TGIS Thomas Grp., Inc. (MM)

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

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Form 10-Q

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THOMAS GROUP, INC.
(Exact name of registrant as specified in its charter)

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NONE
(Former name, former address and former fiscal year, if changed since last report)

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        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  ý     No  o

        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 definition of "large accelerated filer," and "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act. (check one):

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

        As of July 15, 2008, there were 11,022,524 shares of the registrant's common stock outstanding.

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THOMAS GROUP, INC.

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PART I.    FINANCIAL INFORMATION

ITEM 1—Financial Statements

THOMAS GROUP, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except per share amounts)

(Unaudited)

See accompanying notes to consolidated financial statements

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THOMAS GROUP, INC.

CONSENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share data)

(Unaudited)

See accompanying notes to consolidated financial statements.

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THOMAS GROUP, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)

See accompanying notes to consolidated financial statements.

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THOMAS GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

        1.      Basis of Presentation —The unaudited condensed consolidated financial statements of Thomas Group, Inc. include all adjustments, which include only normal recurring adjustments, which are, in the opinion of management, necessary to present fairly the results of operations of Thomas Group for the interim periods presented. The unaudited financial statements should be read in conjunction with the consolidated financial statements and notes thereto in the Thomas Group Form 10-K for the 2007 fiscal year, filed with the Securities and Exchange Commission. The results of operations for the three and six month periods ended June 30, 2008 are not necessarily indicative of the results of operations for the entire year ending December 31, 2008. Certain amounts from prior periods have been reclassified to conform to the 2008 presentation.

        2.      Earnings per Share —Basic earnings per share is based on the number of weighted average shares outstanding. Diluted earnings per share includes the effect of dilutive securities such as stock options, stock warrants, and restricted stock awards expected to vest. The following table reconciles basic earnings per share to diluted earnings per share under the provisions of Statement of Financial Accounting Standards No. 128, "Earnings Per Share."

        The computation of diluted earnings (loss) per share of common stock for the three and six months ended June 30, 2008, excludes options representing 199,081 shares, which comprises all of our outstanding stock options at June 30, 2008. These options are excluded because the inclusion of such options would have the effect of decreasing the diluted loss per common share from continuing operations for both of these periods (that is, their effect would be "antidilutive").

        Stock options outstanding that are not included in the diluted earnings per share computation due to the antidilutive effects were approximately 29,000 and 5,000 for the three and six months ended June 30, 2007. Such options are excluded because their exercise prices exceed the average market value of Thomas Group's common stock for the period.

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THOMAS GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

        3.      Stock Based Compensation —Options to purchase shares of Thomas Group common stock have been granted to directors, officers and employees. The majority of the options granted become exercisable at the rate of 33% per year and generally expire ten years after the date of grant. At June 30, 2008, options to purchase 199,081 shares of our common stock were outstanding and exercisable. We have not issued any stock options since January 2003.

        Since the adoption of our 2005 Omnibus Stock and Incentive Plan (the "2005 Omnibus Plan"), we have granted our employees restricted stock awards representing 880,000 shares of our common stock pursuant to that plan. As of June 30, 2008, awards representing 63,333 shares remained outstanding and subject to restrictions. The remaining 816,667 shares covered by such awards had either vested or been forfeited by the award holders according to the terms of the respective awards. At June 30, 2008, 603,333 shares remain authorized and available for grant under the 2005 Omnibus Plan. The 2005 Omnibus Plan will terminate on December 20, 2015.

        On March 1, 2008, the Compensation and Corporate Governance Committee of our Board of Directors (the "Compensation Committee") and our Board of Directors, upon the Compensation Committee's recommendation, approved a new incentive compensation plan titled the 2008 Omnibus Stock and Incentive Plan for Thomas Group, Inc. (the "2008 Omnibus Plan"). The 2008 Omnibus Plan provides a means for us to grant awards to officers, employees or consultants in the form of options, restricted shares, performance awards and stock appreciation rights. A total of 1,000,000 shares of our common stock was reserved for issuance pursuant to awards to be made under the 2008 Omnibus Plan. The 2008 Omnibus Plan received stockholder approval at our 2008 Annual Meeting of Stockholders, held on June 26, 2008.

        On March 1, 2008, the Compensation Committee granted Michael McGrath, our newly appointed Executive Chairman, an initial award of 100,000 restricted shares of our common stock and a performance share award entitling Mr. McGrath to receive up to 350,000 shares of our common stock if certain conditions related to our profitability are satisfied. The initial restricted share award was granted pursuant to the 2005 Omnibus Plan. The performance share award was granted pursuant to the 2008 Omnibus Plan. On March 10, 2008, the Compensation Committee granted Earle Steinberg, our newly appointed President and Chief Executive Officer, an initial award of 50,000 restricted shares of our common stock and a performance share award entitling Mr. Steinberg to receive up to 380,000 shares of our common stock if certain conditions related to our profitability are satisfied. The initial restricted share award was granted pursuant to the 2005 Omnibus Plan. The performance share award was granted pursuant to the 2008 Omnibus Plan.

        The 100,000 restricted shares granted to Mr. McGrath vested upon the date of grant. The 50,000 restricted shares granted to Mr. Steinberg remain subject to restrictions and generally will vest on the one-year anniversary of their grant.

        The awards vest according to the agreements with each individual as we achieve certain established profit levels. The awards automatically terminate on the first to occur of (i) the date when all the performance shares have been delivered, (ii) the date the Compensation Committee determines that the performance target for the final year has not been met or (iii) the holder's termination of employment.

        The restricted stock awards were valued on the date of grant using the closing price of our common stock on the Nasdaq Global Market on that date.

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THOMAS GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

        4.      Significant Clients —We recorded revenue from one client, CACI, Inc.—Federal, a wholly owned subsidiary of CACI International, Inc. ("CACI") (www.caci.com), of $1.9 million, or 35% of revenue, and $6.7 million, or 38% of revenue, for the three and six month periods ended June 30, 2008. Revenue from the same client totaled $5.8 million, or 41% of revenue, and $11.9 million, or 41% of revenue, for the three and six month periods ended June 30, 2007. All revenues derived from CACI represent contracts with the United States Navy in which we utilize CACI as the prime contractor.

        We recorded revenue from a second client, the United States Navy (the "Navy"), of $0.4 million, or 8% of revenue, and $4.6 million, or 26% of revenue, for the three and six month periods ended June 30, 2008. Revenue from the same client totaled $6.6 million, or 47% of revenue, and $13.5 million, or 47%, of revenue, for the three and six month periods ended June 30, 2007. Revenues from the Navy decreased during the first half of 2008 as compared to the first half of 2007 due to the expiration of some of our Navy programs and to loss of some of our remaining Navy programs due to the government consolidating these programs into a single contracting vehicle in which we were not the successful bidder.

        We recorded revenue from a third client, Amtrak, of $1.1 million, or 20% of revenue, and $2.8 million, or 16% of revenue, for the three and six month periods ended June 30, 2008. Revenue from the same client totaled $0.7 million, or 5% of revenue, and $1.5 million, or 5% of revenue, for the three and six month periods ended June 30, 2007.

        There were no other clients from whom revenue exceeded 10% of total revenue in the three or six month periods ended June 30, 2008 and 2007, respectively.

        5.      Concentration of Credit Risk —Financial instruments that potentially subject us to concentrations of credit risk consist primarily of trade receivables. We encounter a certain amount of credit risk as a result of a concentration of receivables among a few significant customers. Accounts receivable from our largest customer, CACI, totaled approximately $50,000 and $3.7 million, or 4% and 36%, of accounts receivable at June 30, 2008 and December 31, 2007, respectively. Accounts receivable from another client, the Navy, totaled $0.3 million and $3.7 million, or 23% and 37%, of accounts receivable at June 30, 2008 and December 31, 2007, respectively. Accounts receivable from another client, Amtrak, totaled $0.4 million and $1.3 million, or 31% and 12%, of accounts receivable at June 30, 2008 and December 31, 2007, respectively. As of June 30, 2008, there was a $225,000 allowance assessed against receivables with the Navy and no allowances assessed against CACI and Amtrak. There were no reserves or allowances assessed against the receivables from CACI, the Navy or Amtrak as of December 31, 2007.

        6.      Supplemental Disclosure of Cash Flow Information

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THOMAS GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

        7.      Geographical Data —We operate in one industry segment and conduct our business primarily in North America with minimal activity in Asia/Pacific and Europe. During the second quarter of 2008, we closed our office in the Asia/Pacific region. We expect that any future business in that region will be handled out of our offices in North America. Information regarding these areas follows:

        8.      Property and Equipment

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THOMAS GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

        9.      Stockholders' Equity

Options

        A summary of the status of our stock options to employees for the six months ended June 30, 2008 is presented below. As of June 30, 2008, there were no unvested stock options or remaining stock-based compensation costs related to outstanding stock options.

Restricted Stock Awards

        In March 2008, we granted a restricted stock award for 100,000 shares of Thomas Group common stock to Michael E. McGrath, our Executive Chairman, and a second restricted stock award for 50,000 shares to Earle Steinberg, our President and Chief Executive Officer. Each of these awards was granted pursuant to the 2005 Omnibus Plan. Mr. McGrath's share award was granted without restrictions and Mr. Steinberg's share award vests on the one year anniversary of its issuance if Mr. Steinberg remains in our employment through such date.

        Also in March 2008, we granted a performance share award entitling Mr. McGrath to receive up to 350,000 shares in the future if certain performance targets are satisfied, and a second performance share award entitling Mr. Steinberg to receive up to 380,000 shares in the future if certain performance targets are satisfied. Each of these awards was granted pursuant to the 2008 Omnibus Plan for Thomas Group, Inc., which was approved on June 26, 2008 at our 2008 Annual Meeting of Stockholders. Mr. McGrath becomes entitled to receive such shares in annual increments over a three year period if we meet certain profitability targets in such years. Mr. Steinberg becomes entitled to receive such shares in annual increments over a four year period if we meet certain profitability targets in such

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THOMAS GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

years. A summary of the restricted stock award activity for the six months ended June 30, 2008 is presented below.

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(1)

The 880,000 shares identified in this table as "Awards granted" consist of: (i) 100,000 shares of stock granted to Mr. McGrath without restrictions and deemed immediately vested, (ii) 50,000 shares of restricted stock granted to Mr. Steinberg, (iii) a performance share award entitling Mr. McGrath to receive up to 350,000 shares if certain performance targets are satisfied over a three-year period and (iv) a performance share award entitling Mr. Steinberg to receive up to 380,000 shares if certain performance targets are satisfied over a four-year period.

(2)

During the second quarter of 2008, the holders of awards representing 410,000 fully restricted shares ceased to be employed by Thomas Group and all such 410,000 unvested fully restricted shares were forfeited without issuance. The additional 6,667 shares lapsed due to vesting criteria not being met.

(3)

Vested Shares are shares on which all restrictions have lapsed under the terms of the award and that have been issued to the holder and constitute outstanding common stock. A holder of Vested Shares has all rights, powers and privileges of a holder of unrestricted shares of Thomas Group common stock.

(4)

The 530,000 restricted shares indicated consist of (i) 430,000 fully restricted shares and (ii) 100,000 restricted shares that were classified as "Available Shares." The 430,000 fully restricted shares were subject to issuance if vesting conditions specified in the applicable award were satisfied.

(5)

Available Shares are issued upon the satisfaction of conditions specified in the related awards, but are not released to the holder until the satisfaction of certain additional vesting conditions. A holder of Available Shares has all rights, powers and privileges of a holder of unrestricted shares of Thomas Group common stock, including (in most cases) the right to receive distributions thereon except that such shares and any related distributions are not released to the holder until the date on which they become Vested Shares. During the second quarter of 2008, the holder of the award representing the 100,000 Available Shares ceased to be employed by Thomas Group under conditions that resulted in such shares becoming Vested Shares. As a result, these shares were delivered to the holder as unrestricted shares.

        For the six months ended June 30, 2008 we have recognized $0.6 million in stock based compensation expense. At June 30, 2008 there was approximately $2.4 million of stock based compensation costs related to unvested restricted stock awards to be recognized over an average vesting period of 3.2 years.

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THOMAS GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

        10.    Income Taxes

        We follow SFAS No. 109, "Accounting for Income Taxes," which requires use of the asset and liability method of accounting for deferred income taxes and providing deferred income taxes for all significant temporary differences and FASB Interpretation No. 48 ("FIN 48"), Accounting for Uncertainty in Income Taxes , which prescribes a comprehensive model for how companies should recognize, measure, present, and disclose in their financial statements uncertain tax positions taken or expected to be taken on a tax return.

        Income tax benefit of $824,000 for the six month period ended June 30, 2008 reflected an effective rate of 35%, compared to income tax expense of $2.2 million, or an effective rate of 37%, for the six month period ended June 30, 2007. We had no FIN 48 liabilities as of June 30, 2008 or December 31, 2007.

        During the second quarter of 2008, we received notice from the Internal Revenue Service ("IRS") that it is finalizing its review of our 2006 federal employment tax return and stock option practice review. During 2007, we reported that certain grants of stock options made during the period under investigation were priced below fair market value, rather than at fair market value. Consequently, certain grants intended to be classified as incentive stock options or "ISOs", requiring pricing at no less than fair market value on the date of grant, should have been classified as nonqualified stock options, or "NQs". Given the significant differences in the tax treatment between ISOs and NQs, we may have underreported or underwithheld certain payroll taxes for those options which were exercised during the period of review, August 1993 through December 2006, and therefore recorded an estimated tax liability of $0.1 million. Subsequent to June 30, 2008 we entered into a settlement agreement with the IRS and agreed to pay approximately $67,000 in employment taxes and withholding related to our stock option granting practices. This payment is considered as additional compensation for the named individuals. As such, the company will claim this expense as an adjustment to its 2006 corporate tax return. In connection with the 2006 audit, other than this adjustment, no material adjustments have been proposed. We do not anticipate any material impact on our financial statements as a result of the 2006 audit.

        11.    Financing Agreement —On December 15, 2006, we entered into a credit agreement with JPMorgan Chase Bank, N.A. This credit agreement forms the basis of a $5.5 million revolving line of credit maturing March 31, 2009. Interest on the outstanding amount under the credit facility is payable either quarterly or at the end of the applicable LIBOR interest period elected by us, at a rate equal to, at our option, either (i) the bank's prime rate then currently in effect minus 1.5% or (ii) the LIBOR rate plus 1.25%. Our obligations under the credit facility are secured by a security interest in our accounts and related collateral as well as a security interest in our equity ownership of all subsidiaries. The credit agreement limits our ability to, among other things, make certain distributions and dividends, incur liens, dispose of our assets and consummate any merger, certain acquisitions and other business combination transactions. We are also required to meet certain financial covenants under the credit agreement, including maintaining a minimum tangible net worth as defined in the credit agreement.

        For the six month periods ended June 30, 2008 and 2007, we had no borrowings or repayments on our credit facility and we had no outstanding balance on our credit facility as of June 30, 2008, or December 31, 2007. As of June 30, 2008 we were in compliance with our debt covenants.

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THOMAS GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

        12.    Issuer Repurchases of Shares —In January and October of 1999, we announced two common stock repurchase plans for up to 250,000 and 500,000 shares, respectively, to be purchased on the open market. In August 2000, we announced an additional stock repurchase plan of up to 750,000 shares to be purchased on the open market. As of March 6, 2008, we had 505,450 shares available to be repurchased under the plans. On March 6, 2008, we announced that our Board of Directors authorized us to repurchase up to the remaining 505,450 shares from time to time, subject to market conditions.

        During the first quarter of 2008, we established a written plan pursuant to Rule 10b5-1 under the Securities Exchange Act of 1934, which provides for the purchase of our common stock in support of our announced share repurchase program. After a waiting period, repurchases commenced on April 7, 2008. During the second quarter of 2008, 164,891 shares were repurchased under the Rule 10b5-1 Plan at an average market price of $2.59 per share or $2.63 per share, including commissions and fees. We are continuing to purchase shares under this repurchase program in the third quarter of 2008.

        13.    Recently Adopted Accounting Pronouncements —On January 1, 2008, we adopted SFAS No. 157, Fair Value Measurement . The objective of SFAS 157 is to increase consistency and comparability in fair value measurements and to expand disclosures about fair value measurements. SFAS 157 defines fair value, establishes a framework for measuring fair value in accordance with generally accepted accounting principles, and expands disclosures regarding fair value measurements. SFAS 157 applies under other accounting pronouncements that require or permit fair value measurements and does not require any new fair value measurements. The adoption of this statement did not have a material effect on our reported financial position or results of operations.

        On January 1, 2008, we adopted SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities—Including an Amendment of FASB Statement No. 115 . This statement permits entities to choose to measure many financial instruments and certain other items at fair value. Most of the provisions of SFAS No. 159 apply only to entities that elect the fair value option. However, the amendment to SFAS No. 115 " Accounting for Certain Investments in Debt and Equity Securities " applies to all entities with available-for-sale and trading securities. The adoption of this statement did not have a material effect on our reported financial position or results of operations as we did not elect the fair value option for any eligible financial assets or liabilities not already carried at fair value.

        14.    Recently Issued Accounting Pronouncements —In December 2007, the FASB issued SFAS No. 160, Non Controlling Interests in Consolidated Financial Statements—an amendment of ARB 51 which is effective for fiscal years and interim periods within those years beginning on or after December 15, 2008. SFAS No. 160 amends ARB 51 to establish accounting and reporting standards for the non controlling ownership interest in a subsidiary and for the deconsolidation of a subsidiary. The adoption of this statement is not expected to have a material effect on our financial statements.

        In March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities—an amendment of FASB Statement No. 133, as amended and interpreted . SFAS No. 161 changes the disclosure requirements for derivative instruments and hedging activities. Entities are required to provide enhanced disclosures about (a) how and why an entity uses derivative instruments, (b) how derivative instruments and related hedged items are accounted for under SFAS No. 133 and its related interpretations, and (c) how derivative instruments and related hedged items affect an entity's financial position, financial performance, and cash flows. SFAS No. 161 is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008. Early adoption is permitted. The adoption of this statement is not expected to have a material effect on our financial statements.

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ITEM 2—Management's Discussion and Analysis of Financial Condition and Results of Operations

"Safe Harbor" Statement Under The Private Securities Litigation Reform Act:

        Various sections contained or incorporated by reference in this Quarterly Report on Form 10-Q include forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, Section 21E of the Securities Exchange Act of 1934 and the Private Securities Litigation Reform Act of 1995. Forward-looking statements may be identified by the context of the statement and generally arise when we are discussing our beliefs, estimates or expectations. Such statements may contain the words "believe," "anticipate," "expect," "estimate," "intend," "project," "could,", "should", "may," "will be," "will likely continue," "will likely result," or words or phrases of similar meaning. These statements are not historical facts or guarantees of future performance but instead represent only our belief at the time the statements were made regarding future events. In particular, statements under Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations contain forward-looking statements, including but not limited to statements regarding our expectations regarding the sufficiency of our liquidity sources and the expected impact of legal proceedings with which we may become involved. All forward-looking statements are based largely on the expectations of management and are subject to a number of risks and uncertainties which may cause actual results and outcomes to differ materially from what we express or forecast in these forward-looking statements. In evaluating these statements, you should consider the risks and uncertainties discussed under Item 1A Risk Factors in this Quarterly Report on Form 10-Q and in of our Annual Report on Form 10-K for the fiscal year ended December 31, 2007, as well as the following list of some but not all of the factors that could cause actual results or events to differ materially from anticipated results or events:

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further disruption in our relationships with major customers;



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difficulty in expanding our commercial sector business or rebuilding our governmental sector business;



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an inability to successfully implement sufficient cost containment initiatives;



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the competitive environment of the industry in which we operate;



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customer acceptance of our product and service offerings; and



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an inability to attract, hire, develop, train and retain experienced Resultants.

        These forward-looking statements and such risks, uncertainties and other factors speak only as of the date of this Quarterly Report on Form 10-Q, and we expressly disclaim any obligation or undertaking to disseminate any updates or revisions to any forward-looking statement contained herein, to reflect any change in our expectations with regard thereto, or any other change in events, conditions or circumstances on which any such statement is based.

Overview

        We are an operations and process improvement services firm headquartered in Irving, Texas that provides process improvement solutions that enhance business' efficiency, competitiveness and financial performance. We develop and employ methodologies to transform the processes, procedures and people within our clients' organizations, enabling more efficient and seamless operations. Our methodologies address business processes throughout the "Extended Enterprise." Extended Enterprise is a term we use to describe the full spectrum of a client's value chain from its suppliers, through its internal operations, and to its customers.

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        As specialists in operations and process improvement, we create and implement process improvement solutions that remove barriers, increase productivity, improve cultures and enable our clients to improve and sustain operational performance as measured by the following:

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total cycle time;



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time-to-market;



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delivery lead times;



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operational and administrative productivity;



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cost savings;



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product yields;



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inventory turns; and



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return on assets.

        To deliver these solutions, we utilize our staff of professionals, whom we refer to as "Resultants™," who average over 20 years of business experience. To manage our client engagements, our Resultants often leverage our Process Value Management, or PVM, approach, which incorporates our proprietary Total Cycle Time®, or TCT®, methodology along with other industry accepted process improvement methodologies. PVM is used to manage client engagements, identify process inefficiencies and implement change within our clients in order to achieve a total transformation to what we refer to as the "Process Managed Enterprise." A Process Managed Enterprise is one in which management focus and systems are centered on customers and managed around processes.

        In addition, we have supplemented our Process Value Management methodology with new tools that enable us to offer enhanced value to our clients in less time. Some of the other new offerings we provide to facilitate our clients' improvement include:

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OpTTMize™—which focuses on improving time to market and reducing costs in new product development;



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Asset Productivity—which focuses on reducing the fixed costs of the business with improved throughput;



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Maintenance Effectiveness—which is designed to improve productivity and reduce costs of large scale maintenance operations;



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Sales and Operations Planning—which is designed to improve the productivity of the business through coordination of the sales and production operations to achieve enhanced shareholder value;



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Strategic Procurement—which is designed to improve the procurement process, reduce costs, and improve shareholder value;



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Lean & Six-Sigma productivity tools—which are utilized to implement sustainable strategic improvements in operations; and



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Strategic Training—which is designed to assist organizations in implementing transformational change.

        Historically, most of our clients have been large, diversified commercial or government enterprises in North America, Europe, and Asia. During the last four years, however, our engagements have involved primarily various government entities, principally the United States Navy. We have also served international clients in previous years from our former offices in Switzerland, Sweden, Germany, Singapore, China and Hong Kong. Currently, we are focused on delivering our solutions in North

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America. In some instances, we provide solutions to the same organization under separate contractual arrangements. While we believe our methodologies are applicable to any industry, we have developed a significant amount of subject-matter expertise relevant to specific industries, including automotive, aviation, distribution, government, including the military services, healthcare, manufacturing, semiconductor, textiles and transportation. Additional information related to our customer relationships and challenges arising from the recent expiration of contracts that accounted for approximately 85% of our revenue in 2007 is discussed below under the heading "Significant Contract Expirations and Related Recovery Plan."

        We generally derive our revenue from fees for the implementation of business operations improvement programs delivered by our Resultants. Total revenue consists of fees and other billings derived from fixed fees, task-based fees, incentive fees and reimbursed travel expenses. Our fee type and structure for each client engagement is dependant on a number of variables, including the size of the client, the complexity and geographic dispersion of its business, the level of the opportunity for us to improve the client's processes and other factors.

        Fixed fee revenue is recognized on the proportional performance model (which approximates the percentage completion method), based on direct labor hours expended and, when applicable, the completed performance model. In order to calculate the completion ratio on a given project, time and effort to date are divided by the total estimated time and effort for the entire project. This ratio is then multiplied by the total fixed fee to be earned on the project, resulting in the amount of revenue earned to date. A few of our fixed fee contracts, primarily assessments, are recognized using the completed contract performance model as these contracts are generally one to six weeks in duration and conclude with a presentation or agreed upon deliverable to the clients' management. Revenues attributable to fixed fees were 48% and 31% of consolidated revenue for the three and six month periods ended June 30, 2008, respectively, and 7% and 8% of consolidated revenue for the three and six month periods ended June 30, 2007, respectively.

        Task-based fees are recognized as revenue when the relevant task is completed. Typically, task-based revenue recognition involves the delivery of a report, minutes or some other evidence of completion. Revenues attributable to task-based fees were 43% and 64% of consolidated revenue for the three and six month periods ended June 30, 2008 respectively, and 92% and 91% of consolidated revenue for the three and six month periods ended June 30, 2007, respectively.

        Incentive fees are tied to improvements in a variety of client performance measures typically involving cycle time, asset utilization and productivity. Incentive fee revenue is recognized in the period in which the related client improvements are achieved and we obtain the client's acceptance. Our incentive fee agreements with our clients define in advance the performance improvement standards that will form the basis for the payment of incentive fees. In order to mitigate the risk of disputes arising over the achievement of performance improvements, which drive incentive fees, we obtain customer agreement to these achievements prior to recognizing revenue. Incentive fees are affected by our clients' business performance and prevailing economic conditions. We had no revenues attributable to incentive fees for each of the three and six month periods ended June 30, 2008 and 2007. As of June 30, 2008, we had two contractual arrangements which provide for potential incentive fees in the future.

        Reimbursement revenue represents our clients' repayment of mutually agreed upon travel expenses as incurred. All billable travel expenses are submitted to and approved by each client. Revenues attributable to reimbursements were 9% and 5% of consolidated revenue for the three and six month periods ended June 30, 2008, respectively, and 1% of consolidated revenue for each the three and six month periods ended June 30, 2007.

        Cost of sales represents the direct costs involved in providing services and solutions to our clients. The components include, but are not limited to, direct labor and benefit costs, support costs such as

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telecommunications and computer costs, travel costs and other costs incurred in providing services and solutions to our clients.

        Selling, general and administrative expenses include the costs of all labor and other goods and services necessary for our selling and marketing efforts, human resource support, accounting and finance services, legal and other professional services, facilities and equipment, information technology and telecommunications support and services, and other corporate functions. Selling, general and administrative expenses also include depreciation and amortization on the fixed assets used to support these functions.

        In December 2005, we instituted our first annual dividend policy, which was subsequently increased to $0.30 per share annually in June 2006 and $0.40 per share annually in December 2006. On February 19, 2008, our Board of Directors suspended the payment of future quarterly dividends.

        Sublease losses and income arise from the sublease contracts we maintained with former subtenants in our Reston, VA and Troy, MI offices. Losses are generally the result of a subtenant defaulting on a lease or at the termination of a lease in which we anticipate that the future subtenant income will not be sufficient to recoup our costs associated with the subleased office space. Sublease income is recognized generally upon the termination of a sublease in which we, as a result of the termination, are able to avoid future anticipated costs previously recognized as sublease losses. As of December 31, 2007, we no longer maintain these leases or subleases.

        In addition to our United States operations, we have minimal activities in the Asia/Pacific region and Europe. A portion of our revenue related transactions have been denominated in the local currency where the client is located. Historically, the majority of our operating expenses for our subsidiaries have been denominated in the local currency of the subsidiary. Therefore, we are exposed to currency fluctuation risks. See Item 3. "Quantitative and Qualitative Disclosure About Market Risk."

Significant Contract Expirations and Related Recovery Plan

        In the spring of 2007, we learned that the government was combining our largest two U.S. Navy programs, which accounted for approximately 85% of our revenue in 2007, into one contracting vehicle using a competitive request for proposal. In January 2008, we learned that we, and the team with which we were partnered, were not awarded the new contract. One of these contracts expired March 31, 2008 and the other expired April 30, 2008.

        In response to the loss of these material contracts with the U.S. Navy, we reduced our labor force by approximately one third during the second quarter of 2008, recruited a new management team, and reorganized to focus our marketing and delivery of services initially in six practice areas, representing Aerospace and Defense, Air Force, Army and Navy, Healthcare, Industrial, and Transportation and Logistics. Along with the new practice areas, we are broadening the solutions we provide to our clients and increasing our flexibility in the ways that we provide services to our clients. By reorganizing our management structure, and leveraging what we believe to be our strong brand recognition, we are striving to rebuild Thomas Group into a premier consulting organization providing strategic and operations advice to our clients and target markets.

        The reduction in staff that we implemented during the second quarter of 2008, although a cost containment measure, was not sufficient to ensure our profitability at our current level of revenues, as demonstrated by our financial results for the three month period ended June 30, 2008. We made a strategic decision to balance the need for reduction in cost with the need to be able to rebuild our business in the current year. This means that we currently have more Resultants on our payroll than can be supported by current revenue. We are using these additional personnel to develop new product offerings and tools that are intended to add additional revenue opportunities in each of our practice areas. We are also investing in training our Resultants to deliver these new service offerings.

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        We have also implemented enhanced marketing, sales, and business development processes aimed at generating a more robust sales pipeline that we expect ultimately to result in increasing revenue in future periods.

        Although we have seen some early indications of positive results from these efforts, these are not quick "fixes" that will result in a short-term return to profitability. We continue to manage aggressively to return to profitability, although there can be no assurances when or if we will achieve this goal.

        As discussed below under the heading "Liquidity and Capital Resources," we have a strong working capital position as well as an unused line of credit. Management continues to believe that these combined resources should be sufficient to allow us to return to profitability if our efforts outlined above are successful.

Critical Accounting Policies

         General —The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the accompanying financial statements and related notes. Management bases its estimates and assumptions on historical experience, observance of industry trends and various other sources of information and factors. Actual results could differ from these estimates. Critical accounting policies are defined as those that are reflective of significant judgments and uncertainties, and potentially could result in materially different results under different assumptions and conditions.

         Revenue Recognition —Revenue is recognized when realizable and earned, generally as services and solutions are provided over the life of a contract. Fixed fee revenue is recognized using a proportional performance model (which approximates the percentage completion method), based on direct labor hours expended and, when applicable, the completed performance model. Task-based, or deliverable-based, fees are recognized when the relevant task or deliverable is completed. Incentive fee revenue is recognized in the period in which the related improvements are achieved and the client has agreed that performance improvements have in fact been achieved. Our incentive fee agreements with our clients define in advance the performance improvement standards that will form the basis of our incentive fees earned.

         Unbilled Receivables —Although fixed fee revenue recognition generally coincides with billings, as an accommodation to our clients, we may structure fee billings in a different pattern. In such instances, amounts collectible for services provided but not yet billed are represented in unbilled receivables.

         Deferred Taxes —Income taxes are calculated using the asset and liability method required by FASB Statement No. 109, "Accounting for Income Taxes." Deferred income taxes are recognized for the tax consequences resulting from timing differences by applying statutory tax rates applicable to future years. These timing differences are associated with differences between the financial and the tax basis of existing assets and liabilities. Under FAS No. 109, a statutory change in tax rates will be recognized immediately in deferred taxes and income. Net deferred taxes are recorded both as a current deferred income tax asset and as other long-term liabilities based upon the classification of the related timing difference. A valuation allowance is recognized if, based on the weight of available evidence, it is more likely than not that some portion or all of a deferred tax asset will not be realized. All available evidence, both positive and negative, is considered when determining the need for a valuation allowance. Judgment is used in considering the relative impact of negative and positive evidence. The weight given to the potential effect of negative and positive evidence is commensurate with the extent to which it can be objectively verified. In accordance with Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes, evidence, such as operating results during the most recent three-year period, is given more weight than our expectations of future profitability, which are inherently uncertain.

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        In addition to timing differences arising from operating assets and liabilities, we also record deferred tax assets for the tax benefits of net operating losses and foreign tax credits. For United States federal tax purposes, at December 31, 2002, we had net operating loss ("NOL") carryovers of approximately $4.2 million. Under the Section 382 limitation, discussed below, $0.7 million was used to offset United States taxable income in 2003. In 2004, $0.2 million expired under Section 382, but $8.1 million in United States net operating loss was generated, resulting in a balance of $11.4 million at December 31, 2004. In 2005, we used $8.1 million of the net operating loss to offset United States taxable income and used $0.2 million of the net operating loss carryforward limited under Section 382, resulting in a net operating loss carryforward balance of $3.1 million at December 31, 2005. In each of fiscal years 2006 and 2007, we used $0.2 million of the net operating loss carryforward balance, resulting in a $2.9 million and $2.8 million balance at December 31, 2006 and December 31, 2007, respectively. As of June 30, 2008, we had a $2.8 million NOL balance.

        In assessing the realizability of deferred tax assets, we consider whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. During 2006, however, we determined that a deferred tax asset valuation allowance was appropriate on only approximately $117,000 of the NOL carryforward, due to annual limitations under Section 382. Therefore, we removed $1.8 million of the deferred tax asset valuation allowance. As of June 30, 2008 and December 31, 2007, our deferred tax asset valuation allowance was approximately $117,000. We continue to assess our need for a valuation allowance against our current NOL balances. While we reported a loss for the six months ended June 30, 2008, do not believe, based on future expectations, that an additional valuation allowance is needed at this time.

        If future analyses of the positive and negative evidence indicates that it is more likely than not that some portion or all of the net deferred tax asset will not be realized, a partial or full deferred tax asset valuation allowance may be required, which could have a negative impact on net income in the period that it becomes more likely than not that deferred tax assets will not be realized.

        We also follow the guidance under FASB Interpretation No. 48 ("FIN 48"), Accounting for Uncertainty in Income Taxes , which prescribes a comprehensive model for how companies should recognize, measure, present, and disclose in their financial statements uncertain tax positions taken or expected to be taken on a tax return. Tax law is subject to varied interpretation, and whether a tax position will ultimately be sustained may be uncertain. Under FIN 48, tax positions shall initially be recognized in the financial statements when it is more likely than not the position will be sustained upon examination by the tax authorities. Such tax positions shall initially and subsequently be measured as the largest amount of tax benefit that is greater than 50% likely of being realized upon ultimate settlement with the tax authority assuming full knowledge of the position and all relevant facts. FIN 48 also requires additional disclosures about unrecognized tax benefits associated with uncertain income tax positions and a reconciliation of the change in the unrecognized benefit. In addition, FIN 48 requires interest to be recognized on the full amount of deferred benefits for uncertain tax positions. An income tax penalty is recognized as expense when the tax position does not meet the minimum statutory threshold to avoid the imposition of a penalty. As of June 30, 2008 we did not have any FIN 48 liabilities or associated interest.

        During the second quarter of 2008 we received notice from the Internal Revenue Service ("IRS") that it is finalizing its review of our 2006 federal employment tax return and stock option practice review. During 2007, we reported that certain grants of stock options made during the period under investigation were priced below fair market value, rather than at fair market value. Consequently, certain grants intended to be classified as incentive stock options or "ISOs", requiring pricing at no less than fair market value on the date of grant, should have been classified as nonqualified stock options, or "NQs". Given the significant differences in the tax treatment between ISOs and NQs, we may have underreported or underwithheld certain payroll taxes for those options which were exercised during the period of review, August 1993 through December 2006, and therefore recorded an estimated tax

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liability of $0.1 million. Subsequent to June 30, 2008 we entered into a settlement arrangement with the IRS and agreed to pay approximately $67,000 in employment taxes and withholding related to our stock option granting practices. This payment is considered as additional compensation for the named individuals. As such, the company will claim this expense as an adjustment to its 2006 corporate tax return. In connection with the 2006 audit, other than this adjustment, no material adjustments have been proposed. We do not anticipate any material impact on our financial statements as a result of the 2006 audit.

         Stock based compensation —We account for stock based compensation arrangements in accordance with the provisions of Financial Accounting Standard (SFAS) No. 123R, "Share Based Payment". SFAS No. 123(R) requires us to measure all stock based compensation awards at the grant date using a fair value method and to record expense in the financial statements over the requisite service period of the award. We estimate the fair value of options using the Black Sholes method, which considers a risk-free interest rate, volatility, expected life, forfeitures, and dividend rates. We use the U.S. 10-year Treasury Bond yield to estimate the risk-free interest rate; and, our estimate of volatility is based on our historical stock price for a period of at least or equal to the expected life of award. Our estimate of forfeitures considers the term of the awards granted and historical forfeiture experience and our estimate of the expected life of awards is based on the anticipated time the award is held. The restricted stock awards and performance share awards are valued on the date of grant using the closing price of our common stock on the Nasdeq Global Market on that date.

         Recently Adopted Accounting Pronouncements —On January 1, 2008, we adopted SFAS No. 157, Fair Value Measurement . The objective of SFAS 157 is to increase consistency and comparability in fair value measurements and to expand disclosures about fair value measurements. SFAS 157 defines fair value, establishes a framework for measuring fair value in accordance with generally accepted accounting principles, and expands disclosures regarding fair value measurements. SFAS 157 applies under other accounting pronouncements that require or permit fair value measurements and does not require any new fair value measurements. The adoption of this statement did not have a material effect on our reported financial position or results of operations.

        On January 1, 2008, we adopted SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities—Including an Amendment of FASB Statement No. 115 . This statement permits entities to choose to measure many financial instruments and certain other items at fair value. Most of the provisions of SFAS No. 159 apply only to entities that elect the fair value option. However, the amendment to SFAS No. 115 " Accounting for Certain Investments in Debt and Equity Securities " applies to all entities with available-for-sale and trading securities. The adoption of this statement did not have a material effect on our reported financial position or results of operations as we did not elect the fair value option for any eligible financial assets or liabilities not already carried at fair value.

         Recently Issued Accounting Pronouncements —In December 2007, the FASB issued SFAS No. 160, Non Controlling Interests in Consolidated Financial Statements—an amendment of ARB 51 which is effective for fiscal years and interim periods within those years beginning on or after December 15, 2008. SFAS No. 160 amends ARB 51 to establish accounting and reporting standards for the non controlling ownership interest in a subsidiary and for the deconsolidation of a subsidiary. The adoption of this statement is not expected to have a material effect on our financial statements.

        In March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities—an amendment of FASB Statement No. 133, as amended and interpreted . SFAS No. 161 changes the disclosure requirements for derivative instruments and hedging activities. Entities are required to provide enhanced disclosures about (a) how and why an entity uses derivative instruments, (b) how derivative instruments and related hedged items are accounted for under SFAS No. 133 and its related interpretations, and (c) how derivative instruments and related hedged items affect an entity's financial position, financial performance, and cash flows. SFAS No. 161 is effective for

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financial statements issued for fiscal years and interim periods beginning after November 15, 2008. Early adoption is permitted. The adoption of this statement is not expected to have a material effect on our financial statements.

        On June 20, 2008, the Securities and Exchange Commission issued a press release announcing the approval of a one-year extension of the date by which smaller public companies must comply with the 404(b) auditor attestation requirements of internal control over financial reporting. We will now be required to comply with Section 404(b) in our annual reports for fiscal years ending on or after December 15, 2009.

Results of Operations

        The following table sets forth the percentages which the identified items in our condensed consolidated statements of operations bear to revenue:

Three Month Period Ended June 30, 2008 Compared to the Three Month Period Ended June 30, 2007

         Revenue —In the second quarter of 2008, total revenues decreased $8.6 million, or 61%, to $5.4 million from $14.0 million in the second quarter of 2007. Task based revenue was $2.3 million, or 43% of revenue, in the second quarter of 2008, compared to $12.8 million, or 92% or revenue in the first quarter of 2007. Fixed fee revenue was $2.6 million, or 48% of revenue, in the second quarter of 2008, compared to $1.0 million, or 7% of revenue, in the first quarter of 2007. Reimbursement revenues were $0.5 million, or 9% of revenue in the second quarter of 2008 compared to $0.2 million, or 1% of revenue, in the second quarter of 2007. As of June 30, 2008, we had two active incentive fee based contracts.

        North America region revenue decreased $9.4 million, or 67%, to $4.6 million in the second quarter of 2008, compared to $14.0 million in the second quarter of 2007. The decrease in North America revenues for the second quarter of 2008 compared to the second quarter of 2007 is due primarily to a decrease in our government business, offset slightly by an increase in our commercial business. The decrease in task based revenue, which is associated with our government contracts, is due primarily to the ending of some of our U.S. Navy programs and our inability to expand our remaining U.S. Navy programs following the government's decision to consolidate these programs into a single contracting vehicle for which we were not named as a provider. The increase in fixed fee revenue, which is associated with our commercial contracts, is due primarily to having a larger volume of our commercial contracts, along with the contracts having a higher contract value for the three months ended June 30, 2008 compared to the three months ended June 30, 2007. Reimbursable revenues,

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which also are associated with our commercial contracts, increased due to the increases in commercial activity.

        We did not have any revenues from our Asia/Pacific region in the second quarters of 2008 and 2007. During the second quarter of 2008, we closed our office in the Asia/Pacific region.

        During the second quarter of 2008, we recorded $0.8 million in revenue from a client located in Europe, compared to $32,000 in the second quarter of 2007. Although we discontinued our European operations in 2006, we maintain a strategic relationship in Europe through which we may periodically obtain business.

         Gross Profit —Gross profit margins were 37% of revenue, or $2.0 million, in the second quarter of 2008, compared to 51%, or $7.1 million, in the second quarter of 2007. Costs of sales consists of direct labor, travel, and other direct costs incurred by our Resultants to provide services to our clients and to complete client related projects, including training. The decrease in gross profit margin, as a percentage of revenue, is attributable to lower utilization rates of our Resultants in the second quarter of 2008 related to a slowdown of our government programs.

         Selling, General and Administrative Expenses —Selling, general, and administrative expenses for the second quarter of 2008 were $5.0 million, compared to $4.3 million in the second quarter of 2007. The $0.7 million increase is primarily related to a $1.1 million increase in costs related primarily to individuals working on sales efforts, as compared to the prior year when a majority of these individuals were working on client projects, and $0.4 million in severance costs related to the reduction in our labor force during the second quarter of 2008, offset by a $0.3 decrease in the use of outside consultants and outside professional services, $0.2 million collection of a receivable written off in the first quarter of 2008, and a $0.3 million decline in other costs due to a decrease in activity and the number of resultants as compared to prior year.

         Sublease Losses —During 2007, the remaining rent reserve balance related to our Reston, Virginia office, was being amortized ratably against rent expense until the expiration of the lease on October 31, 2007.

Six Month Period Ended June 30, 2008 Compared to the Six Month Period Ended June 30, 2007

         Revenue —For the first half of 2008, total revenues decreased $11.1 million, or 38%, to $17.8 million from $28.9 million in the first half of 2007. Task based revenue was $11.4 million, or 64% of revenue, in the first half of 2008, compared to $26.1 million, or 91% or revenue in the first half of 2007. Fixed fee revenue was $5.5 million, or 31% of revenue, in the first half of 2008, compared to $2.4 million, or 8% of revenue, in the first half of 2007. Reimbursement revenues were $0.9 million, or 5% of revenue in the first half of 2008 compared to $0.4 million, or 1% of revenue, in the first half of 2007.

        North America region revenue decreased $12.3 million, or 43%, to $16.3 million in the first half of 2008, compared to $28.9 million in the first half of 2007. The decrease in North America revenues for the first half of 2008 compared to the first half of 2007 is due primarily to a decrease in our government business, offset by an increase in our commercial business. The decrease in task based revenue, which is associated with our government contracts, is due primarily to the natural ending of our U.S. Navy programs and our inability to expand our remaining U.S. Navy programs following the government's decision to consolidate these programs into a single contracting vehicle for which we were not named as a provider. The increase in fixed fee revenue, which is associated with our commercial contracts, is due primarily to our commercial contracts having a higher contract value for the six months ended June 30, 2008 compared to the six months ended June 30, 2007. Reimbursable revenues, which also are associated with our commercial contracts, increased due to the increases in commercial activity.

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        We did not have any revenues from our Asia/Pacific region in the first half of 2008 and 2007. During the second quarter of 2008, we closed our office in the Asia region.

        During the first half of 2008, we recorded $1.5 million in revenue from a client located in Europe, compared to $32,000 in the first half of 2007. Although we discontinued our Europe operations in 2006, we maintain a strategic relationship in Europe through which we may periodically obtain business.

         Gross Profit —Gross profit margins were 45% of revenue, or $8.0 million, in the first half of 2008, compared to 50%, or $14.6 million, in the first half of 2007. Costs of sales consists of direct labor, travel, and other direct costs incurred by our Resultants to provide services to our clients and to complete client related projects, including training. The decrease in gross profit margin, as a percentage of revenue, is attributable to lower utilization rates of our Resultants in the first half of 2008 related to a slowdown of our government programs.

         Selling, General and Administrative Expenses —Selling, general, and administrative expenses for the first half of 2008 were $10.5 million, compared to $9.0 million in the first half of 2007. The $1.5 million increase is primarily related to a $1.2 million increase in costs related primarily to individuals working on sales efforts, as compared to the prior year when a majority of these individuals were working on client projects, $0.5 million increase in stock based compensation, $0.4 million in severance costs related to the reduction in our labor force during the second quarter of 2008, $0.2 million increase in recruiting costs, and a $0.2 million increase in bad debt allowance, offset by a $0.6 million decrease in professional expenses related primarily to the review of our historical stock option practices in the first half of 2007, a $0.2 million decrease in consultants used related to the decrease in activity, and a $0.2 million decline in other costs due to a decrease in activity and the number of resultants as compared to prior year.

Liquidity and Capital Resources

        Our cash and cash equivalents increased by $2.4 million during the first six months of 2008. At June 30, 2008, we had cash and cash equivalents of $14.4 million compared with cash and cash equivalents of $12.0 million at December 31, 2007. In addition, at both dates we had unused capacity of $5.5 million available under our senior secured revolving credit facility. At June 30, 2007, we had cash and cash equivalents of $10.1 million. The major components of our liquidity and capital resources are described below.

         Cash Flows from Operating Activities —Operating activities provided net cash of $4.3 million in the first six months of 2008, compared to $4.9 million in the first six months of 2007. This decrease is due primarily to a decrease in our accrued liabilities, resulting from the payment of our dividends outstanding at December 31, 2007, offset by the increased collection of our accounts receivable balance, as compared to prior year.

         Cash Flows Used In Investing Activities —We used $89,000 in cash for investing activities during the first six months of 2008 related to the purchase of new computers and software, compared to $818,000 used for investing activities in the first six months of 2007 related primarily to improvements and expansion of our Dallas training facility.

         Cash Flows Used In Financing Activities —We used $1.8 million for financing activities during the first six months of 2008 related to the $1.2 million payment of dividends, the $0.4 million purchase of stock under our stock repurchase plan, and the $0.2 million net tax effect of stock issuances, compared to $2.5 million used in financing activities in the first six months of 2007, consisting primarily of $0.3 million for the net tax effect of stock issuances and $2.2 million for the payment of dividends.

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        During the second quarter of 2008, we announced a reduction in force affecting approximately one-third of our employees as a part of a restructuring plan approved by our board of directors. We recorded a charge of approximately $240,000, net of tax effects, for one-time termination benefits related to employee severance and other benefits in our second quarter 2008 operating results. We estimate that these activities will eliminate approximately $6.0 million of our annualized operating costs. No other charges are expected as a result of these actions. We paid the one-time termination benefits in the second quarter of 2008 out of cash from operations.

        On March 6, 2008 our Board of Directors reaffirmed our previously existing stock repurchase program and authorized the repurchase of shares of our common stock. At that time a total of 505,450 shares representing approximately 5% of our outstanding shares remained subject to repurchase under the stock repurchase program. On March 6, 2008 we entered into a Rule 10b5-1 repurchase plan to establish a systematic program authorizing a stockbroker to execute repurchases in accordance with the terms of the Rule 10b5-1 plan. After a waiting period, repurchases commenced on April 7, 2008. During the second quarter of 2008 164,981 shares were repurchased under the Rule 10b5-1 plan at an average market price of $2.59 per share or $2.63 per share including commissions and fees. We are continuing to purchase shares under this repurchase program in the third quarter of 2008.

         $5.5 million Credit Facility with JPMorgan Chase Bank, N.A. —On December 15, 2006, we entered into a credit agreement with JPMorgan Chase Bank, N.A. The senior secured revolving credit facility will be used as needed for ongoing working capital needs and general corporate purposes. At June 30, 2008 and December 31, 2007, no amounts were outstanding under this credit facility. This credit facility will mature on March 31, 2009, at which time it will terminate and any outstanding amounts will be due and payable. The obligations under the senior secured revolving credit facility are secured by first priority liens on all of our accounts and proceeds thereof.

        We may prepay all loans under the senior secured revolving credit facility at any time without premium or penalty (other than customary LIBOR breakage costs and payment of accrued interest), subject to certain notice requirements. Amounts borrowed and repaid under the senior secured revolving credit facility may be reborrowed. Indebtedness under the senior secured revolving credit facility bears interest at our option at either the bank's reference rate minus 1.50% or LIBOR plus 1.25%. We incur quarterly commitment fees based on the unused amount of the credit facility.

        The credit agreement for the senior secured revolving credit facility contains various covenants that, among other restrictions, limit our ability to:

•

incur additional indebtedness;



•

create liens;



•

sell our assets or consolidate or merge with or into other companies;



•

make loans, extend guarantees or enter into other certain investments;



•

engage in transactions with affiliates; and



•

make capital expenditures.

        The credit agreement for the senior secured revolving credit facility also contains a covenant requiring us to maintain minimum levels of tangible net worth (as defined in the credit agreement).

        Each of the following would be an event of default under the senior secured revolving credit facility:

•

failure to pay any principal, interest, fees, expenses or other amounts when due;

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•

failure to observe any agreement, obligation, or covenant in the credit agreement, subject to cure periods for certain failures;



•

certain judgments against us or any of our subsidiaries, in excess of certain allowances;



•

certain bankruptcy or insolvency events involving us or our subsidiaries;



•

a change in control not consented to by the bank; and



•

the failure of any representation or warranty to be true and correct when made.

        As of June 30, 2008, we are not in default under any of the covenants of this credit agreement.

        In March 2007, we signed an amendment to the credit facility that increases the capital expenditures we can incur in compliance with the terms of the credit agreement. The capital expenditure limit was increased to $1.0 million for the year ending December 31, 2007 from the original limit of $0.5 million annually. Effective January 1, 2008, the annual limit reverted to $0.5 million.

        In June 2007 we signed an amendment waiving certain covenants related to our liquidated subsidiary Thomas Group Hong Kong Limited. In November 2007, we signed an amendment authorizing us to form a wholly owned subsidiary, Thomas Group Global LLC, to procure and develop business and selling activities in foreign nations.

        As of June 30, 2008, we had no material commitments for capital expenditures or off-balance sheet arrangements.

         Additional Cash Flow Information —As previously disclosed in our filings with the Securities and Exchange Commission and elsewhere in this quarterly report on Form 10-Q, in the second quarter of 2008 we ceased providing services under two government programs that accounted for approximately 85% of our revenue in 2007. The impact of these contract expirations, in conjunction with not having new customer contracts sufficient to replace the associated revenue, has caused us to experience losses for the first six months of 2008. Based on current internal estimates, we believe that our cash balances, together with cash generated from operations and available borrowings under our senior secured revolving credit facility, should be sufficient to provide adequate funds for our operating needs for the next twelve months.

        We have limited fixed costs, such as the rent of our corporate offices in Irving, Texas. A large percentage of our costs are variable and dependent on the number of people we employ. The majority of our cash expenditures are used to pay the salaries and benefits of our employees, to train our employees, to conduct sales efforts to obtain new contracts, and to pay general office expenditures that are necessary to run our business appropriately.

        If our current internal estimates for the net use of cash prove incorrect, we may need to undertake additional actions to obtain adequate cash to operate our business. These actions could include initiating further cost reduction efforts or delaying capital expenditures, and seeking additional debt or equity capital. Our ability to execute any of these strategies could be significantly impacted by numerous factors, including changes in the economic or business environment, financial market volatility and the performance of our business. We must carefully and constantly continue to monitor our progress against these estimates.

        We have implemented enhanced marketing, sales, and business development processes aimed at generating a more robust sales pipeline that we expect ultimately to result in increasing our cash flow in future periods. Although we have seen some early indications of positive results from these efforts, these are not quick 'fixes' that will result in a short-term return to profitability. We continue to manage aggressively to return to profitability, although there can be no assurances when or if we will achieve this goal.

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         Inflation —Although our operations are influenced by general economic conditions, we do not believe inflation had a material effect on the results of operations during the six month periods ended June 30, 2008 or 2007. However, there can be no assurance our business will not be affected by inflation in the future.

ITEM 3—Quantitative and Qualitative Disclosure About Market Risk

        There have been no material changes in circumstances affecting our exposure to interest rate or foreign exchange rate risk since December 31, 2007. For a discussion of our exposure to these risks, see "Item 7A. Quantitative and Qualitative Disclosures About Market Risk" in our Annual Report on Form 10-K for the year ended December 31, 2007.

ITEM 4—Controls and Procedures

        Based on the evaluation of our disclosure controls and procedures as of the end of the period covered by this quarterly report, Earle Steinberg, our President and Chief Executive Officer, and Frank Tilley, our Vice President and Interim Chief Financial Officer, have concluded that, as of June 30, 2008, in their judgment, our disclosure controls and procedures are effective to ensure that information required to be disclosed by us, including our subsidiaries, in the reports we file, or submit under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission's rules and forms. Our disclosure controls and procedures include controls and procedures designed to ensure that information required to be disclosed in reports filed or submitted under the Exchange Act is accumulated and communicated to our management, including our President and Chief Executive Officer and Vice President and Interim Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. Management necessarily applied its judgment in assessing the costs and benefits of such controls and procedures, which, by their nature, can provide only reasonable assurance regarding management's control objectives. The design of any system of controls and procedures is based in part upon certain assumptions about the likelihood of future events. There can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions, regardless of how remote.

        There were no changes in our internal controls over financial reporting during Thomas Group's last fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.

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PART II—OTHER INFORMATION

ITEM 1—Legal Proceedings

        During the second quarter of 2008 we received notice from the Internal Revenue Service ("IRS") that it is finalizing its review of our 2006 federal employment tax return and stock option practice review. During 2007, we reported that certain grants of stock options made during the period under investigation were priced below fair market value, rather than at fair market value. Consequently, certain grants intended to be classified as incentive stock options or "ISOs", requiring pricing at no less than fair market value on the date of grant, should have been classified as nonqualified stock options, or "NQs". Given the significant differences in the tax treatment between ISOs and NQs, we may have underreported or underwithheld certain payroll taxes for those options which were exercised during the period of review, August 1993 through December 2006, and therefore recorded an estimated tax liability of $0.1 million. Subsequent to June 30, 2008 we entered into a settlement agreement with the IRS and agreed to pay approximately $67,000 in employment taxes and withholding related to our stock option granting practices. This payment is considered as additional compensation for the named individuals. As such, the company will claim this expense as an adjustment to its 2006 corporate tax return. In connection with the 2006 audit, other than this adjustment, no material adjustments have been proposed. We do not anticipate any material impact on our financial statements as a result of the 2006 audit.

        We may become subject to various claims and other legal matters, such as collection matters initiated by us in the ordinary course of conducting our business. We believe neither such claims and legal matters nor the cost of prosecuting and/or defending such claims and legal matters will have a material adverse effect on our consolidated results of operations, financial condition or cash flows. No material claims are currently pending; however, no assurances can be given that future claims, if any, will not be material.

ITEM 1A—Risk Factors

A failure to replace lost client relationships will have a material adverse effect on our results of operations.

        In January 2008, we learned that we had not been awarded a competitive request for proposal for work with the U.S. Navy which accounted for approximately 85% of our revenue in 2007. During the second quarter of 2008, the contracts for this business expired. We expect that our revenue for 2008 will decrease significantly as compared to 2007. In response to the loss of these contracts, we have implemented cost-containment initiatives, reorganized our management structures, enhanced our product and service offerings and implemented enhanced business development processes. If we are unable to develop significant new client relationships and generate increased revenue from new consulting engagements, our recovery will be adversely affected.

A significant or prolonged economic downturn could have a material adverse effect on our results of operations.

        Our results of operations are affected by the level of business activity of our clients, which in turn is affected by the level of economic activity in the industries and markets they serve. Budgets for consulting services typically decrease during times of adverse economic conditions. A decline in the level of business activity of our clients could affect our ability to secure new client engagements, increase the likelihood of existing client engagement contract cancellations and reduce our utilization rates, which would have a material adverse impact on our ability to generate revenue and our operating results. It is currently unclear what effect the current economic downturn will have on our business and results of operations. It is possible that the current economic downturn could cause some clients to reduce or defer their expenditures for consulting services. We have implemented and will continue to implement cost-savings initiatives to manage our expenses as a percentage of revenue; however, current

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and future savings initiatives may not be sufficient to maintain our margins if the economic environment should weaken for a prolonged period.

Our current cash resources might not be sufficient to meet our expected cash needs over time. We continue to believe that our cash balances, together with cash generated from operating activities and available borrowings under our senior secured credit facility, will be sufficient to provide adequate funds for our anticipated internal growth and operating needs. However, if we cannot consistently generate sufficient positive cash flows from operating activities to fund our needs, our business, financial condition and results of operations could be materially and adversely affected.

        During the first half of 2008, we have experienced net losses. If we cannot consistently generate sufficient positive cash flows from operating activities, we will need to meet operating shortfalls with existing cash on hand, avail ourselves of the capital or credit markets or implement or seek alternative strategies. These alternative strategies could include seeking improvements in working capital management, reducing or delaying capital expenditures and seeking additional debt or equity capital. There can be no assurances that existing cash will be sufficient, we will have timely access to the capital or credit markets or that any of these strategies can be implemented on satisfactory terms, on a timely basis, or at all.

If we do not maintain compliance with the listing requirements of the NASDAQ Global Market, our common stock could be delisted, which could, among other things, reduce the price of our common stock and the levels of liquidity available to our stockholders.

        Our securities could be delisted in the future if we do not maintain compliance with applicable listing requirements. If our securities are delisted from the NASDAQ Global Market and we are unable to satisfy the listing requirements of the NASDAQ Capital Market, our securities would subsequently be transferred to the National Quotation Service Bureau, or "Pink Sheets." The trading of our common stock on the Pink Sheets may reduce the price of our common stock and the levels of liquidity available to our stockholders. In addition, the trading of our common stock on the Pink Sheets will materially adversely affect our access to the capital markets and our ability to raise capital through alternative financing sources on terms acceptable to us or at all. Securities that trade on the Pink Sheets are no longer eligible for margin loans, and a company trading on the Pink Sheets cannot avail itself of federal preemption of state securities or "blue sky" laws, which adds substantial compliance costs to securities issuances, including pursuant to employee option plans, stock purchase plans and private or public offerings of securities. If our securities are delisted in the future and transferred to the Pink Sheets, there may also be other negative implications, including the potential loss of confidence by suppliers, customers and employees.

ITEM 2—Unregistered Sales of Equity Securities and Use of Proceeds

        On March 6, 2008 our Board of Directors reaffirmed our previously existing stock repurchase program and authorized the repurchase of shares of our common stock. At that time a total of 505,450 shares representing approximately 5% of our outstanding shares remained subject to repurchase under the stock repurchase program. On March 6, 2008 we entered into a Rule 10b5-1 repurchase plan to establish a systematic program authorizing a stockbroker to execute repurchases in accordance with the terms of the Rule 10b5-1 plan. After a waiting period, repurchases commenced on April 7, 2008.

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        The following table details our repurchases of shares of our common stock during the three months ended June 30, 2008:

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(1)

During June 2008, we repurchased a total 36,362 shares at an average price of $2.49 per share. As of June 30, 2008, transactions to purchase 7,100 of these shares were not yet settled and these shares are still included as shares outstanding as of June 30, 2008. We purchased these shares with our cash from operations.

ITEM 3—Defaults Upon Senior Securities

        None.

ITEM 4—Submission of Matters to a Vote of Security Holders

        On June 26, 2008, we held our Annual Meeting of Stockholders. A total of 10,564,961 shares out of 11,239,665 shares outstanding were represented in person or by proxy at the meeting. At the Annual Meeting, the following matters were addressed:

        (1)   Michael E. McGrath, John T. Chain, Jr., Edward P. Evans, Dorsey R. Gardner, and David B. Mathis were elected as directors to serve for a one-year term until the 2009 Annual Meeting. Voting results for these nominees are summarized below:

        (2)   Stockholders approved, adopted, and ratified the appointment of Hein & Associates LLP as the Company's independent registered public accounting firm for fiscal year 2008 as set forth in Proposal 2 of the Thomas Group Proxy Statement dated April 30, 2008. Voting results are summarized as follows:

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        (3)   Stockholders ratified the 2008 Omnibus Stock and Incentive Plan for Thomas Group, Inc., as set forth in Proposal 3 of the Thomas Group Proxy Statement dated April 29, 2008. Voting results are summarized as follows:

ITEM 5—Other Information

        None.

ITEM 6—Exhibits

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SIGNATURES

        Pursuant to the requirements of 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.

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Thomas Group, Inc.
Form
Exhibit Index

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