UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


WASHINGTON,
D.C. 20549


FORM
10-QSB








(Mark
One)





x
    Quarterly
      Report pursuant to Section 13 or 15 (d) of the Securities Exchange Act of
      1934 for the quarterly period ended March 31,
2005.





o
    TransitionReport
      pursuant to Section 13 or 15 (d) of the Securities Exchange Act of 1934
      for the transition period from ______________________ to
    _________.





Commission
File No. 000-30294




**DIALOG
      GROUP, INC.**(Name of Small Business Issuer in its
      Charter)Delaware
    
    
    
    87-0394290(State or Other Jurisdiction of
    
    
    
    (I.R.S. EmployerIncorporation
      or Organization)
    
    
    
    Identification
      Number)




Twelfth Floor, 257 Park Avenue South, New York, NY
    
    10010(Address
      of Principal Executive Offices)
    
    (Zip
      Code)212.254.1917(Issuer's Telephone Number)






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





Check
whether the registrant filed all documents and reports required to be filed by
Section l2, 13 or 15(d) of the Exchange Act after the distribution of securities
under a plan confirmed by a court. Yes x  No
o





State the
number of shares outstanding of each of the issuer's classes of common equity,
as of the latest practicable date.





At May
20, 2004 there were 149,081,084 shares of common stock, par value $.001 per
share outstanding.





Transitional
Small Business Disclosure Format (check one):  Yes o  Nox










DIALOG
GROUP, INC. AND SUBSIDIARIES





INDEX





Page
      Number**Part
      I - Financial Information**Item
      1
    Financial
      StatementsF-1
    Condensed
      Consolidated Balance Sheets as of December 31, 2004 (audited) and March
      31, 2005 (unaudited)F-2
    Condensed
      Consolidated Statements of Operations and Comprehensive Loss for the Three
      Months Ended March 31, 2005 (unaudited) and March 31, 2004
      (unaudited)F-3
    Condensed
      Consolidated Statements of Cash Flows for the Three Months Ended March 31,
      2005 (unaudited) and March 31, 2004 (unaudited)F-
      4 to
      F-
      19
    Notes
      to Condensed Consolidated Financial Statements
  (unaudited)3 -
      8
    Item
      2.
    Management’s
      Discussion and Analysis or Plan of Operation9
    Item
      3.
    Controls
      and Procedures**Part
      II - Other Information**10
    Item
      1
    Legal
      Proceedings11
    Item
      2
    Recent
      Unregistered Sales of Equity Securities and Use of
  Proceeds13
    Item
      6.
    Exhibits











**DIALOG
      GROUP, INC. AND SUBSIDIARIES****CONSOLIDATED
      BALANCE SHEETS****ASSETS**
    
    **March
      31,**
    
    **December
      31****2005**
    
    **2004****(Unaudited)****CURRENT
      ASSETS:**Cash
    
    
    -
    
    
    131,690Accounts
      receivable (Net)
    
    
    834,324
    
    
    608,985Letter
      of Credit
    
    
    90,000
    
    
    -Prepaid
      expenses and other current assets
    
    
    208,133
    
    
    68,114Total
      current assets
    
    
    1,132,457
    
    
    808,789**PROPERTY
      AND EQUIPMENT, NET**
    
    
    39,922
    
    
    42,087**OTHER
      ASSETS:**Data
      Assets (Net)
    
    
    554,067
    
    
    538,978Website
      (Net)
    
    
    74,583
    
    
    89,364Security
      Deposits
    
    
    73,088
    
    
    75,338Total
      other assets
    
    
    701,738
    
    
    703,680**TOTAL
      ASSETS**
    
    
    1,874,117
    
    
    1,554,556**LIABILITIES****CURRENT
      LIABILITIES:**Bank
      overdraft
    
    
    34,558
    
    
    -Accounts
      payable
    
    
    1,852,374
    
    
    1,615,925Accrued
      expenses
    
    
    979,752
    
    
    880,547Deferred
      revenue
    
    
    614,200
    
    
    808,490Notes
      and Loans Payable
    
    
    491,867
    
    
    226,915Current
      Liabilities Due to related parties
    
    
    141,000
    
    
    113,011Other
      current liabilities
    
    
    59,837
    
    
    18,139Total
      current liabilities
    
    
    4,173,588
    
    
    3,663,027**LONG
      TERM DEBT:**Griffin
      Xover Fund 5% Convertible Note - Related Party
    
    
    555,000
    
    
    510,000Convertible
      Notes - Related Parties
    
    
    118,045
    
    
    118,045**TOTAL
      LONG TERM DEBT:**
    
    
    673,045
    
    
    628,045**STOCKHOLDERS'
      EQUITY (DEFICIENCY):**Preferred
      stock
    
    
    313
    
    
    313Common
      stock
    
    
    149,082
    
    
    116,673Additional
      paid-in-capital
    
    
    6,080,346
    
    
    5,912,491Accumulated
      deficit
    
    
    (9,162,457
    )
    
    (8,765,993
    )Dividends-
      Preferred Stock
    
    
    (39,800
    )
    
    -Total
      stockholders' equity (deficiency)
    
    
    (2,972,516
    )
    
    (2,736,516
    )**TOTAL
      LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIENCY)**
    
    
    1,874,117
    
    
    1,554,556


F-1


**DIALOG
      GROUP, INC. AND SUBSIDIARIES****CONSOLIDATED
      STATEMENTS OF OPERATIONS AND COMPREHENSIVE
    LOSS****FOR
      THE THREE MONTHS ENDED MARCH 31, 2005 AND
2004****(Unaudited)****2005**
    
    **2004****REVENUES**
    
    $
    1,716,718
    
    $
    1,945,432**COST
      OF REVENUES**
    
    
    692,653
    
    
    939,970**GROSS
      PROFIT**
    
    
    1,024,065
    
    
    1,005,462**OPERATING
      EXPENSES:**Selling,
      General and Administrative Expenses
    
    
    1,316,040
    
    
    1,390,901Total
      Operating Expenses
    
    
    1,316,040
    
    
    1,390,901**LOSS
      FROM OPERATIONS**
    
    
    (291,974
    )
    
    (385,440
    )**OTHER
      INCOME (EXPENSES):**Interest
      expense
    
    
    (43,336
    )
    
    (18,504
    )Other
      (Expenses)
    
    
    
    
    
    1,400Forgiveness
      of Debt
    
    
    3,750Other
      income
    
    
    -
    
    
    92,264Net
      Other Income (Expenses)
    
    
    (39,586
    )
    
    75,160**NET
      LOSS BEFORE DISCOUNTINUED OPERATIONS**
    
    
    (331,560
    )
    
    (310,280
    )**INACTIVE
      & DISCONTINUED OPERATIONS**Income
      (Loss) from Inactive Operations
    
    
    (290
    )**TOTAL
      COMPREHENSIVE LOSS**
    
    $
    (331,850
    )
    $
    (310,280
    )NET
      LOSS PER SHARE, BASIC
    
    $
    (0.002
    )
    $
    (0.004
    )NET
      LOSS PER SHARE, FULLY DILUTED
    
    $
    (0.002
    )
    $
    (0.003
    )****WEIGHTED
      AVERAGE COMMON SHARES OUTSTANDING
      B**ASIC**
    
    
    149,081,084
    
    
    87,796,266**FULLY
      DILUTED**
    
    
    193,200,806
    
    
    114,780,491


F-2




**DIALOG
      GROUP, INC. AND SUBSIDIARIES****CONSOLIDATED
      STATEMENTS OF CASH FLOWS****FOR
      THE THREE MONTHS ENDING MARCH 31, 2005 &
    2004**2005
    
    2004Cash
      Flows from Operating Activities:Net
      Loss form Continuing Operations
    
    $
    (331,560
    )
    $
    (310,280
    )Gain/(Loss)from
      Inactive Operations
    
    
    (290
    )Loss
      from Operations
    
    $
    (331,850
    )
    $
    (310,280
    )Adjustments
      to reconcile net lossto
      net cash used in operating activities of continuing operations:Gain
      on debt settlement
    
    
    3,750Depreciation
      and amortization
    
    
    99,223
    
    
    82,994Bad
      debt expense
    
    
    4,008
    
    
    11,447Common
      stock, warrants and stock options issued for services
    
    
    78,161Changes
      in operating assets and liabilities: (Increase) DecreaseAccounts
      receivable
    
    
    (229,348
    )
    
    (311,022
    )Prepaid
      and other current assets
    
    
    (230,019
    )
    
    18,877Other
      current receivables
    
    
    
    
    
    (1,320
    )Security
      Deposits
    
    
    2,250Accounts
      payable and accrued expenses: Increase (Decrease)
    
    
    429,151
    
    
    196,676Current
      liabilities - Due to related parties
    
    
    27,989Other
      current liabilities
    
    
    41,698
    
    
    (98,536
    )Deferred
      revenues
    
    
    (194,290
    )
    
    226,900Net
      Cash Used in Operating Activities
    
    
    (299,277
    )
    
    (184,264
    )Cash
      Flows from Investing Activities of Continuing Operations:Purchase
      of property and equipment
    
    
    (1,662
    )
    
    (13,543
    )Purchase
      of database
    
    
    (95,703
    )Net
      Cash Used in Investing Activities
    
    
    (97,365
    )
    
    (13,543
    )Cash
      Flows from Financing Activities of Continuing Operations:Note
      Receivable - Findstar
    
    
    
    
    
    25,000Short
      Term Borrowing, net
    
    
    264,952
    
    
    (9,439
    )Proceeds
      from sale of common stock
    
    
    -
    
    
    35,000Net
      Cash Provided by Financing Activities
    
    
    264,952
    
    
    50,561Increase
      (decrease) in cash
    
    
    (131,690
    )
    
    (147,246
    )Cash
      at Beginning of Period
    
    $
    131,690
    
    $
    147,246Cash
      at Period End
    
    $
    -
    
    $
    -**SUPPLEMENTAL
      DISCLOSURE OF CASH FLOW INFORMATION:**Interest
      Paid During the Period
    
    $
    43,336
    
    $
    17,982**SUPPLEMENTAL
      DISCLOSURE OF NON-CASH INVESTING****AND
      FINANCING ACTIVITIES:**Conversion
      of Accounts Payable to Common Stock
    
    $
    7,500Conversion
      of Accrued Expenses to Common Stock
    
    $
    52,524
    
    $
    20,000


F-3




**DIALOG
GROUP, INC. AND SUBSIDIARIES**
 **NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS**
 **March
31, 2005**


**NOTE 
1 -**  **SUMMARY
OF SIGNIFICANT ACCOUNTING POLICIES**
 
 **ORGANIZATION
AND CAPITALIZATION**
 
 Dialog
Group, Inc. was incorporated under the laws of the State of Delaware on October
4, 2002. The Company’s authorized capital stock consisted of 1,000 shares with
no par value.
 
 IMX
Pharmaceuticals, Inc., formerly IMX Corporation, was organized under the laws of
the State of Utah on June 2, 1982. The Company changed its name to IMX
Pharmaceuticals, Inc. on June 30, 1997.
 
 On
November 12, 2002, IMX Pharmaceutical, Inc. and Dialog Group, Inc. merged into a
single Delaware corporation (the “Company”) for the sole purpose of
reincorporating IMX Pharmaceutical, Inc. in Delaware. The name of the surviving
corporation is Dialog Group, Inc.
 
 In
conjunction with the merger, the Company’s Certificate of Incorporation was
restated to increase the total number of shares of capital stock that the
Company has the authority to issue to 101,000,000. The total number of
authorized shares of common stock, $0.001 par value, was 100,000,000 and the
total number of authorized preferred stock, $0.001 par value, was 1,000,000. The
Board of Directors is authorized to establish the preferred stock in one or more
series and to fix the rights, preferences, privileges, and restrictions thereof,
including dividend rights, conversion rights, voting rights, terms of
redemption, liquidation preferences and the number of shares constituting each
series or the designation of such series.
 
 On May
23, 2003, the Company further increased the total number of shares of capital
stock of authorized shares of $0.001 par value common stock available for
issuance to 175,000,000 and the total number of authorized $0.001 par value
preferred stock available for issuance to 1,500,000.
 
 Further,
on June 18, 2004, the Company increased the total number of shares of capital
stock of authorized shares of $0.001 par value common stock available for
issuance to 200,000,000 and the total number of authorized $0.001 par value
preferred stock available for issuance to 1,500,000. And, on June 18, 2004, the
Company eliminated its Class C preferred stock. Also, on June 18, 2004 the terms
of the Company’s Class E preferred stock were restated. The number of shares of
authorized Class E preferred stock is 200 shares. In the event of liquidation,
dissolution or winding-up or sale of more than 50% of the voting securities of
the Company, holders of the Class E preferred stock shall be entitled to
Liquidation Rights equivalent to $10,000.00 per share plus any accumulated but
unpaid dividends.
 
 BUSINESS
ACTIVITY
 
 The
Company, which is headquartered in New York, NY, has offices in Valencia,
California; Sunrise, Florida; and Houston, Texas. The Company’s two divisions,
Data Dialog and Healthcare Dialog, provide a combination of traditional
advertising (print, broadcast) and marketing services (broadcast, new media, and
internet-based promotional venues); as well as a broad spectrum of proprietary
and exclusive databases for healthcare, pharmaceutical, consumer and
business-to-business market clients.
 
 F-4
 **DIALOG
GROUP, INC. AND SUBSIDIARIES**
 **NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS**
 **March
31, 2005**
 Additionally,
the Company maintains exclusive contracts with leading multi-national
pharmaceutical companies to operate, maintain and provide content for their
consumer-directed Web sites.
 
 Both
Dialog Group’s divisions currently market its product and service offerings
through three branded, business organizations. The Healthcare Dialog division:
nFusion, +Media, and iData. The Data Dialog division: Data Dialog Marketing,
Data Dialog Digital and Mail Mogul.
 
 CONCENTRATION
OF CREDIT RISK
 
 Financial
instruments that potentially subject the Company to concentrations of credit
risk consist principally of cash.
 
 The
Company maintains cash balances at several banks. Accounts at each institution
are insured by the Federal Deposit Insurance Corporation up to $100,000. From
time to time, the Company had cash in financial institutions in excess of
federally insured limits.
 
 ACCOUNTS
RECEIVABLE
 
 The
Company conducts business and extends credit based on the evaluation of its
customers’ financial condition, generally without requiring collateral. Exposure
to losses on receivables is expected to vary by customer due to the financial
condition of each customer. The Company monitors credit losses and maintains
allowances for anticipated losses considered necessary under the circumstances.
Recoveries of accounts previously written off are recognized as income in the
periods in which the recoveries are made. The Company has a $350,000 line of
credit with a commercial asset-backed lender with a term of two years beginning
August 2004.It is secured by the Company’s accounts receivables, equipment, and
inventory. At March 31, 2005, the allowance for doubtful accounts is $142, 085.
Of this amount, $132,500 is related to an agreement and issuance of
non-qualified stock options (see Note 6- Non-Trade Accounts Receivable) and the
Company’s collection efforts.
 
 PROPERTY
AND EQUIPMENT
 
 Property
and equipment are stated at cost. Depreciation is computed using the
straight-line method over the estimated useful life of the assets, which range
from three years to five years. Expenditures for major betterments and additions
are capitalized, while replacement, maintenance and repairs, which do not extend
the lives of the respective assets, are charged to expense currently. Any gain
or loss on disposition of assets is recognized currently. The Company has a
$350,000 line of credit with a commercial asset-backed lender with a term of two
years beginning August 2004.It is secured by the Company’s accounts receivables,
equipment, and inventory.
 
 GOODWILL
AND OTHER ASSETS
 
 Goodwill
 The
Company tests goodwill and other assets for impairment annually. The provisions
of SFAS No. 142 require the completion of an annual impairment test, with the
impairments recognized in current earnings.
 
 F-5
  **DIALOG
GROUP, INC. AND SUBSIDIARIES**
 **NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS**
 **March
31, 2005**
 Databases
 
 The
databases consist of the one acquired from Healthcare Horizons and other
acquired from Azimuth Target Marketing along with the costs of expanding the
databases through the use of telephone surveys. As the databases, along with
current telephone surveys, are generating revenue streams and are expected to do
so in the future, no impairment is required. The databases are amortized over a
three year period, while the telephone surveys are amortized over a five year
period.
 
 Website
 
 The
Company accounts for website development and maintenance costs in accordance
with the guidance of EITF 00-2 “Accounting for Website Development Costs” and
Statement of Position 98-1 “Software Developed or Obtained for Internal Use”.
Costs incurred in the planning stage are expensed as incurred. Costs incurred in
connection with the development stage are capitalized during the application
development stage and amortized over a three year period. Costs incurred during
the post-implementation operation stage, and fees incurred for web hosting, are
expensed as incurred
 
 IMPAIRMENT
OF LONG-LIVED ASSETS AND LONG-LIVED ASSETS TO BE DISPOSED OF
 
 The
Company reviews long-lived assets for impairment whenever events or changes in
circumstances indicate that the carrying amount of an asset may not be
recoverable. Recoverability of assets to be held and used is measured by a
comparison of the carrying amount of an asset to future undiscounted cash flows
expected to be generated by the asset. If such assets are considered to be
impaired, the impairment to be recognized is measured by the amount by which the
carrying amount of the assets exceeds the fair value. Assets to be disposed of
are reported at the lower of the carrying amount or fair value less costs to
sell.
 
 FAIR
VALUE OF FINANCIAL INSTRUMENTS
 
 The
Company’s financial instruments consist primarily of cash, accounts receivable,
other receivable, accounts payable, accrued expenses, current liabilities and
debt. The carrying amounts of such financial instruments approximate their
respective estimated fair value due to the short-term maturities and approximate
market interest rates of these instruments. The estimated fair value is not
necessarily indicative of the amounts the Company would realize in a current
market exchange or from future earnings or cash flows.
 
 USE OF
ESTIMATES
 
 The
preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosures of contingent assets and liabilities at the date of
the financial statements and the reported amount of revenues and expenses during
the reported period. Actual results could differ from those
estimates.
 
 F-6
 **DIALOG
GROUP, INC. AND SUBSIDIARIES**
 **NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS**
 **March
31, 2005**
  COMPENSATED
ABSENCES
 
 The
Company only accrues for compensated absences of employees with employment
agreements with the Company that require the Company to provide for this
benefit. Accordingly, the liability, if any, for such absences has been recorded
in the accompanying consolidated financial statements.
 
 REVENUE
RECOGNITION
 
 The
Company recognizes revenues in accordance with SAB 101, which reflects the basic
principles of revenue recognition in existing generally accepted accounting
principles. Accordingly, revenues are recognized in the Healthcare Division upon
a monthly review by management of each agreement to determine the percentage of
the goods, or services actually delivered, or provided to customers. In the Data
Division revenues derived from the sale of twelve-month subscriptions to the
Company’s mailing lists are deferred and included in income on a monthly basis
as revenues are earned. Revenues are earned on other goods or services when
actually delivered or provided to the customer.
 
 NET
LOSS PER COMMON SHARE AND DILUTIVE SECURITIES
 
 Earnings
(loss) per share are computed in accordance with SFAS No. 128, “Earnings per
Share”. Basic earnings per share is computed by dividing net income, after
deducting preferred stock dividends accumulated during the period, by the
weighted-average number of shares of common stock outstanding during each
period. Diluted earnings (loss) per share is computed by dividing net income
(loss) by the weighted-average number of shares of common stock, common stock
equivalents and other potentially dilutive securities outstanding during the
period.
 
 The
following is a summary of the securities that could potentially dilute basic
earning (loss) per share in the future. These were not included in the
computation of the diluted earnings (loss) per share because their exercise or
conversion would be anti-dilutive.
 
 
 Period
    
    PeriodEnded
    
    EndedMarch
      31,
    
    March
      31,2005
    
    2004Preferred
      stock
    
    
    20,786,274
    
    
    20,296,904Warrants
    
    
    6,921,865
    
    
    2,991,640Stock
      options
    
    
    3,477,500
    
    
    1,877,500Convertible
      notes
    
    
    12,934,083
    
    
    1,818,182Total
    
    
    44,119,722
    
    
    26,984,225
  F-7
 
 **DIALOG
GROUP, INC. AND SUBSIDIARIES**
 **NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS**
 **March
31, 2005**
 INCOME
TAXES
 
 The
Company accounts for income taxes using SFAS No. 109, “Accounting for Income
Taxes *,* ” which
requires recognition of deferred tax liabilities and assets for expected future
tax consequences of events that have been included in the financial statements
or tax returns. Under this method, deferred tax liabilities and assets are
determined based on the difference between the financial statement and tax bases
of assets and liabilities using enacted tax rates in effect for the year in
which the differences are expected to reverse. A valuation allowance is recorded
for deferred tax assets if it is more likely than not that some portion or all
of the deferred tax assets will not be realized.
 
 ADVERTISING
COSTS
 
 Advertising
costs are expensed as incurred. The Company incurred $8,061 and $7,091in
advertising costs for the period ended March 31, 2005 and March 31, 2004,
respectively.
 
 STOCK-BASED
COMPENSATION
 
 On
December 2004, the FASB issued SFAS No. 123R, "Accounting for Stock-Based
Compensation". This statement is a revision to SFAS No. 123, "Accounting for
Stock-Based Compensation" and supersedes APB Opinion No.25, "Accounting for
Stock Issued to Employees". This statement requires a public entity to measure
the cost of employee services received in exchange for an award of equity
instruments based on the grant-date fair value of the award (with limited
exceptions). That cost will be recognized over the period during which an
employee is required to provide service, the requisite service period (usually
the vesting period). The grant-date fair value of employee share options and
similar instruments will be estimated using option-pricing models.
 
 In
addition, a public entity is required to measure the cost of employee services
received in exchange for an award of liability instruments based on its current
value. The fair value of that award will be re-measured subsequently at each
reporting date through the settlement date. Changes in fair value during the
requisite service period will be recognized as compensation cost over the
period.
 
 For
public entities that file as small business issuers, this statement is effective
as of the beginning of the first interim or annual reporting period that begins
after December 15, 2005.
 
 At the
required effective date, all public entities that used the fair value method for
either recognition or disclosure under Statement 123 are required to apply this
statement using a modified version of prospective application. Under that
transition method, compensation cost is recognized on or after the required
effective date for the portion of outstanding awards for which the requisite
service has not yet been rendered, based on the grant-date fair value of those
awards calculated under Statement 123 for either recognition or pro-forma
disclosures. For periods before the required effective date, those entities may
elect to apply the modified version of retrospective application under which
financial statements for prior periods are adjusted on a basis consistent with
the pro forma disclosures required for those periods by Statement 123. The
Company does not expect SFAS No. 123R to have a material effect on its financial
statements.
 
 F-8
 **DIALOG
GROUP, INC. AND SUBSIDIARIES**
 **NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS**
 **March
31, 2005**
 
 PRINCIPLES
OF CONSOLIDATION
 
 In the
opinion of the Company, the accompanying unaudited consolidated financial
statements prepared in accordance with instructions for Form 10-QSB, include all
adjustments (consisting only of normal recurring accruals) which are necessary
for a fair presentation of the results for the periods presented. It is
suggested that these consolidated financial statements be read in conjunction
with the Company's Annual Report for the year ended December 31, 2004.The
balance sheet as of December 31, 2004 was derived from audited financial
statements as of that date. The results of operations for the three months ended
March 31, 2005 are not necessarily indicative of the results to be expected for
the full year.
 
 The
consolidated financial statements include the accounts of the Company, Dialog
Group, Inc., and its wholly-owned subsidiaries; Data Dialog, Inc. Healthcare
Dialog, Inc., IP2M, and Mail Mogul, Inc. All material intercompany transactions
and balances have been eliminated in consolidation.
 
 REPORTING
PERIOD
 
 The
accompanying condensed consolidated financial statements for the three months
ended March 31, 2005 depict the results of operations and cash flows of DDI,
DGI, HCD, IP2M, and MMI.
 
 RECLASSIFICATIONS
 
 Certain
reclassifications have been made to the prior year financial statements in order
for them to be in conformity with the current year presentation.
 
 RESTATEMENT
 
 In 2004
and during the first quarter of 2005, no restatements were required to be
made.
 
 **NOTE
2- ACTUAL RESULTS OF OPERATIONS**
 
 The
following set forth the Company’s actual results of operations for the three
months ended March 31, 2005, with comparative actual results for the three
months ended March 31, 2004
 
 F-9
 
 **DIALOG
GROUP, INC. AND SUBSIDIARIES**
 **NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS**
 **March
31, 2005**
 UnauditedThree
      months
    
    Three
      monthsEnding
    
    EndingMarch
      31, 2005
    
    March
      31, 2004REVENUE
    
    $
    1,716,718
    
    $
    1,945,432COST
      OF SALES
    
    
    692,652
    
    
    939,970GROSS
      PROFIT
    
    
    1,024,065
    
    
    1,005,462OPERATING
      EXPENSES:Other
      Selling, General, and Administrative Expenses
    
    
    1,316,040
    
    
    1,390,901TOTAL
      OPERATING EXPENSE
    
    
    1,316,040
    
    
    1,390,901INCOME
      (LOSS) FROM OPERATIONS
    
    
    (291,974
    )
    
    (385,440
    )Other
      Income (Expenses):Interest
      expenses
    
    
    (43,336
    )
    
    (18,504
    )Other
      expenses
    
    
    
    
    
    1,400Other
      income
    
    
    
    
    
    92,264Forgiveness
      of Debt
    
    
    3,750Total
      other income (expenses)
    
    
    (39,586
    )
    
    75,160Net
      Profit/(Loss) Before Inactive and Discontinued Operations
    
    
    (331,560
    )
    
    (310,280
    )Discontinued
      Operations
    
    
    (290
    )
    
    0Net
      Loss
    
    
    (331,850
    )
    
    (310,280
    )
 
 **NOTE
-4**  **INACTIVE
AND DISCONTINUED SUBSIDARIES**
 
 During
the fourth quarter of 2004, the Company treated IP2M as an inactive business
unit. IP2M did not have operational activity for more than fifteen months. The
activities formally conducted by IP2M have been absorbed into the operating
activities and results of Healthcare Dialog. This required the elimination of
inter-company balances and related transactions of Dialog Group, Healthcare
Dialog, and of IP2M. During 2004, in addition to transactions related to IP2M,
discontinued operations included transactions related primarily to
ThinkDirectMarketing employees’ labor arbitration awards and related expenses
for legal services.
 
 **NOTE
5** -  **GOING
CONCERN CONSIDERATIONS**
 
 The
accompanying condensed consolidated financial statements have been presented
assuming the continuity of the Company as a going concern. However, the Company
has incurred substantial losses resulting in an accumulated deficit of
$8,982,457 as of March 31, 2005. These conditions raise substantial doubt as to
the ability of the Company to continue as a going concern.
 
 Management’s
plans with regards to this issue are as follows:
 
 LIQUIDITY
 
 The
Company continues review means of raising funds including issuing debentures and
equity instruments. The Company is also reviewing the sale of non-core assets.
 
 The
Company reduced its current obligations of approximately $133,000 which
consisted of accounts payable, accrued payroll, and accrued vacation. The
President and C.E.O. along with the C.O.O. and C.F.O. amended their employment
contacts for 2005 with the Company that reduced the Company’s payroll
requirements. Additionally, the President and C.E.O., C.O.O. and C.F.O, and a
related party converted approximately $52,000 of accrued compensation to common
stock, while a supplier converted approximately $8,000 of open invoices to
common stock. See Note 18- Subsequent events, item along with two for additional
transactions.
 
 F-10
 **DIALOG
GROUP, INC. AND SUBSIDIARIES**
 **NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS**
 **March
31, 2005**
  
 PROFITABILITY
 
 The
Company intends to develop new and increased revenues and gross margins in all
areas of operations. Specifically, the Company intends to:
 
 ·  Restructure
its sales organization to allow for more effective sales processes. These steps
include, among others, consolidating sales operations, and the expansion of
sales organization.
 ·  Reduce
expenses through improved labor utilization.
 ·  Enter
into strategic relationships with data suppliers that will return higher levels
of match rate with a better quality of data.
 ·  Reduce
operating costs through improved procurement procedures.
 
 Presently,
the Company cannot ascertain the eventual success of management’s plans with any
degree of certainty. The accompanying condensed consolidated financial
statements do not include any adjustments that might result from the eventual
outcome of the risks and uncertainty described above.
 
 **NOTE
6-** **NON-TRADE
RECEIVABLE**
 
 On
November 19, 2004, the Company amended a prior agreement pursuant to which a
non-qualified stock option had been issued. On November 19, 2004, the optionee
executed its rights to purchase $200,000 of Dialog Group, Inc. common stock at
the price of $0.06 per share for a total of 3,333,333 immediately upon the
registration and delivery of shares. The Company complied with the requirements
of Notice of Option Purchase. The optionee, to date, has provided only
approximately $67,000 of the $200,000 that it is committed to pay to the
Company. The Company has reserved for the entire unpaid balance of $132,500 due
to the uncertainty of collection. The Company has hired an attorney In March to
pursue collection of the unpaid balance. Prior to hiring the attorney, the
Company was pursuing collection of the unpaid balance directly with
optionee.
 
 **NOTE
7-** **LETTER
OF CREDIT**
 
 In
connection with supplier agreement of Healthcare Dialog, the Company arranged
for a standby Letter of Credit in the amount of $90,000 in February of 2005. The
Letter of Credit is in effect for one year from February 2005. The collateral
for the Letter of credit is secured by personal assets of the Company’s
President and C.E.O. (See Note 15-Related Party Transactions).The agreement with
the supplier requires Healthcare Dialog to replenish any draws by the supplier
against the standby Letter of Credit. During the first quarter of 2005, the
supplier did not draw against the Letter of Credit.
 
 **NOTE
8-** **STOCK-BASED
COMPENSATION**
 
 During
the period ending March 31, 2005, the Company entered into the following
stock-based compensation transactions.
 
 As
consideration for personally guaranteeing certain obligations of the Company,
the Board of Directors authorized the Company to issue 4,750,000 shares of
common stock for $23,750 the President and C.E.O. for 4,750,000 shares and
350,000 shares of common stock for $1,750 to the C.O.O. and C.F.O.
 
 F-11
 **DIALOG
GROUP, INC. AND SUBSIDIARIES**
 **NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS**
 **March
31, 2005**
 In
connection with amending their employment contracts with the Company for the
balance of 2005, the President and C.E.O agreed to a salary reduction of
$100,000, while the C.O.O. and C.F.O agreed to a salary reduction of $65,000,
the Board of Directors authorized 10,000,000 and 6,500,000 shares of common
stock to be issued to the President and C.E.O and to the C.O.O. and C.F.O,
respectively.
 
 For
performing additional services that are not included in his employment contract,
the Company agreed to issue 2,000,000 shares of common stock for $10,000, to the
Secretary of the Corporation.
 
 The
Company amended one existing consulting services agreement to limit its
obligation to 1,456,398 shares and entered into new consulting services
agreement for 1,000,000 shares, for $13,835 and $7,000, respectively. The
companies will, or have provided general investor relations and marketing
services.
 
 The
Company offered two employees with potential stock awards. The Company will
provide 350,000 shares valued at $3,500. To receive the award, the employees
must be employed at the Company at December 31, 2005.
 
 The
Company will issue the shares in the near future. The Company accounted for the
transactions in accordance with FASB 123R as issued in December
2004.
 
 **NOTE
9-** **ACCRUED LIABILITES**
 
 As of
March 31, 2005, accrued liabilities consisted of the following:
  Accrued
      professional fees and other expenses
    
    $
    183,211Accrued
      payroll and payroll taxes
    
    
    292,055Accrued
      interest
    
    
    20,438Accrued
      settlements and contingencies
    
    
    484,046$
    979,752
 See Note
16-Litigation for the specific items that comprise the $484,046 in Accrued
settlements and contingencies.
 
 **NOTE
10 -** **EQUITY**
 
 COMMON
STOCK
 
 During
the period ending March 31, 2005, the Company issued 2,839,076 shares in
connection with the payment of the series E Preferred Stock dividends. As a
result of non completion of an agreement in the 1st quarter, the Company
cancelled 799,999 shares.
 
 PREFERRED
STOCK
 
 During
the first quarter of 2005, no preferred stock was issued.
 During
the first quarter of 2005, no debt was converted into preferred
stock.
 
 F-12
 **DIALOG
GROUP, INC. AND SUBSIDIARIES**
 **NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS**
 **March
31, 2005**
 STOCK
OPTIONS
 
 Stock
options for 100,000 were granted to an unrelated party, while no options were
exercised during the period ending March 31, 2005
 
 STOCK
WARRANTS
 In
connection with issuance of a $45,000 convertible note, convertible into common
stock at price of $0.025 per share, warrants provide holders to purchase the
common stock at the price of $0.025. Warrants to purchase 540,000 shares have
been issued to the holder of this convertible note. The warrants are exercisable
until September 30, 2009. Warrants to purchase a total of 6,381,865 shares have
been issued to all convertible note holders.
 
 CLASS
E PREFERRED STOCK DIVIDENDS
 
 The
dividends accrue at the rate of $400 per share per quarter. Pursuant to the
provisions of the Class E Preferred Stock Declaration, shares of common stock,
based on the average closing price for the shares during the last 20 trading
days before the dividends were due, may be paid in lieu of cash.
 
 During
the first quarter of 2005, quarterly dividends accrued on its Class E Preferred
Stock at the rate of $400 per share, per quarter, for a total of $39,800 accrued
and unpaid for at March 31, 2005.
 
 CONVERSION
OF PREFERRED STOCK INTO COMMON STOCK
 
 During
the first quarter of 2005, 247,120 shares of series B Preferred stock was
converted into 3,086,196 shares of common stock.
 
 CONVERSION
OF DEBT
 
 During
the first quarter of 2005, approximately $60,000 of debt and accrued expenses
were converted into common stock
 
 **NOTE
11 -** **STOCK
OPTIONS**
 
 Effective
January 1, 2003, the Company adopted the recognition provisions of SFAS No. 148,
“Accounting for Stock-Based Compensation - Transition and Disclosure. Prior to
2002, the Company accounted for employee stock options using the provisions of
APB No. 25 “Accounting for Stock Issued to Employees” and related
interpretations. During the quarter ended March 31, 2005, 100,000 stock options
were granted to employees, non-employee directors, officers, or consultants.
180,900 options vested in the three months ending March 31, 2005, while 9,504
options are forfeited by former employees during the first quarter of
2005.
 
 F-13
 **DIALOG
GROUP, INC. AND SUBSIDIARIES**
 **NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS**
 **March
31, 2005**
  
 Stock
options activity for 2005 at March 31,  2005 is
as follows:
 
 Number
    
    Weighted
      AverageOf
      Shares
    
    Exercise
      PriceOptions
      Outstanding, December 31, 2004
    
    
    3,366,898
    
    $
    0.121Options
      Granted
    
    
    100,000
    
    
    0.012Options
      Forfeited
    
    
    (9,504
    )
    
    3.000Options
      Expired
    
    
    0
    
    
    0Options
      Exercised
    
    
    0
    
    
    0Options
      outstanding, March 31, 2005
    
    
    3,457,394
    
    
    0.112
 **NOTE
12-** **COMMITMENTS
AND CONTINGENCIES**
 
 OPERATING
LEASES
 
 The
Company has entered into five lease obligations for office space along with a
corporate apartment in New York City. The offices are located in California,
Florida, New York, and Texas.
 
 California
Lease
 
 The
California lease was executed on June 19, 2003. The term of the lease is from
August 1, 2003 through October 31, 2006. The lease contains an option for the
Company to extend the lease for an additional three-year period.
 
 Florida
Lease
 
 The
Florida lease was executed on April 15, 2003. The term of the lease is from May
1, 2003 through April 30, 2008. The lease includes in addition to the office
space, various office furniture remaining from a prior lessee.
 
 New
York
 
 The New
York lease was executed on June 8, 2004. The term of the lease is from June 1,
2004 through May 31, 2007.
 
 The
corporate apartment in New York City lease was renewed on January 1, 2005. The
term of the lease is from January 1, 2005 through December 31,
2007.
 
 Texas
Lease
 
 The lease
was amended on September 1, 2003 to extend the lease agreement period to
September 30, 2006.
 
 F-14
 **DIALOG
GROUP, INC. AND SUBSIDIARIES**
 **NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS**
 **March
31, 2005**
 EMPLOYMENT
CONTRACTS
 
 The
Company has employment contracts with four employees. Employment contracts at
March 31, 2005 are as follows.
  AnnualPosition
    
    CompensationPresident
      and C.E.O
    
    $
    250,000C.O.O.
      and C.F.O.
    
    $
    150,000Administrative
      Head of Healthcare Dialog
    
    $
    150,000Corporate
      Secretary
    
    $
    66,000
 The
employment contracts for the President and C.E.O, C.O.O. and C.F.O., and the
Administrative Head of Healthcare Dialog are for one year, with initial term
ending March 31, 2005, extendable for successive one year terms, unless
terminated at the end of the term by
 
 either
party upon ninety days written notice to the other party. Annual increases at
the first of every year shall be at least the percentage of the prior year’s
C.P.I. If for any reason, the employee is not paid the employee’s base salary
for the year, the difference between the base salary and the amount paid shall
be paid to the employee prior to payment of any year-end bonus to any other
employee. Employee shall be entitled to not less than five (5) weeks paid
vacation for each full calendar year prorated for any partial year. Employee
shall accrue earned and unused vacation. Employee shall receive all benefits and
fringes made available to other employees and officers of the Company including
pension, medical, dental, life, and disability insurance and other similar
plans. Employee and spouse shall receive these benefits fully paid by the
Company. Health insurance for the employee and family will be provided by the
Company. Health club memberships for the employee will be paid for by the
company. Life insurance at a cost of at least $1,000 per month will be paid by
the Company. Long and short term disability insurance for the employee will be
paid by the Company. The employee is entitled to a monthly automobile allowance
of $1,500 per month.
 
 The
employment agreement with the Corporate Secretary is effective June 1, 2004 to
May 31, 2005. It does not contain a renewal clause. If for any reason, the
employee is not paid the employee’s base salary for the year, the difference
between the base salary and the amount paid shall be paid to the employee prior
to payment of any year-end bonus to any other employee. Health insurance for the
employee is paid by the Company. Employee shall accrue earned and unused
vacation. Employee shall receive all benefits and fringes made available to him
from time to time by the Company.
 
 **NOTE
13 -** **SEGMENT
DISCLOSURES**
 
 The
Company's reportable operating segments are categorized in three components: (1)
Healthcare; which includes Healthcare Dialog, Inc., (2) Data; which includes
Mail Mogul, Inc., and Data Dialog, Inc., (3) Corporate which is Dialog Group,
Inc.
 
 F-15
 **DIALOG
GROUP, INC. AND SUBSIDIARIES**
 **NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS**
 **March
31, 2005**
   HEALTHCARE
 
 Healthcare
Dialog designs, develops and distributes direct marketing and customer
relationship management products and services for the healthcare
industry.
 
 Revenues
are generated by Strategic and Creative Services:
 ·
    direct
      mail campaigns ·
    creation
      of sales representative training materials ·
    creation
      and dissemination of patient and professional education materials ·
    consumer
      advertising ·
    creation
      and management of websites ·
    to
      place internet advertising ·
    for
      the use of our healthcare database 
 + Media
provides, maintains and delivers healthcare information over the internet and
television.
 
 DATA
 
 Mail
Mogul is an online market place for sellers of direct mail, providing leads,
website applications, mailing lists, mailing supplies as well as other products
and services.
 
 Revenues
are generated from
 ·
    data
      from data dialog master database ·
    mail
      room supplies ·
    membership
      in “RFQ” an online marketplace for quoting direct mail
  jobs ·
    sale
      of licensed databases and database products and
services ·
    data
      updating services 
 Data
Dialog provides online marketing list, direct mail programs and creates target
lists for specific direct marketing categories for small to medium sized
businesses. The company allocates the costs of revenues and direct operating
expenses to these segments.
 
 Revenues
are generated from
 ·
    data
      from the Dialog Group databases ·
    Data
      Dialog Digital, a product that automatically appends names and addresses
      to telephone numbers on inbound calls to telephone service centers. ·
    direct
      mail campaigns 
 CORPORATE
 This is
comprised of general and administrative functions and related expenses. These
costs are retained at corporate and are not allocated to the business segments.
Costs that are specifically attributable to a business unit are charged to that
unit. Management’s philosophy is charging the units for specific attributable
costs, such as I.T services, rent, and depreciation or amortization of assets
owned by Corporate that have a benefit to the business unit more accurately
reflects the operating costs of Corporate and the matching of revenues and costs
of the respective business unit.
 
 F-16
 **DIALOG
GROUP, INC. AND SUBSIDIARIES**
 **NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS**
 **March
31, 2005**
 Three
months ended March 31, 2005 Actual Unaudited Results
 
 ConsolidatedCorporate
    
    Healthcare
    
    Data
    
    TotalREVENUE
    
    $
    0
    
    $
    803,199
    
    $
    913,519
    
    
    1,716,718COST
      OF SALES
    
    
    0
    
    
    353,643
    
    
    339,009
    
    
    692,653GROSS
      PROFIT
    
    
    0
    
    
    449,556
    
    
    574,509
    
    
    1,024,065OPERATING
      EXPENSES:Selling,
      General and Administration Expenses
    
    
    465,536
    
    
    316,372
    
    
    534,131
    
    
    1,316,040TOTAL
      OPERATING EXPENSE
    
    
    465,536
    
    
    316,372
    
    
    534,131
    
    
    1,316,040INCOME
      (LOSS) FROM OPERATIONS
    
    
    (453,536
    )
    
    133,184
    
    
    40,378
    
    
    (291,974
    )Other
      Income(Expenses)Interest
      incomeInterest
      expense
    
    
    (24,556
    )
    
    (15,863
    )
    
    (2,916
    )
    
    (43,336
    )Other
      (expense)Other
      incomeForgiveness
      of debt
    
    
    3,750
    
    
    
    
    
    
    
    
    3,750Total
      other income(expenses)
    
    
    (20,806
    )
    
    (15,863
    )
    
    (2,916
    )
    
    (39,586
    )Income/(Loss)
      Before Inactive and Discontinued Operations
    
    
    (486,343
    )
    
    117,321
    
    
    37,462
    
    
    (331,850
    )Inactive
      Operations
    
    
    
    
    
    (290
    )Discontinued
      operationsNet
      Income/(Loss)
    
    
    (486,343
    )
    
    117,031
    
    
    37,462
    
    
    (331,850
    )Total
      Net Assets
    
    
    813,051
    
    
    795,787
    
    
    266,279
    
    
    1,874,117Gross
      Fixed and Other Assets
    
    
    1,054,807
    
    
    0
    
    
    255,034
    
    
    1,309,841Accumulated
      Depreciation and Amortization
    
    
    518,384
    
    
    0
    
    
    122,886
    
    
    641,270
 
 
 F-17
 
 **DIALOG
GROUP, INC. AND SUBSIDIARIES**
 **NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS**
 **March
31, 2005**
 Three
months ended March 31, 2004 Actual Results
 
 ConsolidatedCorporate
    
    Healthcare
    
    Data
    
    TotalREVENUE
    
    $
    0
    
    $
    933,817
    
    $
    1,011,615
    
    $
    1,945,432COST
      OF SALES
    
    
    
    
    
    449,318
    
    
    490,652
    
    
    939,970GROSS
      PROFIT
    
    
    
    
    
    484,499
    
    
    520,963
    
    
    1,005,462OPERATING
      EXPENSES:Selling,
      General and Administration Expenses
    
    
    605,243
    
    
    199,147
    
    
    586,511
    
    
    1,390,901TOTAL
      OPERATING EXPENSE
    
    
    605,243
    
    
    199,147
    
    
    586,511
    
    
    1,390,901INCOME
      (LOSS) FROM OPERATIONS
    
    
    (605,243
    )
    
    285,352
    
    
    (65,549
    )
    
    (385,440
    )Other
      Income(Expenses)Interest
      incomeInterest
      expense
    
    
    (10,336
    )
    
    (8,168
    )
    
    
    
    
    (18,504
    )Other
      (expense)Other
      incomeForgiveness
      of debt
    
    
    92,264
    
    
    
    
    
    1,400
    
    
    93,663Total
      other income(expenses)
    
    
    81,927
    
    
    (8168
    )
    
    1,400
    
    
    75,160Income/(Loss)
      Before Inactive and Discontinued Operations
    
    
    (523,316
    )
    
    277,184
    
    
    (64,150
    )
    
    (310,280
    )Inactive
      OperationsDiscontinued
      operationsNet
      Income/(Loss)
    
    
    (523,316
    )
    
    277,184
    
    
    (64,150
    )
    
    (310,280
    )Total
      Net Assets
    
    
    678,763
    
    
    821,794
    
    
    459,732
    
    
    1,960,289Gross
      Fixed and Other Assets
    
    
    816,313
    
    
    0
    
    
    197,973
    
    
    1,014,286Accumulated
      Depreciation and Amortization
    
    
    227,343
    
    
    0
    
    
    47,399
    
    
    274,742
 
 **NOTE
14** **-
LOANS AND NOTES PAYABLE**
 
 Loans and
notes payable due to non-related parties consisted of the following as of March
31, 2005.
 
 Convertible
      notes in the aggregate amount of $100,000 due to three former IP2M note
      holders assumed by the Company. The notes are due August 31, 2004. The
      notes bear interest at the rate of 10% per annum. The notes are
      convertible into shares of the Company’s common stock. The number of
      shares to be issued upon conversion will be determined by the closing bid
      price of the Company’s common stock on the date of conversion. Each holder
      is entitled to convert up to 25% of the initial balance of the note
      (including accrued interest) each month. During the Second Quarter of 2004
      $75,000.00 of Notes were converted to Common Stock
    
    $
    25,000
  $115,000
      revolving credit agreement with a commercial bank matured on October 13,
      2004. The Company is currently in discussions with the bank. The line of
      credit bears interest at prime plus 2% per annum and is personally
      guaranteed by the Company’s President and C.E.O.
    
    $
    114,689  F-18
  **DIALOG
GROUP, INC. AND SUBSIDIARIES**
 **NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS**
 **March
31, 2005**
 Small
      business loan assumed upon the purchase of Azimuth Target Marketing. The
      loan bears interest at prime plus 2 1⁄4 % per annum, due in equal
      installments over 36 months, maturing during 2006.
    
    $
    2,911$350,000
      line of credit with commercial asset-backed lender with a term of two
      years beginning August 2004. The line of credit bears interest at prime
      plus 4% per annum plus on-going fees. It is secured by the Company’s
      accounts receivables, equipment, inventory, and up to $150,000 of the debt
      is personally guaranteed by the President and C.E.O. of the Company and
      his spouse.
    
    $
    349,267Total
      loans and notes payable
    
    $
    491,867Less:
      Current maturities
    
    $
    (491,867
    )Long
      Term Debt
    
    $
    0
 
 Please
see Note 15- Related Party Transactions Due to Related Parties for information
about additional Company debt.
 
 **NOTE15
-** **RELATED
PARTY TRANSACTIONS**
 
 CONVERTIBLE
NOTES DUE TO RELATED PARTIES
 
 During
      2004, the Company began issuing a Convertible Note. The notes all bear
      interest at the rate of five (5%) percent per annum. They mature on May
      31, 2006. The holders of the notes can convert them into Company common
      stock at a price of $0.06 per share. After the Company’s shares close over
      $0.12 per share for twenty trading days, the Company can compel the
      holders to convert their notes and all accrued interest into shares of
      common stock at the conversion price.
 
 By
      the end of the 1stquarter, 2005, the Company had issued notes with an aggregate of $628,045
      in initial principal amount. At the time the notes were issued, the
      Company issued warrants granting the holders the right to purchase an
      aggregate of 3,140,225 shares at a price of $0.075.
 
 Convertible
      Notes in the aggregate amount of $118,045 were issued to the President and
      C.E.O, the C.O.O. and C.F.O., along with two employees for unpaid payroll
      at December 31, 2004.
    
    $
    118,045
 
 Three
      notes, in the initial principal amounts of $250,000, $135,000, $125,000,
      and $45,000 were issued to a fund through the efforts of an affiliated
      broker-dealer. The Company paid an aggregate of approximately $55,000 to a
      company whose president is a member of the board of directors of the
      Company for arranging the sale of these notes. See Note-18
      Subsequentevents,
      item one for additional information.
    
    $
    555,000
 
 F-19
 
 **DIALOG
GROUP, INC. AND SUBSIDIARIES**
 **NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS**
 **March
31, 2005**
 DUE TO
RELATED PARTIES
  In December 2004, a group of individuals,
      including a member of board of directors provided approximately $113,000
      directly to a supplier for unpaid invoices. The advance is non-interest
      bearing and due on demand. In January of 2005, a significant portion was
      repaid.
    
    $
    26,000In
      conjunction with the Company obtaining a Letter of Credit for the benefit
      of a supplier of Healthcare Dialog (see Note-7 Letter of Credit), the
      President and C.E.O. of the Company personally secured the Letter of
      Credit by pledging personal assets in the amount of the Letter. Unless,
      the Letter of Credit is drawn down on, no amount is due.
    
    $
    90,000The
      President and C.E.O. of Company provided the Company with $25,000 of
      short-term, interest-free, unsecured debt.
    
    $
    25,000Total
      loans and notes payable due to related parties
    
    $
    814,045Less:
      Current maturities
    
    $
    (141,000
    )Long
      Term Debt due to related parties
    
    $
    673,045
  CONVERSION
OF DEBT DUE TO RELATED PARTIES
 
 During
the period ending March, 31, 2005, related parties converted approximately
$53,000 of debt, or accrued expenses into equity of the Company.
  RENT
TO RELATED PARTIES
 
 The
Company leases an apartment from January 1, 2005 through December 31, 2007 from
a company controlled by the C.O.O. and C.F.O. of the Company. Rent expense paid
to the company controlled by the related parties amounted to $6,000 for three
months ended March 31, 2005.
 
 **NOTE
16 -** **LITIGATION**
 
 SUPPLIERS
 
 During
July of 2003, Axiom Corporation commenced an action against
ThinkDirectMarketing, Inc., a discontinued subsidiary. The complaint seeks
$400,000 on a note payable, and $295,415 for unpaid data usage, and $1,250,000
for unused minimum usage requirements for 2003 and 2004. The debts, if any, are
those of the discontinued entity. This litigation is still in the preliminary
stages and no amounts have been accrued.
 
 Wells
Fargo Financial Leasing, Inc. filed an action against the Company for
non-payment of equipment lease commitments made by Healthcare Dialog, Inc.
Subsequent to year-end, a settlement was reached and both parties executed the
agreement. The amount is fully recorded
 
 F-20
 
 **DIALOG
GROUP, INC. AND SUBSIDIARIES**
 **NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS**
 **March
31, 2005**
 in the
accounts payables of the Company. The balance at March 31, 2005 is $5,000. In
April, 2005 balance was paid.
 
 Collins
Ink, in June 2004, obtained a judgment of $92,347 for unpaid invoices. The full
amount is recorded in the accounts payable of the Company. The balance at March
31, 2005 is $33,109.
 
 Label
Source, in June 2004, obtained a judgment of $121,037 for unpaid invoices. The
full amount is recorded in the accounts payable of the Company. The balance at
March 31, 2005 is $87,314. As payments are behind the payment plan schedule, the
Company was informed that plaintiff obtained a lawyer in New York.
 
 USA
Direct, in April 2004 obtained a $39,025 judgment related to a discontinued
operation of the Company. This amount is recorded in the accounts payable of the
Company. In December 2004, the Company and USA Direct reached an agreement of
$20,000 and a payment plan. The balance at March 31, 2005 is
$10,000.
 
 The New
York State Department of Taxation in December 2004 provided a letter to QD
Corporation, a discontinued unit that the Department claims that QD Corporation
owes $7,936 in taxes and interest for corporate income taxes for the period
ending December 31, 2002. After reviewing the consolidated tax return, QD
Corporation is not required to file a separate return. This information has been
provided to New York State Department of Taxation in response to its December
2004 letter. As the Company believes it has properly reported the taxes to the
State of New York, no accrual for additional taxes and charges are recorded.
  EMPLOYEES
 
 In April
2003, Dialog Group received a summons from a Colorado State District Court
seeking to enforce a former employee’s termination agreement. A settlement
agreement was reached for $47,330. TDMI, a discontinued subsidiary, made
payments of approximately $45,000 during 2003 and 2004. The balance at March 31,
2005, is $2000 and recorded as an accrual on the books of the Company. This
amount is included in accrued settlements and contingencies in Note 9.The
balance was paid in April, 2005.
 
 In April
2003, two former TDMI employees commenced arbitration proceeding against the
Company relating to their termination of employment. The employees seek damages
totaling $375,789. TDMI, a discontinued subsidiary, accrued $147,000 against
this potential liability. The Company has accrued for additional legal fees to
contest the claims. In January 2005, the
 Company
received notice from the American Arbitration Association Employment Arbitration
Tribunal that reviewed the claims. Its decision was to award the claimants a
total of approximately $478,000 including fees. The amount is fully accrued for
in the financial statements of the Company. The balance at March 31, 2005 is
$473,898. This amount is accrued on the books of the Company. It is included in
accrued settlements and contingencies in note 9. In April, the Company and the
two former employees of TDMI executed a settlement agreement for $501,872 that
includes a schedule of payments over two and half years that includes
approximately $25,000 of interest.
 
 F-21
 **DIALOG
GROUP, INC. AND SUBSIDIARIES**
 **NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS**
 **March
31, 2005**
 The
Company reached a settlement with a former employee for claims against an
employment contract. It was settled by conversion to series E preferred stock in
2004.The Company accrued for a liability sufficient to cover the settlement. The
balance at March 31, 2005 is $8,149 and is included in accrued settlements and
contingencies in Note 9.
 
 **NOTE
17-** **FORGIVENESS
OF DEBT**
 
 During
the period ending March 31, 2005, Management arranged the settlement of accounts
payable and other obligations resulting in approximately $3,800 of
debt.
 
 **NOTE
18** - **SUBSEQUENT
EVENTS**
 
 In April,
2005, the Company and the holder of $555,000 in convertible notes had these
notes cancelled and purchased by another related party. As part of canceling the
notes, the accrued interest was forgiven and the attached warrants were
cancelled. A new note, for $555,000 was issued to replace the four notes that
were cancelled.
 
 In April,
2005, the Company issued a 5% convertible note in the amount of $550,000 in a
related party transaction. The Company obtained $500,000 in April. In connection
with arranging the sale of this note, the Company paid $50,000 to a company
whose president is a member of the board of directors of the
Company.
 
 In May,
2005, the Company signed a letter of intent to acquire an online advertising and
affiliate marketing company. The company has developed several new highly
customizable online technologies that enhance advertising and marketing
performance. The proposed acquisition would allow Dialog Group, Inc. to expand
our means of distributing our data services and increase our online presence.
The exact terms of the transaction are subject to board of directors’ approval
along with agreement on a definitive contract.
 
 In April,
2005, the Company entered into a settlement agreement and payment arrangement
with two former employees of TDMI, a discontinued operation. See
Note16-Litagation, Employees. The settlement agreement’s payment plan stated the
former employees be paid an initial amount of $100,000 and the balance over the
next thirty months. The $100,000 payment was made in April 2005.


F-22





**Item
2. Management’s Discussion and Analysis or Plan of
Operation.**





***General***





Dialog
Group, Inc. (DLGG) is a publicly traded corporation, headquartered at 257 Park
Avenue South, Suite 1201, New York, New York 10010, with offices in Valencia,
California; Sunrise, Florida; and Houston, Texas. The company’s two divisions,
Data Dialog and Healthcare Dialog, provide a broad spectrum of proprietary and
exclusive databases for healthcare, pharmaceutical, consumer and
business-to-business market clients. The company also provides a combination of
traditional customer relationship management support applications such as
advertising (print, broadcast) and marketing services (broadcast, new media, and
Internet-based promotional venues). Dialog Group maintains exclusive contracts
with leading multinational pharmaceutical companies to operate, maintain, and
provide content for their consumer-directed Web sites.





***Description
of the Divisions***





Both of
Dialog Group’s divisions each currently market its product and service offerings
through three branded business organizations. The Data Dialog Division’s are
Data Dialog Marketing, Data Dialog Digital and Mail Mogul. The Healthcare Dialog
Division’s are nFusion, +Media, and iData.





**Data
Dialog Division**





***Data
Dialog Marketing*** serves
the direct marketing needs of small- and medium-sized businesses with systems
and tools that generate business and consumer prospect leads, provide data
services, and streamline business processes by integrating the collection and
distribution of data. Data Dialog Marketing offers a host of data-related
services, such as targeted marketing lists, turnkey direct mail programs, and
data cleansing to multiple market segments including insurance, financial
planning, real estate, auto dealerships and other segments that are users of
direct mail and prospect marketing. Data Dialog Marketing also offers a unique
subscription-based product featuring limited selections of data specifically
designed for the small business segment. The unit markets a proprietary online
list creation tool, Data Dialog Select.





***Data
Dialog Digital*** is a
customer data integration product that automatically appends name and
address information, as well as demographic & sociographic
information, to telephone numbers on calls made by consumer and business
customers to CTI Platforms. Data Dialog Digital primarily markets its
products to call centers and Interactive Voice Response system users
operating in-bound and blended call centers with 5 to 500 seats. Data Dialog
Digital currently has contracts and sub-contracts with 27 **** businesses
in this market segment and an additional 20 agreements with resellers which
service this market. The real time format of this unit’s products gives
customers instant access to data, and speeds up their promotional efforts and
improves customer service.





***Mail
Mogul*** **** brings
one-stop shopping to the small- to medium-sized mail shop industry. Mail Mogul
helps mail shops improve their business opportunities through a
total-business-solutions approach. Proprietary and external lists are sold at
competitive prices both on and off line to mail shops for their customers. In
addition, list hygiene services are offered to mail shops that have customer
lists which need to be updated and or standardized. Its “Hot Leads” product is
this market’s first online commerce center to link customers who need direct
mail job quotes with mail shops and direct marketing service organizations with
letter-shop capabilities. Finally, Mail Mogul offers consumable supplies to its
customers for their equipment and to round out its offerings.





3


**Healthcare
Dialog Division**





**iData** uses
proprietary technologies to support healthcare and pharmaceutical clients in
their direct marketing efforts, clinical trial recruitment, and consumer/patient
market research efforts. It offers unique healthcare data on almost 2 million
households, and serves as the foundation for the highly targeted and efficient
communication plans of pharmaceutical companies, retailers, and other healthcare
companies. Its exclusive data is compiled from respondents who agree to
telephone interviews. The primary function of this business unit is to identify
patient/consumer targets and enhance patient/consumer databases.





***nFusion*** delivers
advertising, relationship marketing and communications services to the
healthcare industry. Clients use its strategic and creative services to build
comprehensive programs for healthcare professionals, consumers, and sales
representatives. These include training materials development, patient and
professional education materials distribution, and targeted direct mail and
advertising campaigns. Clients rely on ***nFusion’s*** interactive services to produce sophisticated promotional Web sites,
educational  Web
sites, interactive training and educational CD-ROMs, Internet advertising,
e-mail campaigns, and proprietary marketing programs.





***+Media’s*** **** platform
provides, maintains, and delivers healthcare, beauty and pet content across a
national network of 87 local affiliate TV and radio station Web sites. The
content, which includes over 15,000 text articles, attracts over a million
unique health information seekers per day to the broadcast stations’ Web sites
for a combined US household penetration of 75%. Here, client public relations,
promotional material, and educational material are blended into a seamless
presentation for maximum viewer impact. To maintain repeat traffic, all features
are refreshed daily.





***Results
of Operations***





***Dialog
Group***





Management
continued to evaluate the margins of some of the products offered and focused
more on profit improvement and not Revenue alone. Revenues for the quarter ended
March 31, 2005 were $1,716,700 compared with $1,945,400 for the quarter ended
March 31, 2004. This represents a decline of $228,700 or 11% from the same
period a year ago. Sales from the high margin data companies were $913,500 or
47% of total. With the addition of iData sales, which are reported in the
Healthcare Dialog total, data sales were $1,038,400 or 53% of total Revenue.
Data Sales in total for the first quarter of 2005 are ahead of the first quarter
of 2004. Revenue for each of the companies and some of the products will be
addressed in more detail below.





4
 
  Costs of
Revenues for the quarter ended March 31, 2005 were $692,700, some 40% of sales,
compared with $940,000 or approximately 48% of sales in the quarter ended March
31, 2004. The decline in Revenue of $228,700 was offset by the $247,300 decline
in Cost of Revenue from a year ago for the same period. Improved terms from data
suppliers and the greater utilization of company data assets rather than relying
on external sources and a change in the mix of Revenue drove down Cost of
Revenue in the first quarter of 2005 from the same quarter of the prior
year. The
sources of the Revenue and costs for each division are discussed in more detail
by company in the sections which follow.





Operating
Expenses for the quarter ended March 31, 2005 were $1,316,000 compared with
$1,390,900 for the quarter ended March 31, 2004. This represents a reduction of
$74,900 from the first quarter of 2004. Management plans to continue to reduce
overhead in the quarters ahead. Dialog Group in 2005 is allocating some
administrative and IT expenses to the divisions which it did not do in 2004, the
details of which are explained in more detail in the individual company
comments.





Losses
from Operations were $292,000 for the quarter ended March 31, 2005, compared
with $385,400 for the quarter ended March 31, 2004, an improvement of
approximately $93,400 from the same period a year ago. The positive results can
be attributed to lower Cost of Revenue resulting from higher margin businesses
making up a greater percentage of Total Sales in the first quarter of 2004 than
for the comparable period in 2004. A reduction of Operating Expenses also
contributed to the improved results. “Reduce Overhead” has and will continue to
be the Dialog Group credo.





Net Other
Income/Expense was an expense of $39,600 for the quarter ended March 31, 2005,
compared with Net Other Income/Expense was income of $75,200 for the quarter
ended March 31, 2004, an increase of $114,800. The company’s other
income/expense for this year included interest expenses of approximately $43,300
and income of $3,800, arising from gain on forgiveness of debt. Last year
included interest expense of $18,500 and other income of $93,700 that arose
primarily from the review of accrued expenses and adjustment to current
estimates.




The Net
Loss for the quarter ended March 31, 2005 was $331,800, compared with a Net Loss
$310,300 in the quarter ended March 31, 2004, representing an increase of
$21,500.





***Data
Dialog Division*** **:**





Data
Dialog had Sales of $392,000 for the period ending March 31, 2005, compared to
approximately $198,000 for the first quarter of 2004. Data Dialog Marketing,
which sells data and marketing services to small- and mid sized-end users,
accounted for approximately $261,000 of total Data Dialog Sales for the period
ending March 31, 2005. The company’s Data Dialog Digital call center reverse
append product was the second largest revenue producer for the first quarter,
contributing $102,100 in Revenue. Data Dialog Management, which sells data to
large end users and brokers, produced the balance. Specialty List sales sold by
two of the divisions provided the greatest proportion of the Revenue for Data
Dialog. The Data Dialog Marketing subscription list products were the second
strongest Revenue producer.





5


Mail
Mogul’s Revenues were $521,500 for the quarter ended March 31, 2005, compared
with **** $813,700
for the same period ended March 31, 2004. The year began with weak sales
resulting from fewer experienced sales people on staff and increased
competition. During the first quarter of 2005, Sales from Mail Mogul’s highest
margin “Hot Lead” category was up from the same period a year ago. While highly
profitable list Sales were off for the period ending March 31, 2005 from the
same periods a year ago, the Sales of low margin consumable supplies were off
more significantly from the first quarter of 2004 to first quarter 2005.





Data
Dialog’s Costs of Revenue for the first three months of 2005 were $114,800 or
29% of Sales, compared with $52,500, or 27% of sales in the first quarter of
2004. The savings from the Company sales from company-owned data assets was
negatively offset by the increase in sales of the lower margin wholesale
products along with sales of printing and fulfillment. Cost of Revenue by
product varied from 17% of sales to 43% of sales. As sales continue to improve
in the quarters ahead, Cost of Revenue percentage should continue to improve as
a result of fixed expenses relating to data acquisition and Internet
marketing.





Mail
Mogul’s Costs of Revenue were $224,200 for the quarter ended March 31, 2005,
representing 43% of revenue, compared with $438,100 and 54% of revenue for the
quarter ended March 31, 2004. The mix of the business was the major reason for
the reduction in the Cost of Revenues percent for Mail Mogul in the first
quarter. Sales from the company’s lowest Cost of Revenue product “Hot Leads” in
the first quarter of 2005 was up for the period ending March 31, 2005, compared
to the period ending March 31, 2004. “Hot Leads” is an online community where
member mail shops bid on mailing jobs. Sales of low margin mail shop consumable
supplies were down significantly from a year ago while sales of higher margin
data made up a greater percentage of the total Revenue for the period. Mail
Mogul’s Cost of Revenue reduction of approximately $214,000 helped to offset the
reduction in Revenue during the first quarter of 2005 compared to the first
quarter of 2004.





Data
Dialog’s Operating Expenses for the three month period ended March 31, 2005 were
$330,000, an improvement of approximately $65,000 from the same period a year
ago when the figure was $394,900. Operating Expenses decreased from the first
quarter of 2004 to the first quarter of 2005, while sales doubled during the
same period, contributing to the overall profit improvement of this company.
Certain data expenses paid exclusively by Data Dialog in 2004 are being shared
in the amount of $17,500 with Mail Mogul in 2005, along with $28,000 of
inter-company cost allocations to other divisions, and approximately $ 25,000
related to the transfer of employees from Data Dialog.





Mail
Mogul’s Operating Expenses $235,600 for the quarter ended March 31, 2005
compared with **** $228,000
for the quarter ended March 31, 2004. In 2005, allocation of $35,000 for
marketing, administrative and IT expenses were charged to Mail Mogul during the
period ending March 31, 2005 that were not charged for the same period in 2004.
Management believes the 2005 approach yields a more accurate presentation of
operating results.





6


Data
Dialog’s Net Loss from Operations was $52,800 for the first quarter of 2005,
compared to a loss of approximately $250,000 for the first quarter of 2004.
Investments made in sales staff and an online platform for Data Dialog Marketing
are having a positive impact on Data Dialog. Data Dialog Digital was the one
product line of the three which showed a profit for the first quarter.





Mail
Mogul’s Net Income from Operations for the quarter ended March 31, 2005 was
$61,700, compared with approximately $158,000 for the same quarter in 2004. Mail
Mogul sales ending March 31, 2005 were down almost $300,000 from the same period
a year ago, while Net Income is down by less than $100,000. Management believes
the results of the first quarter were attributed to the turnover of experienced
sales people and a conscious effort to divert resources away from lower margin
categories. Even with a decrease in Revenue, this company was still profitable
in the first quarter of 2005, and Management believes the strategy in place will
return the bottom line to past year levels.





***Healthcare
Dialog Division***




Total
Revenue for Healthcare Dialog was $803,200 for the first quarter of 2005
compared to $933,800 for the same period a year ago. A metamorphosis of Dialog
Group into a company with products that are broader-based and include clients
other than pharmaceutical companies is taking place. The company is less
dependent on a few large pharmaceutical clients than in the past. Resources and
assets formally allocated to Healthcare Dialog are being deployed in other
divisions.




Sales in ***nFusion*** for the
three months ended March 31, 2005 were $518,000, or about 64% of the total
Healthcare Dialog business in the first quarter of 2005. This healthcare-focused
marketing business is the single largest segment of Healthcare Dialog. Sales of ***nFusion*** for the
first quarter of 2004 were $470,000.




***+Media*** produced
sales of $160,300 for the period ending March 31, 2005, which was also below the
2004 level of $461,700 for the same period. While orders placed were below last
year by about $100,000, sales the first quarter of 2004 were further depressed
because inventory was not made available from the supplier which owns the TV Web
Sites.Sales that were booked but not placed as a result of a shortage of online
inventory in the first quarter will be filled and revenue realized later in
2005.





The
remaining healthcare segment, ***iData*** , ****** which
conducts telephone surveys primarily for healthcare companies, had Revenue for
the first quarter of 2005 of $125,000. This compares favorably to the same
period a year ago when Sales were about $40,000. Contracted Sales for 2005 are
ahead of 2004 actual revenues.





Healthcare
Dialog’s Costs of Revenue was $335,000 for the quarter ended March 31, 2005, or
42% of revenue compared with $424,000, and 45% of revenue for the quarter ended
March 31, 2004 The reduction is related to using fewer consultants and
freelancers for savings of approximately $125,000.. One factor affecting the
Cost of Revenue rate was a change in the technology used for the ***iData*** surveys.
This more cost-effective approach was not introduced until after the end of the
first quarter of 2004.





7


The
Healthcare Dialog’s consolidated Total Operating Expenses were approximately
$316,400 for the three months ended March 31, 2005, compared to $199,100 for the
same period a year ago. In the first quarter of 2005, expenses included
allocation of approximately $80,000 for IT and administration that were not
included in 2004 along with approximately $43,000 related to transfers of
employees to Healthcare Dialog from other divisions. Management believes the new
approach more accurately presents operating results for each business
unit.





For the
three months ended March 31, 2005, Healthcare Dialog’s consolidated Net Income
from Operations was approximately $153,000 compared to $311,000 in the first
quarter of 2004. Healthcare Dialog experienced a decline in volume in the first
quarter of 2005, compared to the same period a year ago. It still produced the
highest Income from Operations of any of the Dialog Group companies and was
still able to produce a 19% Net Income from Operations.





***Liquidity
& Capital Resources***





DGI had a
consolidated working capital deficit of approximately ($3,041,000) on March 31,
2005 as compared to a deficit of approximately ($2,854,000) at December 31,
2004. The increase of approximately $187,000 is the result increase in accounts
payable, accrued expenses and short-term borrowing due a reduced level of sales
in the first quarter that did not provide the level of accounts receivable
required to fund operations.





On March
31, 2005 the Healthcare Dialog Division’s financial condition included a working
capital deficit, of about ($952,000) as compared to a deficit of approximately
($909,000) at December 31, 2004.





At the
end of March, the Data Dialog Division had a working capital deficit of
approximately ($867,000) as compared to a deficit of about ($665,000) on
December 31, 2004. This is the result of current assets essentially remaining
unchanged while accounts payable and other current liabilities
increased.




***Inflation***




Inflation rates in the United States have not had a significant impact on
operating results for the periods presented.




8





**Item
2**   **Controls
and Procedures.**





Management
continues its focus on the issue of internal control. To that end, it is
continuing the process of centralizing the accounting function and developing
policies and procedures that enhance the Company’s internal controls Management
continues to evaluate and test present measures while at the same time reviewing
areas that require improvement. Additionally, it continues the process of hiring
persons with the skill sets appropriate to fill the Company’s
needs.





9





**Part
II. Other Information**





Items 3
and 4 are omitted as they are either not applicable or have been included in
Part I.





**Item
1.**  ****  **Legal
Proceedings**





*Suppliers*





During
July of 2003, Axiom Corporation commenced an action against
ThinkDirectMarketing, Inc., a discontinued subsidiary. The complaint seeks
$400,000 on a note payable, and $295,415 for unpaid data usage, and $1,250,000
for unused minimum usage requirements for 2003 and 2004. The debts, if any, are
those of the discontinued entity. This litigation is still in the preliminary
stages and no amounts have been accrued.





Wells
Fargo Financial Leasing, Inc. filed an action against the Company for
non-payment of equipment lease commitments made by Healthcare Dialog, Inc.
Subsequent to year-end, a settlement was reached and both parties executed the
agreement. The amount is fully recorded in the financial statements of the
Company. The balance at March 31, 2005 is $5,000. In April, balance was
paid.





Collins
Ink, in June 2004, obtained a judgment of $92,347 for unpaid invoices. The full
amount is recorded in the financial statements of the Company. The balance at
March 31, 2005 is $33,109.





Label
Source, in June 2004, obtained a judgment of $121,037 for unpaid invoices. The
full amount is recorded in the financial statements of the Company. The balance
at March 31, 2005 is $87,314. As payments are behind the payment plan schedule,
the Company was informed that plaintiff obtained a lawyer in New
York.





USA
Direct, in April 2004 obtained a $39,025 judgment related to a discontinued
operation of the Company. This amount is fully accrued in the financial
statements of the Company. In December 2004, the Company and USA Direct reached
an agreement of $20,000 and a payment plan. The balance at March 31, 2005 is
$10,000.





The New
York State Department of Taxation in December 2004 provided a letter to QD
Corporation, a discontinued unit that the Department claims that QD Corporation
owes $7,936 in taxes and interest for corporate income taxes for the period
ending December 31, 2002. After reviewing the consolidated tax return, QD
Corporation is not required to file a separate


return.
This information has been provided to New York State Department of Taxation in
response to its December 2004 letter. As the Company believes it has properly
reported the taxes to the State of New York, no additional taxes and charges are
recorded.





*Employees*





In April
2003, Dialog Group received a summons from a Colorado State District Court
seeking to enforce a former employee’s termination agreement. A settlement
agreement was reached for $47,330. TDMI, a discontinued subsidiary, made
payments of approximately $45,000 during 2003 and 2004. The balance at March 31,
2005, is $2000. The balance was paid in April.





10


In April
2003, two former TDMI employees commenced arbitration proceeding against the
Company relating to their termination of employment. The employees seek damages
totaling $375,789. TDMI, a discontinued subsidiary, accrued $147,000 against
this potential liability. The Company has accrued for additional legal fees to
contest the claims. In January 2005, the Company
received notice from the American Arbitration Association Employment Arbitration
Tribunal that reviewed the claims. Its decision was to award the claimants a
total of approximately $478,000 including fees. The amount is fully accrued for
in the financial statements of the Company. The balance at March 31, 2005 is
$473,898. In April, the Company and the two former employees of TDMI executed a
settlement agreement for $501,872 that includes a schedule of payments over two
and half years that includes approximately $25,000 of interest.





**Item
2**   **Unregistered
Sales of Equity Securities and Use of Proceeds**





*Class
E Preferred Stock Dividends*





During
the second quarter, the Board decided to pay the quarterly dividends on the
Company’s Class E Preferred Stock in shares of common stock. The dividends, at a
rate of $400 per share per quarter, for the last three quarters of 2004 had not
been paid. Pursuant to the provisions of the Class E Preferred Stock
Declaration, shares of common stock, based on the average closing price for the
shares during the last 20 trading days before the dividends were due, maybe paid
in lieu of cash. During January a total of 2,839,076 shares
were issued to settle $109,000 of dividends due at that time. The holders of the
Class E Preferred Stock had represented themselves in writing to be accredited
investors who were purchasing those shares and any shares issued as dividends
for their own investment and agreed to restrictions on resale placed with the
Company’s transfer agent and the printing of a legend on his certificate.
Because of these factors, this issuance is exempt from registration under the
Securities Act as not involving a public distribution under section
4(2).





*Consultants*





In
January the Company issued 1,456,298 shares of common stock to Knightsbridge
Holdings, Inc. in connection with consulting services related to regaining
Bulletin Board trading status. These shares were valued at $13,835.78.





Also in
January, the Company issued 1,000,000 shares to Peter Nasca Associates, Inc. for
public relations services. These shares were valued at $7,000.





Both
consultants are accredited investors who accepted those shares for their own
investment and agreed to restrictions on resale placed with the Company’s
transfer agent and the printing of a legend on his certificate. Because of these
factors, this issuance is exempt from registration under the Securities Act as
not involving a public distribution under section 4(2).





11


*Employees*





In
January, the Company issued a total of 350,000 shares to two employees on the
condition that they remain Company employees through the end of 2005. The shares
are held in escrow to assure their compliance with their obligations. These
shares are valued at $3,500. Both employees are accredited investors who
accepted these shares for their own investment and agreed to restrictions on
resale placed with the Company’s transfer agent and the printing of a legend on
his certificate. Because of these factors, this issuance is exempt from
registration under the Securities Act as not involving a public distribution
under section 4(2).





*Guarantees*





Peter
DeCrescenzo and Vincent DeCrescenzo, Sr. have guaranteed Company obligations and
provided Company access to their personal credit cards, on which the Company
carries substantial balances. Pursuant to Board of Directors resolutions, they
have been issued 4,750,000 and 350,000 shares respectively as compensation for
providing these guarantees and access to credit. These shares were values at
$19,000 and $1,400 respectively. Both guarantors are accredited investors who
accepted these shares for their own investment and agreed to restrictions on
resale placed with the Company’s transfer agent and the printing of a legend on
his certificate. Because of these factors, this issuance is exempt from
registration under the Securities Act as not involving a public distribution
under section 4(2).





*Convertible
Note*





In
January 2005, Dialog Group issued its convertible note to one purchaser. The
note is due May 31, 2006, bears interest at a rate of 5% per annum, and is
convertible with respect to both principal and interest at $0.025 commencing
April 1, 2005. At the same time, Dialog Group granted to the purchaser a warrant
to purchase 540,000 shares of common stock at $0.025 per share commencing April
1, 2005 and continuing until September 30, 2009. The purchaser represented
itself in writing to be an accredited investor who was purchasing these notes
for its own investment. The note and the warrant will bear a Securities Act
legend and the purchaser has agreed, with respect to any common shares to be
issued upon conversion or exercise, to restrictions on resale placed with the
Company’s transfer agent and the printing of a legend on any certificates.
Because of these factors, this sale is exempt from registration under the
Securities Act as not involving a public distribution under section
4(2).





*Other
issues*





See
Current Report on Form 8-K, filed April 27, 2005, for details of other recent
sales of securities.





The
proceeds of all shares issued for cash were used for general business
purposes.




12





**Item
6. Exhibits**





**Exhibits**




*Exhibit
      No.*
    *Description*31(i)
    302
      Certification of Chief Executive Officer31(ii)
    302
      Certification of Chief Financial Officer32(i)
    906
      Certification of Chief Executive Officer32(ii)
    906
      Certification of Chief Financial Officer





13





**SIGNATURES**




In
accordance with Section 13 or 15(d) 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.




**DIALOG
GROUP, INC.**




Date: May
20, 2005




By:   /s/
Peter V. DeCrescenzo




Peter V.
DeCrescenzo, President and Chief Executive Officer




**Signature**
    
    **Title**
    
    **Date**/s/
      Peter V. DeCrescenzo
      Peter
      V. DeCrescenzo
    
    Chief
      Executive Officer
    
    May
      20, 2005/s/Vincent
      DeCrescenzo
      Vincent
      DeCrescenzo
    
    Chief
      Financial
      and
      Accounting Officer
    
    May
      20, 2005







14





**INDEX
TO EXHIBITS**





Exhibit
      Number
    
    Page Number
    
    Description31(i)
    
    --
    
    302
      Certification of Chief Executive Officer31(ii)
    
    --
    
    302
      Certification of Chief Financial Officer32(i)
    
    --
    
    906
      Certification of Chief Executive Officer32(ii)
    
    --
    
    906
      Certification of Chief Financial
Officer





15