, adopt more aggressive pricing policies and make more attractive
offers to our existing and potential employees and strategic partners. In
addition, current and potential competitors have established or may establish
cooperative relationships among themselves or with third parties that may
further impact our ability to effectively compete.




New
competitors, including large computer hardware, software, professional services
and other technology and telecommunications companies, may enter our markets and
rapidly acquire significant market share. As a result of increased competition
and vertical and horizontal integration in the industry, we could encounter
significant pricing pressures. These pricing pressures could result in
significantly lower average selling prices for our products and services. We may
not be able to offset the effects of any price reductions with an increase in
the number of customers, higher revenue from consulting services, cost
reductions or otherwise. In addition, professional services businesses are
likely to encounter consolidation in the near future, which could result in
decreased pricing and other competition.


12


Moreover,
there is a high degree of competition among companies seeking to acquire
interests in IT service companies such as those we have historically targeted
for acquisition. We are and will continue to be a minor participant in the
business of seeking business relationships with, and acquisitions of interests
in such companies. A large number of established and, in some cases,
well-financed entities, including venture capital firms, are active in acquiring
interests in companies that we may find desirable acquisition candidates. Many
of these investment-oriented entities have significantly greater financial
resources, technical expertise and managerial capabilities than we do.
Consequently, we may be at a competitive disadvantage in negotiating and
executing possible investments in these entities. Entrepreneur-founders of
privately held IT service companies, including those suffering as a result of
the volatile economic climate of recent years and those facing potential
bankruptcy restructuring or liquidation, generally place greater emphasis on
gaining access to capital than obtaining the management skills and networking
services that we can provide. Even if we are able to successfully compete with
these other entities, this competition may affect the terms and conditions of
potential acquisitions and, as a result, we may pay more than expected for
targeted companies. If we cannot acquire interests in attractive companies on
reasonable terms, our growth by acquisition strategy may not
succeed.




Operations
interruptions caused by systems failures could adversely affect our
business.




Our
business depends on the efficient and uninterrupted operation of our computer
and communications hardware systems and infrastructure. We currently maintain
most of our computer systems in our facilities in New York, NY and at business
unit offices in Needham, MA, Stoneham, MA, West Chester, OH, Indianapolis, IN,
Jacksonville, FL, Alpharetta, GA, Makati City, Philippines and North Palm Beach,
FL. Interruptions could result from natural disasters, as well as power loss,
telecommunications failure and similar events. We also lease telecommunications
lines from local and regional carriers, whose service may be interrupted. Any
damage or failure that interrupts or delays network operations could materially
and adversely affect our business.




Security
breaches could expose our Company to a risk of loss or liability.




Our
infrastructure is potentially vulnerable to physical or electronic break-ins,
viruses or similar problems. If a person or entity circumvents our security
measures, they could jeopardize the security of confidential information stored
on our systems, misappropriate proprietary information or cause interruptions in
our operations. We may be required to make significant additional investments
and efforts to protect against or remedy security breaches. Security breaches
that result in access to confidential information could damage our reputation
and expose us to a risk of loss or liability.




We
may not be able to identify suitable acquisition candidates or successfully
integrate their operations with our own.




A key
element of our expansion strategy is to grow through acquisitions. If we
identify suitable candidates, we may not be able to make investments or
acquisitions on commercially acceptable terms. Acquisitions may cause a
disruption of our ongoing business, distract management, require other resources
and make it difficult to maintain our standards, controls and procedures. We may
not be able to retain key employees of the acquired companies or maintain good
relations with their customers or suppliers. We may be required to incur
additional debt, if available, and we may be required to issue equity
securities, which may be dilutive to existing stockholders, to fund
acquisitions.


13


Unsuccessful
acquisitions could adversely affect our business.




There can
be no assurance that any completed acquisition will enhance our business. Since
the normal consideration in our acquisitions comprises both cash and shares of
our common stock, if we proceed with one or more significant acquisitions, the
potential impacts are (1) a substantial portion of our available cash could be
used to consummate the acquisitions and/or we could incur or assume significant
amounts of additional indebtedness, and (2) our stockholders could suffer
significant dilution of their interest in our common stock.




Also,
acquisitions are required to be accounted for under the purchase method of
accounting, which results in us recording significant amounts of goodwill. The
inability of a subsidiary to sustain profitability may result in an impairment
loss in the value associated with that subsidiary, principally
goodwill.




In
accordance with accounting standards, purchased goodwill should not be
amortized, but rather, should be periodically reviewed for impairment. Such
impairment could be caused by internal factors as well as external factors
beyond our control. Furthermore, at the time goodwill is considered impaired, an
amount equal to the impairment loss should be charged as an operating expense in
the statement of operations. The timing of such an impairment (if any) of
goodwill acquired in past and future transactions is uncertain and difficult to
predict. Our results of operations in periods following any such impairment
could be materially adversely affected. We are required to determine whether
goodwill acquired in past acquisitions has been impaired in accordance with
accounting standards, and, if so, charge such impairment as an expense. We have
goodwill of approximately $16.5 million at December 31, 2009, so if we are
required to take such additional impairment charges, or if financial analysts or
investors believe we may need to take such action in the future, our stock price
and operating results could be materially adversely affected.




We review
for impairment annually on October 31, or sooner if events or changes in
circumstances indicate that the carrying amount could exceed fair value. Due to
uncertain market conditions and potential changes in our strategy and customer
demand, it is possible that the forecasts we use to support our goodwill could
change in the future. Significant judgments are required to estimate the fair
value of goodwill including estimating future cash flows, determining
appropriate discount rates, estimating the applicable tax rates and interest
rates, projecting the future industry trends and market conditions, and making
other assumptions. Changes in these estimates and assumptions, including changes
in our reporting structure, could materially affect our determinations of fair
value.




Our
success depends on our retaining key personnel.




There is
intense competition for qualified personnel in the sectors in which we operate.
The loss of existing personnel or the failure to recruit additional qualified
managerial, technical, and sales personnel, as well as expenses in connection
with hiring and retaining personnel, could adversely affect our business. We
also depend on the performance of our executive officers and key employees, most
of whom have not entered into employment agreements.


14


As of
December 31, 2009, we had 204 full-time employees. We will need to attract,
train and retain more employees for management, engineering, programming, sales
and marketing, and customer service and support positions. Competition for
qualified employees, particularly engineers, programmers and consultants
continues to be high. Because of the competition in our industry and other
reasons, we may not be successful in attracting, training and retaining the
people we need to continue to offer solutions and services to present and future
customers in a cost effective manner or at all.




Fluctuation
in quarterly operating results may negatively impact the market price of our
common stock.




Our
revenues and operating results may vary significantly from quarter to quarter
due to a number of factors, not all of which are within our control. Quarter to
quarter comparisons of the results of operations as an indication of future
performance should not be relied upon. It is possible that in some future
periods our results of operations may be below the expectations of public market
analysts and investors. In that event, the market price of our common stock may
fall.




Factors
that could cause quarterly results to fluctuate include:




·
            change
      in customer demand for, or the inability of our customers to pay for, our
      products and services;




·
            timing
      of the expansion of operations;




·
            changes
      in pricing by us or our
competitors;




·
            introduction
      of new products or services by competitors or
  Zanett;




·
            costs
      related to acquisitions of technology or
  businesses;




·
            continued
      volatility in the U.S. economy or a slow economy recovery;
    or




·
            termination
      or non-renewal of customer
contracts.




Changes
in government regulations may adversely impact our business.




There are
an increasing number of laws and regulations pertaining to the Internet. These
laws and regulations relate to liability for information received from or
transmitted over the Internet, online content regulation, user privacy, taxation
and quality of products and services. The government may also seek to regulate
some segments of our activities as basic telecommunications services. Moreover,
the applicability to the Internet of existing laws governing intellectual
property ownership and infringement, copyright, trademark, trade secret,
obscenity, libel, employment, personal privacy and other issues is uncertain and
developing. We cannot predict the impact, if any, that future regulation or
regulatory changes may have on our business.




We
may be faced with potential claims for liability if we cannot adequately meet
our customers’ expectations.




Our
services involve development, implementation and maintenance of computer systems
and computer software that are critical to the operations of our customers'
businesses. Our failure or inability to meet a customer's expectations in the
performance of our services could harm our business reputation or result in a
claim for substantial damages against us, regardless of our responsibility for
such failure or inability. In addition, in the course of performing services,
our personnel often gain access to technologies and content that includes
confidential or proprietary customer information. Any such unauthorized
disclosure or use could result in a claim for substantial damages. The
successful assertion of one or more large claims against us that are uninsured,
exceed available insurance coverage or result in changes to our insurance
policies, including premium increases or the imposition of a large deductible or
co-insurance requirements, could adversely affect us.


15


We
may become subject to legal claims relating to the content in the web sites we
may host or in email messages that we transmit.




The law
relating to the liability of online service providers, private network operators
and Internet service providers for information carried on or disseminated
through their networks is currently unsettled. We may become subject to legal
claims relating to the content in the web sites we may host or in email messages
that we transmit. For example, lawsuits may be brought against us claiming that
material inappropriate for viewing by young children can be accessed from the
web sites we may host. Claims could also involve matters such as defamation,
invasion of privacy and copyright infringement. Providers of Internet products
and services have been sued in the past, sometimes successfully, based on the
content of material. If we have to take costly measures to reduce our exposure
to these risks, or are required to defend ourselves against such claims, our
business may be materially adversely affected.




The
market price of our common stock could decline as a result of future sales by
existing stockholders.




The
market price of our common stock could decline as a result of sales by existing
stockholders of a large number of shares of common stock in the market or the
perception that these sales may occur. These sales also might make it more
difficult for us to issue equity securities in the future at a time and at a
price that it reflects fair value.




As of
December 31, 2009, we had granted options to purchase 1,617,773 shares under our
2001 Stock Option Plan. The total number of options authorized under the 2001
Stock Option Plan, as amended, is 2,500,000.




If the
holders of these options and any other options we have issued were to exercise
their rights and sell the shares issued to them, it could have an adverse effect
on the market price of the common stock.




The
market price for our common stock has been volatile, and if we do not remain compliant with Nasdaq listing
requirements, our common stock may be delisted from the Nasdaq Capital
Market.




On
September 15, 2009, the Company received a notice from the Nasdaq Stock Market
(“Nasdaq”) notifying us we were out of compliance with Nasdaq Listing Rule
5550(a)(2) because the bid price of our common stock had closed at less than
$1.00 per share over the previous 30 consecutive business
days.  Nasdaq gave us 180 calendar days, or until March 15, 2010, to
regain compliance with the rule.  On March 16, 2010, we received a
second notification from Nasdaq that we had not regained compliance with the
minimum closing bid price rule.  Because we had met all initial
listing criteria for the Nasdaq Capital Market other than the minimum closing
bid price rule on March 15, 2010, Nasdaq gave us an additional 180 days to
regain compliance with the rule.  On March 17, 2010 we received a
letter from Nasdaq notifying us that we had regained compliance with the minimum
closing bid price rule, however there is no assurance we will continue to be in
compliance with the Nasdaq minimum bid price rule or the other listing
requirements in the future.  If we do not remain compliant with the
Nasdaq listing requirements, our common stock may be delisted from the Nasdaq
Capital Market.


16




We
have not historically paid, and do not anticipate in the foreseeable future
paying cash dividends on our common stock.




We have
never paid cash dividends on our common stock and do not anticipate paying cash
dividends in the foreseeable future. Instead, we intend to retain future
earnings for reinvestment in our business and/or to fund future
acquisitions.Our
credit facility with Bank of America prohibits us from declaring or paying any
dividends, except for dividends or other distributions made by ZCS to us;
provided, however, that we may accrue (but not pay) dividends as payment in
kind.  We expect any replacement financing to contain similar
restrictions.




The
concentrated ownership of our Company may discourage potential transactions
involving Zanett.




Claudio
Guazzoni, our Chief Executive Officer owned approximately 24.1% of the
outstanding common stock as of March 26, 2010, and in addition, Mr. Guazzoni’s
uncle, Bruno Guazzoni, owned, as of March
26, 2010, approximately 27.8% of the
outstanding common stock. Moreover, as a result of the voting agreement entered
into between Claudio Guazzoni and Rockport Investments, Ltd. on March 31, 2010,
Mr. Guazzoni will have the right to vote an additional approximately 28% of the
outstanding Common Stock, effective upon stockholder approval of the issuance of
the convertible note and related transactions (although as a result of such
transaction Claudio Guazzoni’s ownership interest is approximately 17.3% and
Bruno Guazzoni’s ownership interest is approximately 20%). As a result, the
Guazzoni family possesses significant influence over Zanett’s decision making on
business matters, including the election of directors.




The
concentration of Zanett share ownership may:




·
            delay
      or prevent a change in the control of
Zanett;




·
            impede
      a merger, consolidation, takeover, or other transaction involving our
      Company; or




·
            discourage
      a potential acquirer from making a tender offer or otherwise attempting to
      obtain control of Zanett.




Our
rapid growth has strained, and may continue to strain, managerial and
operational resources.




Our rapid
growth has placed, and is expected to continue to place, a significant strain on
managerial and operational resources. Further, as we grow, we will be required
to manage multiple relationships with various customers, strategic partners and
other third parties. Further growth or an increase in the number of strategic
relationships may increase this strain on existing managerial and operational
resources, inhibiting our ability to successfully implement our strategy without
incurring additional corporate expenses.




Our
future growth is dependent on producing revenue sufficient to cover increasing
expenses.




Expenses
will increase as we continue to build our infrastructure to implement our
strategy. We expect to hire additional employees and expand information
technology systems. We also may increase our operating expenses to:




17


·
            broaden
      our support capabilities for our
clients;




·
            explore
      acquisition opportunities and alliances with other companies;
      and




·
            facilitate
      business arrangements among our business
units.




If the
higher expenses are not accompanied by increased revenue, our earnings will be
lower than anticipated or we may incur losses.




Item
2.  Properties





The
Company currently leases approximately 5,500 square feet of office space in New
York, New York, for its corporate offices from Ironwood Realty
Corporation.  Its use of this space and related facilities are subject
to the terms of a ten year lease between Ironwood Realty Corporation and the
Company at a fixed monthly fee that expires in December 2014.





ZCS
leases approximately 5,977 square feet of office space in Burlington,
Massachusetts, from a third party at a fixed monthly fee that will be expiring
on June 30, 2011. ZCS also leases 5,210 square feet of office space in Carmel,
Indiana, 3,651 square feet of office space in West Chester, Ohio and 6,777
square feet in Jacksonville, Florida, and 2,893 square feet in Makati City,
Philippines.  These leases are with third parties at fixed monthly
fees and expire in December 2013 and August 2015 and March 2010, respectively.
ZCS leases approximately 2,662 square feet of office space in Alpharetta,
Georgia from the former owner of DBA; this lease expires in December
2010.  Additionally, ZCS leases 737 square feet in North Palm Beach,
Florida from the former owner of PS GoLive; this lease expires in October
2010.  We are currently renegotiating our lease in the
Philippineswith the existing
landlord.





In
management’s opinion, these properties are in good condition and adequately
covered by insurance.  The Company has no other properties and
management believes that its office space is currently adequate for its
operating needs.





Item 3.
Legal Proceedings





None





Item 4.
Reserved





PART
II





Item 5.
Market for Registrant's Common Equity and Related Stockholder
Matters





The
following table sets forth the quarterly high and low sale prices for Zanett’s
Common Stock, which trades under the symbol "ZANE", as reported in the NASDAQ
Capital Market for each quarter during the two years ended December 31,
2009.





The
following table shows quarterly low and high salesprice information for the Common Stock for each quarter during the two
years ended December 31, 2009:


18





High
                  
                  
                  LowYear
      Ended December 31, 2009Fourth
      Quarter
                  
                  $
                  0.59
                  
                  
                  
                  0.22Third
      Quarter
                  
                  
                  0.84
                  
                  
                  
                  0.40Second
      Quarter
                  
                  
                  0.72
                  
                  
                  
                  0.32First
      Quarter
                  
                  
                  0.60
                  
                  
                  
                  0.17Year
      Ended December 31, 2008Fourth
      Quarter
                  
                  $
                  1.17
                  
                  
                  
                  0.41Third
      Quarter
                  
                  
                  1.65
                  
                  
                  
                  0.90Second
      Quarter
                  
                  
                  1.68
                  
                  
                  
                  0.32First
      Quarter
                  
                  
                  0.74
                  
                  
                  
                  0.36





Records
of Zanett’s stock transfer agent indicate that as of March 26, 2010, there were 8,738,833 shares of Common
Stock outstanding. The most recent information available to the Company
indicates that there were shares held by approximately 64 holders of record and
1,953 holders whose shares are legally held by a broker. Our credit facility
with Bank of America prohibits the Company from declaring or paying any
dividend, except for dividends or other distributions made by ZCS to the
Company, provided, however, that the Company may accrue (but not pay) dividends
as payments in kind.  The Company has not paid any cash dividends to
date and does not anticipate or contemplate paying cash dividends in the
foreseeable future. The Company plans to retain any earnings for use in the
operation of its business and to fund future growth, including
acquisitions.





The
following table summarizes Zanett's securities issued or authorized for issuance
under the Company's equity compensation plans as of December 31,
2009.




Number
      ofsecuritiesNumber
      of
                            
                            
                            Weighted-
                            
                            
                            remainingsecurities
      to
                            
                            
                            average
                            
                            
                            available
      forbe
      issued
                            
                            
                            exercise
                            
                            
                            future
      issuanceupon
      exercise
                            
                            
                            price
      of
                            
                            
                            under
      equityof
                            
                            
                            outstanding
                            
                            
                            compensation
      plansoutstanding
                            
                            
                            options,
                            
                            
                            (exludingoptions,
                            
                            
                            warrants
                            
                            
                            securitieswarrants
      and
                            
                            
                            and
      rights
                            
                            
                            reflected
      inPlan
      Category
                            
                            rights
      (a)
                            
                            
                            (b)
                            
                            
                            Column
      a) (c)Equity
      compensation plans approved by security holders
                            
                            
                            1,617,773
                            
                            
                            $
                            6.99
                            
                            
                            
                            882,227Equity
      compensation plans not approved by security holders
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            -Total
                            
                            
                            1,617,773
                            
                            
                            $
                            6.99
                            
                            
                            
                            882,227


The above
table excludes options issued in connection with acquisitions, which were not
covered under the Company's equity compensation plans.


19





Recent
Sales of Unregistered Securities





On March
9, 2009, the Company issued 502,672 unregistered shares of restricted Common
Stock to the former DBA shareholders as the stock portion of the contingent
consideration paid based on DBA’s operating performance for the 12 months ended
January 31, 2009.  The shares were valued at $.47 per share based on
the three day average before January 31, 2009 closing price of the Common Stock.
The issuance of these unregistered shares was made pursuant to the private
placement exemption under Section 4(2) of the Securities Act of 1933, as
amended.These unregistered
shares are restricted under lock-up agreements with the Company that prohibit
the holders from reselling or otherwise disposing of their shares prior to the
fifth anniversaryof the date of
issuance.  A percentage of the holder's shares may be released from
these lock-up restrictions when the Common Stock reaches certain specified
prices.





There
were no options exercised in 2009 and 2008.





Our 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.  However, there were no shares
repurchased in 2009.  Pursuant to the Company’s previous stock
repurchase plan, as of December 31, 2008, we had repurchased a total of 14,915
shares of common stock. These shares are reflected as treasury stock on the
balance sheet.





Item
      7.
            Management's
      Discussion and Analysis of Financial Condition and Results of
      Operations





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.





2009
versus 2008 - Results of Operations





Revenues
decreased 13.3% for the year ended December 31, 2009 to $41,376,100 from
$47,728,669 during the year ended December 31, 2008.  This decrease in
revenue can be attributed primarily to a reduction
in demand for our services due tothe weakened economy and decreasing
demand in the IT industryas a
whole.





Particularly
in the first quarter of 2009, we saw a significant decline in our pipeline of
potential contracts with customers.  This decrease resulted in fewer
closed customer deals in 2009.  We saw this pipeline increase late in 2009 and
continue strong in the first three months of 2010.





Costs of
revenues decreased 10.4% to $29,518,856 during the year ended December 31, 2009,
versus $32,936,179 for the prior year. This decrease was primarily attributed to
our decline in revenueand, accordingly, a
corresponding decrease in the billable hours for which we utilized our work
force.  As a result, gross margins in fiscal 2009 decreased to
28.7% of revenues from 30.7% in fiscal 2008.  As a result of an
increase in our business in late 2009 and
early 2010,work force utilization has
rebounded in the first three months of 2010 to first quarter 2009
levels.




We
decreased our selling and marketing expense by 2.8% to $5,673,605 for the year
ended December 31, 2009, as compared with $5,835,123 during the year ended
December 31, 2008.  This decrease in costs is related to a further
reduction in commission and other various marketing expenses in the third
quarter of 2009, as part of our overall cost-containment
efforts.


20





General
and administrative expenses for the year ended December 31, 2009, were
$8,202,328 as compared with $8,177,276 during 2008, remaining relatively
flat.





Consolidated
Net(Loss)/Income





On a
consolidated basis, the decrease in operating expenses partly offset the effect
of the decrease in revenue resulting in an operating loss of $2,018,689 for the
year ended December 31, 2009, as compared to operating income of $780,091 for
the year ended December 31, 2008.





Net
interest expense for the yearended December 31,
2009 was $1,292,027 compared to $1,493,082 in 2008.  The
decrease was a result of the decrease of the prime rate in 2009 versus
2008.





Our loss
from continuing operations before income taxes was $3,310,716 for the year ended
December 31, 2009, as compared to a loss from continuing operations of $712,991
for the year ended December 31, 2008.





We
recorded an income tax benefit of $98,795 for the year ended December 31, 2009,
compared to an income tax provision of $162,153 for 2008.





We
recorded a $887,500 and $1,932,913 gain on the sale of PDI net of taxes, in the
years ended December 31, 2009 and December 31, 2008, respectively. Loss from the
discontinued operations of PDI, net of tax, was $285,919 for the year ended
December 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 all of the above, for the year ended December 31, 2009, we reported a
consolidated net loss of $2,324,421 as compared to
consolidated net income of $771,850 for the year ended December 31,
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 consolidated 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.


21





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 to independent contractors and certain key employees.
The Company has also issued stock options to employees and non-employees. 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 equity instruments and the risk free rate
based on information that was available to management at the time the
Black-Scholes option-pricing calculations were performed.





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.




22





Goodwill





The
excess of the purchase consideration over the fair value of the net assets of
acquired businesses is considered to be goodwill.  Under authoritative
guidance, purchased goodwill is not amortized, but rather, periodically (but at
least annually) reviewed for impairment.  We have remaining goodwill
of $16,479,746 and $15,762,216 at December 31, 2009 and 2008,
respectively.  This goodwill resulted from the acquisition of all of
the stock or substantially all of the assets, as applicable, of Back Bay
Technologies, Inc., INRANGE Global Consulting, Whitbread Technology Partners,
Inc., Data Road, Inc., DBA Group, LLC. and PS GoLive, LLC. We test goodwill for
impairment at the reporting unit level and have determined that we have only one
reporting unit, ZCS.





In
October 2009 and 2008, we performed our annual test for impairment of goodwill
and concluded that no impairment charge was required for either
year.  Under authoritative guidance we are required to follow the
two-step impairment test.  In the first step, we compare the fair
value of our reporting unit to its carrying value.  We determined the
fair value of our reporting unit based on an combined income approach using a
discounted cash flow methodology, and market approach based upon comparable
values of companies similar to ZCS and the market capitalization of the Company.
This approach requires us to use significant judgment including estimation of
future cash flows, which is dependent on internal forecasts, estimation of the
long-term rate of growth for our business, determination of our weighted average
cost of capital for purposes of establishing a discount rate, and relevant
market data.  If the fair value of the reporting unit exceeds the
carrying value of the net assets assigned to the reporting unit, goodwill is not
impaired and we are not required to perform further testing.  If the
carrying value of the net assets of the reporting unit exceeds the fair value of
the reporting unit, then we must perform the second step of impairment testing
in order to determine the implied fair value of the reporting unit’s
goodwill.  If the carrying value of a reporting unit’s goodwill
exceeds its implied fair value then we record an impairment loss equal to the
difference.  Based on our valuation results, we determined that the
fair value of our reporting unit at October 31, 2009 ranged from 101% of its
carrying value based solely on a discounted cash flow method, to 152% based upon
a blended discounted cash flow, comparable market value and market
capitalization approach, which are discussed in detail
below.  Therefore, management determined that no goodwill impairment
charge was required as of October 31, 2009.





Market
capitalization is a relevant and objective, but not conclusive, indicator of the
Company’s fair value considered in our evaluation of goodwill
impairment.  During its fiscal 2009 year, the Company’s closing stock
price fluctuated from a low of $.17 to a high of $1.65.  As directed
by authoritative guidance, we evaluated the trading activity in the Company’s
common stock, including bid-ask spreads and the significant decline in trading
volumes.  Based on this evaluation, we concluded that it would not be
appropriate to place significant reliance on the stock prices we observed as
being representative of the our reporting unit’s fair value.  In
particular, we noted that the volume had significantly decreased and
transactions may not be orderly as well as the fact that the Company’s market
capitalization includes corporate costs and debt not related to the ZCS
reporting unit.  Accordingly, at the measurement date we placed
greater reliance on the projected discounted cash flow method.


23





During
the fall of 2008, our market capitalization declined significantly, along with
that of other public companies in and outside of our industry as a result of
declining worldwide economic conditions caused by the tightening of global
credit markets.  The Company’s stock has traded below net book value
per share over the past year.  We do not believe the recent general
downturn in the U.S. and global equity markets is representative of any
fundamental change in our business.  The global recession has
generally impacted both the timing and size of our customer orders.





Our
discounted cash flow projections were based on a five-year financial
forecast.  The five-year forecast was based on annual financial
forecasts developed internally by management for use in managing our
business.  The significant assumptions of these five-year forecasts
which were used in determining fair value of our single reporting unit
included:





· annual
revenue growth rates ranging from 13% to 17%, which are in line with our recent
historical growth rates;


· gross
margins of 30% which are similar to our recent historic gross margins;
and


· future
cash flows were discounted to present value using an end-of-year convention and
weighted average cost of capital of 19.5%.





We
believe these estimated assumptions are appropriate for our circumstances,
in-line with or below our historical results and consistent with our forecasted
long-term business model.  These assumptions also have considered the
current economic environment.  However, due to uncertain market
conditions and potential changes in our strategy and product portfolio, it is
possible that the forecasts we use to support our goodwill could change in the
future.  Changes in these estimates or assumptions, including changes
in our reporting structure, could materially affect our determination of fair
value.  Accordingly, there can be no assurance that our estimates and
assumptions made for purposes of our goodwill impairment testing as of Ocotber
31, 2009 will prove to be accurate predictions of the future.





If our
estimates and assumptions are not materially accurate, we may be required to
record goodwill impairment charges in future periods, whether in connection with
the next annual impairment testing October 31, 2010 or prior to that, if any
such changes constitutes a triggering event outside of the quarter from when the
annual goodwill impairment test is performed.  It is not possible at
this time to determine if any such future impairment charge would result or, if
that does, whether such charge would be material.  Reference should
also be made to “Item 1A: Risk Factors – “Unsuccessful acquisitions could
adversely affect our business”





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.


24





Factors
we consider important which could trigger an impairment review include the
following:





·
            significant
      negative industry or economic
trends;


·
            significant
      decline in our stock price for a sustained
  period;


·
            our
      market capitalization relative to net book value;
  and


·
            significant
      changes in the manner of our use of the acquired assets or the strategy
      for our overall business.





When we
determine that the carrying value of intangibles or long-lived assets may not be
recoverable, based upon the existence of one or more of the above indicators of
impairment, we measure any impairment based on a projected discounted cash flow
method.  We determined that there was no impairment as of December 31,
2009 and 2008.





Liquidity
and Capital Resources





At
December 31, 2009 we had cash and cash equivalents of $180,598 representing a
decrease of $269,706 from the December 31, 2008 year-end balance of
$450,304.  This decrease was attributable to the decline in our
revenues in the last nine months of 2009.





Cash used
in operating activities was $428,549 for the year ended December 31, 2009
compared to cash provided by operating activities of $311,156 in
2008.  The decrease in cash provided by operating activities was
primarily due to decline in our operating results and a decrease in accounts
receivable as a result of our revenue decline, partially offset by a increase in
accounts payable.





Cash used
in investing activities was $137,422 for the year ended December 31, 2009
compared to cash provided by investing activities of $6,005,221 in 2008. The
change primarily reflects net proceeds of $7,848,964 received in 2008 for the
PDI sale compared to $736,548 in 2009. In addition, we incurred expenses related
to additions to property and equipment of $494,682 and $719,576 in 2009, and
2008, respectively.  In 2008 we had cash paid for acquisitions of
$397,120, but we did not have any cash outflows for acquisitions in 2009. In
2009 and 2008 we had $337,507 and $727,047 of contingent consideration
paid.





Cash
provided by financing activities for the year ended December 31, 2009 was
$296,265 versus cash used in financing activities of $7,127,138 in
2008.  This activity in 2008 included approximately $7,300,000 of loan
repayments from the proceeds of the PDI transaction.





On
December 31, 2006 we entered into a revolving credit facility with LaSalle Bank
National Associations, which facility is now with Bank of America, N.A., as
successor-by-merger to LaSalle.  The credit agreement was amended on
May 31, 2007, November 14, 2007, March 18, 2008, January 22, 2009 and December
21, 2009. As amended, the available line of credit is based on 80% of eligible
accounts receivable up to a maximum of $6 million.  Loans under the
revolving credit facility bear interest at a rate per annum equal to the
greatest of (a) the prime rate, (b) the federal funds rate plus 0.5% and (c) the
30-day LIBOR rate plus 1.0%, in each case plus 3.0% per annum.  The
credit facility terms require the Company to meet certain financial covenants,
including a fixed charge coverage ratio of 1.25 to 1.0, a maximum senior debt
ratio of 2.5 to 1.0, maintenance of minimum net availability of $500,000 at all
times, and excess cash flow of not less than $0 at all times, tested
quarterly.  The Company was not in compliance with these covenants as
of December 31, 2009.  As of March 24, 2010, the outstanding loan
balance was $4,350,090 with available borrowings of $668,562.  As the
credit facility matures on June 21, 2010, we are currently in discussions with
various senior lenders to replace or refinance this facility.


25





As of December 31, 2009, our other source of
liquidity was a $3,000,000 line of credit
agreement with Bruno Guazzoni, the uncle of our Chief Executive Officer and
owner of 27.8% of our outstanding common
stock as of March 26, 2010.  Advances under this line of credit bear
interest at prime plus 2%.  As of December 31, 2009, our balance on
the line of credit was $1,327,000 with available borrowings of
$1,673,000.  As of the end of fiscal 2009, we also had two promissory notes originally issued to Bruno Guazzoni in the
aggregate principal amount of $5,325,000.  These notes bear interest
at 11%, payable quarterly.  The
line of credit and bothpromissory notes matured on March 15,
2010.  However, Mr. Guazzoni sold the line of credit and promissory
notes to Rockport Investments, Ltd. in a
private transactionon February 28,
2010.  On March 31, 2010 we exchanged the debt held by Rockport
Investments, Ltd. for a new note convertible into shares of our common stock at
any time following stockholder approval of the transaction at the option of the
noteholder (provided, however, that without stockholder approval of the
transaction, the note may not be converted into more than 19.99% of the common
stock outstanding before the issuance of the convertible note).  The note has a principal amount of $7,131,983 and bears
interest at a rate of 7.95% per annum, payable quarterly in
arrears.  The conversion rate is initially equal to the closing bid
price immediately preceding the closing date.  Rockport may, at its
option, reset the conversion price once per calendar year to the greater of (a)
the average of the closing price of the Company’s common stock during the
preceding 20 consecutive trading day period and (b) $0.10.  The
conversion price is also subject to adjustment in the event of dilutive
issuances by the Company or the Company’s issuance of options, warrants or other
rights to purchase the Company’s common stock or convertible securities (subject
to certain exceptions, including the grant of options to purchase common stock
to employees, officers, directors or consultants of the Company).  In
addition, the noteholder has the right to vote on all matters to which holders
of our common stock are entitled to vote, on an as-converted basis using the
closing bid price immediately preceding the closing date as the conversion rate,although this voting right does not become effective until our
stockholders approve the terms of the convertible note that provide for the
potential issuance of more than 19.99% of the Company’s common stock (on a
pre-transaction basis) upon conversion of the convertible note by Rockport and
grant this voting power to the noteholder.  Pursuant to the terms of
the convertible note, effective upon such stockholder approval, Rockport would
have the right to vote approximately 28% of the Company’s common stock; however,
Rockport has entered into a voting agreement with our Chief Executive Officer,
Claudio Guazzoni, pursuant to which it has appointed Mr. Guazzoni as its proxy
to vote on Rockport’s behalf in all matters to which stockholders are entitled
to vote beginning upon such stockholder approval and continuing for the life of
the note.  See Note 22 to our
Consolidated Financial Statements included in this Annual Report on Form 10-K
for further discussion of this exchange transaction and the new convertible
note.


Because
of our net loss from continuing operations of $3,304,152 in 2009, our working
capital deficit, the current maturity dates of our revolving credit facility,
and our limited access to additional borrowings under these financing
arrangements, there is substantial doubt about our ability to continue as a
going concern. The accompanying consolidated financial statements do not include
any adjustments relating to the recoverability of the carrying amount of
recorded assets or the amount of liabilities that might result should the
Company be unable to continue as a going concern.





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 the scheduled debt maturities
discussed above 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 also continue to explore other opportunities that may be
available to maximize the Company’s value for its stockholders, including
strategic transactions.  As a result of tightening of the credit
markets and volatility in the 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, and we may need to reduce the scope
of our existing operations and/or curtail some of our present
operations.


26





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.





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 thestock
repurchase plan, as of December 31, 2009, we had repurchased 14,915 shares of
our Common Stock at a cost of $179,015. None of these shares were repurchased in
2009 or 2008. 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 2009, no one
      customer accounted for more than 10% of revenues, although our largest
      customer, Reynolds Consumer Products Company, accounted for approximately
      10% of revenues. During 2008, one customer accounted for approximately 7%
      of revenues.  At December 31, 2009 and December 31, 2008, the
      Company did not have a customer account that accounted for over 12% of
      accounts receivable.





Off-Balance
Sheet Arrangements





The
Company has no off-balance sheet arrangements.





Inflation





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


27





Recent
Accounting Pronouncements





In June
2009, the Financial Accounting Standards Board (“FASB”) issued its final
Statement of Financial Accounting Standards (“SFAS”) No. 168 – “The FASB Accounting Standards ASC
Topic and the Hierarchy of Generally Accepted Accounting Principles a
replacement of FASB Statement No. 162” (“SFAS No. 168”).  SFAS
No. 168 made the FASB Accounting Standards Codification (the “ASC”) the single
source of U.S. Generally Accepted Accounting Policies (“U.S. GAAP”) used by
nongovernmental entities in the preparation of financial statements, except for
rules and interpretive releases of the SEC under authority of federal securities
laws which are sources of authoritative accounting guidance for SEC
registrants.  The ASC is meant to simplify user access to all
authoritative accounting guidance by reorganizing U.S. GAAP pronouncements into
roughly 90 accounting topics within a consistent structure; its purpose is not
to create new accounting and reporting guidance.  The ASC supersedes
all existing non-SEC accounting and reporting standards and was effective for
the Company beginning July 1, 2009.  Following SFAS No. 168, the Board
will not issue new standards in the form of Statements, FASB Staff Positions, or
Emerging Issues Task Force Abstracts; instead, it will issue Accounting
Standards Updates.  The FASB will not consider Accounting Standards
Updates as authoritative in their own right; these updates will serve only to
update the ASC topic, provide background information about the guidance, and
provide the bases for conclusions on the change(s) in the ASC.  In the
description of ASC and Accounting Standards Updates (“ASU”) that follows,
references in italics relate to ASC or ASU topics and their descriptive titles,
as appropriate.





In
September 2009, the FASB issued ASU 2009-14, “Certain Revenue Arrangements That
Include Software Elements” (“ASU 2009-14”), which excludes tangible
products containing software components and non-software components that
function together to deliver the product’s essential functionality from the
scope of Subtopic 985-605, “Revenue
Recognition.”  ASU 2009-14 is effective for periods beginning
after December 15, 2009 with earlier adoption permitted.  The Company
is currently evaluating the timing of its adoption of ASU 2009-14 and the impact
that ASU 2009-14 will have on its consolidated financial
statements.





In
October 2009, the FASB issued ASU 2009-13 which supersede certain guidance in
ASC 605-25, “Revenue
Recognition – Multiple Element Arrangements”.  This topic
requires an entity to allocate arrangement consideration at the inception of an
arrangement to all of its deliverables based on their relative selling
prices.  This topic is effective for annual reporting periods
beginning after June 15, 2010.  The Company is currently evaluating
the impact that this topic will have on its consolidated financial
statements.





Item
      8.
            Financial
      Statements and Supplemental Data





The
Company’s Consolidated Financial Statements and accompanying Footnotes are
attached to this Annual Report on Form 10-K.





Item
      9.
            Changes
      in and Disagreements with Accountants on Accounting and Financial
      Disclosure





None.


28





Item
9A(T). Controls and Procedures





As
required by Rule 13a-15(b) under the Exchange Act, our management carried out an
evaluation of the effectiveness of the design and operation of the Company’s
“disclosure controls and procedures” as of December 31, 2009. This evaluation
was carried out under the supervision and with the participation of our
management, including our Company’s Chief Executive Officer and Chief Financial
Officer. As defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act,
disclosure controls and procedures are controls and other procedures of the
Company that are designed to ensure that information required to be disclosed by
the Company in the reports it files or submits under the Exchange Act is
recorded, processed, summarized and reported within the time periods specified
in the SEC’s rules and forms. Disclosure controls and procedures include,
without limitation, controls and procedures designed to ensure that information
required to be disclosed by the Company in the reports it files or submits under
the Exchange Act is accumulated and communicated to the Company’s management,
including the Company’s Chief Executive Officer and Chief Financial Officer, as
appropriate, to allow timely decisions regarding required disclosure. Based upon
that evaluation, the Company’s Chief Executive Officer and Chief Financial
Officer concluded that the Company’s disclosure controls and procedures were
effective as of December 31, 2009. It should be noted that the design of any
system of controls is based in part upon certain assumptions about the
likelihood of future events, and there can be no assurance that any design will
succeed in achieving its stated goals under all potential future conditions,
regardless of how remote.





Internal
Control over Financial Reporting





Our
management is responsible for establishing and maintaining adequate internal
control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) of
the Exchange Act. Internal control over financial reporting is a process to
provide reasonable assurance regarding the reliability of our financial
reporting and the preparation of financial statements for external purposes in
accordance with GAAP. Internal control over financial reporting includes
maintaining records that in reasonable detail accurately and fairly reflect our
transactions and disposition of assets; providing reasonable assurance that
transactions are recorded as necessary for preparation of our financial
statements in accordance with generally accepted accounting principles;
providing reasonable assurance that receipts and expenditures of Company assets
are made in accordance with authorization of management and directors of the
Company; and providing reasonable assurance that unauthorized acquisition, use
of disposition of Company assets that could have a material effect on out
financial statements would be prevented or detected on a timely basis. Because
of its inherent limitations, internal control over financial reporting is not
intended to provide absolute assurance that a misstatement of out financial
statements would be prevented or detected. In addition, projections of any
evaluation of effectiveness to future periods are subject to the risk that,
owing to changes in conditions, controls may become inadequate, or that the
degree of compliance with policies of procedures may deteriorate.





Management
conducted an evaluation of the effectiveness of our internal control over
financial reporting based on the framework in Internal Control-Integrated
Framework issued by the Committee of Sponsoring Organizations of the Treadway
Commission. Based on this evaluation, management concluded that the Company’s
internal control over financial reporting was effective as of December 31, 2009.
There were no changes in our internal control over financial reporting during
the quarter ended December 31, 2009 that have materially affected, or are
reasonably likely to materially affect, our internal control over financial
reporting.


29





This
annual report does not include an attestation report of the Company’s
independent registered public accounting firm regarding internal control over
financial reporting. Management’s report was not subject to attestation by the
Company’s independent registered public accounting firm pursuant to temporary
rules of the SEC that permit the Company to provide only management’s report in
this annual report.





Item
9B.  Other Information





None


30


PART
III





Item
      10.
            Directors
      and Corporate Governance





The
response to this Item will be contained in the Company’s 2010 Proxy Statement
under the captions “Election of Directors” and “Code of Conduct and Ethics” and
is incorporated herein by reference.





Section
16(a) Beneficial Ownership Reporting Compliance





Information
with respect to compliance with Section 16(a) of the Securities Exchange Act of
1934, as amended, will be contained in the Company’s 2010 Proxy Statement under
the caption “Section 16(a) Beneficial Ownership Reporting Compliance” and is
incorporated herein by reference.





Board of
Directors and Committees of the Board of Directors


Information
with respect to committees of our Board of Directors will be contained in the
Company’s 2010 Proxy Statement under the caption “Information about the Board of
Directors and Committees of the Board of Directors” and is incorporated herein
by reference.





Item
      11.
            Executive
      Compensation





The
response to this Item will be contained in the Company's 2010 Proxy Statement
under the caption "Executive Compensation" and is incorporated herein by
reference.





Item
      12.
            Security
      Ownership of Certain Beneficial Owners and Management and Related
      Stockholder Matters





The
response to this Item will be contained in the Company's 2010 Proxy Statement
under the caption "Security Ownership of Management and Principal Shareholders"
and is incorporated herein by reference.





Item
      13.
            Certain
      Relationships, Related Transactions and Director
    Independence





Information
with respect to the independence of our directors will be included in our 2010
Proxy Statement under the caption “Election of Directors” and is incorporated
herein by reference.





During
the year ended December 31, 2009, the Company was a party to the following
transactions with related parties:





In March
2009, the Company extended the maturity date on a line of credit agreement with
Bruno Guazzoni, the uncle of Zanett’s Chief Executive Officer, Claudio Guazzoni,
and the owner of approximately 27.8% of Zanett’s outstanding common stock
(calculated as of March 26, 2010) from March 15, 2009 to March 15,
2010.  The maximum borrowings under this line of credit are $3,000,000
and the interest rateis prime plus two
percent (2%).  As of December 31, 2009 this line had an outstanding
balance of $1,327,000 with available borrowings of $1,673,000. Interest expense
attributed to this line of credit for the year ended December 31, 2009 was
$58,752.  The Company paid Mr. Guazzoni $41,372 of principal and
interest under this line of credit in 2009.  This line of credit was
sold by Bruno Guazzoni to Rockport Investments, Ltd. in a private transaction on
February 28, 2010.


31





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.  Also on March 15, 2009, ZCS replaced an existing promissory
note issued to Bruno Guazzoni in the aggregate principal amount of $750,000 with
a new note with identical terms, except the maturity date was extended from
March 15, 2009 to March 15, 2010.  These two new notes required
quarterly payments of interest at the rate of eleven percent (11%) per
annum.  These two promissory notes were sold by Bruno Guazzoni to
Rockport Investments, Ltd. in a private transaction on February 28, 2010. In
respect of these promissory notes, interest expense was $585,750 for the year
ended December 31, 2009.  As of December 31, 2009, there was $292,875
interest accrued under these notes.  In 2009, the Company paid
$439,314 to Mr. Guazzoni in respect of these promissory notes.




As a
policy, all transactions involving the Company and any related parties are
reviewed by the President, CFO and CEO for approval. Additionally, all related
party transactions are reviewed at each regular quarterly meeting the board of
directors as we review with, and highlight for, the board any changes occurring
during the quarter.





Item 14.
Principal Accountant Fees and Services





The
response to this Item will be contained in the Company’s 2010 Proxy Statement
under the caption “Principal Accountant Fees and Services” and is incorporated
herein by reference.





Item 15.
Exhibits, Financial Statement Schedules





(a)  Exhibits





Exhibit
                  Number
                
                Item2.1
                
                Agreement
      and Plan of Merger by and among Back Bay Technologies, Inc., Planet
      Zanett, Inc., Planet Zanett Merger Sub BBT, Inc. and the stockholders of
      Back Bay Technologies, Inc. dated as of December 7,
20012.2
                
                Agreement
      and Plan of Merger by and among Brandywine Computer Group, Inc., Planet
      Zanett, Inc., Planet Zanett Merger Sub BCG, Inc. and the stockholders of
      Brandywine Computer Group, Inc. dated as of May 31,
20022.3
                
                Agreement
      and Plan of Merger by and among Paragon Dynamics, Inc., Zanett, Inc.,
      Zanett Inc. Merger Sub PDI, Inc. and the stockholders of Paragon Dynamics,
      Inc. dated as of January 31, 20032.4
                
                Agreement
      and Plan of Merger by and among DeltaData, Inc., Zanett, Inc., Zanett
      Merger Sub DCG, Inc. and the majority stockholder of DeltaData, Inc. dated
      as of November 30, 20032.5
                
                Asset
      Purchase Agreement between Brandywine Computer Group, Inc. and Computer
      Network Technology Corporation dated as of April 23,
  20042.6
                
                Stock
      Purchase Agreement by and among Whitbread Technology Partners, Inc.,
      Zanett, Inc., and Joel D’Arcy dated as of March 1,
2005.2.7(1)
                
                Agreement
      and Plan of Merger of Whitbread Technology Partners, Inc. and Zanett
      Commercial Solutions, Inc. dated as of December 30,
  2005.2.8(1)
                
                Agreement
      and Plan of Merger of INRANGE Consulting Corporation and Zanett Commercial
      Solutions, Inc. dated as of December 30,
2005.


32





Exhibit
                  Number
                
                Item2.9(1)
                
                Agreement
      and Plan of Merger of Back Bay Technologies, Inc. and Zanett Commercial
      Solutions, Inc. dated as of December 30, 2005.2.11(2)
                
                Stock
      Purchase Agreement by and among Data Road, Inc., Zanett, Inc., Zanett
      Commercial Solutions, Inc. and Jeffrey Francis and John Vaughan, dated as
      of May 1, 2006.2.12(3)
                
                Agreement
      and Plan of Merger among DBA Group, LLC, Zanett DBA Group, Inc., Zanett,
      Inc., Jose David Rincon, Billy Hyden and David Wolf dated as of March 6,
      2007.2.14(4)
                
                Asset
      Purchase Agreement by and among Zanett Commercial Solutions, Inc., PS
      GoLive LLC and Michael Johnson dated as of November 25,
    2008.2.15(5)
                
                Stock
      Purchase Agreement by and among Zanett, Inc., Delta Communications Group,
      Inc. and Howard Norton dated as of February 28, 2006.2.16(6)
                
                Stock
      Purchase Agreement dated as of March 12, 2008, by and among KOR
      Electronics, Paragon Dynamics, Inc. and Zanett, Inc.3.1(7)
                
                Amended
      and Restated Certificate of Incorporation of Zanett,
  Inc.3.2
                
                By-laws
      of Zanett, Inc.4.1(8)
                
                Indenture
      between Zanett, Inc. and U.S. Bank National Association, dated February 1,
      20054.2(8)
                
                Form
      of Note4.3(8)
                
                Form
      of Note Confirmation4.4(8)
                
                Form
      of Subscription Agreement10.1
                
                Zanett
      Inc. Amended and Restated Incentive Stock Plan*10.4(9)
                
                Promissory
      Note in the amount of $4,575,000 issued by Zanett Commercial Solutions,
      Inc. to Bruno Guazzoni, dated March 15, 2009.10.5(9)
                
                Promissory
      Note in the amount of $750,000 issued by Zanett Commercial Solutions, Inc.
      to Bruno Guazzoni, dated March 15, 2009.10.6(10)
                
                Loan
      and Security Agreement dated as of December 21, 2005 by and among Zanett,
      Inc., Zanett Commercial Solutions, Inc., Paragon Dynamics, Inc., Delta
      Communications Group, Inc. and LaSalle National Bank.10.7(11)
                
                First
      Amendment and Modification to Loan and Security Agreement and Other Loan
      Documents, by and among LaSalle Bank National Association, Zanett, Inc.,
      Zanett Commercial Solutions, Inc. and Paragon Dynamics, Inc. dated May 18,
      2007.10.8(12)
                
                Second
      Amendment and Modification to Loan and Security Agreement by and among
      LaSalle Bank National Association, Zanett, Inc., Zanett Commercial
      Solutions, Inc. and Paragon Dynamics, Inc. dated November 14,
      2007.10.9(6)
                
                Third
      Amendment and Modification to Loan and Security Agreement by and among
      LaSalle Bank National Association, Zanett, Inc., Zanett Commercial
      Solutions, Inc. and Paragon Dynamics, Inc. dated March 17,
      2008.10.10(13)
                
                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
      Bank National Association, dated January 22, 2009.10.11(14)
                
                Sixth
      Amendment and Modification to Loan and Security Agreement and Other Loan
      Documents with Bank of America, N.A., as successor-by-merger to LaSalle
      Bank National Association, dated December 21, 2009.21.1
                
                List
      of Subsidiaries




33





Exhibit
                      Number
                    
                    Item31.1
                    
                    Certification
      by the Chief Executive Officer pursuant to Rule
      13a-14(a)/15d-14(a).31.2
                    
                    Certification
      by the Chief Financial Officer pursuant to Rule
      13a-14(a)/15d-14(a).32.1
                    
                    Certification
      by the Chief Executive Officer pursuant to Section
1350.32.2
                    
                    Certification
      by the Chief Financial Officer pursuant to Section
  1350.








*
            Management
      contract or compensatory plan or
arrangement





(1)
            Incorporated
      by reference to Post-Effective Amendment No. 1 on Form SB-2 to our
      Registration Statement on Form S-2 filed February 10,
  2006.





(2)
            Incorporated
      by reference to our Current Report of Form 8-K filed April 24,
      2006.





(3)
            Incorporated
      by reference to our Post-Effective Amendment No. 2 on Form S-1 filed July
      17, 2007.





(4)
            Incorporated
      by reference to our Current Report on Form 8-K filed December 2,
      2008.





(5)
            Incorporated
      by reference to our Quarterly Report on Form 10-Q for the quarter ended
      March 31, 2006.





(6)
            Incorporated
      by reference to our Current Report on Form 8-K filed March 24,
      2008.





(7)
            Incorporated
      by reference to our Quarterly Report on Form 10-Q for the quarter ended
      June 30, 2009.





(8)
            Incorporated
      by reference to our registration statement on Form S-2/A field February 1,
      2005.





(9)
            Incorporated
      by reference to our Annual Report on Form 10-K for the year ended December
      31, 2008.





(10)
            Incorporated
      by reference to our Current Report on Form 8-K filed on December 28,
      2006.





(11)
            Incorporated
      by reference to our Current Report on Form 8-K filed on May 24,
      2007.





(12)
            Incorporated
      by reference to our Annual Report on Form 10-K for the year ended December
      31, 2007.





(13)
            Incorporated
      by reference to our Current Report on Form 8-K filed January 30,
      2009.





(14)
            Incorporated
      by reference to our Current Report on Form 8-K filed December 24,
      2009.


34





SIGNATURES





Pursuant
to the requirements of Section 13 or 15(d) or the Securities Exchange Act of
1934, the registrant has duly caused this report to be signed on its behalf by
the undersigned, thereunto duly authorized.




ZANETT,
      INC.BY:
      /s/ Claudio M. GuazzoniClaudio
      M. GuazzoniChief
      Executive Officer(Principal
      Executive Officer)Date:
      March 31, 2010





Pursuant
to the requirements of the Securities Exchange Act of 1934, this Annual Report
has been signed below by the following persons on behalf of the registrant and
in the capacities and on the dates indicated.





SIGNATURE
            
            TITLE
            
            DATE/s/ Claudio M. Guazzoni
            
            Chairman
      & ChiefClaudio
      M. Guazzoni
            
            Executive
      Officer
            
            March
      31, 2010/s/ Dennis Harkins
            
            President
      & ChiefDennis
      Harkins
            
            Financial
      Officer(Principal
      Financialand
      Accounting Officer)
            
            March
      31, 2010/s/ L. Scott Perry
            
            Director
            
            March
      31, 2010L.
      Scott Perry/s/ William H. Church
            
            Director
            
            March
      31, 2010William
      H. Church/s/ Leonard G. Goldstein
            
            Director
            
            March
      31, 2010Leonard
      G. Goldstein/s/ Charles T. Johnstone
            
            Director
            
            March
      31, 2010Charles
      T. Johnstone


35


ZANETT,
INC.


INDEX TO
CONSOLIDATED FINANCIAL STATEMENTS





PageReport
      of Independent Registered Public Accounting Firm
              
              37Consolidated
      Balance Sheets as of December 31, 2009 and 2008
              
              38Consolidated
      Statements of Operations for the years ended December 31, 2009 and
      2008
              
              39Consolidated
      Statements of Changes in Stockholders' Equity for the years ended December
      31, 2009 and 2008
              
              40Consolidated
      Statements of Cash Flows for the years ended December 31, 2009 and
      2008
              
              41Notes
      to Consolidated Financial Statements
              
              42


36


REPORT OF
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM





To the
Board of Directors and Stockholders of Zanett, Inc.


New York,
NY





We have
audited the accompanying consolidated balance sheets of Zanett, Inc. and
subsidiaries (the “Company”) as of December 31, 2009 and 2008 and the related
consolidated statements of operations, stockholders’ equity, and cash flows for
the years then ended.  These consolidated financial statements are the
responsibility of the Company’s management.  Our responsibility is to
express an opinion on the consolidated financial statements based on our
audits.





We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States).  Those standards require
that we plan and perform the audit to obtain reasonable assurance about whether
the consolidated financial statements are free of material
misstatement.  The Company is not required to have, nor were we
engaged to perform, an audit of its internal control over financial
reporting.  Our audits included consideration of internal control over
financial reporting as a basis for designing audit procedures that are
appropriate in the circumstances, but not for the purpose of expressing an
opinion on the effectiveness of the Company’s internal control over financial
reporting.  Accordingly, we express no such opinion.  An
audit also includes examining, on a test basis, evidence supporting the amounts
and disclosures in the consolidated financial statements, assessing the
accounting principles used and significant estimates made by management, as well
as evaluating the overall consolidated financial statement
presentation.  We believe that our audits provide a reasonable basis
for our opinion.





In our
opinion, the consolidated financial statements referred to above present fairly,
in all material respects, the financial position of Zanett, Inc. at December 31,
2009 and 2008 and the results of their operations and their cash flows for the
years then ended, in conformity with accounting principles generally accepted in
the United States of America.





The
accompanying consolidated financial statements have been prepared assuming the
Company will continue as a going concern.  As more fully described in
Note 1 to the consolidated financial statements, the Company has incurred a
significant loss from continuing operations, has a working capital deficit and
all of its outstanding debt is either currently payable or payable within the
next twelve months.  These conditions raise substantial doubt about
the Company’s ability to continue as a going concern.  Management’s
plans in regard to these matters are also described in Note 1 to the
consolidated financial statements.  The consolidated financial
statements do not include any adjustments that may result from the outcome of
this uncertainty.





/s/
      Amper, Politziner & Mattia, LLPMarch
      31, 2010New
      York, New York


37


ZANETT,
INC.


CONSOLIDATED
BALANCE SHEETS





December 31,2009
                        
                        
                        2008AssetsCurrent
      assets:Cash
      and cash equivalents
                        
                        $
                        180,598
                        
                        
                        $
                        450,304Accounts
      receivable net of allowance for doubtful accounts of $432,490 and
      $332,945, respectively
                        
                        
                        6,536,874
                        
                        
                        
                        6,855,916Income
      tax receivable
                        
                        
                        51,863
                        
                        
                        
                        56,062Unbilled
      revenue
                        
                        
                        206,681
                        
                        
                        
                        296,341Prepaid
      expenses
                        
                        
                        250,335
                        
                        
                        
                        319,436Customer
      deposits
                        
                        
                        535,000
                        
                        
                        
                        535,000Other
      current assets
                        
                        
                        174,306
                        
                        
                        
                        224,637Total
      current assets
                        
                        
                        7,935,657
                        
                        
                        
                        8,737,696Property
      and equipment, net
                        
                        
                        1,304,522
                        
                        
                        
                        1,333,280Goodwill
                        
                        
                        16,479,746
                        
                        
                        
                        15,762,216Intangibles,
      net
                        
                        
                        615,088
                        
                        
                        
                        962,292Other
      assets
                        
                        
                        165,349
                        
                        
                        
                        245,113Total
      assets
                        
                        $
                        26,500,362
                        
                        
                        $
                        27,040,597Liabilities
      and stockholders' equityCurrent
      liabilities:Accounts
      payable
                        
                        $
                        1,235,640
                        
                        
                        $
                        620,466Accrued
      expenses
                        
                        
                        2,836,387
                        
                        
                        
                        3,150,959Short
      term debt-line of credit
                        
                        
                        4,350,090
                        
                        
                        
                        4,235,551Short
      term debt-related party
                        
                        
                        6,652,322
                        
                        
                        
                        1,027,322Short
      term renewable unsecured subordinated debt
                        
                        
                        1,123,048
                        
                        
                        
                        1,185,379Other
      current liabilities
                        
                        
                        1,032,620
                        
                        
                        
                        931,004Income
      taxes payable
                        
                        
                        14,591
                        
                        
                        
                        33,691Deferred
      revenue
                        
                        
                        1,228,802
                        
                        
                        
                        916,249Deferred
      income taxes
                        
                        
                        30,645
                        
                        
                        
                        27,054Capital
      lease obligations
                        
                        
                        35,988
                        
                        
                        
                        8,173Total
      current liabilities
                        
                        
                        18,540,133
                        
                        
                        
                        12,135,848Notes
      payable-related party
                        
                        
                        -
                        
                        
                        
                        5,325,000Long
      term renewable unsecured subordinated debt
                        
                        
                        1,131,104
                        
                        
                        
                        1,114,565Capital
      lease obligation
                        
                        
                        47,980
                        
                        
                        
                        -Deferred
      rent expense
                        
                        
                        76,535
                        
                        
                        
                        70,000Deferred
      income taxes
                        
                        
                        25,053
                        
                        
                        
                        160,296Total
      liabilities
                        
                        
                        19,820,805
                        
                        
                        
                        18,805,709Commitments
      and contingencies
                        
                        
                        -
                        
                        
                        
                        -Stockholders'
      equityPreferred
      stock, $0.004 par value;10,000,000
      shares authorized;none
      issued and outstanding
                        
                        
                        -
                        
                        
                        
                        -Common
      stock, $0.004 par value;50,000,000
      shares authorized8,738,833
      and 7,608,506 sharesissued
      and outstanding, respectively
                        
                        
                        32,443
                        
                        
                        
                        30,434Additional
      paid-in capital
                        
                        
                        32,482,502
                        
                        
                        
                        31,715,421Treasury
      stock, at cost -14,915 shares
                        
                        
                        (179,015
                        )
                        
                        
                        (179,015
                        )Accumulated
      deficit
                        
                        
                        (25,656,373
                        )
                        
                        
                        (23,331,952
                        )Total
      stockholders' equity
                        
                        
                        6,679,557
                        
                        
                        
                        8,234,888Total
      liabilities and stockholders' equity
                        
                        $
                        26,500,362
                        
                        
                        $
                        27,040,597





The
accompanying notes are an integral part of these consolidated balance
sheets.


38





ZANETT,
INC.


CONSOLIDATED
STATEMENTS OF OPERATIONS





Years Ended December 31,2009
                  
                  
                  2008Revenue
                  
                  $
                  41,376,100
                  
                  
                  $
                  47,728,669Operating
      expenses:Cost
      of revenue
                  
                  
                  29,518,856
                  
                  
                  
                  32,936,179Selling
      and marketing
                  
                  
                  5,673,605
                  
                  
                  
                  5,835,123General
      and administrative
                  
                  
                  8,202,328
                  
                  
                  
                  8,177,276Total
      operating expenses
                  
                  
                  43,394,789
                  
                  
                  
                  46,948,578Operating(loss)/income
                  
                  
                  (2,018,689
                  )
                  
                  
                  780,091Other
      income/(expense):Interest
      income
                  
                  
                  -
                  
                  
                  
                  10,540Interest
      expense
                  
                  
                  (1,292,027
                  )
                  
                  
                  (1,503,622
                  )Total
      other expense, net
                  
                  
                  (1,292,027
                  )
                  
                  
                  (1,493,082
                  )Loss
      from continuing operationsbefore
      income taxes
                  
                  
                  (3,310,716
                  )
                  
                  
                  (712,991
                  )Income
      tax (benefit)/expense
                  
                  
                  (98,795
                  )
                  
                  
                  162,153Loss
      from continuing operations
                  
                  
                  (3,211,921
                  )
                  
                  
                  (875,144
                  )Loss
      from discontinued operations, net of taxes
                  
                  
                  -
                  
                  
                  
                  (285,919
                  )Gain
      on sale of discontinued operations, net of taxes
                  
                  
                  887,500
                  
                  
                  
                  1,932,913Net
      (loss)/income
                  
                  $
                  (2,324,421
                  )
                  
                  $
                  771,850Basic
      and diluted (loss)/income per share:Continuing
      operations
                  
                  $
                  (0.37
                  )
                  
                  $
                  (0.11
                  )Discontinued
      operations
                  
                  $
                  0.10
                  
                  
                  $
                  0.21Net
      (loss)/income per common share–basic and diluted
                  
                  $
                  (0.27
                  )
                  
                  $
                  0.10Weighted
      average shares outstanding – basic and diluted
                  
                  
                  8,628,034
                  
                  
                  
                  7,620,192





The
accompanying notes are an integral part of these consolidated financial
statements.


39


ZANETT,
INC.


CONSOLIDATED
STATEMENTS OF STOCKHOLDERS' EQUITY


For the
years ended December 31, 2009 and 2008




AdditionalCommon Stock
                      
                      
                      Paid-in
                      
                      
                      Treasury Stock
                      
                      
                      AccumulatedShares
                      
                      
                      Amount
                      
                      
                      Capital
                      
                      
                      Shares
                      
                      
                      Amount
                      
                      
                      Deficit
                      
                      
                      TotalBalance,
      January 1, 2008
                      
                      
                      7,481,301
                      
                      
                      $
                      29,925
                      
                      
                      $
                      31,203,565
                      
                      
                      
                      14,915
                      
                      
                      $
                      (179,015
                      )
                      
                      $
                      (24,103,802
                      )
                      
                      $
                      6,950,673Issuance
      of common stock in connection with acquisitions
                      
                      
                      127,205
                      
                      
                      
                      509
                      
                      
                      
                      304,781
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      305,290Compensatory
      restricted common stock and options issued to non-employees and
      employees
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      207,075
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      207,075Net
      income
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      771,850
                      
                      
                      
                      771,850Balance,
      December 31, 2008
                      
                      
                      7,608,506
                      
                      
                      
                      30,434
                      
                      
                      
                      31,715,421
                      
                      
                      
                      14,915
                      
                      
                      
                      (179,015
                      )
                      
                      
                      (23,331,952
                      )
                      
                      
                      8,234,888Issuance
      of common stock in connection with acquisitions
                      
                      
                      515,327
                      
                      
                      
                      2,009
                      
                      
                      
                      241,357
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      243,366Compensatory
      restricted common stock and options issued to non-employees and
      employees
                      
                      
                      615,000
                      
                      
                      
                      -
                      
                      
                      
                      525,724
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      525,724Net
      loss
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      (2,324,421
                      )
                      
                      
                      (2,324,421
                      )Balance,
      December 31, 2009
                      
                      
                      8,738,833
                      
                      
                      $
                      32,443
                      
                      
                      $
                      32,482,502
                      
                      
                      $
                      14,915
                      
                      
                      $
                      (179,015
                      )
                      
                      $
                      (25,656,373
                      )
                      
                      $
                      6,679,557




The
accompanying notes are an integral part of these consolidated financial
statements.


40





ZANETT,
INC.


CONSOLIDATED
STATEMENTS OF CASH FLOWS




Years Ended December 31,2009
                  
                  
                  2008Cash
      flows from operating activities:Net
      (loss)/income
                  
                  $
                  (2,324,242
                  )
                  
                  $
                  771,850Adjustments
      to reconcile net (loss)/income to net cash (used in)/provided by operating
      activities:Depreciation
      and amortization
                  
                  
                  870,644
                  
                  
                  
                  829,901Stock
      based compensation and services
                  
                  
                  525,724
                  
                  
                  
                  207,075Gain
      on sale of PDI
                  
                  
                  (887,500
                  )
                  
                  
                  (1,932,913
                  )Provision
      for doubtful accounts
                  
                  
                  99,545
                  
                  
                  
                  325,485Deferred
      rent expense
                  
                  
                  6,535
                  
                  
                  
                  3,599Deferred
      income taxes
                  
                  
                  (131,652
                  )
                  
                  
                  (62,458
                  )Changes
      in, net of acquisitions:Accounts
      receivable
                  
                  
                  219,497
                  
                  
                  
                  1,268,519Unbilled
      revenue
                  
                  
                  89,660
                  
                  
                  
                  (404,965
                  )Prepaid
      expenses and other current assets
                  
                  
                  167,916
                  
                  
                  
                  121,012Other
      assets
                  
                  
                  79,764
                  
                  
                  
                  182,816Accrued
      expenses
                  
                  
                  (148,020
                  )
                  
                  
                  513,215Accounts
      payable
                  
                  
                  615,174
                  
                  
                  
                  (1,518,830
                  )Other
      current liabilities
                  
                  
                  90,754
                  
                  
                  
                  (14,973
                  )Income
      tax receivable
                  
                  
                  4,199
                  
                  
                  
                  33,543Income
      taxes payable
                  
                  
                  (19,100
                  )
                  
                  
                  33,691Deferred
      revenue
                  
                  
                  312,553
                  
                  
                  
                  (45,411
                  )Net
      cash (used in)/provided by operating activities
                  
                  
                  (428,549
                  )
                  
                  
                  311,156Cash
      flows from investing activities:Cash
      received from sale of business, net
                  
                  
                  726,133
                  
                  
                  
                  7,848,964Cash
      paid for acquisitions, net of cash acquired
                  
                  
                  -
                  
                  
                  
                  (397,120
                  )Cash
      paid as contingent consideration related to past
    acquisitions
                  
                  
                  (368,873
                  )
                  
                  
                  (727,047
                  )Additions
      to property and equipment
                  
                  
                  (494,682
                  )
                  
                  
                  (719,576
                  )Cash
      flows (used in)/provided by investing activities
                  
                  
                  (137,422
                  )
                  
                  
                  6,005,221Cash
      flows from financing activities:Payments
      for debt issuance costs
                  
                  
                  (48,484
                  )
                  
                  
                  (128,181
                  )Redemption
      of unsecured notes
                  
                  
                  (45,792
                  )
                  
                  
                  -Proceeds
      from unsecured notes
                  
                  
                  -
                  
                  
                  
                  178,272Proceeds
      from notes payable to related party
                  
                  
                  300,000
                  
                  
                  
                  -Repayments
      of short term borrowings
                  
                  
                  -
                  
                  
                  
                  (2,904,524
                  )Proceeds
      from short term borrowings
                  
                  
                  114,538
                  
                  
                  
                  -Repayments
      of notes payable to related party
                  
                  
                  -
                  
                  
                  
                  (4,272,678
                  )Capital
      lease payments
                  
                  
                  (23,997
                  )
                  
                  
                  (27
                  )Cash
      flows provided by/(used in) financing activities
                  
                  
                  296,265
                  
                  
                  
                  (7,127,138
                  )Net
      decrease in cash and cash equivalents
                  
                  
                  (269,706
                  )
                  
                  
                  (810,761
                  )Cash
      and cash equivalents, beginning of year
                  
                  
                  450,304
                  
                  
                  
                  1,261,065Cash
      and cash equivalents, end of year
                  
                  $
                  180,598
                  
                  
                  $
                  450,304Supplemental
      Disclosures of Cash Flow Information:Fair
      value of assets acquired
                  
                  $
                  -
                  
                  
                  $
                  397,120Net
      cash paid for acquisition
                  
                  
                  -
                  
                  
                  
                  397,120Liabilities
      assumed
                  
                  $
                  -
                  
                  
                  $
                  -Cash
      paid during the year for:Interest
                  
                  $
                  930,073
                  
                  
                  $
                  1,430,411Income
      taxes
                  
                  $
                  61,999
                  
                  
                  $
                  86,809Non-cash
      investing activitiesShares
      issued for contingent consideration
                  
                  
                  243,372
                  
                  
                  
                  127,205








41





ZANETT, INC.


NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS





Note
      1.
            Summary
      of Business and Organization





Zanett
Inc. (the “Company”) is an information technology ("IT") company that provides
customized IT solutions to Fortune 500 corporations and mid-market
companies.  Until the disposition of Paragon Dynamic, Inc. ("PDI") in
2008, the Company also provided such solutions to classified government
agencies.





The
Company provides commercial solutions through its wholly-owned subsidiaries:
Back Bay Technologies, Inc., (“BBT”), based in Burlington, Massachusetts,
INRANGE Consulting Corporation(“ICC”), based in West Chester, Ohio, and,
Whitbread Technology Partners, Inc. (“WTP”), also based in Burlington,
Massachusetts.  On December 30, 2005, BBT, ICC and WTP merged with and
into another of the Company’s wholly-owned subsidiaries, Zanett Commercial
Solutions, Inc. (“ZCS”).  In May 2006 ZCS acquired Data Road, based in
Jacksonville, Florida. In March 2007, ZCS acquired DBA Group, Inc. (“DBA”),
based in Alpharetta, Georgia, and DBA was merged into ZCS in connection with
that acquisition. In December 2008, ZCS acquired PS GoLive, LLC (“PS GoLive”),
based in North Palm Beach, FL.





The
Company provides full lifecycle, end-to-end business solutions. These include
services to initiate, develop and implement e-business systems, application
development, project management, business analysis, architecture design, package
customization, testing and quality assurance and implementation management,
implementation of ERP, supply chain management (“SCM”) and customer relationship
management (“CRM”) systems, and voice and data communications network
integration solutions that include the provision of hardware, peripheral
equipment and telecommunications lines for voice and data communications
networks as well as related security and design services.





The
Company has an administrative office in the Philippines; however, at this time
the operations of this office are insignificant to the Company’s overall
business and consolidated financial statements.





The
Company’s former government segment consisted of PDI, which was acquired in
January 2003. PDI was treated as a discontinued operation as of December 31,
2007 because the decision was reached in the fourth quarter of 2007 to exit the
government IT engineering business that is PDI's principal business activity. In
December 2007, the Company entered into a letter of intent to sell PDI to KOR
Electronics, which sale was completed on March 17, 2008. See also Note
9.





Liquidity





During
the year ended December 31, 2009, the Company incurred a loss from continuing
operations of $3,211,921and had an excess of
current liabilities compared to current assets of approximately $10.6 million at
December 31, 2009.  As of December 31, 2009, the Company’s revolving
line of credit with Bank of America, as successor-by-merger to LaSalle Bank,
which matures June 21, 2010, had a balance of $4,350,090 with available
borrowings of $668,562.  In March 2007, the Company entered into a
line of credit agreement with a principal shareholder of the Company in the
amount of $3 million (see Note 14). This line is available for working capital
requirements and is unrestricted. As of December 31, 2008 this line of credit
had a balance of $1.327 million with available borrowings of $1.7
million.  This line of credit was sold by the principal shareholder to
a third party in a private transaction on February 28, 2010.  The line
matured on March 15, 2010, but the Company is currently in negotiations with the
new lender to refinance this debt.


42





The loss
from continuing operations, working capital deficit, current maturity dates of
the Company's outstanding debt and limited available borrowings raise
substantial doubt about the Company's ability to continue as a going
concern.





The
Company is currently negotiating the replacement or refinancing of its
outstanding debt and line of credit arrangements or is otherwise looking to
secure additional funding, though there can be no assurances that such financing
will be obtained.  The accompanying financial statements do not
include any adjustments relating to the recoverability of the carrying amount of
recorded assets or the amount of liabilities that might result should the
Company be unable to continue as a going concern.





Note
      2.
            Significant
      Accounting Policies





Principles
of Consolidation





The
accompanying consolidated financial statements include the accounts of the
Company and its wholly owned subsidiaries.  All significant
inter-company transactions and balances have been eliminated in
consolidation.





Use of
Estimates





The
preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America 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 revenue and expenses during
the reporting period.  Actual results could differ from those
estimates.  Examples of such estimates include, but are not limited
to, revenue recognition, including estimates to complete on fixed fee contracts,
allowance for doubtful accounts, impairment of goodwill and intangibles,
depreciation and amortization, the fair value of equity securities underlying
stock-based compensation, the fair value of acquired assets, purchase price
allocations and the realizability of deferred tax assets and
liabilities.





Reverse
Stock Split





On June
30, 2008, the Company effected a reverse stock split pursuant to which each four
outstanding shares of common stock, par value $0.001, were automatically
converted into one share of common stock, par value $0.001 (the “Reverse Stock
Split”).  All of the share numbers, stock price and per-share amounts
have been adjusted, on a retroactive basis, to reflect the effect of the Reverse
Stock Split.





Cash and
Cash Equivalents





We
consider all highly liquid debt instruments with an original maturity of three
months or less when purchased to be cash equivalents.


43





The
following table summarizes the basis used to measure certain financial assets
and liabilities at fair value on a recurring basis in the consolidated balance
sheet:





FairValueMeasurementsatDecember31,2009UsingQuoted Prices
                                      
                                      
                                      Significantin Active
                                      
                                      
                                      Other
                                      
                                      
                                      SignificantBalance at
                                      
                                      
                                      Marktets for
                                      
                                      
                                      Observable
                                      
                                      
                                      Unobservable(In thousands)
                                      
                                      December 31,
                                      
                                      
                                      Identical Items
                                      
                                      
                                      Inputs
                                      
                                      
                                      InputsDescription
                                      
                                      2009
                                      
                                      
                                      (Level1)
                                      
                                      
                                      (Level2)
                                      
                                      
                                      (Level3)Cash
      in Bank
                                      
                                      $
                                      180,598
                                      
                                      
                                      $
                                      180,598
                                      
                                      
                                      $
                                      -
                                      
                                      
                                      $
                                      -





Fair Value Measurements at December 31, 2008
      UsingQuoted Prices
                          
                          
                          Significantin Active
                          
                          
                          Other
                          
                          
                          SignificantBalance at
                          
                          
                          Marktets for
                          
                          
                          Observable
                          
                          
                          Unobservable(In
      thousands)
                          
                          December 31,
                          
                          
                          Identical Items
                          
                          
                          Inputs
                          
                          
                          InputsDescription
                          
                          2008
                          
                          
                          (Level1)
                          
                          
                          (Level2)
                          
                          
                          (Level3)Cash
      in Bank
                          
                          $
                          450,304
                          
                          
                          $
                          450,304
                          
                          
                          $
                          -
                          
                          
                          $
                          -





Fair
Value of Financial Instruments





The
Company's short-term financial instruments consist of cash, customer deposits
and cash equivalents, accounts receivable, income tax receivable, accounts
payable, accrued expenses and short-term debt.  The carrying amounts
of all short-term financial instruments at December 31, 2009 and 2008
approximate their fair values due to their short maturities.  We place
our cash and cash equivalents primarily in commercial checking accounts and
money market funds.  Commercial bank balances may from time to time
exceed federal insurance limits; money market funds are uninsured.





Based on
interest rates currently available to the Company for borrowings with similar
terms and maturities, the carrying value of the Company's notes payable and
long-term debt approximates their current fair value.





Goodwill





In
connection with its acquisitions, the Company allocates the total acquisition
costs to all tangible and intangible assets acquired and all liabilities
assumed, with any excess purchase price recorded to goodwill. To arrive at the
allocation of the total purchase price, management makes certain assumptions in
estimating the fair value of the acquired company’s tangible assets, intangible
assets (such as trademarks, brand, intellectual property rights to developed
technology, customer lists, customer relationships and long-term contracts) and
liabilities.





Goodwill
consists of the excess of the purchase price over the fair value of identifiable
net assets of businesses acquired.  Goodwill is evaluated for
impairment at least annually and whenever events or circumstances indicate
impairment may have occurred.  The Company performs its evaluation as
of October 31, the assessment requires the comparison of the fair value of each
of the Company's reporting units to the carrying value of its 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 reporting unit goodwill exceeds
the implied fair value of that goodwill, an impairment loss shall be recognized
by the Company in an amount equal to that excess.


44





Intangibles





Intangibles
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 other intangible 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 compares that to
the carrying value. If the carrying value exceeds the estimated cash flows, the
recorded value of the asset is reduced to its estimated fair value.





Deferred
Rent





Rent
expenses related to operating leases where scheduled rent increases exist is
determined by expensing the total amount of rent due over the life of the
operating lease on a straight-line basis.  The difference between the
rent paid under the terms of the lease and the rent expensed on a straight-line
basis is recorded as a liability.  The non-current portion of deferred
rent at December 31, 2009 and 2008 was $76,535 and $70,000, respectively, and is
included in other liabilities on the Consolidated Balance Sheets.  The
current portion of deferred rent at December 31, 2009 and 2008 was $7,400 and
$3,600, respectively, and is included in other current liabilities on the
Consolidated Balance Sheets.





Allowance
for Doubtful Accounts





We
perform ongoing credit evaluations of our customers.  We record an
allowance for doubtful accounts based on specifically identified amounts that
are believed to be uncollectible.  We also record additional
allowances based on certain percentages of our aged receivables, which are
determined based on historical experience and an assessment of the general
financial conditions affecting our customer base.  If our actual
collections experience changes, revisions to our allowance may be
required.  After all attempts to collect a receivable have failed, the
receivable is written off against the allowance.  We do not obtain
collateral from our customers to secure accounts receivable.





Revenue
Recognition





The
Company earns revenue primarily from IT professional services.





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
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.


45





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 services are included
in cost of revenues and any amounts re-invoiced to customers are included in
revenues 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.





Deferred
Revenue





Amounts
invoiced or received prior to the performance of services under customer
contracts are recognized as a liability and revenue recognition is deferred
until such time that all revenue recognition criteria have been
met.





Cost of
Revenues





Cost of
revenues includes salaries and related costs of consulting and technical staff
and outside contractors, as well as travel and costs related to the provision of
services at customer locations.  Additionally, the Company pays a
referral fee on certain contracts that is included in cost of
revenues.  This fee is calculated as a percentage of service revenue
billed to customers under the applicable contracts.





Cost of
revenues includes the cost of hardware purchased from suppliers and sold to
customers.





Capitalized
Software Costs





Capitalized
software costs consist of costs to purchase and develop software for internal
use as well as costs for the development of software that is to be sold, leased
or licensed to third parties in the future. Costs incurred during the
application-development stage for software bought and further customized by
outside vendors for the Company's intended use and software developed by a
vendor for the Company's proprietary use have been
capitalized.  Software development costs  for software to be
sold, leased or licensed to third parties are required to be capitalized when a
product’s technological feasibility has been established by completion of a
detailed program design or working model of the product, and ending when a
product is available for release to customers. Costs capitalized include an
allocation of the costs incurred for the Company's own personnel who are
directly associated with software development.  For the years ended
December 31, 2009 and 2008 capitalized software cost totaled $1,026,123 and
$756,893, respectively.


46





Income
Taxes





Effective
January 1, 2007 the Company has accounted for the uncertainty in income taxes
recognized in financial statements and requires the impact of a tax position to
be recognized in the financial statements if that position is more likely than
not of being sustained by the taxing authority. At the adoption date of January
1, 2007 and also as of December 31, 2009 and 2008, the Company did not have any
unrecognized tax benefits. We do not expect that the amount of unrecognized tax
benefits will significantly increase or decrease within the next twelve months.
The Company’s policy is to recognize interest and penalties related to tax
matters in the income tax provision in the Consolidated Statements of
Operations. There was no interest and penalties for the year ended December 31,
2009 and 2008. Tax years beginning in 2005 are generally subject to examination
by taxing authorities.





Deferred
taxes are computed based on the tax liability or benefit in future years of the
reversal of the temporary differences in the recognition of income or deduction
of expenses between financial and tax reporting purposes. The net difference, if
any, between the provision for taxes and taxes currently payable is reflected in
the balance sheet as deferred taxes. Deferred tax assets and/or liabilities, if
any, are classified as current and non-current based on the classification of
the related asset or liability for financial reporting purposes, or based on the
expected reversal date for deferred taxes that are not related to an asset or
liability. Valuation allowances are recorded to reduce deferred tax assets to
that amount which is more likely than not to be realized.





Note
      3.
            Stock
      Based Compensation





The
Company accounts for stock based awards by recording compensation based on the
fair value of the awards on the date of grant, expensed on a straight-line basis
over the vesting period of the awards, which is generally one to five years.
Expected volatility is based on an average of (1) historical volatility of the
Company’s stock and (2) implied volatility from traded options on the Company’s
stock. The risk-free rate for periods within the contractual life of the stock
option award is based on the yield curve of a zero-coupon U.S. Treasury bond on
the date the award is granted with a maturity equal to the expected term of the
award. The Company uses historical data to estimate future forfeitures. The
expected term of awards granted is derived from historical experience under the
Company’s stock-based compensation plans and represents the period of time that
awards granted are expected to be outstanding. For the years ended December 31,
2009 and 2008, the Company recorded stock based compensation expense for
employee related stock options of $98,000 and $105,000,
respectively.





Loss Per
Share Information





Basic
income/(loss) per share is calculated based on the weighted average
number  of common shares outstanding during the
period.  Diluted income/(loss) per share  gives effect to
all dilutive potentially issuable common shares outstanding during the period.
The computation of diluted earnings per share does not assume conversion,
exercise or contingent exercise of securities that would have an anti-dilutive
effect on earnings. At December 31, 2009 and 2008, the Company excluded all of
its 1,617,773 and 1,750,191 stock options, respectively, under the treasury
stock method from the computation of diluted loss per share as they would be
antidilutive because the Company is in a loss position from continued
operations.


47





Recent
Accounting Pronouncements





In June
2009, the Financial Accounting Standards Board (“FASB”) issued its final
Statement of Financial Accounting Standards (“SFAS”) No. 168 – “The FASB Accounting Standards ASC
Topic and the Hierarchy of Generally Accepted Accounting Principles a
replacement of FASB Statement No. 162” (“SFAS No. 168”).  SFAS
No. 168 made the FASB Accounting Standards Codification (the “ASC”) the single
source of U.S. Generally Accepted Accounting Policies (“U.S. GAAP”) used by
nongovernmental entities in the preparation of financial statements, except for
rules and interpretive releases of the SEC under authority of federal securities
laws which are sources of authoritative accounting guidance for SEC
registrants.  The ASC is meant to simplify user access to all
authoritative accounting guidance by reorganizing U.S. GAAP pronouncements into
roughly 90 accounting topics within a consistent structure; its purpose is not
to create new accounting and reporting guidance.  The ASC supersedes
all existing non-SEC accounting and reporting standards and was effective for
the Company beginning July 1, 2009.  Following SFAS No. 168, the Board
will not issue new standards in the form of Statements, FASB Staff Positions, or
Emerging Issues Task Force Abstracts; instead, it will issue Accounting
Standards Updates.  The FASB will not consider Accounting Standards
Updates as authoritative in their own right; these updates will serve only to
update the ASC topic, provide background information about the guidance, and
provide the bases for conclusions on the change(s) in the ASC.  In the
description of ASC and Accounting Standards Updates (“ASU”) that follows,
references in italics relate to ASC or ASU topics and their descriptive titles,
as appropriate.





In
September 2009, the FASB issued ASU 2009-14, “Certain Revenue Arrangements That
Include Software Elements” (“ASU 2009-14”), which excludes tangible
products containing software components and non-software components that
function together to deliver the product’s essential functionality from the
scope of Subtopic 985-605, “Revenue
Recognition.”  ASU 2009-14 is effective for periods beginning
after December 15, 2009 with earlier adoption permitted.  The Company
is currently evaluating the timing of its adoption of ASU 2009-14 and the impact
that ASU 2009-14 will have on its consolidated financial
statements.





In
October 2009, the FASB issued ASU 2009-13 which supersedes certain guidance in
ASC 605-25, “Revenue
Recognition – Multiple Element Arrangements”.  This topic
requires an entity to allocate arrangement consideration at the inception of an
arrangement to all of its deliverables based on their relative selling
prices.  This topic is effective for annual reporting periods
beginning after June 15, 2010.  The Company is currently evaluating
the impact that this topic will have on its consolidated financial
statements.





Note
      4.
            Acquisitions





The
following information is about the Company’s acquisition occurring in
2008:





2008





PS GOLIVE
LLC





On
November 25, 2008, ZCS completed the acquisition of the agreed upon assets of PS
GoLive from the owner of PS GoLive (the "PS GoLive Owners”).





The total
consideration to be paid by ZCS to the PS GoLive Owner is comprised of initial
consideration, a purchase price adjustment based upon the level of PS GoLive net
working capital at closing, and future contingent consideration.





The net
consideration consisted of $386,405 in cash.





The PS
GoLive Owners are eligible to receive contingent consideration of up to
$1,200,000, in the aggregate, for the three successive annual performance
periods commencing December 1, 2008 based upon PS GoLive attaining specified
adjusted income and revenue targets in each period.


48





The
amount of any contingent payment payable to the Seller shall be reduced on a
dollar-for-dollar basis by an amount equal to the initial consideration until
the aggregate amount of reductions equals the initial
consideration.





The post
acquisition consolidated financial statements include the results of operations
of PS GoLive from the acquisition date. The net purchase price of $386,405 has
been allocated to goodwill.





The
following table sets forth the components of the purchase price paid
to


date:





Cash
      Paid
                    
                    $
                    386,405Total
      Purchase
                    
                    $
                    386,405





Note
      5.
            Unaudited
      Pro Forma Disclosures Related to Recent
  Acquisitions





The
following unaudited pro forma summary financial information presents the
consolidated results of operations of the Company as if the acquisition of PS
GoLive had occurred on January 1, 2008. The pro forma results are shown for
illustrative purposes only and do not purport to be indicative of the results of
the Company that would have been reported had the acquisitions actually occurred
on January 1 or indicative of results that may occur in the future.




Year
      ended December 31,2008(unaudited)Pro
      forma results:Revenues
                  
                  $
                  49,661,666Net
      Loss from continuing operations
                  
                  
                  (1,057,532
                  )Loss
      per common share from continued operations-
      Basic and Diluted
                  
                  $
                  (0.14
                  )





Note
      6.
            Segments





The
Company’s current continuing operations are comprised of one segment, Commercial
Solutions.





The
Commercial Solutions segment is comprised of ZCS, under which BBT, ICC, WTP and
DBA operate, and two wholly-owned subsidiaries of ZCS, PS GoLive and Data Road.
These companies provide technology consulting services, including implementation
of enterprise resource planning systems, the planning, development and
implementation of e-business systems, and voice and data communications
solutions, to Fortune 500 and middle market companies throughout the United
States.


49





Note7.
            Intangibles





Intangibles
consisted of the following at December 31, 2009 and 2008:





December31,2009
                    
                    
                    December31,2008Average
                      Remaining
                      Useful Life
                      (in years)
                    
                    
                    Gross Carrying
                      Value
                    
                    
                    Accumulated
                      Amortization
                      Amount
                    
                    
                    Net Carrying
                      Value
                    
                    
                    Gross
                      Carrying
                      Value
                    
                    
                    Accumulated
                      Amortization
                      Amount
                    
                    
                    Net Carrying
                      ValueCustomer Relationships
                    
                    
                    1.37
                    
                    
                    
                    1,577,000
                    
                    
                    
                    (1,149,474
                    )
                    
                    
                    427,526
                    
                    
                    
                    1,577,000
                    
                    
                    
                    (867,325
                    )
                    
                    
                    709,675Non-compete Agreement
                    
                    
                    1.03
                    
                    
                    
                    193,000
                    
                    
                    
                    (161,440
                    )
                    
                    
                    31,560
                    
                    
                    
                    193,000
                    
                    
                    
                    (127,508
                    )
                    
                    
                    65,492Trade Names
                    
                    
                    2.25
                    
                    
                    
                    408,004
                    
                    
                    
                    (252,002
                    )
                    
                    
                    156,002
                    
                    
                    
                    408,000
                    
                    
                    
                    (220,875
                    )
                    
                    
                    187,125Total
                    
                    
                    
                    
                    
                    $
                    2,178,004
                    
                    
                    $
                    (1,562,916
                    )
                    
                    $
                    615,088
                    
                    
                    $
                    2,178,000
                    
                    
                    $
                    (1,215,708
                    )
                    
                    $
                    962,292





Amortization
expense was $347,208 and $432,352 in 2009 and 2008,
respectively.  Based on the Company’s amortization of intangible
assets as of December 31, 2009, the Company expects related amortization expense
for the next three fiscal years to be $260,547, $194,092 and $40,450,
respectively.





Note
      8.
            Goodwill





The
changes in the carrying amount of goodwill for the years ended December 31, 2009
and 2008 are as follows:





Balance
      at January 1, 2008
                    
                    $
                    14,538,761DBA
      acquisition
                    
                    
                    610,580Data
      Road acquisition
                    
                    
                    215,755Contingent
      consideration - Data Road
                    
                    
                    397,120Balance
      at December 31, 2008
                    
                    $
                    15,762,216Balance
      at January 1, 2009
                    
                    $
                    15,762,216Contingent
      consideration - DBA
                    
                    
                    486,745Final
      consideration - Whitbread
                    
                    
                    241,500PSGoLive
      acquisition
                    
                    
                    (10,715
                    )Balance
      at December 31, 2009
                    
                    $
                    16,479,746





In
October 2009 and 2008 we performed our annual test for impairment of goodwill
and concluded that no impairment charge was required for either
year.  The Company has determined that all of its goodwill is
allocated to one reporting unit, ZCS, for 2009 and 2008. In testing for
impairment, the Company compared the carrying value of its reporting unit,
including goodwill, to the fair value of the reporting unit based on
management’s analysis of the relevant facts, including a third-party
valuation.





Note
      9.
            Discontinued
      Operations





The
following amounts relate to the operations of the Company’s disposed business
that have been segregated from continuing operations and reflected as
discontinued operations in each period’s consolidated statement of
operations:




50





Year ended December 31,2008
                      
                      
                      2009Revenue
                      
                      $
                      1,602,575
                      
                      
                      $
                      -Operating
      (loss)/income before income taxes
                      
                      
                      (285,919
                      )
                      
                      
                      -(Loss)/income
      from discontinued operations, net of taxes
                      
                      $
                      (285,919
                      )
                      
                      $
                      -Gain
      on sale of discounted operations, net of taxes
                      
                      $
                      1,932,913
                      
                      
                      $
                      887,500





Note
      10.
            Property
      and Equipment





Property
and equipment consisted of the following at December 31, 2009 and
2008:





December 31,Estimated Useful
                        Life
                      
                      2009
                      
                      
                      2008Computer
      equipment
                      
                      3
      years
                      
                      $
                      1,354,283
                      
                      
                      $
                      1,325,575Computer
      software
                      
                      3
      years
                      
                      
                      1,078,068
                      
                      
                      
                      244,583Furniture
      and fixtures
                      
                      5
      years
                      
                      
                      300,361
                      
                      
                      
                      290,554Leasehold
      improvements
                      
                      Lesser
      of lease term of life of asset
                      
                      
                      360,594
                      
                      
                      
                      143,339Construction
      in progress
                      
                      
                      
                      
                      136,308
                      
                      
                      
                      711,9683,229,614
                      
                      
                      
                      2,716,019Less
      Accumulated depreciation and amortization
                      
                      
                      
                      
                      (1,925,092
                      )
                      
                      
                      (1,382,739
                      )Property
      and equipment, net
                      
                      
                      
                      $
                      1,304,522
                      
                      
                      $
                      1,333,280





As of
December 31, 2009 and 2008, property and equipment financed with capital leases
had a cost of $183,721 and $75,757, respectively, and related accumulated
depreciation of $100,203 and $75,757, respectively. Depreciation expense related
to all property and equipment was $542,353 and $371,593 for the years ended
December 31, 2009 and 2008, respectively.





Note
      11.
            Restricted
      Common Stock





A summary
of restricted stock granted, vested, forfeited and unvested restricted stock
outstanding during the years ended December 31, 2009 and 2008, is presented
below (restricted shares in thousands):


51





Restricted
                  SharesRestricted
      shares outstanding, January 1, 2008
                
                
                -Granted
                
                
                735,413Vested
                
                
                (198,274
                )Forfeited
                
                
                -Restricted
      shares outstanding, December 31, 2008
                
                
                537,139Granted
                
                
                127,205Vested
                
                
                (664,344
                )Forfeited
                
                
                -Restricted
      shares outstanding, December 31, 2009
                
                
                -





Restricted
stock compensation costs are allocated as follows for the years ended December
31, 2009 and 2008 (in thousands):





2009
                  
                  
                  2008General
      and administrative
                  
                  $
                  427
                  
                  
                  $
                  32Sales
      and marketing
                  
                  
                  -
                  
                  
                  
                  4$
                  427
                  
                  
                  $
                  36





All of
the shares of Common Stock issued by the Company in its
acquisitions


of
operating units, as well as shares issued to executives and employees, are
subject to certain transfer restrictions for five years pursuant to lock-up
agreements executed by each shareholder.  A portion of the shares,
however, may be released from such restrictions when the closing price per share
equals or exceeds certain price targets.  As of December 31, 2009,
1,147,046 out of 1,821,761 shares pursuant to the lock-up agreements had been
released from the restrictions. On November 11, 2008, the Company granted awards
of 615,000 shares of restricted common stock to certain of its directors and
officers, pursuant to the Company’s Incentive Stock Plan.  The
restricted shares vested on November 11, 2009.





Note
      12.
            Stock
      Option Activity





In
November 2001, the Company implemented the Zanett, Inc. Incentive Stock Plan
(the "Stock Plan"). The plan provides for the grant of incentive stock options,
stock awards, stock appreciation rights and direct purchases of Common Stock
(collectively "Stock Rights").  The Board of Directors and management
of the Company believe that the grant of Stock Rights will be a significant
factor in the Company's growth and its ability to attract, retain and motivate
qualified employees, directors and consultants.  The Stock Plan gives
broad powers to the Board of Directors to administer or to appoint a committee
to administer, interpret and implement the Stock Plan, including authority to
determine the terms and conditions for all grants of Stock
Rights.  The terms and conditions of each award are determined by a
committee appointed by the Board of Directors of the Company. Under the plan,
the committee may grant either qualified or nonqualified stock options with a
term not to exceed ten years from the grant date and at an exercise price per
share that the committee may determine (which in the case of incentive stock
options may not be less than the fair market value of a share of the Company’s
common stock on the date of the grant). The options generally vest over a four
year period. The Company’s policy for attributing the value of granted vesting
share based payments is on a straight line basis over the requisite service
period for the entire award.





On April
29, 2005, the Company's board of directors adopted an amended and restated Stock
Plan, which increased the number of shares of the Common Stock issuable under
the plan from 7,000,000 shares to 10,000,000 shares.  The plan was
approved by the Company’s shareholders at the annual meeting in June
2005.


52





During
2009 and 2008, the Company issued options to purchase 0 and345,000 shares of its
Common Stock, respectively, under the Stock Plan.  At December 31,
2009, 1,750,191 common shares were available for future issuance under the Stock
Plan.  During 2009, options to purchase 132,418 shares of Common Stock
were forfeited or expired unexercised.





The fair
value of the Company’s stock-based awards issued to employees in the year ended
December 31, 2008 was estimated at the date of grant using Black-Scholes,
assuming no dividends and using an expected life of four years, volatility of
55% and a risk-free rate of 4.62%.





In
October 2006, November 2006, March 2007 and August 2007 the Company issued
966,625 options which vest only when the Company files a Annual Report on Form
10-K showing an annual revenue amount for the fiscal year of $250,000,000, and
which expire after five years.  Currently the Company has incurred no
expense for these options, as only when the occurrence of this event becomes
probable will an expense be recorded.





The
weighted average grant-date fair value of options granted during the years ended
December 31, 2008 was $.70, respectively.  There were no options
granted in 2009.





The
activity with respect to non-vested options under the Company’s stock option
plan was as follows:





WeightedAvg. GrantNumber of
                  
                  
                  Date FairOptions
                  
                  
                  ValueNon-vested
      at January 1, 2009
                  
                  
                  944,725
                  
                  
                  $
                  3.81Granted
                  
                  
                  -
                  
                  
                  
                  -Vested
                  
                  
                  (281,850
                  )
                  
                  
                  1.57Forfeited
                  
                  
                  (112,125
                  )
                  
                  
                  1.87Non-vested
      at December 31, 2009
                  
                  
                  550,750
                  
                  
                  $
                  5.34





At
December 31, 2009, there was no unrecognized compensation cost related to
non-vested non-qualified stock option awards. The total fair value of options
vested in the year ended December 31, 2009 was zero. Currently the Company has
incurred no expense for the remaining non-vested options, as only when the
occurrence of the annual revenue event becomes probable will an expense be
recorded.


53





The
following tables present option activity and options outstanding and
exercisable:





Weighted AverageShares
                  
                  
                  Exercise PriceOutstanding,
      January 1, 2008
                  
                  
                  1,761,033
                  
                  
                  $
                  8.08Granted
      to employees
                  
                  
                  225,000
                  
                  
                  
                  0.70Granted
      to directors
                  
                  
                  120,000
                  
                  
                  
                  0.70Granted
      to vendors
                  
                  
                  -
                  
                  
                  
                  -Exercised
                  
                  
                  -
                  
                  
                  
                  -Forfeited/expired
                  
                  
                  (355,842
                  )
                  
                  
                  7.74Outstanding,
      December 31, 2008
                  
                  
                  1,750,191
                  
                  
                  $
                  6.70Granted
      to employees
                  
                  
                  -
                  
                  
                  
                  -Granted
      to directors
                  
                  
                  -
                  
                  
                  
                  -Granted
      to vendors
                  
                  
                  -
                  
                  
                  
                  -Exercised
                  
                  
                  -
                  
                  
                  
                  -Forfeited/expired
                  
                  
                  (132,418
                  )
                  
                  
                  3.12Outstanding,
      December 31, 2009
                  
                  
                  1,617,773
                  
                  
                  $
                  6.99





Options
Outstanding





Options Outstanding
                                  
                                  
                                  Options ExercisableWeighted
      Avg.Range
      of
                                  
                                  
                                  Options
                                  
                                  
                                  Contractual Life
                                  
                                  
                                  Weighted
      Average
                                  
                                  
                                  Options
                                  
                                  
                                  WeightedExercise
      Prices
                                  
                                  
                                  Outstanding
                                  
                                  
                                  Remaining (Yr)
                                  
                                  
                                  Exercise
      Price
                                  
                                  
                                  Exercisable
                                  
                                  
                                  Exercise$0.70
                                  
                                  
                                  
                                  262,500
                                  
                                  
                                  
                                  8.86
                                  
                                  
                                  $
                                  0.70
                                  
                                  
                                  
                                  262,500
                                  
                                  
                                  $
                                  0.70$1.92
      - $3.84
                                  
                                  
                                  
                                  45,438
                                  
                                  
                                  
                                  7.28
                                  
                                  
                                  
                                  3.59
                                  
                                  
                                  
                                  2,563
                                  
                                  
                                  
                                  3.45$5.00
      - $7.64
                                  
                                  
                                  
                                  531,638
                                  
                                  
                                  
                                  6.53
                                  
                                  
                                  
                                  5.29
                                  
                                  
                                  
                                  38,764
                                  
                                  
                                  
                                  5.59$8.00
                                  
                                  
                                  
                                  430,625
                                  
                                  
                                  
                                  2.65
                                  
                                  
                                  
                                  8.00
                                  
                                  
                                  
                                  430,625
                                  
                                  
                                  
                                  8.00$8.08
      - $10.00
                                  
                                  
                                  
                                  68,259
                                  
                                  
                                  
                                  4.22
                                  
                                  
                                  
                                  9.50
                                  
                                  
                                  
                                  68,259
                                  
                                  
                                  
                                  9.50$10.04
      - $11.00
                                  
                                  
                                  
                                  22,938
                                  
                                  
                                  
                                  4.92
                                  
                                  
                                  
                                  10.94
                                  
                                  
                                  
                                  22,939
                                  
                                  
                                  
                                  10.94$12.24
      - $14.00
                                  
                                  
                                  
                                  116,125
                                  
                                  
                                  
                                  5.62
                                  
                                  
                                  
                                  13.34
                                  
                                  
                                  
                                  101,123
                                  
                                  
                                  
                                  13.40$14.32-$20.32
                                  
                                  
                                  
                                  140,250
                                  
                                  
                                  
                                  5.19
                                  
                                  
                                  
                                  16.07
                                  
                                  
                                  
                                  140,250
                                  
                                  
                                  
                                  16.071,617,773
                                  
                                  
                                  
                                  5.60
                                  
                                  
                                  $
                                  6.99
                                  
                                  
                                  
                                  1,067,023
                                  
                                  
                                  $
                                  10.09




Note
      13.
            Stock
      Repurchase Plan





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.  Under the Company’s
previous stock repurchase plan, as of December 31, 2009, we repurchased a total
of 14,915 shares of common stock. These shares are reflected as treasury stock
on the balance sheet. There were no shares repurchased in 2009 or
2008.





Note
      14.
            Related
      Party Transactions





On March
18, 2008, the Company repaid all amounts outstanding on three promissory notes
in an aggregate principal amount of $1,500,000 issued to Bruno Guazzoni, the
uncle of Zanett’s Chief Executive Officer, Claudio Guazzoni, and the owner of
approximately 27.8% of Zanett’s outstanding common stock (calculated as of March
26, 2010).





54




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.  Also on March 15, 2009, ZCS replaced an existing promissory
note issued to Bruno Guazzoni in the aggregate principal amount of $750,000 with
a new note with identical terms, except the maturity date was extended from
March 15, 2009 to March 15, 2010.  These two new notes require
quarterly payments of interest at the rate of eleven percent (11%) per annum.
These two promissory notes were sold by Bruno Guazzoni to Rockport Investments,
Ltd. in a private transaction on February 28, 2010.





In
respect of all of the promissory notes described above, interest expense was
$585,750 and $634,500 for the years ended December 31, 2009 and 2008,
respectively.  As of December 31, 2009, there was $292,875 interest
accrued under those notes. In 2008 and 2009, the Company paid $677,000 and
$439,314 to Mr. Guazzoni in respect of these promissory notes, respectively,
including scheduled interest payments and the repayment of $1,500,000 principal
amount of notes described above.





In March
2009, the Company extended the maturity date on a line of credit agreement with
Bruno Guazzoni from March 15, 2009 to March 15, 2010.  The maximum
borrowings under this line of credit are $3,000,000 and the interest rate is
prime plus two percent (2%).  As of December 31, 2009 this line had an
outstanding balance of $1,327,000 with available borrowings of
$1,673,000.  This line of credit was sold by Bruno Guazzoni to
Rockport Investments, Ltd. in a private transaction on February 28,
2010.  Interest expense attributed to this line of credit for the
years ended December 31, 2009 and 2008 were $58,752 and $134,910, respectively.
The Company paid Mr. Guazzoni $41,372 and $150,018 of principal and interest
under this line of credit in 2009 and 2008,
respectively.





In 2009
and 2008, the Company was party to a sublease arrangement for its New York City
office with an entity related to the CEO of the Company.   Rent
income of $66,000 was recognized in the year ended December 31, 2008 and
reversed against general and administrative expenses in 2009.





Note
15. Notes
Payable, Revolving Credit Facility, Line of Credit and Subordinated Debt
Arrangements





Notes
payable, a revolving credit facility, a line of credit and subordinated debt
arrangements comprise all of the Company’s outstanding debt at December 31, 2009
and 2008 and were as follows:





Notes
Payable





55




Notes
      Payable
                              
                              2009
                              
                              
                              2008Notes
      payable to principal shareholder, 11% interest, quarterly interest
      payments, matures March 15, 2010
                              
                              $
                              4,575,000
                              
                              
                              $
                              4,575,000Notes
      payable to principal shareholder, 11% interest, quarterly interest
      payments, matures March 15, 2010
                              
                              
                              750,000
                              
                              
                              
                              750,000Total
      notes payable
                              
                              $
                              5,325,000
                              
                              
                              $
                              5,325,000Less:
      Current Portion
                              
                              
                              5,325,000
                              
                              
                              
                              -Long-term
      portion of notes payable
                              
                              $
                              -
                              
                              
                              $
                              5,325,000




The
above-described notes payable were sold by the principal shareholder to a third
party in a private transaction on February 28, 2010.





Revolving Credit
Facility





On
December 31, 2006 the Company entered into a revolving credit facility with
LaSalle Bank National Associations, which facility is now with Bank of America,
N.A., as successor-by-merger to LaSalle.  The agreement was amended on
May 31, 2007, November 14, 2007, March 18, 2008, January 22, 2009 and December
21, 2009.  As amended, the available line of credit is based on 80% of
eligible accounts receivable up to a maximum of $6 million.  Loans
under the revolving credit facility bear interest at a rate per annum equal to
the greatest of (a) the prime rate, (b) the federal funds rate plus 0.5% and (c)
the 30-day LIBOR rate plus 1.0%, in each case plus 3.0% per annum.  In
addition to the credit facility, the bank provides the Company with treasury and
cash management services.  The facility is secured by a first priority
lien on all of the Company’s assets. Availability is calculated using a
borrowing-base formula consisting of 80% of eligible accounts receivable. In
addition to the interest charges there is an Unused Line Fee of 1/2% per annum,
payable monthly. Fees paid to the bank and attorneys were $178,825. These fees
were classified as other assets in our balance sheet and amortized over the life
of the loan. The credit facility terms require the Company to meet certain
financial covenants, including a fixed charge coverage ratio of 1.25 to 1.0, a
maximum senior debt ratio of 2.5 to 1.0, maintenance of minimum net availability
of $500,000 at all times, and excess cash flow of not less than $0 at all times,
tested quarterly.  The Company was not in compliance with these
covenants as of December 31, 2009. As amended, the credit facility matures on
June 21, 2010.





The
Company had borrowings under its revolving line of credit of $4,350,090 and
$4,235,551 to Bank of America as of December 31, 2009 and 2008, respectively,
which are reflected as current liabilities on the balance
sheet.  Borrowing available under the revolving line of credit was
$662,562 as of December 31, 2009.





Line of
Credit





In
February 2007, the Company entered into a line of credit agreement with Bruno
Guazzoni in the amount of $3,000,000.  This line is available for
working capital requirements and is unrestricted.  The interest rate
on the line of credit is prime plus two percent (2%). In March 2009, the Company
extended the maturity of the line of credit to March 15, 2010.  On
February 28, 2010, Bruno Guazzoni sold the line of credit to a third party in a
private transaction.  The line matured on March 15, 2010, but the
Company is currently in negotiations with the new lender to refinance this
debt.  At December 31, 2009, the outstanding balance on this line of
credit was $1,327,322.





56




Renewable unsecured
subordinated debt





In
December 2004 the Company filed a public offering of up to $50 million of
Renewable Unsecured Subordinated Notes which was declared effective in February
2005. Through December 31, 2009, the Company has issued $2,254,152 in renewable
unsecured subordinated notes net of redemptions. The Company had no gains or
losses on redemptions in 2009 and 2008. The table below presents the Company’s
outstanding notes payable as of December 31, 2009:





WeightedPrincipal
                            
                            
                            
                            
                            
                            AverageOriginal Term
                            
                            Amount
                            
                            
                            Percentage
                            
                            
                            Interest RateRenewable
      unsecured
                            
                            3
      months
                            
                            $
                            68,826
                            
                            
                            
                            3.05
                            %
                            
                            $
                            7.69
                            %subordinated
      notes
                            
                            6
      months
                            
                            
                            102,034
                            
                            
                            
                            4.53
                            %
                            
                            
                            8.57
                            %1
      year
                            
                            
                            483,886
                            
                            
                            
                            21.47
                            %
                            
                            
                            11.23
                            %2
      years
                            
                            
                            688,088
                            
                            
                            
                            30.53
                            %
                            
                            
                            12.79
                            %3
      years
                            
                            
                            757,222
                            
                            
                            
                            33.59
                            %
                            
                            
                            13.65
                            %4
      years
                            
                            
                            43,500
                            
                            
                            
                            1.93
                            %
                            
                            
                            14.92
                            %5
      years
                            
                            
                            33,096
                            
                            
                            
                            1.47
                            %
                            
                            
                            9.52
                            %10 years
                            
                            
                            77,500
                            
                            
                            
                            3.43
                            %
                            
                            
                            8.77
                            %Total
                            
                            
                            
                            $
                            2,254,152
                            
                            
                            
                            100.00
                            %
                            
                            
                            12.25
                            %Less
      current portion of notes payable:
                            
                            
                            
                            
                            (1,123,048
                            )Long-term
      portion
                            
                            
                            
                            $
                            1,131,104





Long-term
portion matures as follows:
  Year
      ending December 31,
                
                Amount2011
                
                $
                859,6002012
                
                
                173,4082013
                
                
                20,5962014
                
                
                -2015
                
                
                77,500$
                1,131,104




The
Company made interest payments on the above mentioned unsecured notes during the
year ended December 31, 2009 and 2008, in the amounts of $245,985 and $289,815,
respectively.





Note
      16.
            Accrued
      Expenses





Accrued
expenses are comprised of the following at December 31, 2009 and
2008:





2009
                    
                    
                    2008Employee
      compensation and commissions
                    
                    $
                    1,776,909
                    
                    
                    $
                    2,110,637Professional
      fees
                    
                    
                    157,207
                    
                    
                    
                    178,923Sales
      taxes
                    
                    
                    -
                    
                    
                    
                    11,846Interest
      payable
                    
                    
                    460,314
                    
                    
                    
                    249,609Contractors
      fees
                    
                    
                    359,353
                    
                    
                    
                    527,499Other
                    
                    
                    82,604
                    
                    
                    
                    72,445Total
      accrued expenses
                    
                    $
                    2,836,387
                    
                    
                    $
                    3,150,959


57


Note
      17.
            Employee
      Benefit Plans





Each of
our operating companies have defined contribution savings plans that qualify
under section 401(k) of the Internal Revenue Code of 1986, as amended (the
"Plans”) and cover all employees of the respective subsidiaries meeting certain
service and age requirements.  In general, participants may contribute
amounts, in any given year, up to a limitation set by the Internal Revenue
Service regulations except for participants under certain of the Plans who are
also limited to the lesser of 8% of their gross wages, in any given year, and a
limitation set by the Internal Revenue Service Regulations. Certain of the Plans
provide for mandatory or voluntary matching contributions to be made by the
Company.  The maximum matching contributions range from 50% of the
first 4% to 10% of an employee’s annual wages.  The amount contributed
to the Plans by the Company was approximately $55,729 and $426,155 for the years
ended December 31, 2009 and 2008, respectively.





Note
      18.
            Commitments
      and Contingencies





The
Company leases certain of its offices under non-cancelable operating leases that
expire on various dates through December 31, 2014.  Certain of these
leases call for a monthly base rental plus a pro-rata share of building expenses
and real estate taxes.





At
December 31, 2009 future minimum lease payments under these non-cancelable
operating leases are as follows:





Year ending
                      December 31,
                    
                    Operating
                      leases2010
                    
                    $
                    843,4782011
                    
                    
                    678,8232012
                    
                    
                    637,2892013
                    
                    
                    615,2222014
                    
                    
                    399,673$
                    3,174,485





Total
rent expense under all leases was $881,873 and $697,822 for the years ended
December 31, 2009 and 2008, respectively.





The
Company enters into agreements that contain indemnification provisions in the
normal course of business for which the risks are considered nominal and
impracticable to estimate.  Historically, the Company has not incurred
any significant costs related to performance under these
indemnities.





Note
      19.
            Concentration
      of Credit Risk





Financial
instruments that potentially subject the Company to significant concentrations
of credit risk consist principally of cash and cash equivalents, and trade
accounts receivable. The Company places its cash and cash equivalents primarily
in commercial checking accounts and money market funds. Commercial bank balances
may from time to time exceed federal insurance limits; money market funds are
uninsured.  All of the Company's accounts receivable are unsecured.
The Company believes that any credit risk associated with its receivables is
minimal due to the size and credit worthiness of its customers, which are
principally large domestic corporations.  Receivables are stated at
estimated net realizable value, which approximates fair value.





For the
year ended December 31, 2009, the Company had one customer that accounted for
approximately 10%of total
revenues.  For the year ended December 31, 2008, the Company had one
customer that accounted for approximately 7% of revenues.


58





Note
      20.
            Income
      Taxes





At
December 31, 2009, the Company had federal and state net operating loss
carryforwards for income tax purposes of approximately $5.1 million and $9.9
million, respectively, which can be used to offset current and future federal
and state taxable income starting in 2025 and 2021, respectively.





The
Company accounts for income taxes in accordance with ASC 740, “Accounting for
Income Taxes” (formerly “SFAS 109”). Under ASC 740, 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 ASC 740, including current and historical results of operations,
future income projections and the overall prospects of the Company's business.
Based upon management's assessment of all available evidence, the Company has
provided valuation allowances to offset its deferred tax assets due to the
significant uncertainties related to its ability to generate future taxable
income.





The
income tax provision (benefit) for federal, and state and local income taxes in
the consolidated statements of operation consists of the following:





Year Ended
                  
                  
                  Year EndedDecember 31, 2009
                  
                  
                  Devember 31, 2008Current:Federal
                  
                  $
                  -
                  
                  
                  $
                  33,691State
      and local
                  
                  
                  32,897
                  
                  
                  
                  128,462Total
      Current
                  
                  
                  32,857
                  
                  
                  
                  162,153Deferred:Federal
                  
                  $
                  (115,195
                  )
                  
                  $
                  -State
      and local
                  
                  
                  (16,457
                  )
                  
                  
                  -Total
      Deferred
                  
                  
                  (131,652
                  )
                  
                  
                  -Total
      provision (benefit)
                  
                  $
                  (98,795
                  )
                  
                  $
                  162,153




59





The
significant components of the Company’s net deferred tax asset are summarized as
follows:





December 31, 2009
                
                
                December 31, 2008Stock-based
      compensation
                
                $
                3,722,737
                
                
                $
                3,506,757Net
      operating loss carryforwards
                
                
                2,088,016
                
                
                
                1,540,970Tax/book
      basis difference in assets
                
                
                25,049
                
                
                
                (130,047
                )Reserves
      and other accruals
                
                
                293,739
                
                
                
                236,151Total
      gross deferred tax assets
                
                $
                6,129,541
                
                
                $
                5,153,831Valuation
      allowance
                
                
                (6,185,239
                )
                
                
                (5,341,181
                )Net
      deferred tax liability
                
                $
                (55,698
                )
                
                $
                (187,350
                )Less:
      current deferred tax liability
                
                
                30,645
                
                
                
                27,054Long-term
      deferred tax liability
                
                $
                (25,053
                )
                
                $
                160,296





The
following is a reconciliation of the income tax benefit computed at the
statutory rate to the provision for income taxes:





Year ended Decemeber 31,2009
                
                
                2008Income
      tax provision computed at the federal rate of 35%
                
                $
                (1,139,880
                )
                
                $
                462,889State
      and local income taxes, net of federal benefit
                
                
                4,900
                
                
                
                83,500Permanent
      differences
                
                
                56,446
                
                
                
                111,601Federal
      amount tax credit
                
                
                31,662
                
                
                
                (7,525
                )Other
                
                
                104,019
                
                
                
                43,607Change
      in federal valuation allowance
                
                
                844,058
                
                
                
                (531,919
                )$
                (98,795
                )
                
                $
                162,153





The Tax
Reform Act of 1986 (the Act) provides for a limitation on the annual use of NOL
carryforwards (following certain ownership changes, as defined by the Act) under
IRC 382, which could significantly limit the Company’s ability to utilize these
carryforwards. The Company has experienced various ownership changes, as defined
by the Act, as a result of past financings and may experience changes in
connection with future financings. Accordingly, the Company’s ability to utilize
the aforementioned federal operating loss carryforwards will be limited. The
Company is in the process of determining the impact of ownership changes that
have occurred, as defined by the Act. Additionally, because U.S. tax laws limit
the time during which these carryforwards may be applied against future taxes,
the Company may not be able to take full advantage of these attributes for
federal income tax purposes.





The
Company files income tax returns in the U.S. and various states and local
jurisdictions.  With certain exceptions, the Company is not subject to
U.S. federal and state income tax examinations by tax authorities for years
prior to 2005.  However, NOLs and tax credits generated from those
prior years could still be adjusted upon audit.





The
Company had no unrecognized tax benefits at December 31, 2009 that would affect
the annual effective tax rate.  Further, the Company is unaware of any
positions for which it is reasonably possible that the total amounts of
unrecognized tax benefits will significantly increase or decrease within the
next twelve months.  Interest and penalties would be a component of
income tax expense but no such liabilities have been recorded.


60





Note
      21.
            Supplemental
      Non-Cash Disclosures to the Statements of Cash
  Flows





The
Company had the following non-cash investing and financing activities during the
years ended December 31, 2009 and 2008:





2009
                  
                  
                  2008Issuance
      of Common Stock in connection with acquisitions
                  
                  $
                  -
                  
                  
                  $
                  304,781





Note
      22.
            Subsequent
      Events.




On March
31, 2010, the Company entered into an exchange agreement with Rockport
Investments, Ltd. (“Rockport”), pursuant to which the Company exchanged the
existing promissory notes and line of credit held by Rockport for a new
promissory note convertible into shares of the Company’s common stock at any
time after stockholder approval of the transaction at Rockport's option
(provided, however, that without stockholder approval of the transaction, the
note may not be converted into more than 19.99% of the common stock outstanding
before the issuance of the convertible note).  The note has a
principal amount of $7,131,983, bears interest a rate of 7.95% per annum,
payable quarterly in arrears, and matures on March 31, 2015.  The
conversion rate is initially equal to the closing bid price immediately
preceding the closing date.  Rockport may, at its option, reset the
conversion price once per calendar year to the greater of (a) the average of the
closing sales price of the Company’s common stock during the preceding 20
consecutive trading day period and (b) $0.10.  The conversion price is
also subject to adjustment in the event of dilutive issuances by the Company or
the Company’s issuance of options, warrants or other rights to purchase the
Company’s common stock or convertible securities (subject to certain exceptions,
including the grant of options to purchase common stock to employees, officers,
directors or consultants of the Company).  In addition, Rockport has
the right to vote on all matters to which holders of the Company’s common stock
are entitled to vote, on an as-converted basis using the closing bid price
immediately preceding the closing date as the conversion rate, although this
voting right does not become effective until the Company’s stockholders approve
the terms of the convertible note that provide for the potential issuance of
more than 19.99% of the Company’s common stock (on a pre-transaction basis) upon
conversion of the convertible note by Rockport and grant this voting power to
the noteholder.  Pursuant to the terms of the convertible note,
effective upon such stockholder approval, Rockport would have the right to vote
approximately 28% of the Company’s common stock; however, Rockport has entered
into a voting agreement with the Company’s Chief Executive Officer, Claudio
Guazzoni, pursuant to which it has appointed Mr. Guazzoni as its proxy to vote
on Rockport’s behalf in all matters to which stockholders are entitled to vote
beginning upon such stockholder approval and continuing for the life of the
note.  Payment at maturity of the Note on March 31, 2015 will be made
solely in cash or solely in shares of the Company’s common stock, at the option
of the noteholder.  The Company may prepay the Note at any time,
subject to a prepayment premium.  The Company may request that
Rockport accept any prepayments of principal and/or any scheduled payments of
interest in shares of the Company’s common stock, but Rockport is not required
to accommodate the Company’s request.





61