HACKETT GROUP, INC. - Quarter Report: 2006 September (Form 10-Q)

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

FORM 10-Q

For the quarterly period ended September 29, 2006

OR

For the transition period from              to             

Commission File Number 0-24343

Answerthink, Inc.

(Exact name of Registrant as specified in its charter)

(305) 375-8005

(Registrant’s telephone number, including area code)

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 requirement for the past 90 days.    YES  x    NO  ¨

Indicate by check mark whether registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large Accelerated Filer  ¨    Accelerated Filer  x    Non-Accelerated Filer  ¨

Indicate by check mark whether registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    YES  ¨    NO  x

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date:

As of October 27, 2006, there were 44,580,491 shares of common stock outstanding.

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Answerthink, Inc.

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PART I - FINANCIAL INFORMATION

Item 1. Financial Statements

Answerthink, Inc.

CONSOLIDATED BALANCE SHEETS

(in thousands, except share data)

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

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Answerthink, Inc.

CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share data)

(unaudited)

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

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Answerthink, Inc.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)

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

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Answerthink, Inc.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

1. Restatement

As described in the Company’s Current Report on Form 8-K filed on November 1, 2006, on or about October 26, 2006, the Company learned of a misappropriation by its former UK disbursement agent which related to funds earmarked for payroll taxes due to the United Kingdom Inland Revenue. The disbursement agent had been utilized by the Company from early 2003 to January 2006 to make payroll, payroll tax and vendor disbursements in the UK. The Company initiated a review of the matter, and has concluded that the loss resulting from the misappropriation was approximately $2.2 million of which $0.3 million relates to 2006 as described below. The total loss is comprised of payroll taxes that were not disbursed to the United Kingdom Inland Revenue of approximately $1.8 million, interest owing on past due payroll tax amounts of approximately $0.1 million, and the write-off of funds owed back to the Company from the agent of approximately $0.3 million. The Company’s Audit Committee also initiated a review of the matter. That review is now complete.

The former disbursement agent admitted to the full extent of the misappropriation. A suit was commenced against the former disbursement agent in the UK on October 27, 2006. The Company and the former disbursement agent have agreed to settlement terms that, if satisfied, would include the full repayment of the misappropriation. In connection with the settlement, the agent made an initial cash payment to the Company in January 2007 of $0.4 million and has agreed to make additional payments to the Company on or before August 31, 2007 that, when taken together with the initial payment, approximate $2.5 million (at current foreign currency exchange rates). If the payments are not received by this date, the Company can foreclose certain assets pledged by the agent. The agent has guaranteed to pay any amount by which the initial payment, additional cash payments and the net proceeds from the sale of the pledged assets fall below approximately $2.5 million (at current foreign currency exchange rates). This shortfall amount would be repaid in annual installments of not less than approximately $0.1 million per year (at current foreign currency exchange rates) beginning in 2007, together with interest thereon accruing from January 1, 2008. The Company cannot predict the outcome of whether the former disbursement agent will satisfy the terms of the settlement agreement. Due to this uncertainty, any amounts recovered as a result of the Company’s claim have been and will be accounted for as income in the period collected.

Effects of Restatement

The following tables set forth the effects of the restatement relating to the aforementioned misappropriation on affected line items within financial statements previously reported:

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Answerthink, Inc.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

1. Restatement (continued)

Consolidated Statements of Operations Impact

The following table reconciles the Company’s previously reported results to the restated consolidated statements of operations for the quarters and nine months ended September 30, 2005. The loss from misappropriation had no effect on the income tax provision in the consolidated statements of operations.

ANSWERTHINK, INC.

Consolidated Statements of Operations

(in thousands, except per share data)

(unaudited)

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Answerthink, Inc.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

1. Restatement (continued)

Consolidated Balance Sheets Impact

The following table reconciles the consolidated balance sheets previously reported in the Original 10-Q Filing to the restated amounts as of December 30, 2005:

ANSWERTHINK, INC.

Consolidated Balance Sheets

(in thousands, except share data)

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Answerthink, Inc.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

1. Restatement (continued)

Consolidated Statements of Cash Flows Impact

The restatement did not impact our net cash flows from operating, investing, or financing activities. However, certain items within net cash provided by operating activities were impacted. The following table shows the effect on our previously reported cash flow items in the Original 10-Q Filing for the nine months ended September 30, 2005:

ANSWERTHINK, INC.

Consolidated Statements of Cash Flows

(in thousands)

(unaudited)

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Answerthink, Inc.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

2. Basis of Presentation

The consolidated financial statements of Answerthink, Inc. (“Answerthink” or the “Company”) include the accounts of the Company and all of its wholly owned subsidiaries. All material intercompany transactions and balances have been eliminated in consolidation.

In the opinion of management, the accompanying consolidated financial statements reflect all normal and recurring adjustments which are necessary for a fair presentation of the Company’s financial position, results of operations, and cash flows as of the dates and for the periods presented. The consolidated financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission regarding interim financial reporting. Accordingly, these statements do not include all the disclosures normally required by accounting principles generally accepted in the United States of America for annual financial statements and should be read in conjunction with the consolidated financial statements and notes thereto for the year ended December 30, 2005 included in the Form 10-K/A filed by the Company with the Securities and Exchange Commission. The consolidated results of operations for the quarter and nine months ended September 29, 2006 are not necessarily indicative of the results to be expected for any future period or for the full fiscal year.

3. Net Income (Loss) Per Common Share

Basic net income (loss) per common share is computed by dividing net income (loss) by the weighted average number of common shares outstanding during the period. With regard to common stock subject to vesting requirements or restricted stock units issued to employees, the calculation includes only the vested portion of such stock. Accordingly, common shares outstanding for the basic net income (loss) per share computation is lower than actual shares issued.

Net income (loss) per common share assuming dilution is computed by dividing net income (loss) by the weighted average number of common shares outstanding, increased by the assumed conversion of other potentially dilutive securities during the period. For the quarters ended September 29, 2006 and September 30, 2005 potentially dilutive securities included 572,217 shares and 818,379 shares of unvested restricted stock units issued to employees and 76,236 shares and 216,857 shares of common stock issuable upon the exercise of stock options following the treasury stock method.

For the nine months ended September 29, 2006 potentially dilutive securities were excluded from the dilutive net loss computation because their effects would have been anti-dilutive to the loss incurred by the Company. Potentially dilutive securities which were not included in the dilutive loss per share calculation for the nine month period ended September 29, 2006 includes 1,324,225 shares of unvested restricted stock units issued to employees and 219,913 shares of common stock issuable upon the exercise of stock options following the treasury stock method. For the nine months ended September 30, 2005, potentially dilutive securities include 1,714,470 shares of unvested common stock subject to vesting requirements and restricted stock units issued to employees and 228,880 shares of common stock issuable upon the exercise of stock options following the treasury stock method.

Approximately 1.7 million and 1.9 million stock options were excluded from the computations of diluted net income per common share for the quarters ended September 29, 2006 and September 30, 2005, respectively, as their stock price was higher than the Company’s average stock price.

4. Comprehensive Income (Loss)

The Company accounts for comprehensive income under SFAS No. 130, Reporting Comprehensive Income. Comprehensive income (loss) is summarized below (in thousands):

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Answerthink, Inc.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

5. Accounts Receivable and Unbilled Revenue, Net

Accounts receivable and unbilled revenues, net consists of the following (in thousands):

6. Loan Payable

At December 30, 2005, the Company had a loan with a financial institution of $3.7 million, classified as loan payable in the accompanying balance sheet. The loan was secured by $3.7 million of cash, classified as current restricted cash in the accompanying balance sheet as of December 30, 2005. This bank loan carried interest on the balance, net of restricted cash, of 2% over National Westminster Bank’s base rate, which was 4.5% at December 30, 2005. During March 2006, the Company used the restricted cash amount to repay the loan.

7. Restructuring Accrual

The Company recorded restructuring costs of $10.9 million and $5.6 million in fiscal years 2002 and 2001, respectively, for reductions in associates and functional support personnel and for closure and consolidation of facilities and related exit costs. These actions were taken as a result of the decline in demand for technology services throughout 2001 and 2002. The Company took steps to reduce its costs to better align its overall cost structure and organization with anticipated demand for services.

In 2004 and 2003, the Company recorded restructuring costs of $3.7 million and $4.9 million, respectively, to increase existing reserves to account for potentially higher estimated losses on the sublease of facilities as a result of lower than expected sublease rates and longer than expected time estimates to sublease excess facilities. The 2004 and 2003 restructuring costs consisted of additions of $1.8 million and $3.1 million to the 2002 restructuring accrual and $1.9 million and $1.8 million to the 2001 restructuring accrual, respectively. Also in 2004, the 2002 restructuring accrual was reduced by $370 thousand relating to the final settlement of a lease obligation which was recorded as income from discontinued operations in the consolidated statement of operations for the year ended December 31, 2004.

During the first and fourth quarters of 2005, the Company recorded restructuring costs of $2.9 million which related to $1.1 million for the consolidation of additional facilities and related exit costs not included in previously established reserves primarily as a result of the REL Consultancy Group acquisition on November 29, 2005 and $1.8 million for increases in previously established reserves in 2002 and 2001 for the closure and consolidation of facilities, of which $1.1 million is specifically related to the increase of previously established reserves in order to reflect the negotiated buyout of our New York City lease obligation. As a result of the buyout, the Company was fully released from $20 million of future lease obligations, assigned two subleases to the lessor, wrote-off $1.4 million receivable from the lessor, and paid $3.1 million in cash to the lessor. The remaining $700 thousand related to increases in the reserves to account for higher estimated losses on the sublease of facilities as a result of lower than expected sublease rates and longer than expected time estimates to sublease facilities based on current market conditions. The 2005 restructuring costs of $1.8 million related to previously established reserves consisted of additions of $1.2 million and $600 thousand to the 2002 and 2001 restructuring accruals, respectively.

During the first quarter of 2006, the Company recorded restructuring costs of $6.3 million, which was comprised of $2.8 million relating to the 2005 restructuring for the consolidation of additional facilities and related exit costs primarily as a result of the REL Consultancy Group acquisition and $3.5 million for increases in previously established reserves in 2002 and 2001 for the closure and consolidation of facilities to account for higher estimated losses on the sublease of facilities as a result of lower than expected sublease rates and longer than expected time estimates to sublease facilities based on current market conditions. Included in the $2.8 million is a further reduction of occupied space in our technology focused facility in Philadelphia and related severance costs for a senior executive as the Company’s primary business model shifts to a proprietary best practice and intellectual capital and strategic advisory services firm.

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Answerthink, Inc.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

7. Restructuring Accrual (continued)

The following table sets forth the detail and activity in the restructuring expense accrual during the nine months ended September 29, 2006 (in thousands):

2001 Restructuring Accrual

2002 Restructuring Accrual

2005 Restructuring Accrual

8. Stock Based Compensation

In December 2004, the Financial Accounting Standards Board issued SFAS No. 123R, Share-Based Payment (“SFAS No. 123R”). This Statement is a revision of SFAS No. 123, Accounting for Stock-Based Compensation (“SFAS No. 123”), and supersedes Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (“APB No. 25”), and its related implementation guidance. On December 31, 2005, the Company adopted the provisions of SFAS No. 123R using the modified prospective method. SFAS No.123R focuses primarily on accounting for transactions in which an entity obtains employee services in share-based payment transactions. The Statement requires entities to recognize compensation expense for awards of equity instruments to employees based on the grant-date fair value of those awards (with limited exceptions). SFAS No. 123R also requires the benefits of tax deductions in excess of recognized compensation expense to be reported as a financing cash flow, rather than as an operating cash flow as prescribed under the prior accounting rules. This requirement reduces net operating cash flows and increases net financing cash flows in periods after adoption. Total cash flow remains unchanged from what would have been reported under prior accounting rules. Upon the adoption of SFAS No. 123R, the Company recognized an immaterial one-time gain based on SFAS No. 123R’s requirement to apply an estimated forfeiture rate to unvested restricted stock and restricted stock unit awards. Previously, the Company recorded forfeitures as incurred for such awards.

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Answerthink, Inc.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

8. Stock Based Compensation (continued)

Prior to the adoption of SFAS No. 123R, the Company followed the intrinsic value method in accordance with APB No. 25 to account for its employee stock plans. Accordingly, no compensation expense was recognized for the issuance of stock options or shares granted through the Employee Share Purchase Plan (the “ESPP”); however, compensation expense was recognized in connection with the issuance of restricted stock units and common stock subject to vesting requirements. The adoption of SFAS No. 123R primarily resulted in the Company estimating forfeitures for all unvested common stock subject to vesting requirements and restricted stock unit awards and the recognition of compensation expense for the unvested portion of previously granted stock options.

The following table shows the effect of adopting SFAS No. 123R on selected reported items (“As Reported”) and what those items would have been under previous guidance under APB No. 25:

Results for the quarter and nine months ended September 30, 2005 have not been restated. Had compensation expense for employee stock options granted under the Company’s stock plans been determined based on fair value at the grant date consistent with SFAS No. 123, the Company’s net income and net income per share for the quarter and nine months ended September 30, 2005 would have been adjusted to the pro forma amounts indicated below:

Stock Plans

Total share based compensation included in the net income (loss) for the quarter and nine months ended September 29, 2006 was $1.0 million and $3.2 million, respectively. The number of shares available for future issuance under the plans at September 29, 2006 is 10,653,483 shares. The Company issues new shares as shares are required to be delivered under the plan.

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Answerthink, Inc.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

8. Stock Based Compensation (continued)

Stock Options

The Company has granted stock options to employees and directors of the Company at exercise prices equal to the market value of the stock at the date of grant. The options generally vest ratably over four years, based on continued employment, with a maximum term of 10 years.

Stock option activity under the Company’s stock option plans is summarized as follows:

Other information pertaining to option activity during the quarter was as follows (in thousands):

No options were granted during the quarter and nine months ended September 29, 2006. The Company recorded stock-based compensation totaling $107 thousand and $390 thousand during the quarter and nine months ended September 29, 2006, respectively, related to the unvested portion of previously granted stock options. No options were granted during the quarter ended September 30, 2005. The Company granted 45,000 options during the nine months ended September 30, 2005.

SFAS No. 123R requires the use of a valuation model to calculate the fair value of stock option awards. The Company has elected to use the Black-Scholes option-pricing model, which incorporates various assumptions including volatility, expected life, and interest rates. The expected volatility is based on the historical volatility of the Company’s common stock over the most recent period commensurate with the estimated expected life of the Company’s stock options. The expected life of an award is based on historical experience and on the terms and conditions of the stock awards granted to employees. The following assumptions were used by the Company to determine the fair value of stock options granted during 2005 using the Black-Scholes options-pricing model:

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Answerthink, Inc.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

8. Stock Based Compensation (continued)

Restricted Stock Units

Under the stock plans, participants may be granted restricted stock units, each of which represents a conditional right to receive a common share in the future. The restricted stock units granted under this plan generally vest over a four-year period, with 50% vesting on the second anniversary and 25% of the shares vesting on the third and fourth anniversaries of the grant date. Upon vesting, the restricted stock units will convert into an equivalent number of shares of common stock. The amount of expense relating to the restricted stock units is based on the closing market price of the Company’s common stock on the date of grant and is amortized on a straight-line basis over the four-year requisite service period. Restricted stock unit activity for the nine months ended September 29, 2006 was as follows:

The Company recorded stock based compensation totaling $2.3 million and $2.1 million, respectively, related to restricted stock units during the nine months ended September 29, 2006 and September 30, 2005. As of September 29, 2006, there was $5.5 million of total restricted stock unit compensation expense related to nonvested awards not yet recognized, which is expected to be recognized over a weighted average period of 1.38 years.

As of September 30, 2005, the Company had 169,295 of stock options which were accounted for under variable plan accounting pursuant to FASB Interpretation No. 28, Accounting for Stock Appreciation Rights and Other Variable Stock Option or Award Plans. Variable plan accounting resulted in a reduction of stock compensation expense of approximately $49 thousand for the nine months ended September 30, 2005.

Common Stock Subject to Vesting Requirements

Shares of common stock subject to vesting requirements were issued in connection with an acquisition to the employees of such company. Employees of the acquired company vest in these shares over a period of four years. Compensation expense was based on the market value of the Company’s common stock at the time of grant and is recognized on a straight-line basis. Restricted stock activity for the nine months ended September 29, 2006 was as follows:

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Answerthink, Inc.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

8. Stock Based Compensation (continued)

The Company recorded compensation expense totaling $506 thousand during the nine months ended September 29, 2006 related to common stock subject to vesting requirements. As of September 29, 2006, there was $2.1 million of total stock based compensation related to common stock subject to vesting requirements not yet recognized, which is expected to be recognized over a weighted average period of 1.92 years.

9. Shareholders’ Equity

Employee Stock Purchase Plan

Effective July 1, 1998, the Company adopted an Employee Stock Purchase Plan to provide substantially all employees who have completed three months of service as of the beginning of an offering period an opportunity to purchase shares of its common stock through payroll deductions. Purchases on any one grant are limited to 10% of eligible compensation. Participant account balances are used to purchase shares of stock at the lesser of 85% of the fair market value of shares on the first trading day of the six-month offering period or on the last trading day of such offering period. The aggregate fair market value, determined as of the first trading date of the offering period, as to shares purchased by an employee may not exceed $25,000 annually. During the fourth quarter of fiscal 2005, the Board of Directors approved a change to the common stock purchase discount and approved the elimination of the related look back period. As a result, effective beginning in fiscal 2006, shares of our common stock may be purchased by employees at six month intervals at 95% of the fair market value on the last trading day of each six month period. The plan, as amended, is considered non-compensatory, and as such, no stock based compensation was recorded in connection with the plan during the nine months ended September 29, 2006. The Employee Stock Purchase Plan expires on July 1, 2008. A total of 4,275,000 shares of common stock are available for purchase under the plan with a limit of 400,000 shares of common stock to be issued per offering period.

Treasury Stock

On July 30, 2002, the Company announced that its Board of Directors approved the repurchase of up to $5.0 million of Answerthink’s common stock. In 2003, 2004 and 2005, the Board of Directors approved the repurchase of an additional $25.0 million of the Company’s common stock, thereby increasing the total program size to $30.0 million. Under the repurchase plans, the Company may buy back shares of its outstanding stock from time to time either on the open market or through privately negotiated transactions, subject to market conditions and trading restrictions. During the quarter ended September 29, 2006, the Company repurchased 623,500 shares of its common stock at a cost of approximately $1.7 million. As of September 29, 2006, the Company had repurchased 7,157,655 shares of its common stock at an average price of $3.33 per share.

10. Litigation

As described in the Company’s Current Report on Form 8-K filed on November 1, 2006, on or about October 26, 2006, the Company learned of a misappropriation by its former UK disbursement agent which related to funds earmarked for payroll taxes due to the United Kingdom Inland Revenue. The disbursement agent had been utilized by the Company from early 2003 to January 2006 to make payroll, payroll tax and vendor disbursements in the UK. The Company initiated a review of the matter, and has concluded that the loss resulting from the misappropriation was approximately $2.2 million of which $0.3 million relates to 2006 as described below. The total loss is comprised of payroll taxes that were not disbursed to the United Kingdom Inland Revenue of approximately $1.8 million, interest owing on past due payroll tax amounts of approximately $0.1 million, and the write-off of funds owed back to the Company from the agent of approximately $0.3 million. The Company’s Audit Committee also initiated a review of the matter. That review is now complete.

The former disbursement agent admitted to the full extent of the misappropriation. A suit was commenced against the former disbursement agent in the UK on October 27, 2006. The Company and the former disbursement agent have agreed to settlement terms that, if satisfied, would include the full repayment of the misappropriation. In connection with the settlement, the agent made an initial cash payment to the Company in January 2007 of $0.4 million and has agreed to make additional payments to the Company on or before August 31, 2007 that, when taken together with the initial payment, approximate $2.5 million (at current foreign currency exchange rates). If the payments are not received by this date, the Company can foreclose certain assets pledged by the agent. The agent has guaranteed to pay any amount by which the initial payment, additional cash payments and the net proceeds from the sale of the pledged assets fall below approximately $2.5 million (at current foreign currency exchange rates). This shortfall amount would be repaid in annual installments of not less than approximately $0.1 million per year (at current foreign currency exchange rates) beginning in 2007, together with interest thereon accruing from January 1, 2008. The Company cannot predict the outcome of whether the former disbursement agent will satisfy the terms of the settlement agreement.

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Answerthink, Inc.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

(unaudited)

10. Litigation (continued)

Due to this uncertainty, any amounts recovered as a result of the Company’s claim have been and will be accounted for as income in the period collected.

In addition to the matter described above, the Company is involved in legal proceedings, claims, and litigation arising in the ordinary course of business not specifically discussed herein. In the opinion of management, the final disposition of such matters will not have a material adverse effect on the financial position, cash flows or results of operations of the Company.

11. Geographic and Service Group Information

Revenues are attributed to geographic areas as follows (in thousands):

Long-lived assets are attributed to geographic areas as follows (in thousands):

As of September 29, 2006 and December 30, 2005, foreign assets included $18 million and $31 million of goodwill and intangible assets related to REL, a UK based company, respectively.

The Company’s revenue is derived from the following service groups (in thousands):