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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Washington, D.C. 20549
Form 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2006
Commission file number 0-19941
MEDQUIST INC.
(Exact name of registrant as specified in its charter)
| New Jersey | 22-2531298 | |
| (State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) | |
1000 Bishops Gate Blvd, Suite 300, Mount Laurel, NJ08054-4632
(Address of principal executive offices)
(Address of principal executive offices)
Registrant’s telephone number, including area code:
(856) 206-4000
Securities registered pursuant to Section 12(b) of the Act:
NONE
Securities registered pursuant to Section 12(g) of the Act:
Common Stock (no par value)
(Title of Class)
(Title of Class)
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o No þ
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o No þ
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes o No þ
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 ofRegulation S-K is not contained herein and will not be contained, to the best of registrant’s knowledge, in definite proxy or information statements incorporated by reference in Part III of thisForm 10-K or any amendment to thisForm 10-K. o
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” inRule 12b-2 of the Exchange Act.
| Large accelerated filer o Accelerated filer þ Non-accelerated filer o |
Indicate by check mark whether the registrant is a shell company (as defined inRule 12b-2 of the Exchange Act). Yes o No þ
The aggregate market value of the outstanding common stock held by non-affiliates of the registrant as of June 30, 2007, was $103,783,561. Such aggregate market value was computed by reference to the closing price of the common stock as reported on the “Pink Sheets” on June 30, 2007.
The number of registrant’s shares of common stock, no par value, outstanding as of July 31, 2007 was 37,483,723.
Documents incorporated by reference
None
None
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MedQuist Inc.
Annual Report onForm 10-K
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Annual Report onForm 10-K
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| Item 1. | Business |
General
We are the leading provider of medical transcription technology and services, which are integral to the clinical documentation workflow. We service health systems, hospitals and large group medical practices throughout the U.S., and we employ approximately 6,300 skilled medical transcriptionists (MTs), making us the largest employer of MTs in the U.S. In the clinical documentation workflow, we provide, in addition to medical transcription technology and services, digital dictation, speech recognition, electronic signature and medical coding technology and services. We are a member of the Philips Group of Companies and collaborate with Philips Medical Systems in marketing and product development to leverage Philips’ technology and professional expertise to deliver industry-leading solutions for our customers.
We perform a substantial majority of our medical transcription services utilizing the DocQmenttm Enterprise Platform (DEP), our proprietary, web-based dictation and medical transcription management system. Our proprietary technologies enable our customers to efficiently manage the clinical documentation workflow from dictation through coding.
Clinical Documentation Workflow
The clinical documentation workflow begins when physicians or other medical professionals dictate findings and plans of care into one of several input devices, including standard telephones, handheld devices, or PC-based dictation stations. Once dictated, the voice files securely route through our DEP to either an MT or our speech recognition engine for conversion to text. The resulting draft report may then proceed to the editing and quality assurance process prior to being routed back to the physician or other medical professional for review, finalization, execution and incorporation into a patient’s medical record. Throughout this process, our DEP utilizes security measures that assist our customers with their compliance with privacy and security standards and regulations, including those adopted under the Health Insurance Portability and Accountability Act of 1996 (HIPAA), and the
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protection of the confidentiality of medical records. We also provide document retention services and manual and automated coding services that facilitate reimbursement to our customers.
Significant Events Over The Past Few Years
As a result of the significant events discussed below, we did not file our Annual Report onForm 10-K for the year ended December 31, 2005 (2005Form 10-K) until July 5, 2007.
Over the past few years, a number of significant events have impacted us. The following is a summary of these significant events. This summary should be read together with additional disclosures concerning us contained in this report.
In November 2003, one of our employees raised allegations that we had engaged in improper billing practices. In response, our board of directors undertook an independent review of these allegations and engaged the law firm of Debevoise and Plimpton LLP, who in turn retained PricewaterhouseCoopers LLP, to assist in the review (Review). On March 16, 2004, we announced that we had delayed the filing of our 2003 annual report onForm 10-K pending completion of the Review. Subsequently, on March 25, 2004, we filed aForm 8-K detailing our determination that the Review would not be completed by the March 30, 2004 filing deadline for our 2003Form 10-K. As a result of our noncompliance with the U.S. Securities and Exchange Commission’s (SEC) periodic disclosure requirements, our common stock was delisted from the NASDAQ National Market on June 16, 2004.
On July 30, 2004, we issued a press release entitled “MedQuist Announces Key Findings Of Independent Review Of Client Billing,” which announced certain findings in the Review regarding our billing practices (July 2004 Press Release). The Review found, among other things, that with respect to our medical transcription services contracts that called for billing based on the “AAMT line” billing unit of measure, we used ratios and formulae to help calculate the number of AAMT medical transcription lines for which our customers (AAMT Customers) were billed rather than counting each of the relevant characters to determine a billable line as provided for in the contracts. With respect to these contracts, our use of ratios and formulae to arrive at AAMT line counts was generally not disclosed to our AAMT Customers.
The AAMT line unit of measure was developed in 1993 by three medical transcription industry groups, including the American Association for Medical Transcription (AAMT), in an attempt to standardize industry billing practices for medical transcription services. Following the development of the AAMT line unit of measure, customers increasingly began to request AAMT line billing. Accordingly, we, along with other vendors in the medical transcription industry, began to incorporate the AAMT line unit of measure into certain customer contracts. The AAMT line definition provides that a “line” consists of 65 characters and defined the term “character” to include such things as macros and function keys as well as other information necessary for the final appearance and content of a document. However, these definitions turned out to be inherently ambiguous and difficult to apply in practice. As a result, the AAMT line was applied inconsistently throughout the medical transcription industry. In fact, no single set of AAMT characters was ever defined or agreed upon for this unit of measure, and it was eventually renounced by the groups responsible for its development.
The Review concluded that our rationale for using ratios and formulae to determine the number of AAMT transcription lines for billing was premised on a good faith attempt to adopt a consistent and commercially reasonable billing method given the lack of common standards in the industry and ambiguities inherent in the AAMT line definition. The Review concluded that the use of ratios and formulae within the medical transcription platform setups may have resulted in over billing and under billing of some customers. In addition, in some instances, customers’ ratios and formulae were adjusted without disclosure to the AAMT Customers. However, the Review found no evidence that the amounts we billed AAMT Customers were, in general, commercially unfair or inconsistent with what competitors would have charged. Moreover, it was noted in the Review that we have been able to attract and retain customers in a competitive market.
Following the issuance of the July 2004 Press Release, we began an extensive review of our historical AAMT line billing (Management’s Billing Assessment) and in August 2004 informed our current and former customers that we would be contacting them to discuss how they might have been impacted. In response, several former and current customers, including some of our largest customers, contacted us requesting, among other things, (i) an
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explanation of the billing methods employed by us for the customer’s account; (ii) an individualized review of the customer’s past billings,and/or (iii) a meeting with a member of our management team to discuss the July 2004 Press Release as it pertained to the customer’s particular account. Some customers demanded an immediate refund or credit to their account; others threatened to withhold payment on invoicesand/or take their business elsewhere unless we timely responded to their informationand/or audit requests.
In response to our customers’ concern over the July 2004 Press Release, we made the decision to take action to try to avoid litigation and preserve and solidify our customer business relationships by offering a financial accommodation to our AAMT Customers. In connection with this decision, we analyzed our historical billing information and the available report-level data to develop individualized accommodation offers to be made to our AAMT Customers (Accommodation Analysis). This analysis took approximately one year to complete. The methodology utilized to develop the individual accommodation offers was designed to generate positive accommodation outcomes for our AAMT Customers. As such, the methodology was not a calculation of potential over billing or damages nor was the performance of the Accommodation Analysis intended to reflect any admission of liability due and owed to our AAMT Customers. Instead, the Accommodation Analysis was a methodology that was developed to arrive at commercially reasonable and fair accommodation offers that would be acceptable to our AAMT Customers without negotiation.
In the fourth quarter of 2005, based on the Accommodation Analysis, our board of directors authorized management to make cash accommodation offers totaling $65 million. This amount was subsequently adjusted in 2005 to $65.4 million and in 2006 to $66.6 million. By accepting our accommodation offer, an AAMT Customer must agree, among other things, to release us from any and all claims and liability regarding AAMT line and other billing related issues.
The goal of our accommodation program was to reach a settlement with our AAMT Customers. However, the Accommodation Analysis for certain AAMT Customers did not result in positive accommodation outcomes. For certain other customers, the Accommodation Analysis resulted in calculated cash accommodation offers that we believed were insufficient as a percentage of their historical AAMT line billing to motivate such customers to resolve their billing disputes with us. Therefore, in 2006, we modified our accommodation program to enable us to offer this group of AAMT Customers credits for the purchase of future productsand/or services from us over a defined period of time. On July 21, 2006, our board of directors authorized management to make credit accommodation offers up to an additional $8.7 million beyond amounts previously authorized. During 2006, this amount was adjusted by a net additional amount of $0.5 million based on a refinement of the Accommodation Analysis, resulting in an aggregate amount of $9.2 million.
As part of this process, we also conducted an analysis in an attempt to quantify the economic consequence of potentially unauthorized adjustments to AAMT Customers’ ratios and formulae within the transcription platform setups (Quantification). This Quantification was calculated to be approximately $9.8 million.
Of the authorized cash accommodation amount of $66.6 million, $1.2 million and $57.7 million was treated as consideration given by a vendor to a customer and accordingly recorded as a reduction of revenues in 2006 and 2005, respectively. The balance of $9.8 million was accounted for as a billing error associated with the Quantification resulting in a reduction of revenues in various reporting periods from 1999 to 2005.
On July 5, 2007, we filed our 2005Form 10-K. The 2005Form 10-K was our first periodic report covering periods after September 30, 2003. Several aspects of the 2005Form 10-K differed from other annual reports. The 2005Form 10-K contained, among other things:
| • | Consolidated balance sheets as of December 31, 2005, 2004 and 2003, and the related consolidated statements of operations, cash flows and shareholders’ equity and other comprehensive income for each of the years in the three-year period ended December 31, 2005; | |
| • | Regulation S-X, Article 10 Interim Financial Statements for each fiscal quarter in 2005 and in 2004 (including comparable information for the corresponding quarters in 2003, which information contains restated numbers from our previously issued consolidated interim financial statements for each of the first three fiscal quarters in 2003); |
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| • | Management’s Discussion and Analysis of Financial Condition and Results of Operations (MD&A) liquidity and capital resources disclosure as of December 31, 2005, 2004 and 2003 and as of the end of the first three fiscal quarters in 2005, 2004 and 2003. In addition, we included MD&A results of operations disclosure (including a comparison to the comparable period in the prior year) for (i) the year ended December 31, 2005; (ii) the year ended December 31, 2004; (iii) the year ended December 31, 2003; (iv) the three months ended December 31, 2005; (v) the three months ended September 30, 2005; (vi) the three months ended June 30, 2005; (vii) the three months ended March 31, 2005; (viii) the three months ended December 31, 2004; (ix) the three months ended September 30, 2004; (x) the three months ended June 30, 2004; and (xi) the three months ended March 31, 2004; and | |
| • | A restatement of our previously issued consolidated financial statements included in ourForms 10-Q filed during 2003 and our Form10-K for the fiscal year ended December 31, 2002. Please note that on November 2, 2004, we filed a Form 8-K disclosing our board of directors’ conclusion that our previously issued consolidated financial statements included in our Form 10-K for the fiscal year ended December 31, 2002, our Forms 10-Q filed during 2002 and 2003, and all earnings releases and similar communications relating to such periods, should no longer be relied upon. |
Immediately preceding the filing of this report onForm 10-K for the fiscal year ended December 31, 2006, we filed ourForms 10-Q for the first three fiscal quarters of 2006.
Customer Accommodations
As discussed above, based on the Accommodation Analysis, our board of directors authorized management to make cash accommodation offers to AAMT Customers in the aggregate amount of $66.6 million and credit accommodation offers in the aggregate amount of $9.2 million. A large number of customers have accepted our offers under the accommodation program and, in return, released us from any and all claims and liability regarding AAMT line billing and other billing related issues that they may have had against us. As of July 31, 2007, we have entered into agreements with certain customers who have accepted cash accommodation offers and paid or credited to their account an aggregate amount of $53.6 million. In addition, as of July 31, 2007, we have made cash accommodation offers to certain other customers in the aggregate amount of $1.8 million. Further, as of July 31, 2007, we have entered into agreements with certain customers who have accepted credit accommodation offers with a total credit value of $4.4 million and have extended credit accommodation offers to certain other customers with a total credit value of $0.7 million.
We intend to continue making cash and credit accommodation offers in the future, although the timing and amount of such offers have not yet been determined and our plans may change. The accommodation offers made to date, and those offers which may be made in the future, are not an admission of liability by us of any wrongdoing or an admission or acknowledgement that our billing practices with respect to such customers were or are incorrect.
Governmental Investigations and Civil Litigation
Disclosure of the findings of the Review, along with the delisting of our common stock, precipitated a number of governmental investigations and civil lawsuits. These events are discussed in summary below. A fuller description of these events can be found in Item 3, Legal Proceedings.
Governmental Investigations
The SEC is currently conducting a formal investigation of us relating to our billing practices. We have been fully cooperating with the SEC since it opened its investigation in 2004. We have complied and are continuing to comply with information and document requests by the SEC.
We received an administrative HIPAA subpoena from the U.S. Department of Justice (DOJ) on December 17, 2004. The subpoena sought information primarily about our provision of medical transcription services to governmental and non-governmental customers. The information was requested in connection with a dual civil and criminal government investigation into whether we and others violated federal laws in connection with the provision of medical transcription services. We have been fully cooperating with the DOJ since it began its
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investigation in 2004. We have complied, and are continuing to comply, with information and document requests by the DOJ.
The U.S. Department of Labor (DOL) is currently conducting a formal investigation into the administration of our 401(k) plan. We have been fully cooperating with the DOL since it opened its investigation in 2004. We have complied and are continuing to comply with information and document requests by the DOL.
Developments relating to the SEC, DOJand/or DOL investigations will continue to create various risks and uncertainties that could materially and adversely affect our business and our historical and future financial condition, results of operations and cash flows.
Civil Litigation
| • | Customer Litigation — In September 2004, a purported class action was filed against us and some of our current and former officers on behalf of certain of our customers claiming, among other things, that they were wrongfully and fraudulently overcharged for medical transcription services based primarily on our use of the AAMT line billing unit of measure as discussed above. In January 2006, plaintiffs filed a third amended complaint which expanded their claims to include certain of our customers whose charges for medical transcription services were based on other, non-AAMT billing units of measure. On March 30, 2007, the Court issued an order holding that plaintiffs could not make out a claim that we had violated the Racketeer Influenced and Corrupt Organizations Act statute (RICO), thus eliminating any claim against us for treble damages. The Court also found that plaintiffs could not make out a claim that we had engaged in any unfair or deceptive acts or practices in violation of state law or that we were liable for any negligent misrepresentations to plaintiffs. In its ruling, the Court, without reaching a decision of whether any wrongdoing had occurred, allowed plaintiffs to proceed with their claims against us for fraud, unjust enrichment and an accounting. The Court denied our motion to compel arbitration regarding those customers whose contracts contained an agreement to arbitrate. We have appealed that decision to the Third Circuit Court of Appeals and moved the district court to stay all proceedings pending appeal. Plaintiffs oppose any stay and have filed a motion for summary action in the Third Circuit to dismiss the non-arbitration plaintiffs from the appeal. The district court took the motion to stay under submission, and the Third Circuit referred plaintiffs’ motion to the merits panel for decision after full briefing. In addition, on July 18, 2007, the Third Circuit issued notice that the case had been assigned to mediation in the Court’s mediation program. On August 1, 2007, plaintiffs filed a motion for expedited review on appeal. We do not oppose this motion, and the parties have agreed to a schedule pursuant to which the appeal will be fully briefed by November 16, 2007. On August 21, 2007, the Third Circuit granted the motion for expedited review. Under the Court’s order, briefing is scheduled to be completed by November 16, 2007. The Third Circuit also has ordered the parties to telephonic mediation, which is scheduled to proceed on September 12, 2007. | |
| • | Shareholder Securities Litigation — In November 2004, a complaint was filed, and thereafter amended twice, against us and some of our former and current officers, directors and auditors, purporting to be a class action under the federal securities laws on behalf of those shareholders who purchased our common stock during a period beginning March 29, 2000 and ending June 14, 2004. A hearing on our motion to dismiss was held on August 17, 2006. On September 29, 2006, the Court issued an order denying our motion to dismiss. However, in the same order, the Court granted the motion to dismiss filed by our former and current external auditors. On March 23, 2007, we entered into a memorandum of understanding and a stipulation of settlement with the lead plaintiff in which we agreed to pay $7.75 million to settle all claims, throughout the class period, against all defendants in the action. On May 16, 2007, the Court issued an Order Preliminarily Approving Settlement and Providing for Notice. The Court conducted a final approval hearing and approved the settlement on August 15, 2007. Neither we nor any of the individuals named in the action has admitted to liability or any wrongdoing in connection with the settlement. | |
| • | Shareholder Derivative Litigation — In November 2004, a shareholder derivative lawsuit was filed against our majority shareholder, Koninklijke Philips Electronics N.V. (Philips), some current and former members of our board of directors, and us, as a nominal defendant, alleging that the defendants had breached their |
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| fiduciary duties. This matter was dismissed with prejudice in September 2005. In December 2005, plaintiff filed an appeal, which was denied on May 25, 2007. |
| • | Medical Transcriptionist Litigation — Between November 2004 and October 2005, three separate actions were filed by different parties against us and some of our current and former company officials, purportedly on behalf of an alleged class of our current and former employees and statutory workers, alleging among other things, breach of contract, breach of the covenant of good faith and fair dealing and unjust enrichment. Since the causes of action in each matter were substantially similar, the three cases were consolidated into one action. A hearing on our motion to dismiss was held on August 7, 2006. On December 21, 2006, the Court issued an order denying our motion to dismiss, and the case has proceeded to the discovery stage. The deadline to complete pre-trial fact discovery is October 30, 2007. |
Developments relating to third party litigation and governmental investigations will continue to create various risks and uncertainties that could materially and adversely affect our business, financial condition, results of operations and cash flows.
Industry Overview
As a provider of medical transcription technology and services, our revenues and growth are affected in part by certain trends in healthcare.
Increased Spending and Demographic Factors in Healthcare Industry
Spending for healthcare in the U.S. has grown rapidly over the past few decades. According to estimates published by the Centers for Medicare & Medicaid Services (CMS) Office of the Actuary, the healthcare sector is growing faster than the overall economy. Healthcare spending increased as a share of U.S. gross domestic product from 13.3% in 2000 to 16% in 2005, as growth in healthcare spending outpaced economy-wide growth.
In 2005, healthcare spending in the U.S. was approximately $2 trillion. CMS estimates that by 2016 healthcare spending will have increased to $4.1 trillion, which will represent 19.6% of the projected U.S. gross domestic product. Demographic factors contribute to long-term growth projections in healthcare spending. According to the U.S. Census Bureau’s 2005 interim projections, there were approximately 35 million Americans aged 65 or older. The number of Americans aged 65 or older is expected to increase to approximately 40 million by 2010 and approximately 70 million by 2030, or 20% of the U.S. population. We believe that the aging of the U.S. population and the continuing growth in healthcare spending will increase demand for our products and services. Older age groups receive proportionately greater numbers of procedures, medical tests and treatments that require clinical documentation. We believe that the high demand for medical transcription services will also be sustained by the need of providers, third-party payors, consumers, regulators and health information networks to share electronic health information.
Competitive Environment
The healthcare industry is increasingly choosing to outsource services such as medical transcription to reduce personnel and administrative burdens and fixed costs as information needs and volume of dictated reports expand. The medical transcription industry itself is highly fragmented and difficult to size based on a general lack of public market data and analysis. As such, we estimate that the U.S. medical transcription market is between $9 and $12 billion on an annual basis, including both outsourced services and medical transcription performed internally by healthcare providers. We believe that the top 10 medical transcription outsource providers based on revenues, of which we are the largest, account for less than 15% of the industry including in-house operations.
Although we are the leading provider of medical transcription services in the U.S., we experience competition from local, regional, national and international businesses. We believe that there are hundreds of companies in the U.S. and India currently performing medical transcription services for the U.S. market. There are currently two large service providers, one of which is us and the other of which is Spheris Inc., several mid-sized service providers with annual revenues of between $15 million and $100 million and hundreds of smaller, independent businesses
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with annual revenues of less than $15 million. We believe that a substantial portion of the medical transcription market is serviced internally by MTs directly employed by the healthcare providers.
We believe the outsourced portion of the medical transcription services market will increase due in part to healthcare providers seeking the following:
| • | reduction in overhead and other administrative costs; | |
| • | improvement in the quality and speed of delivery of transcribed medical reports; | |
| • | access to leading technologies, such as speech recognition technology, without development and investment risk; | |
| • | expertise in implementing and managing a system tailored to the providers’ specific requirements; | |
| • | access to skilled MTs; and | |
| • | support for compliance with governmental and industry mandated privacy and security requirements and electronic health record (EHR) initiatives. |
Our competitive position in the market is characterized primarily by the following factors:
| • | We are the leading medical transcription provider in the U.S., with a strong customer base, the largest pool of MTs and leading technologies capable of handling large volumes and complex workflows. As the largest medical transcription provider in the U.S., we are recognized as the leading brand in the industry. We have a well-established customer base, comprised of hundreds of health systems, hospitals and large group medical practices located throughout the U.S. We have an integrated, flexible and scalable technology platform that can be tailored to meet our customers’ needs. We are the largest employer of MTs and have the most widely deployed technology platform. As health systems, hospitals and large group medical practices increasingly seek to outsource their medical transcription and other clinical document workflow needs, we have the resources to quickly and efficiently provide our customers with comprehensive, scalable solutions. | |
| • | We offer a comprehensive array of products and services. We offer a comprehensive array of products and services for dictation, medical transcription, speech recognition, electronic signature and coding through a combination of remote and on-premise solutions. These solutions are designed to maximize the efficiency, accuracy and security of our customers’ documentation and coding processes, while enhancing their patient care, accelerating their revenue cycle and lowering their costs. | |
| • | We have the strongest financial profile in the medical transcription industry. We continue to maintain a substantial cash balance and have no debt. | |
| • | We face aggressive price competition from competitors providing offshore services. As the outsourced portion of the medical transcription services market continues to increase, the growing acceptance of offshore alternatives has led to increased offshore competition, primarily from India, and corresponding reductions in price. In addition to the increased use of offshore firms, medical transcription rates are reduced increasingly by technological advances, particularly in the area of speech recognition. |
Business Strategy
We intend to maintain our position as the leading provider of medical transcription technology and services while transforming into a leading provider of complete clinical documentation workflow. We plan to achieve this objective through the following strategies:
Retain and Expand Customer Relationships. We constantly seek to improve turnaround time, medical transcription quality and customer communications. We believe that advances in these areas improve retention of existing customers and increase our ability to secure new customers. In addition, in the past we grew our revenue base through acquisitions, and we did not have a centralized sales force for medical transcription services. Today, we have a centralized sales function and have strengthened our marketing team to better focus on customer executive level decision-makers to enhance sales opportunities for new and existing customers.
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Enhance Efficiencies. In response to competitive price pressures driven by increasing market acceptance of speech recognition and offshore labor options, we have improved our operations through the following initiatives:
| • | consolidating over 60 operating facilities and transitioning all MTs to virtual employment; | |
| • | enhancing speech recognition technologies to increase the efficiency of the delivery of our products and services; | |
| • | transitioning to a single national service delivery and support organization for all of our products and services to improve both levels of service and quality for our customers and reduce costs; and | |
| • | partnering with offshore subcontractors to provide us with access to international labor pools to expand and improve our service delivery capabilities. |
Leveraging our DEP. For medical transcription services that we perform on our platform, we have completed the migration of our outsourced medical transcription customers from disparate and older technology platforms to our DEP. We believe that the combination of standardization, advanced functionality and transparency with respect to service metrics provided by this platform will significantly increase our customers’ satisfaction and retention. Our commitment to our DEP allows us to accelerate the rate at which we can offer new functionalities to our customers. In addition, we currently offer and plan to expand the offering of our DEP to healthcare providers and other companies in the medical transcription industry for use as their medical dictation and transcription platform.
Expansion Into New Markets. We believe our breadth of products and services, spanning from dictation through coding, positions us to bridge the gap between traditional medical transcription and the EHR. The U.S. government has developed plans that call for all Americans to have an EHR by 2014. The EHR is directly tied to the national Health Information Technology (HIT) initiative — the creation of a transparent, interoperable and digital system designed to improve patient care and reduce healthcare costs. The EHR concept, which has been endorsed by the current presidential administration and a host of national healthcare associations, is a longitudinal electronic record of patient health information generated by one or more patient encounters in any care delivery setting. The EHR includes patient demographics, past medical history, progress notes, medications, vital signs, health problems, immunizations, laboratory data and radiology reports. The EHR streamlines the providers’ workflow and, in addition to having the ability to generate a complete clinical record of a patient encounter, can also support other care-related activities, including evidence-based decision support, outcomes reporting and quality management.
We intend to leverage our market leading position and proprietary technologies to provide comprehensive solutions to our customers related to the management of health records. Historically, we have provided a combination of traditional medical transcription services, stand-alone products and other professional services to healthcare providers. We anticipate aggregating these existing services and products and new services and products into a comprehensive clinical documentation workflow solution.
Pursue Strategic Transactions. We may pursue strategic transactions or other relationships that expand our customer base or increase our network of labor pools. We may also explore opportunities to acquire technologies which could enhance our product or service offerings and improve efficiencies.
Customer Base
We have a large and prestigious customer base. We believe that over 30% of non-federal acute care U.S. hospitals use at least one of our products or services. Additionally, we have the largest customer base of any medical transcription company in the U.S., currently serving over 1,500 hospital systems, clinics and large physician practices, including approximately 40% of hospitals with more than 500 licensed beds. We believe we are the medical transcription company of choice for large, complex hospitals and health systems in the U.S. due to our size, scale and scope. We provide services to entire healthcare systems as well as discrete departments within hospitals, such as health information management, emergency, radiology, pathology and cardiology departments and all types of clinic settings. None of our customers accounted for more than 10% of our annual net revenues in 2006.
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Products and Services
For the year ended December 31, 2006, approximately 84% of our net revenues were derived from our medical transcription technology and services. In addition, we also derive net revenues from, among other things, maintenance services, medical records coding, SpeechQ for Radiologytm and DocQment Ovation.
Medical Transcription Services
We provide health systems, hospitals and large group medical practices with comprehensive solutions to meet their medical transcription needs. As the largest medical transcription services provider, we employ approximately 6,300 skilled MTs. This scale allows us to continually offer our customers effective, tailored medical transcription services that meet organization-wide or departmental needs. We perform a substantial majority of our medical transcription services utilizing our DEP. In addition, we also service a specialized area of the medical transcription market — specifically, radiology — whereby we retrieve voice files from, and transcribe directly into, customer-hosted transcription platforms.
In the clinical documentation workflow, we provide, in addition to medical transcription technology and services, digital dictation, speech recognition, electronic signature and medical coding technology and services.
Our DEP and flexible dictation solutions provide our customers with easy access to advanced technology and the confidence that medical reports will be completed quickly and accurately. Our DEP, which is a web-based dictation and transcription management system, integrates dictation capture, workflow management, speech recognition, medical transcription, and document distribution through multiple distinct yet integrated modules as follows:
Features and benefits of our DEP include the following:
Security and Scalability
| • | supports all standards required by HIPAA and other applicable laws and regulations | |
| • | utilizes data centers along with24-hour system monitoring and maximum uptime | |
| • | allows for universal and simultaneous user upgrades through server-based web technology | |
| • | fulfills increased clinical document workflow demands through seamless scalability |
Cost Effectiveness
| • | provides one interface for health information systems | |
| • | eliminates the costs and challenges of supporting multiple dictation and medical transcription systems for individual hospitals and departments | |
| • | integrates with and builds on existing systems | |
| • | allows for the centralized maintenance of all system hardware and software at our data centers | |
| • | allows MTs and editors to work remotely |
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| • | eliminates traditional phone charges and other overhead costs associated with home-based medical transcription |
Workflow
| • | allows viewing of medical reports on a real-time basis from multiple locations through a single and secure login, password and company identification | |
| • | increases the level of our customers’ management control over medical transcription workflow across healthcare enterprises | |
| • | reduces the amount of time reports spend in queue as well as MT downtime | |
| • | takes transcribed text and matches it to user pre-defined templates using automatic post-transcription formatting |
Auditing and Reporting
| • | facilitates transparency in the billing process with detailed character count logs for every processed document | |
| • | provides audit trails with detailed information regarding access to patient health information | |
| • | offers quality and turnaround time reporting for tracking of service metrics |
Maintenance Services
We provide onsite maintenance, remote “break-fix” services, and application, hardware and software technical support for our products. We also provide product management functions for released solutions, including service support guides, maintenance contract pricing, parts planning and service policies.
Medical Records Coding
Our health information management coding solutions involve the translation of written narratives of diseases, injuries and procedures into numeric or alphanumeric descriptions to identify the diagnosis, treatment and severity of illness of a patient’s medical episode for reporting and reimbursement purposes. We offer professional coding services for both inpatient and outpatient settings, including same day surgery, emergency and ancillary departments and clinics within the hospital environment as well as physician offices and ambulatory surgery centers. Our coding solutions provide the coded data required to support the reporting and billing requirements of healthcare organizations and professional practices and allow for some of the services to be provided remotely through CodeRunnertm, our proprietary, secure, internet-based computer-assisted coding and workflow management application, by our staff of credentialed codersand/or our customers’ coders. CodeRunner accepts electronic text documents, whether generated by dictation, speech recognition, transcriptionand/or structured templates, as well as electronic imaged documents, generated by scanning. Additionally, CodeRunner automatically generates comprehensive audit trails and reporting of access to the medical records as well as of the coding activity. Its coding management tools provide customers with real-time coder activity monitoring, visibility into medical record coding workflow (including automated quality assurance and auditing capabilities), and the ability to workload balance, all contributing to a more efficient coding process and thus enhancing coder productivity.
SpeechQ for Radiology
SpeechQ for Radiology is a flexible front-end speech recognition software application. It allows radiologists to dictate, edit and sign their reports in a single session or send them to an editor following dictation. SpeechQ for Radiology continuously learns from changes to a specific radiologist’s dictation made by either the radiologist or an editor, increasing the speech recognition accuracy for such radiologist with every edit. Powered by the Philips SpeechMagictm speech engine, SpeechQ for Radiology is designed specifically for radiology, and integrates with most radiology specific information systems providing a workflow that maximizes radiologists’ efficiency and significantly improves report turnaround time.
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DocQment Ovation
Our newest offering in the digital dictation system market is DocQment Ovation, a web-based, enterprise digital voice capture and transport solution. DocQment Ovation creates opportunities to improve productivity by providing an enterprise view that allows medical transcription supervisors to easily manage MTs and voice files from a single dashboard instead of using multiple systems. Specifically engineered to be compatible with our previous generation dictation stations, physicians should have a seamless transition, with little to no training required. An integral component of our growing technology portfolio, DocQment Ovation supports our end-to-end solution from dictation to billing. DocQment Ovation’s enterprise configuration options allow administrators to easily track work and share resources to get the right voice file to the right MTs at the right time.
Technological Capabilities
Research and Development
We invest in our capabilities to ensure we meet current and future customer requirements. Our proprietary software and hardware technologies support our medical transcription and coding outsourced services. Our software capabilities enable us to operate a national service delivery model that includes nationwide multi-modal voice capture. Our expertise in the use of speech recognition enables us and our customers to achieve productivity gains and cost savings. We continue to work to enhance our speech recognition and editing technologies to achieve productivity gains in the medical documentation process. Our DEP and technological expertise in the areas of work routing and work management support a nationwide, scalable model of medical transcription delivery. Our ability to focus on a single dictation and transcription management system, our DEP, based on an application service provider model enables us to efficiently and effectively utilize our research and development resources.
We employ over 100 developers to conduct our research and development in four locations: Joplin, Missouri, Morgantown, West Virginia, Norcross, Georgia, and Malvern, UK. Although we license a portion of our technology from third party vendors, a majority of our technological expertise resides in our development organization. Our development personnel have expertise across the breadth of our solutions, including voice capture management, speech recognition and editing, medical transcription, electronic signature and distribution and coding. All of our development teams follow the same rigorous development methodology which ensures repeatable, high quality and timely delivery of solutions.
Speech Recognition
Our speech recognition technology is provided by Philips Speech Processing GmbH, an affiliate of Philips which is now known as Philips Speech Recognition Systems GmbH (PSRS). For additional information regarding this relationship, see Item 13 — Certain Relationships and Related Transactions, and Director Independence. We have integrated this technology into our DEP which has provided us with productivity gains, streamlined workflow and, through continuous learning from the corrections made by editors, improved quality. Since the beginning of 2003, we have significantly increased our use of automated speech recognition.
Sales and Marketing
We focus a significant portion of our sales and marketing resources on retaining and expanding the business within our existing customer base. In addition, we target healthcare facilities currently performing medical transcription in-house and those facilities that have already outsourced their medical transcription function, but are using a competitor.
Historically, we grew our customer base primarily through acquisitions of regional medical transcription outsource companies. Since 2002, we have been developing a dedicated sales force. Today, we use a direct sales force model of over 100 sales and account management associates, including specialists for national accounts, front-end speech technology, coding and digital dictation. In addition, we have an inside sales department that specializes in telesales and lead generation primarily for ancillary products to our existing customers and our DEP to other medical transcription outsource companies.
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To support our sales initiatives, we utilize various marketing programs to maintain and expand our brand. We promote our offerings regularly through:
| • | attending and sponsoring industry trade shows of national organizations such as the American Health Information Management Association, Healthcare Information and Management Systems Society, American Association of Medical Transcriptionists and Healthcare Financial Management Association; | |
| • | advertising in industry focused print and electronic trade journals; | |
| • | demonstrating our thought leadership on industry topics and trends via webinars and participation in numerous state and regional trade show events; and | |
| • | hosting user group events for existing customers to exchange product and market information. |
Service Delivery and Customer Support
Understanding the need for person-to-person responsiveness within our industry, we reorganized and centralized our service and support organization in 2005. We continue to offer a wide range of customer support services through an expansive staff of over 300 customer-facing service personnel. The customer-facing relationship teams work with, and are supported by, our centrally managed customer service organization.
Centralized service delivery and customer support eliminates the need for local independently managed service centers. This structure enhances workflow management, resulting in improved levels of service and quality for our customers. This has been implemented through the following:
| • | The MedQuist Qtinuum of Caretminitiative. This initiative embraces our entire company by uniting and streamlining process, technology, services and support with one goal in mind — our customer. The Qtinuum of Care focuses on driving increased levels of customer satisfaction through a combination of centralized and integrated customer service and support and field-based customer relationship management with a focused personal touch. As part of the Qtinuum of Care, we have an internal training program we call “The MedQuist Way.” This program promotes quality service and customer focus through comprehensive, customized employee education, which has created an environment where all of our service employees are empowered to take ownership of customer issues until they are completely resolved. | |
| • | Centralized medical transcription service delivery. This centralization coordinates the services of thousands of MTs on a nationwide level, facilitating superior capacity planning even when volume fluctuates. By applying streamlined processes and the highest standards nationwide, we are able to provide quick turnaround time and consistent quality documentation. |
Our service and support organization is comprised of several smaller organizations, or teams, focused on delivering specific aspects of services. In addition to technical and product support, we offer implementation professional services, which provide our customers with complete implementation planning and services beginning with the initial scoping of system requirements through the customer acceptance phase of an implementation.
Medical Transcriptionists
As the leading provider of medical transcription technology and services, we employ approximately 6,300 skilledU.S.-based MTs, making us the largest employer of MTs in the U.S. In addition, we contract with approximately 340 MTs in Canada and have access to offshore MTs through our relationship with several subcontractors. The size of our MT pool allows us to quickly and efficiently provide our customers with the labor resources necessary to implement comprehensive, scalable solutions.
Historically, we conducted our operations through, and a small percentage of our MTs worked out of, local service centers utilizing a number of disparate technology platforms to convert dictation to transcribed reports. In connection with the reorganization and centralization of our service and support organization, we phased out these local service centers and completed the migration of our disparate non-customer hosted medical transcription platforms onto our DEP. As a result, all of our MTs now work from home, largely using computer hardware and telecommunications equipment that we provide, to access dictation files and transcribe reports utilizing the internet.
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Recruitment
Working with a team of professional recruiters, we utilize multiple avenues to ensure that qualified MTs apply for employment opportunities with us. Regular advertisements and articles appear in trade journals and industry publications, and banner ads are placed on industry and trade websites. In addition, we participate in prominent local and national trade shows and work with premier medical transcription schools to offer top graduates an opportunity for employment with us.
Training
Substantially all of our new MTs participate in an on-line training program that includes both a company orientation, as well as training on our DEP. In addition, those MTs that service specialized areas of the medical transcription market involving the direct transcription into customer-hosted medical transcription platforms receive platform-specific training. Prior to performing medical transcription services for our customers, each MT must demonstrate proficiency in the use of our DEP or the applicable customer-hosted platform.
With the emergence of speech recognition technology to produce draft transcribed reports, our MTs have an opportunity to become medical editors (MEs). Before they are eligible to edit the draft transcribed reports, MEs must be formally certified on DocQspeechtm, our DEP’s speech recognition module. Currently over 40% of our MTs have been cross trained as MEs.
Quality Assurance
Our automated technology routes reports with flagged quality issues to our quality assurance personnel for review prior to delivery to the customer. In addition, formal quality reviews are performed on a regular basis at both the individual MT and customer levels. We provide continuous feedback to the MT staff to increase learning and improve up-front quality through QASARtm, our quality assurance scoring and reporting tool. Our MTs participate in an on-going, comprehensive training program in order to maintain a high level of quality assurance.
Intellectual Property
We rely on a combination of copyright, trademark, trade secret, and other intellectual property laws, nondisclosure agreements, license agreements, contractual provisions and other measures to protect our proprietary rights. We have a number of registered trademarks, including MedQuist®, and have current registrations of several domain names, including “www.medquist.com.”
Regulatory Matters
The provision of healthcare services, including the practice of medicine, is heavily regulated by federal and state statutes and regulations, by rules and regulations of state medical boards and state and local boards of health, and by codes established by various medical associations. Although many such laws, regulations and requirements do not directly apply to our operations, future laws and regulations related to the provision of medical transcription services may require us to restructure our operations in order to comply with such requirements.
Although many healthcare laws and regulations do not directly apply to our operations, our hospital and other healthcare provider customers must comply with a variety of requirements related to the handling of patient information, including HIPAA, which protects the privacy, confidentiality and security of protected health information (PHI). As part of the operation of our business, our customers provide us with certain PHI. The provisions of HIPAA require our customers to have agreements in place with us under which we are required to appropriately safeguard the PHI we create or receive on their behalf.
We have structured our operations to comply with these contractual requirements. We have designated a Chief Compliance Officer, as well as a HIPAA compliance officer, and have implemented appropriate safeguards related to the access, useand/or disclosure of PHI to help ensure the privacy and security of PHI consistent with our contractual requirements. We also are required to train personnel regarding HIPAA requirements. If we, or any of our MTs, are unable to maintain the privacy, confidentiality and security of the PHI that is entrusted to us, our customers could be subject to civil and criminal fines and sanctions and we could be found to have breached our
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contracts with our customers. Additionally, because all HIPAA standards are subject to interpretation and change, we cannot predict the future impact of HIPAA on our business and operations. Although it is not possible to anticipate the total effect of these regulations, we have made and continue to make investments in systems to support customer operations that are regulated by HIPAA.
Further, our customers are required to comply with HIPAA security regulations that require them to implement certain administrative, physical and technical safeguards to ensure the confidentiality, integrity and availability of electronic protected health information (EPHI). We are required by contract to protect the security of EPHI that we create, receive, maintain or transmit for our customers consistent with these regulations, including implementing administrative, physical and technical safeguards that reasonably and appropriately protect the confidentiality, integrity and availability of such EPHI. To comply with our contractual obligations, we may have to reorganize processes and invest in new technologies.
To the extent that the laws of the states in which we or our customers operate are more restrictive than HIPAA, we may have to incur additional costs to maintain compliance with any such applicable requirements.
Employees
As of July 31, 2007, we employed 8,200 people. Of these, 6,327 were MTs. Of our total work force, 4,520 were full-time employees and 3,680 were part-time employees.
Available Information
All periodic and current reports, registration statements, and other filings that we are required to file with the SEC, including our annual reports onForm 10-K, quarterly reports onForm 10-Q, current reports onForm 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) of the Securities Exchange Act of 1934 (Exchange Act), are available free of charge from the SEC’s website (www.sec.gov) or public reference room at 100 F Street N.E., Washington, DC 20549(1-800-SEC-0330) or through our website at www.medquist.com. Such documents are available as soon as reasonably practicable after electronic filing of the material with the SEC. Copies of these reports (excluding exhibits) may also be obtained free of charge, upon written request to: Investor Relations, MedQuist Inc., 1000 Bishops Gate Boulevard, Suite 300, Mount Laurel, New Jersey08054-4632. The website addresses included in this report are for identification purposes. The information contained therein or connected thereto are not intended to be incorporated into this report.
Availability of Board of Director Committee Charters
Our board of directors has adopted a charter for its Audit Committee. A copy of this charter is available free of charge through our website at www.medquist.com or to any shareholder who requests it in writing by contacting our Chief Compliance Officer at 1000 Bishops Gate Boulevard, Suite 300, Mount Laurel, New Jersey08054-4632.
| Item 1A. | Risk Factors |
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
This report contains forward-looking statements that are based on current expectations, estimates, forecasts and projections about us, the industry in which we operate and other matters, as well as management’s beliefs and assumptions and other statements regarding matters that are not historical facts. These statements include, in particular, statements about our plans, strategies and prospects. For example, when we use words such as “projects,” “expects,” “anticipates,” “intends,” “plans,” “believes,” “seeks,” “estimates,” “should,” “would,” “could,” “will,” “opportunity,” “potential” or “may,” variations of such words or other words that convey uncertainty of future events or outcomes, we are making forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 (Securities Act) and Section 21E of the Exchange Act. Our forward-looking statements are subject to risks and uncertainties. Actual events or results may differ materially from the results anticipated in these forward-looking statements as a result of a variety of factors. While it is impossible to identify all such factors, factors that could cause actual results to differ materially from those estimated by us include:
| • | each of the factors discussed in this Item 1A, Risk Factors as well as risks discussed elsewhere in this report; |
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| • | each of the matters discussed in Item 3, Legal Proceedings; | |
| • | difficulties relating to our significant management turnover; | |
| • | our ability to recruit and retain qualified MTs and other employees; | |
| • | the impact of our new services and products on the demand for our existing services and products; | |
| • | our current dependence on medical transcription for substantially all of our business; | |
| • | our ability to become current in our periodic reporting obligations under the Exchange Act; | |
| • | our ability to expand our customer base; | |
| • | changes in law, including, without limitation, the impact HIPAA will have on our business; | |
| • | infringement on the proprietary rights of others; | |
| • | our ability to diversify into other businesses; | |
| • | the results of our review of strategic alternatives; | |
| • | our ability to effectively integrate newly-acquired operations; | |
| • | competitive pricing pressures in the medical transcription industry and our response to those pressures; and | |
| • | general conditions in the economy and capital markets. |
Many of these factors are beyond our ability to predict or control. In addition, as a result of these and other factors, our past financial performance should not be relied on as an indication of future performance. The cautionary statements referred to in this section also should be considered in connection with any subsequent written or oral forward-looking statements that may be issued by us or persons acting on our behalf. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law. In light of these risks and uncertainties, the forward-looking events and circumstances discussed in this report might not occur. Furthermore, we cannot guarantee future results, events, levels of activity, performance, or achievements.
Set forth below are certain important risks and uncertainties that could adversely affect our results of operations or financial condition and cause our actual results to differ materially from those expressed in forward-looking statements made by us. Although we believe that we have identified and discussed below the key risk factors affecting our business, there may be additional risks and uncertainties that are not presently known or that are not currently believed to be significant that may adversely affect our performance or financial condition. More detailed information regarding certain risk factors described below is contained in other sections of this report.
We are subject to ongoing investigations, which could require us to pay substantial fines or other penalties or subject us to sanctions and we cannot predict the timing of developments in these matters.
Prior to our July 2004 Press Release, we notified the staff of the SEC that our board of directors had commenced the Review. Following that notification, the SEC began an enforcement proceeding, including an investigation into the facts and circumstances giving rise to the Review. We have been and intend to continue cooperating fully with the SEC.
The Review overseen by our board of directors led to a delay in the filings of this and other required reports with the SEC. Because of this delay, we were not in compliance with the listing standards of NASDAQ and NASDAQ delisted our common stock on June 16, 2004.
On December 17, 2004, we received an administrative HIPAA subpoena for documents from the DOJ. The subpoena seeks information primarily about our provision of medical transcription services to governmental and non-governmental customers. The information was requested in connection with a dual civil and criminal government investigation into whether we and others violated federal laws in connection with the provision of medical transcription services. We have been and intend to continue cooperating fully with the DOJ.
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On November 23, 2004 we received notice from the DOL of its commencement of a formal investigation into the administration of our 401(k) plan. We have been fully cooperating with the DOL since it opened its investigation in 2004. We have complied and are continuing to comply with information and document requests by the DOL.
We cannot predict when the investigations will be completed or the timing of any other developments, nor can we predict what the result of these matters may be. See Item 3, Legal Proceedings, for a further discussion of these matters.
Expenses incurred in connection with these matters (which include substantial fees for lawyers and other professional advisors) could adversely affect our financial position, results of operations and liquidity. We may be required to pay material judgments, fines, penalties or settlements or suffer other penalties, each of which could have a material adverse effect on our business and our historical and future results of operations, financial condition and liquidity. The investigations may adversely affect our ability to obtain,and/or increase the cost of obtaining directors’ and officers’ liability insuranceand/or other types of insurance, which could have a material adverse affect on our ability to retain our current or obtain new senior management and directors. In addition, the findings and outcomes of the investigations described above may adversely affect the course of the civil litigation pending against us.
Several lawsuits have been filed against us involving our billing practices and other related matters and the outcome of these lawsuits may have a material adverse effect on our business, financial condition, results of operations and cash flows.
A number of lawsuits have been filed against us, as well as certain of our past and current officersand/or directors and current majority shareholder, relating to, among other things, allegations of violations of the federal securities laws and various common laws based on allegedly unlawful billing and payroll practices. Substantial damages or other monetary remedies assessed against us could have a material adverse effect on our business, financial condition, results of operations and cash flows. See Item 3, Legal Proceedings, for a further discussion of these matters.
The continuing time, effort, and expense relating to the allegations raised regarding our past billing practices, our efforts to become current in our SEC filings and the development and implementation of improved internal controls and procedures may have an adverse effect on our business.
Our management team has spent considerable time and effort addressing the challenges of the various government investigations and extensive litigation we face, as well as strengthening our accounting and internal controls and updating and developing accounting policies and procedures, disclosure controls and procedures, and corporate governance policies and procedures. To the extent these matters require continued management attention, our operations may be adversely affected.
Our ability to expand our business and properly service our customers depends on our ability to effectively manage our domestic production capacity, including our ability to recruit, train and retain qualified MTs and maintain high standards of quality service in our operations, which we may not be able to do.
Our success depends, in part, upon our ability to effectively manage our domestic production capacity including our ability to attract and retain qualified MTs who can provide accurate medical transcription. There is currently a shortage of qualified MTs in the U.S. and increased workflow has created industry-wide demand for quality MTs. As a result, competition for skilled MTs is intense. We have active programs in place to attract domestic MTs and to partner with global medical transcription service providers. However, this strategy may not alleviate any issues caused by the shortage. Because medical transcription is a skilled position in which experience is valuable, we require that our MTs have substantial experience or receive substantial training before being hired. Competition may force us to increase the compensation and benefits paid to our MTs, which could reduce our operating margins and profitability. In addition, failure to recruit and retain qualified MTs may have an adverse effect on our ability to service our customers, manage our production capacity and maintain our high standards of
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quality service. An inability to hire and retain a sufficient number of MTs could have a negative impact on our ability to grow.
We have experienced significant management turnover.
In the past few years, we have experienced a significant turnover in our senior management. This lack of management continuity, and the resulting lack of long-term history with us, could result in operational and administrative inefficiencies and added costs, could adversely impact our stock price and our customer relationships and may make recruiting for future management positions more difficult. In addition, we must successfully integrate any new management personnel that we hire within our organization in order to achieve our operating objectives, and changes in other key management positions may temporarily affect our financial performance and results of operations as new management becomes familiar with our business. Accordingly, our future financial performance will depend to a significant extent on our ability to motivate and retain key management personnel.
We are not current in our periodic reporting obligations under the Exchange Act.
We are not current in our periodic reporting obligations under the Exchange Act. We have not filed ourForms 10-Q for the first and second quarters of 2007. In addition, we have not filed all periodic reports required during 2004 and 2005. Some of the consequences of our failure to meet our reporting obligations under the Exchange Act include:
| • | our ineligibility to use certain short-form registration statements under the Securities Act, such asForms S-3 andS-8, until we have filed all reports required under the Exchange Act for a continuous period of 12 months; and | |
| • | the unavailability of Rule 144 for holders of outstanding restricted or control securities until we have filed all reports required under the Exchange Act for a continuous period of 12 months. |
In addition, our failure to meet our reporting obligations under the Exchange Act is a violation of Section 13(a) of the Exchange Act and could subject us to SEC investigations and enforcement actions, which could result in injunctions and monetary penalties. There is no assurance whether or when we will become current in our reporting obligations under the Exchange Act.
We have had material weaknesses in our internal control over financial reporting and cannot provide assurance that additional material weaknesses will not be identified in the future. Our failure to effectively maintain our internal control over financial reporting could result in material misstatements in our financial statements which could require us to restate financial statements, cause us to fail to meet our reporting obligations, cause investors to lose confidence in our reported financial information or have a negative affect on our stock price.
We have determined that we had deficiencies in our internal control over financial reporting as of December 31, 2006 that constituted “material weaknesses” as defined by the Public Company Accounting Oversight Board’s Audit Standard No. 2. These material weaknesses are identified in Item 9A, Controls and Procedures.
We cannot assure you that additional material weaknesses in our internal control over financial reporting will not be identified in the future. Any failure to maintain or implement required new or improved controls, or any difficulties we encounter in their implementation, could result in additional material weaknesses, or could result in material misstatements in our financial statements. These misstatements could result in a restatement of financial statements, cause us to fail to meet our reporting obligations or cause investors to lose confidence in our reported financial information, leading to a decline in our stock price.
We have not complied with Section 404 of the Sarbanes-Oxley Act of 2002 (SOX) for our fiscal year ended December 31, 2004.
As directed by Section 404 of SOX (Section 404), the SEC adopted rules requiring certain public companies, including us, to include management’s assessment of the effectiveness of a public company’s internal control over financial reporting in its annual report onForm 10-K. In addition, the independent registered public accounting
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firms auditing certain public companies’ financial statements, including ours, must attest to and report on managements’ assessment of, and the effective operation of, such companies internal control over financial reporting. Although these requirements were first applicable to our annual report onForm 10-K for our fiscal year ending December 31, 2004, we were unable to comply with these requirements for such fiscal year. The time and resources expended in connection with the Review and Management’s Billing Assessment, including the resulting changes in senior management, prevented us from completing our internal documentation, assessment and evaluation of our internal control over financial reporting, all of which are required to be undertaken to comply with Section 404. This correspondingly prevented our independent registered public accounting firm from commencing the required audit of our internal control over financial reporting as of December 31, 2004.
Since we determined that it would not be possible to complete either management’s assessment or an audit of our internal control over financial reporting as of December 31, 2004, our independent registered public accounting firm accordingly did not issue an opinion with respect to our internal control over financial reporting as of December 31, 2004. This failure to obtain an opinion does not comply with the SEC’s rules and regulations under Section 404, and this noncompliance, as well as our failure to provide the required Section 404 management assessment, has resulted in us being in violation of Section 13(a) under the Exchange Act. Section 13(a) establishes the general requirement that public companies must file with the SEC, in accordance with such rules and regulations as the SEC may prescribe, such information, documents and reports as the SEC may from time to time require for the protection of investors, includingForms 10-K and10-Q.
In general, the SEC has broad authority under the Exchange Act to institute investigations, to seek injunctions, to seek monetary penalties, and to otherwise pursue enforcement actions for violations of Section 13(a), including a failure to file aForm 10-K or for the omission of necessary statements in aForm 10-K. Therefore, our failure to comply with the Section 404 requirements in ourForm 10-K could potentially subject us to these same investigations, injunctions, penalties and enforcement actions. Section 404 is a relatively new legal requirement, and there is very little precedent establishing the consequences or appropriate response to a public company’s failure to comply with Section 404. Accordingly, although we have discussed our Section 404 noncompliance with the SEC, we cannot predict what action, if any, the SEC may take against us as a result of a failure to be compliant with our obligations under Section 404 or Section 13(a) of the Exchange Act.
Current and prospective investors, customers and employees may react adversely to the allegations concerning our billing practices and our inability to file in a timely manner all of our SEC filings.
Our future success depends in large part on the support of our current and future investors, customers and employees. Our inability to file on a timely basis all of our SEC filings has caused negative publicity about us and has resulted in the delisting of our common stock from NASDAQ. In addition, the allegations concerning our past billing practices and our inability to file all of our SEC filings in a timely manner could cause current and future customers to lose confidence in us, which may affect their willingness to seek services from us. Finally, employees and prospective employees may factor in these considerations relating to our stability and the value of any equity incentives in their decision-making regarding employment opportunities.
We compete with many others in the market for medical transcription services which may result in lower prices for our services, reduced operating margins and an inability to maintain or increase our market share and expand our service offerings.
We compete with other outsourced medical transcription service companies in a very fragmented market that includes national, regional and local service providers, as well as service providers with global operations. These companies offer services that are similar to ours and compete with us for both customers and qualified MTs. We also compete with the in-house medical transcription staffs of our customers. While we attempt to compete on the basis of fast, predictable turnaround times and consistently high accuracy and document quality, all offered at a reasonable price, there can be no assurance that we will be able to compete effectively against our competitors or timely implement new products and services. Many of our competitors attempt to differentiate themselves by offering lower priced alternatives to our outsourced medical transcription services. Increased competition and cost pressures affecting the healthcare markets in general may result in lower prices for our services, reduced operating margins and the inability to maintain or increase our market share.
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As technology evolves, including the continued refinement of speech recognition technology, health information technology providers may provide services that replace, or reduce the need for medical transcription. Furthermore, companies that provide services complementary to medical transcription, such as electronic medical records, coding and billing, may expand the services they provide to include medical transcription. Current and potential competitors may have financial, technical and marketing resources that are greater than ours. As a result, competitors may be able to respond more quickly to evolving technological developments or changing customer needs or devote greater resources to the development, promotion or sale of their technology or services than we can. In addition, competition may increase due to consolidation of medical transcription companies. As a result of such consolidation, there may be a greater number of providers of medical transcription services with sufficient scale, service mix and financial resources to compete with us to provide services to larger, more complex organizations. Current and potential competitors may establish cooperative relationships with third parties to increase their ability to attract our current and potential customers.
We are reviewing strategic alternatives which could impact our operating results, our stock price and our business.
In July 2007 we engaged Bear, Stearns & Co. Inc. as our financial advisor to review our strategic alternatives. We are uncertain as to what impact any particular strategic alternative will have on our operating results, our stock price and our business if accomplished or whether any transaction will even occur as a result of this review. Other uncertainties and risks relating to our review of strategic alternatives include:
| • | the review of strategic alternatives may disrupt our operations, affect morale, distract management and result in the loss of employees, vendors or customers, which could have a material adverse effect on our operating results and our business; | |
| • | the process of reviewing strategic alternatives may be more time consuming and expensive than we currently anticipate; and | |
| • | we may not be able to identify strategic alternatives that are worth pursuing. |
We may pursue future transactions which could require us to incur debt and assume contingent liabilities and expenses, and we may not be able to effectively integrate new operations.
A significant portion of our historical growth has occurred through transactions, and we may pursue transactions in the future. Transactions involve risks that the combined businesses will not perform in accordance with expectations and that business judgments concerning the value, strengths and weaknesses of the combined businesses will prove incorrect. We cannot guarantee that if we decide to pursue future transactions we will be able to identify attractive opportunities or successfully integrate any business or asset we combine with our existing business. Future transactions may involve high costs and may result in the incurrence of debt, contingent liabilities, interest expense, amortization expense or periodic impairment charges related to goodwill and other intangible assets as well as significant charges relating to integration costs.
We cannot guarantee that we will be able to successfully integrate any business we combine with our existing business or that any combined businesses will be profitable. The successful integration of new businesses depends on our ability to manage these new businesses effectively. The successful integration of future transactions may also require substantial attention from our senior management and the management of the combined businesses, which could decrease the time that they have to service and attract customers. In addition, because we may actively pursue a number of opportunities simultaneously, we may encounter unforeseen expenses, complications and delays, including difficulties in employing sufficient staff and maintaining operational and management oversight. Our inability to complete the integration of any new businesses we combine with our existing business in a timely and orderly manner could reduce our net revenues and negatively impact our results of operations.
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Our success will depend on our ability to adopt and integrate new technology into our DEP, to improve our production capabilities and expand the breadth of our service offerings, as well as our ability to address any unanticipated problems with our information technology systems, which we may not be able to do quickly, or at all.
Our ability to remain competitive in the medical transcription industry is based, in part, on our ability to develop and utilize technology in the services that we provide to our customers to improve our production capabilities and expand the breadth of our service offerings. Because our services are an integral part of our customers operations, we also must quickly address any unanticipated problems with our information technology systems that could cause an interruption in service or a decrease in our responsiveness to customers. Furthermore, as our customers advance technologically, we must be able to effectively integrate our DEP with their systems and provide advanced data collection technology. We plan to develop and integrate new technologies into our current service structure to give our customers high-quality and cost-effective services. We also may need to develop technologies to provide service systems comparable to those of our competitors as they develop new technology. If we are unable to effectively develop and integrate new technologies, we may not be able to expand our technology and service offerings or compete effectively with our competitors. In addition, if the cost of developing and integrating new technologies is high, we may not realize our expected return on investment.
Due to the critical nature of medical transcription to our customers’ operations, potential customers may be reluctant to outsource or change service providers as a result of the cost and potential for disruption in services, which may inhibit our ability to attract new customers.
The up-front cost involved in changing medical transcription service providers or converting from an in-house medical transcription department to an outsourced provider may be significant. Many customers may prefer to remain with their current service provider or keep their medical transcription in-house rather than incur these costs or experience a potential disruption in services as a result of changing service providers. Also, as the maintenance of accurate medical records is a critical element of a healthcare provider’s ability to deliver quality care to its patients and to receive proper and timely reimbursement for the services it renders, potential customers may be reluctant to outsource such an important function.
If our intellectual property is not adequately protected, we may lose our market share to our competitors and be unable to operate our business profitably.
Our success depends, in part, upon our proprietary technology and our ability to license and renew third-party intellectual property. We regard some of the software underlying our services, including our DEP and interfaces, as proprietary, and we rely primarily on a combination of trade secrets, copyright and trademark laws, confidentiality agreements, contractual provisions and technical measures to protect our proprietary rights. Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy aspects of our intellectual property or obtain and use information that we regard as proprietary. There can be no assurance that our proprietary information will not be independently developed by competitors. There can be no assurance that the intellectual property we own or license will provide competitive advantages or will not be challenged or circumvented by our competitors.
We are dependent on third party speech recognition software incorporated in certain of our technologies, and impaired relations with such third party or the inability to enhance such third party software over time could harm our business.
We license speech recognition software from PSRS that we incorporate into our DEP and SpeechQ for Radiology. This license may not continue to be available on commercially reasonable terms or at all. Some of this technology would be difficult to replace. The loss of this license could significantly impact our business until we identify, license and integrate, or develop equivalent software. If we are required to enter into license agreements with third parties for replacement technology, we could face higher royalty payments and our products may lose certain attributes or features.
In addition, our products may be impacted if errors occur in the licensed software that we utilize. It may be more difficult for us to correct any defects in third-party software because the software is not within our control.
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Accordingly, our business could be adversely affected in the event of any errors in this software. There can be no assurance that these third-parties will continue to invest the appropriate levels of resources in their products and services to maintain and enhance the capabilities of their software.
If we fail to comply with extensive contractual obligations and applicable laws and government regulations governing the handling of patient identifiable medical information, including those imposed on our customers in connection with HIPAA, we could suffer material losses or be negatively impacted as a result of our customers being subject to material penalties and liabilities.
As part of the operation of our business, our customers provide us with certain patient identifiable medical information. Although many regulatory and governmental requirements do not directly apply to our operations, our hospital and other healthcare provider customers must comply with a variety of requirements related to the handling of patient information, including laws and regulations protecting the privacy, confidentiality and security of PHI. Most of our customers are covered entities and, in many of our relationships, we function as a business associate. In particular, the provisions of HIPAA require our customers to have business associate agreements in place with a medical transcription company such as ours under which we are required to appropriately safeguard the PHI we create or receive on their behalf. Further, our customers are required to comply with HIPAA security regulations that require them to implement certain administrative, physical and technical safeguards to ensure the confidentiality, integrity and availability of EPHI. We are required by contract to protect the security of EPHI that we create, receive, maintain or transmit for our customers consistent with these regulations. To comply with our contractual obligations, we may have to reorganize processes and invest in new technologies. We also are required to train personnel regarding HIPAA requirements. If we, or any of our MTs or subcontractors, are unable to maintain the privacy, confidentiality and security of the PHI that is entrusted to us, our customers could be subject to civil and criminal fines and sanctions and we could be found to have breached our contracts with our customers. Additionally, because all HIPAA standards are subject to interpretation and change, we cannot predict the future impact of HIPAA on our business and operations. In the event that the standards and compliance requirements under HIPAA change or are interpreted in a way that requires any material change to the way in which we do business, our business, financial condition and results of operations could be adversely affected. To the extent that the laws of the states in which we or our customers operate are more restrictive than HIPAA, we may have to incur additional costs to maintain compliance with any such applicable requirements.
Proposed legislation and possible negative publicity may impede our ability to utilize global service capabilities.
Bills introduced in recent sessions of the U.S. Congress have sought to restrict the transmission of personally identifiable information regarding a U.S. resident to any foreign affiliate, subcontractor or unaffiliated third party without adequate privacy protections or without providing notice of the transmission and an opportunity to opt out. Some of the proposals would require patient consent. If enacted, these proposed laws would impose liability on healthcare businesses arising from the improper sharing or other misuse of personally identifiable information. Some proposals would create a private civil cause of action that would allow an injured party to recover damages sustained as a result of a violation of the new law. A number of states have also considered, or are in the process of considering, prohibitions or limitations on the disclosure of medical or other information to individuals or entities located outside of the U.S. Further, as a result of this negative publicity and concerns regarding the possible misuse of personally identifiable information, some of our customers have contractually limited our ability to use MTs located outside of the U.S.
Philips owns approximately 69.6% of our outstanding common stock, and its interests may conflict with the interests of our other shareholders.
Philips beneficially owns approximately 69.6% of our outstanding common stock. Philips has the ability to cause the election of all of the members of our board of directors, the appointment of new management and the approval of any action requiring the approval of our shareholders, including amendments to our certificate of incorporation and mergers or sales of substantially all of our assets. The directors elected by Philips will be able to make decisions affecting our capital structure, including decisions to issue additional capital stock, implement stock
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repurchase programs and declare dividends. Our interests and the interests of our affiliates, including Philips, could conflict with the interest of our other shareholders. For a further description of these relationships, see Item 13, Certain Relationships and Related Transactions, and Director Independence.
In July 2007, Philips announced that it is reviewing all of its options with respect to its ownership interest in us following a determination by Philips that it views its ownership interest in us to be a non-core holding. In connection with such review, Philips may consider possible transactions or other changes in its ownership interest.
Our stock trades on the over-the-counter “Pink Sheets” market, which may decrease the liquidity of our common stock.
On June 16, 2004, NASDAQ delisted our common stock because we were not able to file our periodic reports with the SEC in a timely manner. Since that time, our common stock has been traded on the over-the-counter “Pink Sheets” market (Pink Sheets) under the symbol “MEDQ.PK.” Broker-dealers often decline to trade in Pink Sheets stocks given that the market for such securities is often limited, the stocks are more volatile, and the risks to investors are greater. Consequently, selling our common stock can be difficult because transactions can be delayed and security analyst and news media coverage of us may be reduced. These factors could result in lower prices and larger spreads in the bid and ask prices for shares of our common stock as well as lower trading volume. Although we intend to apply for the listing of our common stock on a national securities exchange once we are current in our periodic reporting obligations with the SEC, we cannot assure you that we will be successful in those efforts. We do not expect to become current in our periodic reporting obligations until the end of the third quarter of 2007, and we will not be able to apply for listing on a stock exchange until this time. Investors should realize that they may be unable to sell shares of our common stock that they purchase. Accordingly, investors must be able to bear the financial risk of losing their entire investment in our common stock.
| Item 1B. | Unresolved Staff Comments |
None.
| Item 2. | Properties |
We currently do not own any real property. We currently lease approximately 39,000 square feet of office space in Mount Laurel, New Jersey, which houses our corporate headquarters. This lease expires in 2014; however, we have the option to terminate the lease in 2011, subject to certain conditions, including the payment of a termination fee. We also lease approximately 38,000 square feet of office space in Norcross, Georgia for our sales, administrative and research and development functions. This lease expires in 2008. We lease approximately 20,000 square feet for our call center in Marietta, Georgia and this lease expires on December 31, 2007. We expect to renew these leases at commercially reasonable terms. The call center provides technical support and expertise to our customers and MTs. Other than our corporate headquarters, the Norcross facility, and our call center, none of our other properties are material to our business. We believe that our corporate headquarters and other properties are suitable for their respective uses and are, in general, adequate for our present needs.
| Item 3. | Legal Proceedings |
Governmental Investigations
The SEC is currently conducting a formal investigation of us relating to our billing practices. We have been fully cooperating with the SEC since it opened its investigation in 2004. We have complied and are continuing to comply with information and document requests by the SEC.
We also received an administrative HIPAA subpoena for documents from the DOJ on December 17, 2004. The subpoena sought information primarily about our provision of medical transcription services to governmental and non-governmental customers. The information was requested in connection with a government investigation into whether we and others violated federal laws in connection with the provision of medical transcription services. We have complied and are continuing to comply with information and document requests by the DOJ.
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The DOL is currently conducting a formal investigation into the administration of our 401(k) plan. We have been fully cooperating with the DOL since it opened its investigation in 2004. We have complied and are continuing to comply with information and document requests by the DOL.
Developments relating to the SEC, DOJand/or DOL investigations will continue to create various risks and uncertainties that could materially and adversely affect our business and our historical and future financial condition, results of operations, and cash flows.
Shareholder Securities Litigation
A shareholder putative class action lawsuit was filed against us in the United States District Court District of New Jersey on November 8, 2004. The action, entitledWilliam Steiner v. MedQuist, Inc., et al., CaseNo. 1:04-cv-05487-FLW (Shareholder Putative Action), was filed against us and certain of our former officers, purportedly on behalf of an alleged class of all persons who purchased our common stock during the period from April 23, 2002 through November 2, 2004, inclusive (Securities Class Period). The complaint specifically alleged that defendants violated federal securities laws by purportedly issuing a series of false and misleading statements to the market throughout the Securities Class Period, which statements allegedly had the effect of artificially inflating the market price of our securities. The complaint asserts claims under Section 10(b) and 20(a) of the Exchange Act andRule 10b-5, thereunder. Named as defendants, in addition to us, were our former President and Chief Executive Officer and our former Executive Vice President and Chief Financial Officer.
On August 16, 2005, a First Amended Complaint in the Shareholder Putative Class Action was filed against us in the United States District Court District of New Jersey. The First Amended Complaint named additional defendants, including certain current and former directors, certain of our former officers, our former and current external auditors and Philips. Like the original complaint, the First Amended Complaint asserted claims under Sections 10(b) and 20(a) of the Exchange Act andRule 10b-5 thereunder. The Securities Class Period of the original complaint was expanded 20 months to include the period from March 29, 2000 through June 14, 2004. Pursuant to an October 17, 2005 consent order approved by the Court, lead plaintiff Greater Pennsylvania Pension Fund filed a Second Amended Complaint on November 15, 2005. The Second Amended Complaint dropped Philips as a defendant, but alleged the same claims and the same purported class period as the First Amended Complaint. Plaintiffs sought unspecified damages. Pursuant to the provisions of the Private Securities Litigation Reform Act, discovery in the action was stayed pending the filing and resolution of the defendants’ motions to dismiss, which were filed on January 17, 2006, and which were fully briefed as of June 16, 2006. On September 29, 2006, the Court denied our motions to dismiss and the motion to dismiss of the individual defendants. In the same order, the Court granted the motion to dismiss filed by our former and current external auditors. On November 3, 2006, we filed our Answer denying the material allegations contained in the Second Amended Complaint. On March 23, 2007, we entered into a memorandum of understanding and a stipulation of settlement with the lead plaintiff in which we agreed to pay $7.75 million to settle all claims, throughout the class period, against all defendants in the action. On May 16, 2007, the Court issued an Order Preliminarily Approving Settlement and Providing for Notice. The Court conducted a final approval hearing and approved the settlement on August 15, 2007. Neither we nor any of the individuals named in the action has admitted to liability or any wrongdoing in connection with the settlement.
Customer Litigation
A putative class action was filed in the United States District Court for the Central District of California. The action, entitled South Broward Hospital District, d/b/a Memorial Regional Hospital, et al. v. MedQuist, Inc. et al., CaseNo. CV-04-7520-TJH-VBKx, was filed on September 9, 2004 against us and certain of our present and former officials, purportedly on behalf of an alleged class of non-Federal governmental hospitals and medical centers that the complaint claims were wrongfully and fraudulently overcharged for transcription services by defendants based primarily on our use of the AAMT line billing unit of measure. The complaint charged fraud, violation of the California Business and Professions Code, unjust enrichment, conversion, negligent supervision and violation of RICO. Plaintiffs seek damages in an unspecified amount, plus costs and interest, an injunction against alleged continuing illegal activities, an accounting, punitive damages and attorneys’ fees. Named as defendants, in addition to us, were one of our senior vice presidents, our former executive vice president of marketing and new business
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development, our former executive vice president and chief legal officer, and our former executive vice president and chief financial officer.
On December 20, 2004, we and the individual defendants filed motions to dismiss for lack of personal jurisdiction and improper venue, or in the alternative, to transfer the putative action to the United States District Court for the District of New Jersey. On February 2, 2005, plaintiffs filed a Second Amended Complaint both adding and deleting named plaintiffs in an attempt to keep the putative action in the United States District Court for the Central District of California. On March 30, 2005, the United States District Court for the Central District of California issued an order transferring the putative action to the United States District Court District of New Jersey.
On August 1, 2005, we and the individual defendants filed their respective Answers denying the material allegations contained in the Second Amended Complaint. On August 31, 2005, we and the individual defendants filed motions to dismiss the Second Amended Complaint for failure to state a claim and a motion to dismiss in favor of arbitration, or in the alternative, to stay pending arbitration. On December 12, 2005, the plaintiffs filed an Amendment to the Second Amended Complaint. On December 13, 2005, the Court issued an order requiring plaintiffs to file a Third Amended Complaint.
Plaintiffs filed the Third Amended Complaint on January 4, 2006. The Third Amended Complaint expands the claims made beyond issues arising from contracts based on AAMT line billing and beyond customers billed based on an AAMT line, alleging that we engaged in a scheme to inflate customers’ invoices without regard to the terms of individual contracts and even in the absence of any written contract. The Third Amended Complaint also limits plaintiffs’ claim for fraud in the inducement of the agreement to arbitrate to the three named plaintiffs whose contracts contain an arbitration provision and a subclass of similarly situated customers. On January 20, 2006 we and the individual defendants filed motions to dismiss the Third Amended Complaint for failure to state a claim and a motion to compel arbitration of all claims by the arbitration subclass and to stay the case in its entirety pending arbitration. On March 8, 2006 the Court held a hearing on these motions, and took the matter under submission. On March 30, 2007, the Court issued an order holding that plaintiffs could not make out a claim that we had violated the federal RICO statute, thus eliminating any claim against us for treble damages. The Court also found that plaintiffs could not make out a claim that we had engaged in any unfair or deceptive acts or practices in violation of state law, or that we had made any negligent misrepresentations to plaintiffs. In its ruling, the Court, without reaching a decision of whether any wrongdoing had occurred, allowed plaintiffs to proceed with their claims against us for fraud, unjust enrichment and an accounting. In its order, the Court denied our motion to compel arbitration regarding those customers whose contracts contained an agreement to arbitrate. We have appealed that decision to the Third Circuit Court of Appeals, and we moved the district court to stay the matter pending that appeal. The district court heard oral argument on our motion to stay on May 30, 2007 and took the motion under submission. On June 8, 2007, plaintiffs filed a Motion for Summary Action with the Third Circuit Court of Appeals, asking the Court to dismiss plaintiffs who did not enter into arbitration agreements with us from the appeal. We filed our opposition to this motion on June 25, 2007. The Court has referred the motion to the merits panel for decision after full briefing. In addition, on July 18, 2007, the Third Circuit Court of Appeals issued notice that the case had been assigned to mediation in the Court’s mediation program. On August 1, 2007, plaintiffs filed a motion for expedited review on appeal. We do not oppose this motion, and the parties have agreed to a schedule pursuant to which the appeal will be fully briefed by November 16, 2007. On August 21, 2007, the Third Circuit granted the motion for expedited review. Under the Court’s order, briefing is scheduled to be completed by November 16, 2007. The Third Circuit also has ordered the parties to telephonic mediation, which is scheduled to proceed on September 12, 2007. We believe that the claims asserted have no merit and intend to defend the case vigorously.
Medical Transcriptionist Litigation
Hoffmann Putative Class Action
A putative class action lawsuit was filed against us in the United States District Court for the Northern District of Georgia. The action, entitled Brigitte Hoffmann, et al. v. MedQuist, Inc., et al., CaseNo. 1:04-CV-3452, was filed with the Court on November 29, 2004 against us and certain current and former officials, purportedly on behalf of an alleged class of current and former employees and statutory workers, who are or were compensated on a “per line” basis for medical transcription services (Class Members) from January 1, 1998 to the time of the filing of the
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complaint (Class Period). The complaint specifically alleged that defendants systematically and wrongfully underpaid the Class Members during the Class Period. The complaint asserted the following causes of action: fraud, breach of contract, demand for accounting, quantum meruit, unjust enrichment, conversion, negligence, negligent supervision, and RICO violations. Plaintiffs sought unspecified compensatory damages, punitive damages, disgorgement and restitution. On December 1, 2005, the Hoffmann matter was transferred to the United States District Court for the District of New Jersey. On January 12, 2006, the Court ordered this case consolidated with the Myers Putative Class Action discussed below. As set forth below, we believe that the claims asserted in the consolidated Myers Putative Class Action have no merit and intend to vigorously defend that action.
Force Putative Class Action
A putative class action entitled Force v. MedQuist Inc. and MedQuist Transcriptions, Ltd., CaseNo. 05-cv-2608-WSD, was filed against us on October 11, 2005, in the United States District Court for the Northern District of Georgia. The action was brought on behalf of a putative class of current and former employees who claim they are or were compensated on a “per line” basis for medical transcription services but were allegedly underpaid due to the actions of defendants. The named plaintiff asserted claims for breach of contract, quantum meruit, unjust enrichment, and for an accounting. Upon stipulation and consent of the parties, on February 17, 2006, the Force matter was ordered transferred to the United States District Court for the District of New Jersey. Subsequently, on April 4, 2006, the parties entered into a stipulation and consent order whereby the Force matter was consolidated with the Myers Putative Class Action discussed below, and the consolidated amended complaint filed in the Myers action on January 31, 2006 was deemed to supersede the original complaint filed in the Force matter. As set forth below, we believe that the claims asserted in the consolidated Myers Putative Class Action have no merit and intend to vigorously defend that action.
Myers Putative Class Action
A putative class action entitled, Myers, et al. v. MedQuist Inc. and MedQuist Transcriptions, Ltd., CaseNo. 05-cv-4608 (JBS), was filed against us on September 22, 2005 in the United States District Court for the District of New Jersey. The action was brought on behalf of a putative class of our employee and independent contractor transcriptionists who claim that they contracted with us to be paid on a 65 character line, but were allegedly underpaid due to intentional miscounting of the number of characters and lines transcribed. The named plaintiffs asserted claims for breach of contract, unjust enrichment, and request an accounting.
The allegations contained in the Myers case are substantially similar to those contained in the Hoffmann and Force putative class actions and, as detailed above, the three actions have now been consolidated. A consolidated amended complaint was filed on January 31, 2006. In the consolidated amended complaint, the named plaintiffs assert claims for breach of contract, breach of the covenant of good faith and fair dealing, unjust enrichment and demand an accounting. On March 7, 2006 we filed a motion to dismiss all claims in the consolidated amended complaint. The motion was fully briefed and argued on August 7, 2006. The Court denied the motion on December 21, 2006. On January 19, 2007, we filed our answer denying the mutual allegations pleaded in the consolidated amended complaint. The parties are now proceeding with discovery. The deadline to complete pretrial fact discovery is October 30, 2007. No date has been set for a class certification hearing or trial. We believe that the claims asserted in the consolidated actions have no merit and intend to vigorously defend the suit.
Shareholder Derivative Litigation
On October 4, 2005, we announced the dismissal with prejudice of a shareholder derivative action filed in United States District Court for the District of New Jersey. The suit, Rhoda Kanter (Plaintiff) v. Hans M. Barella et al. (Defendants), was filed on November 12, 2004 against Philips and 10 current and former members of our board of directors. We were named as a nominal defendant.
In a ruling dated September 21, 2005, the Court found plaintiff’s allegations that our board of directors breached their fiduciary duties to us to be insufficient. The plaintiff had alleged that for a period from 2001 through 2004, the Defendants violated their fiduciary duties by permitting artificial inflation of billing figures; failing to adequately ensure accurate and lawful billing practices; and failing to accurately report our true financial condition in its published financial statements. On October 3, 2005, plaintiff filed a motion for reconsideration of the Court’s
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order dismissing the action with prejudice. On November 16, 2005, the Court denied plaintiff’s motion for reconsideration. On December 13, 2005, plaintiff filed a Notice of Appeal with the United States Court of Appeals for the Third Circuit. Plaintiff’s appeal was fully briefed as of May 2006, and the Court of Appeals heard oral argument on the appeal on March 1, 2007. Plaintiff’s appeal was denied by the Court of Appeals on May 25, 2007.
| Item 4. | Submission Of Matters To A Vote Of Security Holders |
None.
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PART II
| Item 5. | Market For Registrant’s Common Equity, Related Shareholder Matters And Issuer Purchases Of Equity Securities |
Our common stock is traded on the Pink Sheets under the symbol “MEDQ.PK”. Set forth below are the high and low closing bid quotations (as reported by the Pink Sheets LLC) for each quarter of 2005 and 2006 and the first, second and third quarter (through July 31, 2007) of 2007. The over-the-counter market quotations reflect inter-dealer prices, without retailmark-up, mark-down or commission, and may not necessarily reflect the prices for actual transactions.
| High | Low | |||||||
2005 | ||||||||
| First Quarter | $ | 14.40 | $ | 12.05 | ||||
| Second Quarter | $ | 13.30 | $ | 12.90 | ||||
| Third Quarter | $ | 13.25 | $ | 12.25 | ||||
| Fourth Quarter | $ | 12.35 | $ | 10.16 | ||||
2006 | ||||||||
| First Quarter | $ | 13.94 | $ | 12.14 | ||||
| Second Quarter | $ | 14.90 | $ | 11.89 | ||||
| Third Quarter | $ | 12.45 | $ | 9.05 | ||||
| Fourth Quarter | $ | 13.65 | $ | 11.45 | ||||
2007 | ||||||||
| First Quarter | $ | 13.55 | $ | 9.90 | ||||
| Second Quarter | $ | 9.95 | $ | 7.80 | ||||
| Third Quarter (through July 31, 2007) | $ | 12.18 | $ | 9.10 | ||||
Holders
As of July 31, 2007, the closing price of our common stock was $11.50 and we had 205 shareholders of record.
Dividends
We have never declared or paid any cash dividends on our common stock. We expect to retain any future earnings to fund operations and the continued development of our business and, therefore, do not anticipate paying any cash dividends in the foreseeable future.
| Item 6. | Selected Financial Data |
| For the Year Ended December 31, | ||||||||||||||||||||
| 2006 | 2005 | 2004 | 2003 | 2002 (1) | ||||||||||||||||
| ($ in thousands, except per share data) | Unaudited | |||||||||||||||||||
Statement of Operations Data: | ||||||||||||||||||||
| Net Revenues | $ | 358,091 | (2) | $ | 353,005 | (2)(3) | $ | 451,894 | (3) | $ | 484,762 | (3) | $ | 483,948 | (3) | |||||
| Net Income (loss) | $ | (16,942 | )(4) | $ | (111,632 | )(4)(5) | $ | 3,742 | (4)(6) | $ | 35,567 | $ | 42,244 | |||||||
| Net Income (loss) per share — Basic | $ | (0.45 | ) | $ | (2.98 | ) | $ | 0.10 | $ | 0.96 | $ | 1.14 | ||||||||
| Net Income (loss) per share — Diluted | $ | (0.45 | ) | $ | (2.98 | ) | $ | 0.10 | $ | 0.94 | $ | 1.12 | ||||||||
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| As of December 31, | ||||||||||||||||||||
| 2006 | 2005 | 2004 | 2003 | 2002 (1) | ||||||||||||||||
| Unaudited | ||||||||||||||||||||
Balance Sheet Data: | ||||||||||||||||||||
| Total assets | $ | 441,139 | $ | 493,191 | $ | 540,934 | $ | 526,468 | $ | 477,242 | ||||||||||
| Total non-current liabilities | $ | 18,492 | $ | 18,534 | $ | 4,196 | $ | 3,339 | $ | 1,481 | ||||||||||
| (1) | The selected financial data in 2002, while unaudited, has been prepared on the same basis as our audited consolidated financial statements and, in the opinion of management, contains all adjustments necessary to fairly present the information set forth herein. | |
| (2) | Reflects a reduction in net revenues related to the Accommodation Analysis of $10,402 and $57,678 in 2006 and 2005, respectively, which is described under the caption “Significant Events Over the Past Few Years” in Item 1, Business. | |
| (3) | Reflects a reduction in net revenues related to the Quantification of $133, $931, $2,142 and $2,219 in 2005, 2004, 2003 and 2002, respectively, which is described under the caption “Significant Events Over the Past Few Years” in Item 1, Business. | |
| (4) | In 2006, 2005 and 2004, we recorded a charge of $13,001, $34,127 and $10,253, respectively, for costs associated with the Review and Management’s Billing Assessment, which is described under the caption “Significant Events Over the Past Few Years” in Item 1, Business, as well as legal fees and other costs associated with the matters described in Item 3, Legal Proceedings. | |
| (5) | In the fourth quarter of 2005, a valuation allowance of $56,808 was established against various domestic deferred tax assets. After consideration of all evidence, both positive and negative, management concluded that it was more likely than not that a majority of the domestic deferred tax assets would not be realized. | |
| (6) | In 2004, we recorded a goodwill impairment charge of $14,603 related to our former Solutions reporting unit. Due to reduced sales and margins, expected operating profits and cash flows were forecast lower than previously anticipated. |
| Item 7. | Management’s Discussion And Analysis Of Financial Condition And Results Of Operations |
You should read the following discussion and analysis of our financial condition and results of operations in conjunction with our audited consolidated financial statements and related notes appearing elsewhere in this report. In addition to historical information, this discussion and analysis contains forward-looking statements based on current expectations that involve risks, uncertainties and assumptions, such as our plans, objectives, expectations and intentions set forth in the “Cautionary Statement Regarding Forward-Looking Statements,” which can be found in Item 1A, Risk Factors. Our actual results and the timing of events may differ materially from those anticipated in these forward-looking statements as a result of various factors, including those set forth in the “Risk Factors” section and elsewhere in this report.
Executive Overview
We are the leading provider of medical transcription technology and services, which are integral to the clinical documentation workflow. We service health systems, hospitals and large group medical practices throughout the U.S., and we employ approximately 6,300 skilled MTs, making us the largest employer of MTs in the U.S. In the clinical documentation workflow, we provide, in addition to medical transcription technology and services, digital dictation, speech recognition, electronic signature and medical coding technology and services. We are a member of the Philips Group of Companies and collaborate with Philips Medical Systems in marketing and product development to leverage Philips’ technologies and professional expertise to deliver industry-leading solutions for our customers.
We were incorporated in New Jersey in 1984 and reorganized in 1987 as a group of outpatient healthcare businesses affiliated with a non-profit healthcare provider. In May 1994, we acquired our first medical transcription business. Through the date of this report, we have acquired over 50 companies. By the end of 1995, we had divested all of our non-medical transcription businesses.
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In July 2000, Philips completed a tender offer in which it acquired approximately 60% of our outstanding common stock. Subsequent to the completion of the tender offer, Philips increased its ownership position and currently owns approximately 69.6% of our common stock.
In 2001, we acquired Speech Machines, a company based in the United Kingdom, whose technology has since developed into our DEP. In 2002, we began the process of migrating our customers to our DEP from our many disparate transcription platforms. Following the July 2004 Press Release, we accelerated this process and completed it in the first quarter of 2007. As a result of this process, we encountered customer attrition.
In July 2002, we acquired Lanier Healthcare, LLC (Lanier), which derived revenue largely from the sale and implementation of voice-capture and document management solutions and maintenance service of these products. In conjunction with the Lanier acquisition, we began operating in two segments: a Services segment, through which we provided our customers with medical transcription and coding reimbursement services, and a Solutions segment, which was comprised of the operations of Lanier. Effective January 1, 2005, we changed the way we review our financial performance and thus began operating in one segment for financial reporting purposes.
The past few years have been marked by dramatic changes for both us and our industry. During this period, a significant portion of our time and attention has been devoted to matters outside the ordinary course of business such as replacing key members of our executive management team, cooperating with federal investigators, responding to ongoing legal proceedings, and completing the Review and Management’s Billing Assessment. A summary of significant events that have occurred during this period is more fully described elsewhere in this report under the caption “Significant Events Over the Past Few Years” in Item 1, Business and Item 3, Legal Proceedings.
We have devoted significant resources over the past few years to improving our fundamental business systems, including our corporate governance functions, financial controls, and operational infrastructure. As our organization was focusing on all of these issues, we also pursued major operational initiatives to consolidate technology platforms, communicate actively with our customers, and restructure our business.
During this same period there have been several significant developments in the medical transcription industry, including:
| • | A shortage of qualified domestic MTs has increased the demand for outsourced medical transcription services byU.S.-based healthcare providers. This demand for qualified MTs, as well as budgetary pressures experienced by healthcare providers, has also caused many moreU.S.-based healthcare providers to evaluate and consider the use of offshore medical transcription labor. | |
| • | Several low cost providers have emerged and aggressively moved into our market offering medical transcription services (performed both domestically and offshore) at prices significantly below our traditional price point. While we believe the market for outsourced medical transcription continues to expand, the growing acceptance by customers of the use of offshore labor has further increased the competitive environment in the medical transcription industry. | |
| • | Technological advances by us and our competitors have reduced the length of time required to transcribe medical reports, in turn reducing the overall cost of medical transcription services. |
Although we remain the leading provider of medical transcription services in the U.S., we experience competition from many local, regional and national businesses. The medical transcription industry is highly fragmented, and we believe there are hundreds of companies in the U.S. performing medical transcription services. There are currently two large service providers, one of which is us and the other of which is Spheris Inc., several mid-sized service providers with annual revenues of between $15 million and $100 million and hundreds of smaller, independent businesses with annual revenues of less than $15 million.
We believe the outsourced portion of the medical transcription services market will increase due in part to healthcare providers seeking the following:
| • | reduction in overhead and other administrative costs; | |
| • | improvement in the quality and speed of delivery of transcribed medical reports; |
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| • | access to leading technologies, such as speech recognition technology, without any development and investment risk; | |
| • | expertise in implementing and managing a medical transcription system tailored to the providers’ specific requirements; | |
| • | access to skilled MTs; and | |
| • | support for compliance with governmental and industry mandated privacy and security requirements and EHR initiatives. |
Although we believe the outsourced portion of the medical transcription services market continues to grow, in order to benefit from this trend we must overcome the following challenges: reverse recent market share decline, increase profit margins and continue to benefit from technological advances.
We evaluate our performance based upon the following factors:
| • | revenues; | |
| • | operating income; | |
| • | net income per share; | |
| • | net cash provided by operating activities; and | |
| • | days sales outstanding. |
Our goal is to execute our strategy to yield growth in net revenues, operating income and net income per share.
Critical Accounting Policies, Judgments and Estimates
MD&A is based in part upon our consolidated financial statements which have been prepared in accordance with generally accepted accounting principles in the U.S. (GAAP). We believe there are several accounting policies that are critical to understanding our historical and future performance, as these policies affect the reported amounts of revenues and other significant areas that involve management’s judgments and estimates. These critical accounting policies and estimates have been discussed with our audit committee.
The preparation of our consolidated financial statements requires us to make estimates and judgments that affect our reported amounts of assets, liabilities, expenses and related disclosure of contingent liabilities. On an ongoing basis, we evaluate these estimates and judgments. We base these estimates on historical experience and on various other assumptions that are believed to be reasonable at such time, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may ultimately differ from these estimates. A critical accounting estimate meets two criteria: (1) it requires assumptions about highly uncertain matters, and (2) there would be a material effect on the financial statements from either using a different, although reasonable, amount within the range of the estimate in the current period or from reasonably likely period-to-period changes in the estimate. While there are a number of accounting policies, methods and estimates affecting our financial statements as addressed in Note 3 to our consolidated financial statements, areas that are particularly significant and critical include:
Valuation of Long-Lived and Other Intangible Assets and Goodwill. In connection with acquisitions, we allocate portions of the purchase price to tangible and intangible assets, consisting of acquired technologies, customer relationships, tradenames and non-compete agreements based on independent appraisals received after each acquisition, with the remainder allocated to goodwill. We assess the realizability of goodwill and intangible assets with indefinite useful lives at least annually, or sooner if events or changes in circumstances indicate that the carrying amount may not be recoverable. After our annual impairment test was completed in the second quarter of 2005, we changed our annual goodwill impairment test date to the fourth quarter of each fiscal year. This change in the testing date for impairment was designed to align the testing with our normal business process for updating our
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strategic plan and forecasts which are finalized in the fourth quarter of each fiscal year. We have determined that the reporting unit level is our sole operating segment. The test for goodwill is a two-step process:
| • | First, we compare the carrying amount of our reporting unit, which is the book value of our entire company, to the fair value of our reporting unit. If the carrying amount of our reporting unit exceeds its fair value, we have to perform the second step of the process. If not, no further testing is needed. | |
| • | If the second part of the analysis is required, we allocate the fair value of our reporting unit to all assets and liabilities as if the reporting unit had been acquired in a business combination at the date of the impairment test. We then compare the implied fair value of our reporting unit’s goodwill to its carrying amount. If the carrying amount of our goodwill exceeds its fair value, we recognize an impairment loss in an amount equal to that excess. |
We review our long-lived assets, including amortizable intangibles, for impairment when events indicate that their carrying amount may not be recoverable. When we determine that one or more impairment indicators are present for an asset, we compare the carrying amount of the asset to net future undiscounted cash flows that the asset is expected to generate. If the carrying amount of the asset is greater than the net future undiscounted cash flows that the asset is expected to generate, we compare the fair value to the book value of the asset. If the fair value is less than the book value, we recognize an impairment loss. The impairment loss is the excess of the carrying amount of the asset over its fair value.
Some of the events that we consider as impairment indicators for our long-lived assets, including goodwill, are:
| • | our net book value compared to our market capitalization; | |
| • | significant adverse economic and industry trends; | |
| • | significant decrease in the market value of the asset; | |
| • | the extent that we use an asset or changes in the manner that we use it; and | |
| • | significant changes to the asset since we acquired it. |
During 2004, we recorded an impairment loss of $14.6 million on goodwill and we recorded an impairment loss of $0.5 million related to a tradename that was no longer going to be utilized. A decrease in the value of our business could trigger additional impairment charges related to goodwilland/or amortizable intangible assets.
Deferred income taxes. As of December 31, 2006, we had net deferred income tax assets of $49.2 million prior to consideration of a valuation allowance. These deferred income tax assets result primarily from expenses that have been recorded for book purposes but not yet recorded on tax returns and from net operating loss carry forwards. Deferred income tax assets represent future tax benefits that we expect to be able to apply against future taxable income or that will result in future net operating losses that can be carried forward. Our ability to utilize the deferred income tax assets is dependent upon our ability to generate future taxable income. To the extent that we believe it is more likely than not that a deferred tax asset will not be utilized we record a valuation allowance against that asset. In making that determination we consider all positive and negative evidence and give stronger consideration to evidence that is objective in nature. Based on this analysis we determined that a valuation allowance would be provided against a portion of the deferred income tax assets in the fourth quarter of 2005. No valuation allowance was established against deferred income tax assets to the extent the asset could be benefited through the use of a net operating loss carry back or to the extent we have deferred tax liabilities as of the balance sheet date that will generate taxable income within the same period in which a deferred tax asset will reverse. The valuation allowance was adjusted in 2006 following the same methodology.
In the fourth quarter of 2004 a valuation allowance was established against a portion of our deferred income tax assets related to foreign operations based on projected future earnings of that enterprise.
We will continue to evaluate the realizability of our deferred income tax assets in future periods and adjust the valuation allowance accordingly.
Commitments and contingencies. Other than $7.75 million for the matter referenced under the caption “Shareholder Securities Litigation” contained in Item 3, Legal Proceedings, as of December 31, 2006, we have not
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accrued for potential future settlements or adverse outcomes for the other items contained in Item 3, Legal Proceedings, since no matters were probable and no amount within the range of possible losses represented a better amount within the range. We have insurance coverage which may reimburse us for defense and other costs incurred by us. We consider whether the recovery of certain insurance payments to us are probable. For the year ended December 31, 2006, we were reimbursed $8.7 million by our insurance companies for defense and other costs in connection with litigation matters referenced in Item 3, Legal Proceedings, other than the settlement referenced above.
Revenue recognition. For the year ended December 31, 2006, approximately 84% of our net revenues were derived from our medical transcription technology and services. Medical transcription and medical records coding services revenues are recognized when there is persuasive evidence that an arrangement exists, the price is fixed or determinable, services are rendered and collectibility is reasonably assured. These services are based on contracted rates. Medical transcription and medical records coding services revenues are net of estimates for customer credits. Historically, our estimates have been adequate. If actual results are higher or lower than our estimates, we would have to adjust our estimates and financial statements in future periods.
The remainder of our revenues is derived from the sale and implementation of voice-capture and document management products including software and implementation, training and maintenance services of these products. The application of the accounting guidelines requires judgment regarding the timing of the recognition of these revenues including: (i) whether a software arrangement includes multiple elements, and if so, whether vendor-specific objective evidence of fair value exists for those elements; (ii) whether customizations or modifications of the software are significant; and (iii) whether collection of the software fee is probable. Additionally, for certain contracts we recognize revenues using the percentage-of-completion method. Percentage-of-completion accounting involves estimates of the total costs to be incurred over the duration of the project.
Accounts receivable and allowance for doubtful accounts. Accounts receivable are recorded at the invoiced amount and do not bear interest. The carrying value of accounts receivable approximates fair value. The allowance for doubtful accounts is our best estimate of estimated losses resulting from the inability of our customers to make required payments and for service level credits offered to our customers. This allowance is used to state trade receivables at estimated net realizable value.
We estimate uncollectible amounts based upon our historical write-off experience, current customer receivable balances, aging of customer receivable balances, the customer’s financial condition and current economic conditions. Historically, these estimates have been adequate to cover our accounts receivable exposure.
We enter into medical transcription service arrangements which contain provisions for performance penalties in the event certain service levels, primarily related to turnaround time on transcribed reports, are not achieved. We reduce revenues for any performance penalties incurred and have included an estimate of such credits in our allowance for uncollectible accounts.
Product revenues for sales to end-user customers and resellers are recognized upon passage of title if all other revenue recognition criteria have been met. End-user customers generally do not have a right of return. We provide certain of our resellers and distributors with limited rights of return of our products. We reduce revenues for rights to return our product based upon our historical experience and have included an estimate of such credits in our allowance for uncollectible accounts.
Accounting for consideration given to a customer. In response to our customers’ concerns over the July 2004 Press Release, which is described under the caption “Significant Events Over the Past Few Years” in Item 1, Business, we offered financial accommodations to certain of our customers. Consideration given by a vendor to a customer is presumed to be a reduction of the selling price of the vendor’s services. Therefore, $10.4 million and $57.7 million of the authorized accommodation amount for our customers was characterized as a reduction of revenues in 2006 and 2005, respectively.
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Basis of Presentation
Sources of Revenues
We derive revenues primarily from the provision of medical transcription services to health systems, hospitals and large group medical practices. Our customers are generally charged a rate times the volume of work that we transcribe or edit. In the clinical documentation workflow, we provide, in addition to medical transcription technology and services, maintenance services, digital dictation, speech recognition, electronic signature and medical coding technology and services. Our medical transcription revenues (excluding the impact of our customer accommodation program) have been declining over the past several years, as prices have declined and some customers have switched to alternative vendors. Our technology products and services revenues also declined over the past several years, as many products reached the end of their life and new products have not replaced the lost revenues. We have not filed periodic reports with the SEC disclosing financial information for periods after December 31, 2006, and our historical financial information is not a predictor of financial performance subsequent to 2006 or future financial performance.
As a result of our customer accommodation program described under the caption “Significant Events Over the Past Few Years” contained in Item 1, Business, net revenues for the years ended December 31, 2006 and 2005 were reduced by $10.4 million and $57.7 million, respectively.
Net revenues for customers in the U.S. were $353.5 million, $348.4 million and $447.0 million for the years ended December 31, 2006, 2005 and 2004, respectively. Net revenues for customers outside the U.S. were $4.6 million, $4.6 million and $4.9 million for the years ended December 31, 2006, 2005 and 2004, respectively.
Cost of Revenues
Cost of revenues includes compensation of MTs, other payroll costs (primarily related to operational and production management, quality assurance, quality control and customer and field service personnel), telecommunication and facility costs. Cost of revenues also includes the direct cost of technology products sold to customers. MT payroll cost is directly related to medical transcription revenues and is based on lines transcribed or edited multiplied by a specific rate. Therefore, MT costs trend directly in line with revenues. Fixed costs have been reduced though not at the same pace as net revenues.
Selling, General and Administrative (SG&A)
Our SG&A expenses include marketing and sales costs, accounting costs, information technology costs, professional fees, corporate facility costs, corporate payroll and benefits expenses.
Research and Development (R&D)
Our R&D expenses consist primarily of personnel and related costs, including salaries and employee benefits for software engineers and consulting fees paid to independent consultants who provide software engineering services to us. To date, our R&D efforts have been devoted to new products and services offerings and increases in features and functionality of our existing products and services.
Depreciation and amortization
Depreciation is calculated on a straight-line basis over the estimated useful lives of the assets which range from three to seven years for furniture, equipment and software, and the lesser of the lease term or estimated useful life for leasehold improvements. Intangible assets are being amortized using the straight-line method over their estimated useful lives which range from three to 20 years.
Cost of investigation and legal proceedings
Cost of investigation and legal proceedings include legal fees incurred in connection with the SEC and DOJ investigations and proceedings and the defense of civil litigation matters described in Item 3, Legal Proceedings, litigation support consulting, and consulting services provided by Nightingale and Associates, LLC (Nightingale)
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in connection with the Review and Management’s Billing Assessment described under the caption “Significant Events Over the Past Few Years” in Item 1, Business.
Shareholder Securities Litigation Settlement
Shareholder Securities Litigation Settlement represents the $7.75 million payment made pursuant to the memorandum of understanding and stipulation of settlement described under the caption “Shareholder Securities Litigation” in Item 3, Legal Proceedings.
Consolidated Results of Operations
The following tables set forth our consolidated results of operations for the periods indicated below:
Comparison of Years Ended December 31, 2006 and 2005
| Years Ended December 31, | ||||||||||||||||||||||||
| 2006 | 2005 | |||||||||||||||||||||||
| % of Net | % of Net | |||||||||||||||||||||||
| Amount | Revenues | Amount | Revenues | $ Change | % Change | |||||||||||||||||||
| ($ in thousands) | ||||||||||||||||||||||||
| Net revenues | $ | 358,091 | 100.0 | % | $ | 353,005 | 100.0 | % | $ | 5,086 | 1.4 | % | ||||||||||||
| Operating costs and expenses: | ||||||||||||||||||||||||
| Cost of revenues | 280,273 | 78.3 | % | 315,399 | 89.3 | % | (35,126 | ) | (11.1 | )% | ||||||||||||||
| Selling, general and administrative | 53,675 | 15.0 | % | 54,558 | 15.5 | % | (883 | ) | (1.6 | )% | ||||||||||||||
| Research and development | 13,219 | 3.7 | % | 9,784 | 2.8 | % | 3,435 | 35.1 | % | |||||||||||||||
| Depreciation | 11,802 | 3.3 | % | 17,099 | 4.8 | % | (5,297 | ) | (31.0 | )% | ||||||||||||||
| Amortization of intangible assets | 5,829 | 1.6 | % | 8,193 | 2.3 | % | (2,364 | ) | (28.9 | )% | ||||||||||||||
| Cost of investigation and legal proceedings | 13,001 | 3.6 | % | 34,127 | 9.7 | % | (21,126 | ) | (61.9 | )% | ||||||||||||||
| Shareholder securities litigation settlement | — | — | 7,750 | 2.2 | % | (7,750 | ) | (100.0 | )% | |||||||||||||||
| Impairment charges | — | — | 148 | 0.0 | % | (148 | ) | (100.0 | )% | |||||||||||||||
| Restructuring charges | 3,442 | 1.0 | % | 3,257 | 0.9 | % | 185 | 5.7 | % | |||||||||||||||
| Total operating costs and expenses | 381,241 | 106.5 | % | 450,315 | 127.6 | % | (69,074 | ) | (15.3 | )% | ||||||||||||||
| Operating loss | (23,150 | ) | (6.5 | )% | (97,310 | ) | (27.6 | )% | 74,160 | (76.2 | )% | |||||||||||||
| Equity in income of affiliated company | 874 | 0.2 | % | 500 | 0.1 | % | 374 | 74.8 | % | |||||||||||||||
| Interest income, net | 7,628 | 2.1 | % | 5,940 | 1.7 | % | 1,688 | 28.4 | % | |||||||||||||||
| Loss before income taxes | (14,648 | ) | (4.1 | )% | (90,870 | ) | (25.7 | )% | 76,222 | (83.9 | )% | |||||||||||||
| Income tax provision | 2,294 | 0.6 | % | 20,762 | 5.9 | % | (18,468 | ) | (88.9 | )% | ||||||||||||||
| Net loss | $ | (16,942 | ) | (4.7 | )% | $ | (111,632 | ) | (31.6 | )% | $ | 94,690 | (84.8 | )% | ||||||||||
Net revenues
Net revenues increased $5.1 million, or 1.4%, to $358.1 million for the year ended December 31, 2006 compared with $353.0 million for the year ended December 31, 2005. Excluding the charges for the customer accommodation program ($10.4 million in 2006 and $57.7 in 2005), service revenues decreased by $30.2 million in 2006 due to lower pricing to both new and existing customers and lower medical transcription volume. We believe the reduction in volume was the result primarily of customer losses to other outsourced medical transcription providers due to, among other things, price competition and our requirement that our medical transcription customers migrate from disparate and older technology platforms to our DEP. In addition, net revenues were also
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reduced by lower sales and implementations of our technology products of $12.0 million resulting primarily from the impact of certain technology products reaching the end of their life cycle.
We continue to experience pricing pressures as our existing and potential customers seek out opportunities to reduce costs, particularly through the utilization of offshore labor.
Cost of revenues
Cost of revenues decreased $35.1 million, or 11.1%, to $280.3 million for the year ended December 31, 2006 compared with $315.4 million for the year ended December 31, 2005. This decrease was attributable primarily to:
| • | decreased telecommunications costs of $9.4 million associated with both the decrease in our medical transcription volume and the transition of customers from our non-DEP medical transcription platforms, which required MTs to access dictation using traditional phone lines, to our DEP, which allows MTs to access dictation through the internet; | |
| • | reduced compensation costs of $8.4 million due to the decrease in our medical transcription volume as well as savings from our increased use of speech recognition technology; | |
| • | reduced other costs of $8.1 million resulting primarily from decreased non-MT headcount; | |
| • | reduced technology product costs of $3.4 million related directly to the reduction in our technology product revenues; | |
| • | lower asset impairment costs of $0.2 million in 2006 compared with $3.9 million 2005; | |
| • | reduced costs of $3.4 million resulting from facility closures; offset by | |
| • | increased stock-based compensation expense of $1.3 million |
As a percentage of net revenues, cost of revenues decreased to 78.3% in 2006 from 89.3% in 2005 as a result primarily of higher customer accommodation charges in 2005 partially offset by lower medical transcription service rates in 2006 and the impact of fixed costs in 2006 not declining at the same pace as services revenues excluding customer accommodation charges.
Selling, general and administrative
SG&A expenses decreased $0.9 million, or 1.6%, to $53.7 million for the year ended December 31, 2006 compared with $54.6 million for the year ended December 31, 2005. This decline was attributable primarily to a decrease in bonus and commission expense of $3.0 million, $2.3 million associated with the separation and replacement of certain members of our management team in 2005 that did not recur in 2006, as well as reductions in sales and marketing expense of $1.3 million, human resources consultants of $0.9 million and all other miscellaneous SG&A expenses of $0.5 million. These decreases were offset by an increase in audit and outside consulting fees of $4.7 million related to the audit of our financial statements and the audit of our internal control over financial reporting, an increase in legal costs of $1.1 million due to higher than anticipated fees for matters unrelated to the Review and Management’s Billing Assessment, an increase of $0.7 million in insurance premiums as a result of insurance recoveries related to legal expenses and an increase in stock-based compensation expense of $0.6 million. SG&A expenses as a percentage of net revenues for 2006 were 15.0% compared with 15.5% for 2005.
Research & development
R&D expenses increased $3.4 million, or 35.1%, to $13.2 million for the year ended December 31, 2006 compared with $9.8 million for the year ended December 31, 2005. This increase was due primarily to an increase in compensation expense of $1.8 million due to an increase in headcount, higher professional fees for outside consultants of $0.6 million and higher miscellaneous expenses of $1.0 million. R&D expenses as a percentage of net revenues were 3.7% for the year ended December 31, 2006 compared with 2.8% for the year ended December 31, 2005.
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Depreciation
Depreciation expense decreased $5.3 million, or 31.0%, to $11.8 million for the year ended December 31, 2006 compared with $17.1 million for the year ended December 31, 2005. This decrease was due primarily to a $4.1 million write-off of assets in the fourth quarter of 2005 and assets reaching the end of their depreciation period in 2006. Depreciation expense as a percentage of net revenues was 3.3% for the year ended December 31, 2006 compared with 4.8% for the year ended December 31, 2005.
Amortization
Amortization of intangible assets decreased $2.4 million, or 28.9%, to $5.8 million for the year ended December 31, 2006 compared with $8.2 million for the year ended December 31, 2005. This decrease was the result primarily of several assets reaching the end of their amortization period. Amortization of intangible assets as a percentage of net revenues was 1.6% for the year ended December 31, 2006 compared with 2.3% for the same period in 2005.
Cost of investigation and legal proceedings
Costs and expenses associated with the Review and Management’s Billing Assessment are being reported as cost of investigation and legal proceedings. These costs and expenses decreased $21.1 million, or 61.9%, to $13.0 million for the year ended December 31, 2006 compared with $34.1 million for the year ended December 31, 2005. This reduction in costs was the result of decreases in legal fees incurred in connection with the SEC and DOJ investigations and proceedings and the defense of civil litigation matters as well as litigation support consulting of $11.4 million, lower consulting services provided by Nightingale of $0.2 million related to Management’s Billing Assessment and lower other miscellaneous costs of $0.1 million, as well as an insurance recovery on our legal expenses of $9.4 million.
Shareholder securities litigation settlement
Shareholder securities litigation settlement for the year ended December 31, 2005 represents the $7.75 million payment made pursuant to the memorandum of understanding and stipulation of settlement described under the caption “Shareholder Securities Litigation” in Item 3, Legal Proceedings.
Restructuring charges
During the latter half of 2005, we implemented a restructuring plan based on a centralized national service delivery model to streamline our organizational and operational structure to better service our customers. The 2005 restructuring plan involved the consolidation of operating facilities and a related reduction in workforce. During 2006, we recorded a restructuring charge of $3.4 million comprised of $1.7 million for non-cancelable leases related to the closure of offices, $0.3 million for the write-off of property and equipment and $1.4 million for severance obligations. During 2005, we recorded a restructuring charge of $3.3 million comprised of $2.3 million for non-cancelable leases related to the closure of offices, $0.2 million for the write-off of property and equipment and $0.7 million of severance obligations.
As of December 31, 2006, $0.7 million of restructuring charges remained to be paid in future periods. The payment stream for non-cancelable leases will extend into 2009.
Interest income, net
Interest income, net reflects interest earned on cash and cash equivalent balances. Interest income, net increased $1.7 million, or 28.4%, to $7.6 million for the year ended December 31, 2006 compared with $5.9 million for the year ended December 31, 2005. This increase was attributable primarily to higher weighted average interest rates earned in 2006 (4.6%) compared to 2005 (3.1%), offset by a $28 million lower average cash balance in 2006 compared with 2005.
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Income tax (benefit) provision
The effective income tax rate for the year ended December 31, 2006 was 15.7% compared with an effective income tax rate of 22.8% for the year ended December 31, 2005. The difference in tax rates is related primarily to the decrease in the pre-tax book loss from 2005 to 2006 and the impact of the establishment of a valuation allowance against the deferred income tax assets in 2005. After consideration of all evidence, both positive and negative, management concluded that it was more likely than not that the deferred income tax assets would not be realized. In addition, adjustments were recognized for the year ended December 31, 2006 including the reduction of state tax expense for the expiration of statue of limitations with respect to uncertain tax positions, the recognition of tax benefits for Alternative Minimum Tax credits and adjustments for various exposures related to state taxes.
Comparison of Years Ended December 31, 2005 and 2004
| Years Ended December 31, | ||||||||||||||||||||||||
| 2005 | 2004 | |||||||||||||||||||||||
| % of Net | % of Net | |||||||||||||||||||||||
| Amount | Revenues | Amount | Revenues | $ Change | % Change | |||||||||||||||||||
| ($ in thousands) | ||||||||||||||||||||||||
| Net revenues | $ | 353,005 | 100.0 | % | $ | 451,894 | 100.0 | % | $ | (98,889 | ) | (21.9 | )% | |||||||||||
| Operating costs and expenses: | ||||||||||||||||||||||||
| Cost of revenues | 315,399 | 89.3 | % | 336,232 | 74.4 | % | (20,833 | ) | (6.2 | )% | ||||||||||||||
| Selling, general and administrative | 54,558 | 15.5 | % | 46,436 | 10.3 | % | 8,122 | 17.5 | % | |||||||||||||||
| Research and development | 9,784 | 2.8 | % | 10,539 | 2.3 | % | (755 | ) | (7.2 | )% | ||||||||||||||
| Depreciation | 17,099 | 4.8 | % | 18,521 | 4.1 | % | (1,422 | ) | (7.7 | )% | ||||||||||||||
| Amortization of intangible assets | 8,193 | 2.3 | % | 8,888 | 2.0 | % | (695 | ) | (7.8 | )% | ||||||||||||||
| Cost of investigation and legal proceedings | 34,127 | 9.7 | % | 10,253 | 2.3 | % | 23,874 | 232.8 | % | |||||||||||||||
| Shareholder securities litigation settlement | 7,750 | 2.2 | % | — | — | 7,750 | — | |||||||||||||||||
| Impairment charges | 148 | 0.0 | % | 15,078 | 3.3 | % | (14,930 | ) | (99.0 | )% | ||||||||||||||
| Restructuring charges | 3,257 | 0.9 | % | — | — | 3,257 | — | |||||||||||||||||
| Total operating costs and expenses | 450,315 | 127.6 | % | 445,947 | 98.7 | % | 4,368 | 1.0 | % | |||||||||||||||
| �� | ||||||||||||||||||||||||
| Operating (loss) income | (97,310 | ) | (27.6 | )% | 5,947 | 1.3 | % | (103,257 | ) | — | ||||||||||||||
| Equity in income of affiliated company | 500 | 0.1 | % | 188 | 0.0 | % | 312 | 166.0 | % | |||||||||||||||
| Interest income, net | 5,940 | 1.7 | % | 1,840 | 0.4 | % | 4,100 | 222.8 | % | |||||||||||||||
| (Loss) income before income taxes | (90,870 | ) | (25.7 | )% | 7,975 | 1.8 | % | (98,845 | ) | — | ||||||||||||||
| Income tax provision | 20,762 | 5.9 | % | 4,233 | 0.9 | % | 16,529 | — | ||||||||||||||||
| Net (loss) income | $ | (111,632 | ) | (31.6 | )% | $ | 3,742 | 0.8 | % | $ | (115,374 | ) | — | |||||||||||
Net revenues
Net revenues decreased $98.9 million, or 21.9%, to $353.0 million for the year ended December 31, 2005 compared with $451.9 million for the year ended December 31, 2004. This decrease was attributable primarily to:
| • | reduced service revenues of $95.2 million resulting primarily from a charge of $57.7 million in 2005 related to the customer accommodation program, as well as $37.5 million due to lower pricing to both new and existing customers and lower medical transcription volume. We believe the reduction in volume was the result primarily of customer losses to other outsourced medical transcription providers due to, among other |
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things, price competition and our requirement that our medical transcription customers migrate from disparate and older technology platforms to our DEP; and
| • | reduced sales and implementations of our technology products of $3.7 million resulting primarily from the impact of certain technology products reaching the end of their life cycle. |
Pricing pressures have continued as our existing and potential customers continue to seek out opportunities to reduce costs, particularly through the utilization of offshore labor.
Cost of revenues
Cost of revenues decreased $20.8 million, or 6.2%, to $315.4 million for the year ended December 31, 2005 compared with $336.2 million for the year ended December 31, 2004. This decrease was attributable primarily to:
| • | reduced medical transcription payroll costs of $9.8 million related directly to the decrease in our medical transcription revenues; | |
| • | reduced other costs of $6.5 million resulting primarily from decreased non-MT headcount and facility closures; | |
| • | decreased telecommunications costs of $5.2 million associated with both the decrease in our medical transcription revenues and the transition of customers from our non-DEP medical transcription platforms, which required MTs to access dictation using traditional phone lines, to our DEP, which allows MTs to access dictation through the internet; | |
| • | reduced technology product costs of $3.3 million related directly to the reduction in our technology product revenues; offset by | |
| • | a write-off in 2005 of $3.9 million resulting from an inventory of fixed assets performed during 2005. |
As a percentage of net revenues, cost of revenues increased to 89.3% in 2005 from 74.4% in 2004 as a result primarily of customer accommodation charges, lower medical transcription service rates and the impact of fixed costs not declining at the same pace as net revenues.
Selling, general and administrative
SG&A expenses increased $8.1 million, or 17.5%, to $54.6 million for the year ended December 31, 2005 compared with $46.4 million for the year ended December 31, 2004. This increase was attributable primarily to increases in: compensation expense of $2.1 million for enhancements to our corporate staff, bad debt expense of $1.1 million, sales and marketing expense of $1.1 million, audit and outside consulting fees of $1.0 million related to the audit of our financial statements and the audit of our internal control over financial reporting, human resources consultants of $0.9 million, legal costs of $0.8 million and all other SG&A costs of $2.2 million. These increases were offset by a decrease in costs of $1.1 million associated with the separation and replacement of certain members of our management team. SG&A expenses as a percentage of net revenues for 2005 were 15.5% compared with 10.3% for 2004.
Research & development
R&D expenses decreased $0.8 million, or 7.2%, to $9.8 million for the year ended December 31, 2005 compared with $10.5 million for the year ended December 31, 2004. This decrease was due primarily to lower professional fees for outside consultants of $0.7 million as well as certain costs capitalized into intangible assets for software development of $0.6 million. These reductions were partially offset by an increase in compensation expense of $0.5 million. R&D expenses as a percentage of net revenues were 2.8% for the year ended December 31, 2005 compared with 2.3% for the year ended December 31, 2004.
Depreciation
Depreciation expense decreased $1.4 million, or 7.7%, to $17.1 million for the year ended December 31, 2005 compared with $18.5 million for the year ended December 31, 2004. This decrease was due primarily to assets
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reaching the end of their depreciation period in 2005 combined with a $5.2 million decrease in asset additions in 2005 compared with 2004. Depreciation expense as a percentage of net revenues was 4.8% for the year ended December 31, 2005 compared with 4.1% for the year ended December 31, 2004.
Amortization
Amortization of intangible assets decreased $0.7 million, or 7.8%, to $8.2 million for the year ended December 31, 2005 compared with $8.9 million for the year ended December 31, 2004. This decrease was the result primarily of several assets reaching the end of their amortization period. Amortization of intangible assets as a percentage of net revenues was 2.3% for the year ended December 31, 2005 compared with 2.0% for the same period in 2004.
Cost of investigation and legal proceedings
Costs and expenses associated with the Review and Management’s Billing Assessment are being reported as cost of investigation and legal proceedings. These costs and expenses increased $23.9 million, or 232.8%, to $34.1 million for the year ended December 31, 2005 compared with $10.3 million for the year ended December 31, 2004. These increased costs and expenses include legal fees incurred in connection with the SEC and DOJ investigations and proceedings, the defense of civil litigation matters and litigation support consulting of $21.8 million, $1.8 million for consulting services provided by Nightingale related to Management’s Billing Assessment and $0.3 million for other miscellaneous costs.
Shareholder securities litigation settlement
Shareholder securities litigation settlement represents the $7.75 million payment made pursuant to the memorandum of understanding and stipulation of settlement described under the caption “Shareholder Securities Litigation” in Item 3, Legal Proceedings.
Impairment charges
An impairment charge of $15.1 million was recorded for the year ended December 31, 2004 due to:
| • | a goodwill impairment charge of $14.6 million recorded in December 2004 related to the Solutions reporting unit resulting from reduced sales and margins and lower than forecasted operating profits and cashflows; and | |
| • | an intangible impairment charge of $0.5 million relating to a tradename that was no longer going to be utilized. |
Restructuring charges
During the latter half of 2005, we implemented a restructuring plan based on a centralized national service delivery model to streamline our organizational and operational structure to better service our customers. The 2005 restructuring plan involved the consolidation of operating facilities and a related reduction in workforce. During 2005, we recorded a restructuring charge of $3.3 million comprised of $2.3 million for non-cancelable leases related to the closure of offices, $0.2 million for the write-off of property and equipment and $0.7 million for severance obligations.
As of December 31, 2005, $2.1 million of restructuring charges remained to be paid in future periods. Approximately $3.4 million of additional charges were incurred in 2006. The payment stream for non-cancelable leases will extend into 2009.
Interest income, net
Interest income, net reflects interest earned on cash and cash equivalent balances. Interest income, net increased $4.1 million, or 222.8%, to $5.9 million for the year ended December 31, 2005 compared with $1.8 million for the year ended December 31, 2004. This increase was attributable primarily to higher weighted
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average interest rates earned in 2005 (3.1%) compared to the 2004 period (1%), as well as an $11.2 million higher average cash balance in 2005 compared with 2004.
Income tax (benefit) provision
The effective income tax benefit rate for the year ended December 31, 2005 was 22.8% compared with an effective income tax expense rate of 53.1% for the year ended December 31, 2004. The difference in tax rates is primarily attributable to an increase in the valuation allowance in 2005 than the increase in 2004 combined with a pre-tax book loss in 2005 and pre-tax book earnings in 2004. The increase in the valuation allowance in 2005 related to management’s decision to establish a $56.8 million valuation allowance against a majority of our domestic deferred income tax assets. After consideration of all evidence, both positive and negative, management concluded that it was more likely than not that a majority of the domestic deferred income tax assets would not be realized. In 2004, we recorded a valuation allowance against foreign net operating loss carry forward which increased the effective income tax expense rate.
Liquidity and Capital Resources
As of December 31, 2006, we had net working capital of $145.5 million compared with $150.7 million as of December 31, 2005. Our principal sources of liquidity are cash flows provided by operating activities and available cash on hand. Cash and cash equivalents declined $2.9 million to $175.4 million as of December 31, 2006 from $178.3 million as of December 31, 2005. This decline was driven primarily by purchases of property and equipment of $8.2 million which was somewhat offset by cash provided by operating activities of $5.4 million. The $5.4 million net cash provided by operating activities reflects a $16.9 million net loss and $30.1 million of customer accommodation payments offset by $17.6 million of depreciation and amortization expense, $22.5 million of federal tax refunds received in 2006 for 2005 losses carried back to the 2003 and 2004 tax years and an $11.1 million decrease in accounts receivables driven by improved days sales outstanding. Included in the $16.9 million net loss for the year ended December 31, 2006 was $9.4 million in insurance recoveries related to the billing investigation. As of the date of this report, we have received an additional $16.1 million of insurance recoveries in 2007, with no other recoveries expected in the future related to the billing investigation.
We believe our existing cash and cash equivalents and cash to be generated from operations, if any, will be sufficient to finance our operations for the foreseeable future. However, if we fail to generate adequate cash flows from operations in the future due to an unexpected decline in our net revenues or due to increased cash expenditures in excess of the net revenues generated, then our cash balances may not be sufficient to fund our continuing operations without obtaining additional debt or equity. There are no assurances that sufficient funding from external sources will be available to us on acceptable terms, if at all. For instance, we may have increased cash expenditures relating to:
| • | the SEC, DOJ and DOL investigations and proceedings; and | |
| • | the defense and resolution of the civil litigation matters. |
Off-Balance Sheet Arrangements
We are not involved in any off-balance sheet arrangements that have or are reasonably likely to have a material current or future impact on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures, or capital resources.
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Contractual Obligations
The following table summarizes our obligations to make future payments under current contracts as of December 31, 2006 (in thousands):
| Payment Due By Period | ||||||||||||||||||||
| Less | ||||||||||||||||||||
| than | After | |||||||||||||||||||
| Total | 1 Year | 1-3 Years | 3-5 Years | 5 Years | ||||||||||||||||
| Operating Lease Obligations | $ | 6,605 | $ | 2,531 | $ | 2,528 | $ | 1,351 | $ | 195 | ||||||||||
| Purchase Obligations(1) | 27,738 | 7,753 | 12,200 | 7,785 | — | |||||||||||||||
| Severance and Other Guaranteed Payment Obligations(2) | 1,525 | 717 | 808 | — | — | |||||||||||||||
| Total Contractual Obligations | $ | 35,868 | $ | 11,001 | $ | 15,536 | $ | 9,136 | $ | 195 | ||||||||||
| (1) | Purchase obligations are for telecommunication contracts ($26,085), a software purchase ($1,046) and other recurring purchase obligations ($607). | |
| (2) | Severance and Other Guaranteed Payment Obligations consist of severance payments to our former President (Frank Lavelle) and our former Chief Operating Officer (Linda Reino) incurred during 2007 prior to the filing of this report ($975 and $450, respectively) and a signing bonus for Ms. Donovan ($100) which she became entitled to during 2007 prior to the filing of this report. |
We have agreements with certain of our named executive officers that provide for severance payments to the employee in the event the employee is terminated without cause. As further described in Item 11, Executive Compensation, the maximum cash exposure under these agreements was approximately $1.2 million as of December 31, 2006.
Recent Accounting Pronouncements
In June 2006, the Emerging Issues Task Force reached a consensus on IssueNo. 06-3,How Taxes Collected from Customers and Remitted to Government Authorities Should be Presented in the Income Statement (That Is, Gross versus Net Presentation). The consensus allows a company to choose between two acceptable alternatives based on its accounting policies for transactions in which the company collects taxes on behalf of a governmental authority, such as sales taxes. Under the gross method, taxes collected are accounted for as a component of sales revenue with an offsetting expense. Conversely, the net method allows a reduction to sales revenue. If such taxes are reported gross and are significant, companies should disclose the amount of those taxes. The guidance should be applied to financial reports through retrospective application for all periods presented, if amounts are significant, for interim and annual reporting beginning after December 31, 2006. We have historically presented taxes on a net basis and we do not intend to change our policy.
In July 2006, the Financial Accounting Standards Board (FASB) issued Interpretation 48,Accounting for Uncertainty in Income Taxes(FIN 48). FIN 48 prescribes a comprehensive model for the financial statement recognition, measurement, presentation and disclosure of uncertain tax positions taken or expected to be taken in income tax returns. FIN 48 is effective for fiscal years beginning after December 15, 2006. The cumulative effect, if any, of applying FIN 48 will be recorded as an adjustment to retained earnings as of the beginning of the period of adoption. We are still evaluating the adoption of FIN 48 and have not yet determined the impact, if any, on our consolidated financial statements.
In September 2006, the SEC issued Staff Accounting Bulletin 108,Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements(SAB 108), which addresses how the effects of prior-year uncorrected misstatements should be considered when quantifying misstatements in current-year financial statements. SAB 108 will require registrants to quantify misstatements using both the balance sheet and income-statement approaches and to evaluate whether either approach results in quantifying an error that is material in light of relevant quantitative and qualitative factors. When the effect of initial adoption is determined to be material, SAB 108 allows for a cumulative effect adjustment to beginning retained earnings. The requirements
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are effective for annual financial statements covering the first fiscal year ending after November 15, 2006. The adoption of SAB 108 did not have any impact on our consolidated financial statements.
In September 2006, the FASB issued Statement 157,Fair Value Measurements, (Statement 157) which defines fair value, establishes guidelines for measuring fair value and expands disclosures regarding fair value measurements. Statement 157 does not require any new fair value measurements. The provisions of this statement are effective for fiscal years beginning after November 15, 2007. We do not expect the adoption of Statement 157 to have a material impact on our consolidated financial statements.
In February 2007, the FASB issued Statement 159,The Fair Value Option for Financial Assets and Financial Liabilities, including an amendment of FASB Statement 115 (Statement 159) which permits entities to choose to measure eligible items at fair value at specified election dates. Unrealized gains and losses on items for which the fair value option has been elected will be reported in earnings at each subsequent reporting date. The following balance sheet items are within the scope of Statement 159:
| • | recognized financial assets and financial liabilities unless a special exception applies; | |
| • | firm commitments that would otherwise not be recognized at inception and that involve only financial instruments; | |
| • | non-financial insurance contracts; and | |
| • | most financial instruments resulting from separation of an embedded non-financial derivative instrument from a non-financial hybrid instrument. |
Statement 159 will be effective for fiscal years beginning after November 2007 with early adoption possible but subject to certain requirements. We do not expect the adoption of Statement 159 to have a material impact on our consolidated financial statements.
| Item 7A. | Quantitative and Qualitative Disclosures About Market Risk |
Market risk represents the risk of loss that may impact our financial position due to adverse changes in financial market prices and rates. Our market risk exposure is primarily a result of fluctuations in interest rates. We do not hold or issue financial instruments for trading purposes.
Interest Rate Risk
We earn interest income from our balances of cash and cash equivalents. This interest income is subject to market risk related to changes in interest rates, which affects primarily our investment portfolio. We invest in instruments that meet high credit quality standards, as specified in our investment policy.
Due to the average maturity of our investment portfolio, a material change in interest rates would not have a material effect on the value of our investment portfolio. Management estimates that if the average yield of our investments decreased by 100 basis points, our interest income for the year ended December 31, 2006 would have decreased by approximately $1.6 million. The impact on our future interest income will depend largely on the gross amount of our investments and future changes in investment yields.
| Item 8. | Financial Statements And Supplementary Data |
Our consolidated financial statements and supplementary data required by this item are attached to this report beginning onpage F-1.
| Item 9. | Changes in And Disagreements With Accountants On Accounting And Financial Disclosure |
None.
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| Item 9A. | Controls And Procedures |
| (a) | Evaluation of Disclosure Controls and Procedures |
Our management team, under the supervision and with the participation of our principal executive officer and our principal financial officer, evaluated the effectiveness of the design and operation of our disclosure controls and procedures as such term is defined underRule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended (Exchange Act), as of the last day of the fiscal period covered by this report, December 31, 2006. The term disclosure controls and procedures means our controls and other procedures that are designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is accumulated and communicated to management, including our principal executive and principal financial officer, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure. Based on this evaluation, our principal executive officer and our principal financial officer concluded that, because of the material weaknesses in our internal control over financial reporting described below and our inability to file certain reports required under the Exchange Act within their required time periods, our disclosure controls and procedures were not effective as of December 31, 2006. To compensate for the material weaknesses in our internal control over financial reporting described below, we performed additional manual procedures and analysis and other post-closing procedures in order to prepare the consolidated financial statements included in this report. As a result of these expanded procedures, we believe that the consolidated financial statements contained in this report present fairly, in all material respects, our financial condition, results of operations and cash flows for the fiscal years covered thereby in conformity with US generally accepted accounting principles (GAAP).
| (b) | Management’s Report on Internal Control over Financial Reporting as of December 31, 2006 |
Management is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is defined inRule 13a-15(f) andRule 15d-15(f) under the Exchange Act as a process designed by, or under the supervision of, the issuer’s principal executive and principal financial officers, or persons performing similar functions, and effected by the issuer’s board of directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with GAAP and includes those policies and procedures that:
| • | pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the issuer; | |
| • | provide reasonable assurance that transactions are recorded as necessary to permit the preparation of financial statements in accordance with GAAP, and that receipts and expenditures of the issuer are being made only in accordance with authorizations of management and directors of the issuer; and | |
| • | provide reasonable assurance regarding the prevention or timely detection of unauthorized acquisition, use or disposition of the issuer’s assets that could have a material effect on the financial statements. |
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with existing policies or procedures may deteriorate.
A “significant deficiency” is defined as a control deficiency, or combination of control deficiencies, that adversely affects a company’s ability to initiate, authorize, record, process, or report external financial data reliably in accordance with GAAP such that there is more than a remote likelihood that a misstatement of the annual or interim financial statements that is more than inconsequential will not be prevented or detected. A “material weakness” is defined as a significant deficiency or combination of significant deficiencies that result in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected.
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In accordance with the internal control reporting requirements of the SEC, management completed an assessment of the adequacy of our internal control over financial reporting as of December 31, 2006. In making this assessment, management used the criteria set forth inInternal Control — Integrated Frameworkby the Committee of Sponsoring Organizations of the Treadway Commission (COSO). As a result of management’s assessment, management concluded that our internal control over financial reporting had the following material weaknesses as of December 31, 2006:
Entity Level Controls
We identified the following material weaknesses related to entity level controls:
| • | We did not have adequate procedures to ensure the timely communication of information that involves complex, non-recurring accounting and other matters that impact our financial reporting process. Specifically, the communication of information between senior management and accounting personnel was not adequate to ensure the timely and accurate accounting and reporting of such information in our consolidated financial statements. | |
| • | We did not maintain a sufficient complement of accounting and finance personnel that were adequately trained and that possessed the appropriate level of knowledge in GAAP to properly account for complex accounting transactions. | |
| • | We did not have sufficient processes, controls and management oversight to ensure that our books and records were appropriately maintained and that complex accounting transactions were effectively researched and recorded in accordance with GAAP. There was a lack of appropriate processes and controls within the financial close process, insufficient review of complex accounting transactions, as well as inadequate training and expertise within the accounting and finance organization. |
These material weaknesses resulted in more than a remote likelihood that a material misstatement of our annual or interim consolidated financial statements would not be prevented or detected. These material weaknesses also contributed to the other material weakness identified below.
Revenue Recognition
We identified the following material weakness related to revenue recognition controls:
| • | We did not have adequate policies and procedures to ensure the proper recognition of post-contract customer support (PCS) and related hardware, software and implementation services in accordance with GAAP. In addition, individuals responsible for recording such revenues in our consolidated financial statements did not fully comprehend the criteria for revenue recognition. This material weakness resulted in errors in calculating the proper amount of revenues to defer in our 2006 consolidated financial statements. These errors were corrected prior to the issuance of the Company’s consolidated financial statements as of and for the year ended December 31, 2006. |
This material weakness resulted in more than a remote likelihood that a material misstatement of our annual or interim consolidated financial statements would not be prevented or detected.
Because of the material weaknesses described above, management concluded that, as of December 31, 2006, we did not maintain effective internal control over financial reporting based on the COSO criteria. Management’s assessment of the effectiveness of our internal control over financial reporting as of December 31, 2006 has been audited by KMPG LLP, our independent registered public accounting firm, as stated in its report, which is included elsewhere in thisForm 10-K.
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| (c) | Changes in Internal Control Over Financial Reporting |
Fiscal Quarter Ended December 31, 2006
There have been no changes in our internal control over financial reporting during the fiscal quarter ended December 31, 2006 that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
2007
As a result of initiatives that management undertook in 2007 with oversight from the Audit Committee to address known material weaknesses in our control over financial reporting as of December 31, 2006, we made progress in the remediation of our material weaknesses described above. The following material changes in our internal control over financial reporting were made to help remediate control deficiencies identified in 2006:
| • | Expanded our disclosure committee to include our Chief Executive Officer, our outside litigation counsel and a representative of Nightingale who assisted us with Management’s Billing Assessment and is assisting us with various projects at the direction of our Chief Executive Officer; | |
| • | Retained third party consultants to serve as technical resources to review, evaluate and provide guidance with respect to accounting for complex accounting and tax transactions; | |
| • | Evaluated service delivery requirements associated with various equipment sales transactions including delivery, implementation, training and project management; | |
| • | Established a process to track the status of all project implementations by individuals specifically assigned to various technical and management project aspects; and established a formal accounting methodology and implemented formal, monthly review procedures performed by corporate accounting personnel prior to the recording of any PCS, hardware, software and implementation service revenues; and | |
| • | Centralized accounting related to PCS, implementation services and deferred revenue to our corporate headquarters. |
Although our remediation efforts are underway related to our revenue recognition material weakness, we are in the process of identifying additional procedures and controls intended to remediate the entity level material weaknesses. Material weaknesses will not be considered remediated until new controls over financial reporting are fully implemented and operational for a period of time and are operating effectively.
| Item 9B. | Other Information |
None.
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PART III
| Item 10. | Directors, Executive Officers and Corporate Governance |
Identification of Directors
The following table lists all of our directors as of July 31, 2007. Each director will hold office until his successor is elected and qualified, or until his earlier resignation or removal. We have not held an annual meeting of shareholders since 2003. At our next annual meeting, which we expect to hold as soon as practicable after we meet the applicable requirements for soliciting proxies, our shareholders will elect directors to hold office until the next succeeding annual meeting of shareholders.
| Age on | Date Became a | |||||||
Name | 7/31/07 | Position | Director | |||||
| Clement Revetti, Jr.(1) | 52 | Director | 10/2006 | |||||
| Stephen H. Rusckowski(1)(3) | 49 | Director; Non-Executive Chairman of the Board of Directors; Member of the Nominating Committee (Chair) | 02/2002 | |||||
| Gregory M. Sebasky(1) | 49 | Director | 04/2005 | |||||
| N. John Simmons, Jr.(2) | 52 | Director; Member of the Audit Committee (Chair), Compensation Committee and Supervisory Committee | 07/2005 | |||||
| Richard H. Stowe(2) | 63 | Director; Member of the Audit Committee, Nominating Committee, Compensation Committee and Supervisory Committee (Chair) | 12/1998 | |||||
| John H. Underwood(2) | 48 | Director; Member of the Audit Committee, Compensation Committee (Chair) and Supervisory Committee | 07/1994 | |||||
| Scott M. Weisenhoff(1) | 52 | Director | 02/2003 | |||||
| (1) | Denotes a director designated by Philips (Philips Director) under the terms of the Governance Agreement (as described below). | |
| (2) | Denotes an Independent Director (as defined below) under the terms of the Governance Agreement. | |
| (3) | On October 26, 2006, our board of directors appointed Mr. Rusckowski as Non-Executive Chairman of our board of directors. |
The composition of our board of directors is governed in part by the terms of a Governance Agreement dated May 22, 2000 that we entered into with Philips (Governance Agreement) in connection with the completion of Philips’ tender offer for a majority of our common stock. Under the terms of the Governance Agreement, we agreed to take any and all action necessary so that our board of directors consists of 11 persons, including:
| • | two directors representing management, consisting of our Chief Executive Officer and one additional officer designated by our Chief Executive Officer (Management Directors); | |
| • | six Philips Directors; and | |
| • | three directors nominated by the Nominating Committee of our board of directors to serve as Independent Directors. |
Notwithstanding the preceding, our board of directors has the discretionary authority under the Governance Agreement to increase or decrease the size of our board of directors, provided that:
| • | there are at least two Management Directors and three Independent Directors; and | |
| • | the relative percentage of Management Directors, Independent Directors and Philips Directors is maintained. |
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In addition, the number of directors that Philips is permitted to designate or nominate under the Governance Agreement, which is based upon Philips’ relative ownership of our equity securities having the right to vote generally in any election of our directors, is as follows:
| Philips’ Beneficial Ownership | Number of | |||
of Our Voting Stock | Philips Directors | |||
| More than 50% | 6 | |||
| 36%-50% | 4 | |||
| 27%-35% | 3 | |||
| 18%-26% | 2 | |||
| 5%-17% | 1 | |||
| Less than 5% | 0 | |||
If at any time Philips has the right to designate fewer than six directors under the terms of the Governance Agreement, the Nominating Committee of our board of directors will nominate a number of additional Independent Directors as is necessary to constitute our entire board of directors.
Philips has the right to designate a replacement Philips Director upon the termination of a Philips Director’s term or upon a Philips Director’s death, resignation, retirement, disqualification or removal from office. Our Chief Executive Officer has the right to designate a replacement Management Director upon the termination of a Management Director’s term or upon a Management Director’s death, resignation, retirement, disqualification or removal from office.
Notwithstanding the preceding, the composition of our current board of directors is as follows:
| • | three Independent Directors (Messrs. Simmons, Stowe and Underwood); and | |
| • | four Philips Directors (Messrs. Revetti, Rusckowski, Sebasky and Weisenhoff). |
The Governance Agreement also requires us to establish and maintain the following committees of our board of directors:
| • | A Nominating Committee consisting solely of two Independent Directors, one Philips Director and one Management Director which is responsible, among other things, for the nomination of the Independent Directors. Notwithstanding the preceding, we currently maintain a Nominating Committee composed of one Independent Director (Mr. Stowe) and one Philips Director (Mr. Rusckowski); | |
| • | A Compensation Committee consisting of two Independent Directors and two Philips Directors which is responsible, among other things, for the adoption, amendment and administration of all of our employee benefit plans and arrangements and the compensation of all of our officers. Notwithstanding the preceding, we currently maintain a Compensation Committee composed of three Independent Directors (Messrs. Simmons, Stowe and Underwood); and | |
| • | A Supervisory Committee consisting of at least three Independent Directors which is responsible, among other things, for the general oversight, administration, amendment and enforcement of the Governance Agreement and all other material agreements or arrangements between Philips and us. We currently maintain a Supervisory Committee composed of three Independent Directors (Messrs. Simmons, Stowe and Underwood). |
As used in the Governance Agreement, the term “Independent Director” means a director who is:
| • | not currently, and has never been, an officer or director of ours or any affiliate or associate of ours, or an entity that derived more than 5% of its revenues or earnings in its most recent fiscal year from transactions involving us or any affiliate or associate of ours; |
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| • | not currently, and has never been, an officer, employee or director of Philips or an affiliate or associate of Philips, or an entity that derived more than 5% of its revenue or earnings in its most recent fiscal year from transactions involving Philips or any affiliate or associate of Philips; and | |
| • | nominated to serve as an Independent Director by the Nominating Committee of our board of directors. |
The Governance Agreement will terminate on the first date that Philips is no longer the beneficial owner of at least 5% of our equity securities having the right to vote generally in any election of our board of directors. The provisions of the Governance Agreement relating to the establishment of committees of our board of directors will terminate on the first date that Philips is the beneficial owner of less than a majority of our equity securities having the right to vote generally in any election of our board of directors.
Other than the provisions of the Governance Agreement described above and under the caption “Governance Agreement” contained in Item 13, Certain Relationships and Related Transactions, and Director Independence, we do not know of any arrangements or understandings between any of the individuals listed above and any other person pursuant to which a director was or is to be selected as a director or nominee, other than any arrangements or understandings with our directors acting solely in their capacities as such.
Board Independence
Our board of directors has determined that, except for Messrs. Revetti, Rusckowski, Sebasky and Weisenhoff, all of its members are “independent” as defined under the listing standards of The NASDAQ Stock Market LLC. Each of Messrs. Revetti, Rusckowski, Sebasky and Weisenhoff are affiliated with our majority owner, Philips. Our board of directors believes that the NASDAQ independence requirements contained in the listing standards provide the appropriate standard for assessing director independence and uses the requirements in assessing the independence of each of its members. In making its determination our board of directors did not consider any related party transactions that are not included in Item 13, Certain Relationships and Related Transactions, and Director Independence.
Identification of Executive Officers
The following table lists all of our executive officers as of July 31, 2007. Each of our executive officers will hold office until his or her successor is elected and qualified, or until his or her earlier resignation or removal.
| Age on | Date Became an | |||||||||
Name | 7/31/07 | Position | Executive Officer | |||||||
| Howard S. Hoffmann | 53 | President and Chief Executive Officer | 07/2004 | |||||||
| Kathleen E. Donovan | 47 | Senior Vice President and Chief Financial Officer | 06/2005 | |||||||
| Mark Ivie | 48 | Senior Vice President and Chief Technology Officer | 06/2005 | |||||||
| R. Scott Bennett | 47 | Senior Vice President of Sales and Marketing | 11/2005 | |||||||
| Michael F. Clark | 45 | Senior Vice President of Operations | 02/2005 | |||||||
| James Brennan | 60 | Principal Accounting Officer, Controller and Vice President | 11/2006 | |||||||
| Mark R. Sullivan | 36 | General Counsel, Chief Compliance Officer and Secretary | 09/2006 | |||||||
Other than the provisions of our agreement with Nightingale which is described in Item 11, Executive Compensation, below, we do not know of any arrangements or understandings between any of the individuals listed above and any other person pursuant to which he or she was or is to be selected as an officer, other than any arrangements or understandings with our officers acting solely in their capacities as such.
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Business Experience of Current Directors and Current Executive Officers
Set forth below is biographical information, including business experience for the last five years, for our directors and executive officers.
Directors
Clement Revetti, Jr.
Mr. Revetti has served as a member of our board of directors since October 2006. Mr. Revetti currently serves as the Senior Vice President and Chief Legal Officer of Philips Medical Systems, an affiliate of Philips, a position he has held since September 2004. From September 1999 to September 2004, Mr. Revetti served as the Vice President and General Counsel, Business Development for Atos Origin BV in Amsterdam, Netherlands, where he was responsible for mergers, acquisitions, divestments, strategic alliances and large multinational outsourcing transactions. Atos Origin BV is a global multiservice IT provider.
Stephen H. Rusckowski
Mr. Rusckowski has served as a member of our board of directors since February 2002 and currently serves as the Chairman of the Board and as a member of the Nominating Committee. From December 2003 until February 2004, Mr. Rusckowski served as our interim President and Chief Executive Officer. From February 2004 until July 2004, Mr. Rusckowski served as our interim Chief Executive Officer. He is currently the Chief Executive Officer of Philips Medical Systems and has served in that capacity since November 2006. Mr. Rusckowski joined Philips in August 2001, and has held a number of general management responsibilities for medical imaging, patient monitoring and healthcare information systems. Prior to joining Philips, Mr. Rusckowski held various positions with Hewlett-Packard/Agilent Technologies from 1984 to 2001, most recently serving as Senior Vice President and General Manager of its Healthcare Solutions Group from 1999 to 2001.
Gregory M. Sebasky
Mr. Sebasky has served as a member of our board of directors since April 2005. From February 2004 to March 2005, Mr. Sebasky served as our acting President. He is currently Senior Vice President and Chief Executive Officer of Global Customer Services for Philips Medical Systems, a position he has held since April 2005. Prior to serving as our acting President, Mr. Sebasky served as Senior Vice President of Operations of Cardiac and Monitoring Systems, Philips Electronics Corporation, an affiliate of Philips, from April 1997 to February 2004.
N. John Simmons, Jr.
Mr. Simmons has served as a member of our board of directors since July 2005 and currently serves as the Chairman of the Audit Committee and a member of the Compensation Committee and the Supervisory Committee. Since 1999, Mr. Simmons has served as the President of Quantum Capital Partners, a private equity firm. During his time at Quantum, he also served as President of New Homes Realty, Inc., a national real estate company of buyer’s agents and brokers, from November 2004 to April 2006. He was formerly Vice President and Controller of Eckerd Corporation and Chief Financial Officer of Checkers Drive-In Restaurants. Between 1976 and 1993, Mr. Simmons was with KPMG Peat Marwick and was a partner for seven years. He has served as a director of SRI/Surgical Express, Inc., a provider of surgical instruments, since February 2001.
Richard H. Stowe
Mr. Stowe has served as a member of our board of directors since December 1998 and currently serves as the Chairman of the Supervisory Committee and as a member of the Audit Committee, the Nominating Committee and the Compensation Committee. Mr. Stowe is currently a managing member of the general partner of Health Enterprise Partners, L.P., a private equity investment fund that he co-founded in 2005, and since 2000 he has served as a senior advisor to two related private equity investment funds. From 1999 to 2006, Mr. Stowe was a senior advisor to Capital Counsel, LLC, an investment management firm. From 1979 to 1998 he was a general partner of various private equity funds managed by Welsh, Carson, Anderson & Stowe, a private equity investment firm that
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was the largest shareholder of The MRC Group, Inc. (MRC), and, prior to our acquisition of MRC in 1998, he had served as a member of the board of directors of MRC and its predecessors since 1993. Since 1989 Mr. Stowe has been a member of the board of directors of HMS Holdings Corp. (HMS), a provider of a variety of cost-avoidance, coordination of benefits and program integrity services to government healthcare programs. Shares of HMS are publicly traded on the Nasdaq Global Select Market under the symbol “HMSY.”
John H. Underwood
Mr. Underwood has served as a member of our board of directors since July 1994 and currently serves as the Chairman of the Compensation Committee and a member of the Audit Committee and the Supervisory Committee. Mr. Underwood has served as a Managing Director of Pfingsten Partners, L.L.C., a private equity investment firm, since 1996. Between 1989 and 1996, Mr. Underwood was a Vice President with Heller Equity Capital Corporation and a Senior Vice President of Heller’s parent company, Heller Financial, Inc. From 1986 to 1989, Mr. Underwood served as Vice President of Citicorp North America, Inc.’s leveraged capital group.
Scott M. Weisenhoff
Mr. Weisenhoff has served as a member of our board of directors since February 2003. Mr. Weisenhoff has served as Executive Vice President and Chief Financial Officer of Philips Medical Systems since February 2003. Mr. Weisenhoff served in the same capacity for Philips Components, an affiliate of Philips, from November 2001 to February 2003, and for Philips Domestic Appliances and Personal Care, an affiliate of Philips, from August 1999 to November 2001. From September 1995 to August 1999, Mr. Weisenhoff served as Senior Vice President and Chief Financial Officer of Philips Electronics Asia Pacific PTE, Ltd., an affiliate of Philips.
Executive Officers
Howard S. Hoffmann — President and Chief Executive Officer
Mr. Hoffmann has served as our Chief Executive Officer since July 2004 and as our President since June 2007. Mr. Hoffmann joined Nightingale, a management consulting company specializing in turnarounds and crisis management, in May 1990 and became a Member of Nightingale in February 1997. He has been the Managing Partner of Nightingale since January 2001. We have currently engaged Nightingale for Mr. Hoffmann’s services. See Item 11, Executive Compensation, for a description of our agreement with Nightingale for Mr. Hoffmann’s services. Prior to joining us, Mr. Hoffmann led numerous consulting engagements serving as an advisor to boards of directors, management or creditors as well as serving in various interim executive management positions. Immediately prior to being engaged by us, Mr. Hoffmann served as an advisor to management of a nationwide health club chain from June 2004 to July 2004. He served as interim Chief Executive Officer of Global Knowledge Network, a global provider of technology training solutions from May 2003 to October 2003 after having led a consulting engagement for the same company commencing in August 2002. Mr. Hoffmann has also served as Chief Restructuring Officer of Vision Twenty-One, Inc., a Florida-based integrated eye care company, and as interim Chief Financial Officer and Chief Operating Officer of Soft Sheen Products, Inc., a consumer products company. Mr. Hoffmann currently serves as a director of two privately-held companies — Block Vision, a managed vision care company, and Protocol Marketing Group, Inc., an integrated direct marketing company.
Kathleen E. Donovan — Senior Vice President and Chief Financial Officer
Ms. Donovan has served as our Senior Vice President and Chief Financial Officer since June 2005. Between August 1997 and June 2005, Ms. Donovan held a number of positions with Dendrite International, Inc., a technology company providing sales, marketing, clinical and compliance solutions to global pharmaceutical and other life sciences companies, most recently serving as that company’s Senior Vice President and Chief Financial Officer. Prior to her service in that capacity, Ms. Donovan also served as Dendrite’s Vice President and Treasurer between December 2001 and November 2002, its Chief Financial Officer — Americas Division between April 2001 and December 2001, its Vice President and Corporate Controller between January 1999 and March 2001, and its Director, Financial Operations between August 1997 and December 1998. Ms. Donovan serves on the board of directors of A-Life Medical, Inc., a technology company of which we own a minority interest.
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Mark Ivie — Senior Vice President and Chief Technology Officer
Mr. Ivie has served as our Senior Vice President and Chief Technology Officer since June 2005. Prior to joining us, Mr. Ivie served as General Manager, Enterprise Systems and Technology, of GE Healthcare between June 2003 and May 2005 and General Manager, Global Engineering, of GE Medical Systems between December 1998 and June 2003, where he was responsible for the creation and adoption of standards and for creating the infrastructure for shared functional modules. From January 1992 until December 1998, Mr. Ivie served as a Department Head for the telecom support software business at Lucent Bell Laboratories.
R. Scott Bennett — Senior Vice President of Sales and Marketing
Mr. Bennett has served as our Senior Vice President of Sales and Marketing since November 2005. From August 2004 to October 2005, Mr. Bennett was Senior Vice President of Sales and Marketing of SCI Solutions, Inc., which is also known as Scheduling.com, where he was responsible for the restructuring of that company’s marketing, sales and sales support infrastructure and processes. Between July 2000 and March 2004, Mr. Bennett served as Vice President, Financial Marketing and Vice President, Corporate Sales, of Siemens Medical Solutions, USA.
Michael F. Clark — Senior Vice President of Operations
Mr. Clark has served as our Senior Vice President of Operations since February 2005. Mr. Clark joined us in 1998 through our acquisition of MRC. From November 2003 until February 2005, Mr. Clark served as our Senior Vice President of Operations for our Western Division. From May 2002 until November 2003, Mr. Clark served as our Vice President of Operations for our Southwest Division and from January 1998 until July 2000, he served as Region Vice President for the Southeast. From May 2001 until May 2002, Mr. Clark served as Chief Operating Officer for eScribe, a transcription service provider. While at MRC, Mr. Clark served as Vice President, Marketing and Corporate Services.
James Brennan — Principal Accounting Officer, Controller and Vice President
Mr. Brennan has served as our Principal Accounting Officer, Controller and Vice President since November 2006. From March 2006 until his appointment as our Principal Accounting Officer, Controller and Vice President, Mr. Brennan served as a consultant to us providing Sarbanes-Oxley compliance and financial accounting services. Mr. Brennan has been operating his own consulting firm, specializing in providing Sarbanes-Oxley compliance and financial accounting services, since July 2005. Between May 2000 and July 2005, Mr. Brennan served as the Vice President of Finance for two divisions of IKON Office Solutions. From 1995 to 1998, Mr. Brennan served as Vice President and Business Unit Financial Officer for the GS Electric Division of General Signal. From 1991 to 1995, Mr. Brennan served as Assistant Controller of General Signal Corporation.
Mark R. Sullivan — General Counsel, Chief Compliance Officer and Secretary
Mr. Sullivan serves as our General Counsel, Chief Compliance Officer and Secretary. Mr. Sullivan was appointed as General Counsel in September 2006, Chief Compliance Officer in July 2006 and Secretary in January 2005. From August 2004 until September 2006, Mr. Sullivan served as our Acting General Counsel. Between March 2003 and August 2004, Mr. Sullivan served as our Associate General Counsel and Assistant Secretary. Prior to joining us, Mr. Sullivan was in private practice with Pepper Hamilton LLP from January 2000 until March 2003, and Drinker Biddle & Reath LLP from August 1998 to January 2000.
Committees of the Board of Directors
Our board of directors maintains the following four standing committees: Audit Committee; Compensation Committee; Nominating Committee and Supervisory Committee.
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Audit Committee
The Audit Committee oversees our corporate accounting and financial reporting process. The responsibilities of the Audit Committee, which are set forth in a written charter adopted by our board of directors, include:
| • | review and assess the adequacy of the Audit Committee and its charter at least annually; | |
| • | evaluate, determine the selection of, and if necessary, the replacement/rotation of, our independent registered public accounting firm; | |
| • | ensure timely rotation of lead and concurring audit partner of our independent registered public accounting firm; | |
| • | review our audited consolidated financial statements; | |
| • | review whether interim accounting policies and significant events or changes in accounting estimates were considered by our independent registered public accounting firm to have affected quality of financial reporting; | |
| • | review our financial reports and other information submitted to any governmental body or the public; | |
| • | review with management and our independent registered public accounting firm their judgments about quality of disclosures in our financial statements; | |
| • | obtain from our independent registered public accounting firm its recommendation regarding our internal control over financial reporting and review management’s report on its assessment of the design and effectiveness of our internal control over financial reporting; | |
| • | review our major financial risk exposures; | |
| • | pre-approve all audit and permitted non-audit services and related fees; | |
| • | establish, review and update periodically our code of business conduct and ethics; | |
| • | establish and review policies for approving related party transactions between us and our directors, officers or employees; | |
| • | adopt procedures for receipt, retention and treatment of complaints received by us regarding accounting, internal accounting controls or auditing matters; and | |
| • | adopt regular and separate systems of reporting to the Audit Committee by management and our internal auditors regarding controls and operations of business units. |
The Audit Committee is also responsible or approving or ratifying all related party transactions other than those between us and Philips. The Audit Committee is composed of N. John Simmons, Jr. (Chair), John H. Underwood and Richard H. Stowe, each of whom has been determined by our board of directors to meet the independence standards established by the SEC and The NASDAQ Stock Market LLC, and to be an Independent Director under the terms of the Governance Agreement. Our board of directors has determined that N. John Simmons, Jr. qualifies as an “audit committee financial expert” as that term is defined in Item 407(d)(5) ofRegulation S-K.
Compensation Committee
While our board of directors is responsible for determining and approving the compensation for our executive officers in its sole discretion, including all individuals whose compensation is set forth in the “Summary Compensation Table” below, it frequently solicits the recommendations from the Compensation Committee regarding the following:
| • | the corporate goals and objectives relevant to the compensation and the benefits of our Chief Executive Officer and our other executive officers; | |
| • | the performance of these officers in light of those goals and objectives; and | |
| • | the compensation of these officers based on such evaluations. |
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The Compensation Committee is composed of John H. Underwood (Chair), N. John Simmons, Jr. and Richard H. Stowe, each of whom has been determined by our board of directors to meet the independence standards established by The NASDAQ Stock Market LLC, and to be an Independent Director under the terms of the Governance Agreement.
Nominating Committee
The responsibilities of the Nominating Committee include the selection of potential candidates for our board of directors, including the nomination of “Independent Directors” under the terms of the Governance Agreement. The Nominating Committee also makes recommendations to our board of directors concerning the membership of the other board committees. The Nominating Committee is responsible for developing policies and procedures with regard to the consideration of any director candidates recommended by our shareholders. The Nominating Committee is composed of Stephen H. Rusckowski (Chair) and Richard H. Stowe.
Supervisory Committee
Pursuant to the Governance Agreement, the terms of which are described above and in Item 13, Certain Relationships and Related Transactions, and Director Independence, since 2000 our board of directors has maintained a Supervisory Committee, the responsibilities of which include the general oversight, administration, amendment and enforcement, of the Governance Agreement and all other material agreements or arrangements between Philips and us. The Supervisory Committee is composed of Richard H. Stowe (Chair), John H. Underwood and N. John Simmons, Jr., each of whom has been determined by our board of directors to meet the independence standards established by The NASDAQ Stock Market LLC, and to be an Independent Director under the terms of the Governance Agreement.
Code of Ethics
We have adopted a written code of business conduct and ethics, known as our Financial Code of Ethics, which applies to all of our employees who perform accounting and financial functions, including our principal executive officer, our principal financial officer and our principal accounting officer. Our Financial Code of Ethics is available on our website, www.medquist.com. Any amendments to our Financial Code of Ethics or waivers from the provisions of our Financial Code of Ethics for our principal executive officer, our principal financial officer or our principal accounting officer will be disclosed on our website within four business days following the date of such amendment or waiver.
Section 16(a) Beneficial Ownership Reporting Compliance
Section 16(a) of the Exchange Act requires that each of our executive officers, directors and persons who beneficially own more than 10% of our common stock file with the SEC reports of ownership and changes in their ownership of our common stock. Our executive officers and directors and beneficial owners of greater than 10% of our common stock are required by SEC regulations to provide us with copies of all Section 16(a) forms that they file. Based solely on our review of the copies of such forms furnished to us, we believe that for the year ended December 31, 2006, all of our executive officers, directors and persons owning greater than 10% of our common stock complied with all Section 16(a) filing requirements applicable to them, except the former Chairman of our board of directors, Jouko Karvinen, who failed to timely file a Form 3 at the time he was appointed to our board of directors. Mr. Karvinen has since filed a Form 3.
| Item 11. | Executive Compensation |
Compensation Discussion and Analysis
Compensation Philosophy
We provide our executive officers, including our President and Chief Executive Officer (Mr. Hoffmann), our Chief Financial Officer (Ms. Donovan) and each of our next three most highly compensated executive officers who were serving as executive officers at December 31, 2006 (collectively, named executive officers), with incentives
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tied to the achievement of our corporate objectives. During the past few years, in making executive hiring and compensation decisions, we considered the risks associated with our ongoing litigation and governmental investigation matters, as well as our decision since June 2004 to not provide traditional equity-based long term incentives until we become current in our periodic filing obligations under the Exchange Act. We have not filed ourForms 10-Q for the first and second quarter of 2007. During the past few years, we experienced a significant turnover in our senior management. In light of all of these challenges, our board of directors established a total compensation philosophy and structure designed to accomplish the following objectives:
| • | attract, retain and motivate executives who can thrive in a competitive environment of continuous change and who can achieve positive business results in light of the challenges that we have and continue to face; | |
| • | provide our executives with a total compensation package that recognizes individual contributions, as well as overall business results; and | |
| • | promote and reward the achievement of objectives that our board of directors and management believe will lead to long-term growth in shareholder value, including the resolution of our ongoing litigation and governmental investigation matters, as well as becoming current in our periodic filing obligations under the Exchange Act. |
To achieve these objectives, we intend to maintain compensation arrangements that tie a substantial portion of our named executive officers’ overall compensation to the achievement of key strategic, operational and financial goals.
Setting Executive Compensation
Board of Directors, Compensation Committee and Management
While our board of directors is responsible for determining and approving the compensation of our named executive officers in its sole discretion, it frequently solicits the recommendations from the Compensation Committee regarding the following:
| • | the corporate and individual goals and objectives relevant to the compensation of Nightingale for Mr. Hoffmann’s service to us as our President and Chief Executive Officer and the compensation and benefits of our other executive officers other than Mr. Hoffmann; | |
| • | the evaluation of our corporate performance and the performance of our named executive officers in light of such goals and objectives; and | |
| • | the compensation of our named executive officers, other than Mr. Hoffmann, based on such evaluations. |
Our former President and our former Senior Vice President of Human Resources provided our board of directors with a review of the performance of our named executive officers, other than Mr. Hoffmann and our former President, in 2005 and made recommendations to our board of directors for final approval with respect to the 2006 compensation for those named executive officers. The 2006 compensation of our former President was determined and set by our board of directors in its sole discretion.
The 2006 compensation for Mr. Hoffmann’s services was based on an agreement between us and Nightingale, of which Mr. Hoffmann is the managing partner. The terms of the agreement with Nightingale were negotiated and approved by our board of directors and are described below under the caption “Compensation of our President and Chief Executive Officer.”
Following the departure of our former President in May 2007, Mr. Hoffmann and the Compensation Committee together will review the compensation and performance of our other named executive officers and make recommendations to our board of directors for final approval. Our board of directors currently is, and will continue to be, responsible for setting the compensation for Mr. Hoffmann’s services and evaluating his performance based on corporate goals and objectives.
Our named executive officers do not play a role in their own compensation determination, other than discussing individual performance objectives with Mr. Hoffmann.
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Benchmarking and Analysis of Market Compensation Data
In 2006, we retained Towers Perrin, a global compensation consulting firm, to provide competitive compensation data and general advice in the design of compensation programs for our entire organization including our named executive officers other than Mr. Hoffmann. Towers Perrin performed a market analysis of the compensation paid by comparable healthcare IT companies, which included companies with similar business characteristics including, but not limited to, revenues, headcount and geographic location, and provided our former President and our Vice President of Human Resources with an analysis of its findings and recommendations related to bonus structure, including our named executive officers other than Mr. Hoffmann. The Compensation Committee agreed with these recommendations and presented them to our board of directors, which subsequently approved them.
In 2007, we engaged Compensation Resources, a regional compensation consulting firm, to provide a market analysis of target bonus percentages for certain members of our senior management team including our Chief Technology Officer (Mr. Ivie). Based upon the results of that market analysis and our own internal review of target bonus percentages, an increase of target bonus percentages for certain members of our senior management team including Mr. Ivie was recommended to the Compensation Committee. The Compensation Committee agreed with these recommendations and presented them to our board of directors, which subsequently approved them.
Elements of Compensation
Our executive compensation program utilizes four primary elements to accomplish the objectives described above:
| • | base salary; | |
| • | annual cash incentives linked to corporate and individual performance; | |
| • | long-term incentives in the form of equity awards or cash; and | |
| • | benefits and perquisites. |
We believe that we can meet the objectives of our executive compensation program by achieving a balance among these four elements that is competitive with our industry peers and creates appropriate incentives for our named executive officers. Actual compensation levels are a function of both corporate and individual performance as described under each compensation element below. In making compensation determinations, the Compensation Committee and our board of directors consider the competitiveness of compensation both in terms of individual pay elements and the aggregate compensation package.
Base Salary
We provide our named executive officers, other than Mr. Hoffmann, with base salary in the form of fixed cash compensation to compensate them for services rendered during the fiscal year. Consistent with our compensation philosophy, our board of directors believes that the current base salaries of our named executive officers, other than Mr. Hoffmann, are at levels competitive with similarly-sized public companies in the healthcare IT sector (Peer Companies) with additional consideration given to the challenges we have and continue to face.
The base salary of each of our named executive officers, other than Mr. Hoffmann, is reviewed for adjustment annually by our board of directors. Generally, in making a determination of whether to make base salary adjustments, our board of directors considers the following factors:
| • | our success in meeting our strategic operational and financial goals; | |
| • | our President and Chief Executive Officer’s assessment of such named executive officer’s individual performance; | |
| • | length of service to us of such named executive officer; | |
| • | changes in scope of responsibilities of such named executive officer; and | |
| • | the base salaries of executive officers at Peer Companies possessing similar job titles. |
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In addition, our board of directors considers internal equity within our organization and, when reviewing the base salaries of our named executive officers, their current aggregate compensation from us.
2006 Base Salaries
Based upon the relatively recent hiring of our named executive officers, other than Mr. Hoffmann, and the challenges we continued to face in 2006, our former President and our former Senior Vice President of Human Resources recommended, and our board of directors subsequently determined, that the base salaries of each of our named executive officers, other than Mr. Hoffmann, who does not receive a base salary, would not be increased for 2006.
2007 Base Salaries
Based upon individual and corporate performance, as well as our named executive officers’ base salaries in comparison to similarly titled executive officers at Peer Companies, the Compensation Committee recommended, and our board of directors subsequently determined, that the base salary of each of our named executive officers, other than Mr. Hoffmann (who does not receive a base salary) and Mr. Ivie, would not be increased for 2007. Based upon certain individual achievements during 2006, the Compensation Committee recommended, and our board of directors subsequently determined, that the base salary of Mr. Ivie should be increased 2.7% to $231,000 for 2007.
The base salaries of each of our named executive officers other than Mr. Hoffmann (who does not receive a base salary) are set forth below in the “Summary Compensation Table.”
Annual Incentive Compensation
We believe that performance-based cash incentives play an essential role to motivate our executives to achieve defined annual goals. The objectives of our annual management incentive plans are to:
| • | align the interests of executives and senior management with our strategic plan and critical performance goals; | |
| • | motivate and reward achievement of specific, measurable annual individual and corporate performance objectives; | |
| • | provide payouts commensurate with our performance; | |
| • | provide competitive total compensation opportunities; and | |
| • | enable us to attract, motivate and retain talented executive management. |
2006 Management Incentive Plan
Participation; Eligibility. Select key management level employees, including each of our named executive officers other than Mr. Hoffmann, were eligible to participate in our 2006 Management Incentive Plan (2006 Plan). Other criteria for participation included the following:
| • | a participant must have received a performance rating of “solid performer” or better for 2006 to receive an incentive award; and | |
| • | a participant must have been an active employee as of the award payout date to receive an incentive award. |
Performance Period; Timing of Payment. The 2006 Plan operated on a calendar year schedule. Incentive awards, if earned, would have been paid out within the first two and a half months of 2007.
Incentive Targets. Each of our named executive officers, other than Mr. Hoffmann, was eligible to receive a target annual cash incentive award expressed as a percentage of his or her base salary for 2006 as set forth in his or her employment agreement (Target Incentive). The table below entitled “Grants of Plan Based Awards” (and, specifically, the information under the caption “Estimated Possible Payouts”) illustrates the threshold, target and maximum amounts of cash incentives that were potentially payable to our named executive officers, other than Mr. Hoffmann, with respect to 2006 performance under the 2006 Plan.
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Performance Measures. Payment of incentive awards were based on a combination of corporate and individual performance objectives which were established for each of our named executive officers, other than Mr. Hoffmann, during the first quarter of 2006 as a way to communicate our expectations and to maintain and unify our executives’ focus on key strategic objectives, as well as to measure performance. The objectives, which were both qualitative and quantitative, reflected our strategic priorities.
With the exception of our former President, whose employment agreement sets forth the criteria for determining the amount of his incentive award, and Mr. Hoffmann, who is not eligible to participate in the 2006 Plan, the amount of a named executive officer’s incentive award under the 2006 Plan was based on the following criteria:
| • | 70% upon the achievement of individual performance objectives; and | |
| • | 30% upon such executive’s overall 2006 performance as determined by the discretionary evaluation of our former President and our board of directors. This was a variable percentage and could have been increased or decreased based upon under or over achievement. |
With respect to our former President, the determination of his annual cash incentive was based upon the following criteria set forth in his employment agreement:
| • | 75% upon achievement of our 2006 corporate performance objectives; and | |
| • | 25% upon achievement of specific strategic and tactical initiatives in 2006, as determined by our board of directors. |
Corporate Performance Component
For 2006, the corporate performance objectives approved by our board of directors were operating income and net revenues. The degree to which these targets were achieved established the amount of cash available for distribution under the 2006 Plan. The following table shows the payouts (as a percent of target) for performance at different levels for 2006:
No incentive awards for a particular named executive officer other than Mr. Hoffmann would be earned, regardless of whether such particular named executive officer achieved his or her individual performance objectives, in the event performance was below either the operating income threshold of 95% of target or the net revenues threshold of 98% of target. Additionally, no payments in excess of 100% of a participant’s Target Incentive would be paid without prior approval of the Compensation Committee.
Individual Performance Component
The 2006 individual performance objectives for our named executive officers, other than Mr. Hoffmann and our former President, were set by our former President. The 2006 individual performance objectives for our former President were set by our board of directors. The goals, which are both qualitative and quantitative, reflected our strategic priorities in 2006.
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Disclosure of Corporate and Individual Targets and Objectives
Other than as described above, the actual operating income and net revenues targets under the 2006 Plan and the individual performance objectives for each named executive officer, other than Mr. Hoffman, under the 2006 Plan were based on certain internal financial goals set in connection with our board of directors’ consideration and approval of our annual operating plan for 2006. These internal financial goals involve confidential strategic, commercial and financial information which, if disclosed, may result in competitive harm to us. However, we believe that the internal financial goals, although not guaranteed, were capable of being achieved if our named executive officers met or exceeded their individual objectives, if we performed according to our 2006 annual operating plan and if the assumptions in our 2006 annual operating plan proved correct.
2006 Incentive Award Calculation and Payments. During the first quarter of 2007, both our corporate performance and the performance of each of our named executive officers, other than Mr. Hoffmann, were assessed against the specific goals established under the 2006 Plan. We did not meet the 2006 Plan targets for operating income and net revenues, and, therefore, no cash bonuses were earned or paid (regardless of individual performance) under the 2006 Plan. However, notwithstanding our failure to meet the 2006 Plan targets for operating income and net revenues, our board of directors awarded a discretionary cash incentive to each of our named executive officers, other than Mr. Hoffmann and our Senior Vice President of Sales and Marketing (Mr. Bennett), equal to 50% of each such named executive officer’s Target Incentive. Our employment agreement with Mr. Bennett guaranteed payment of 50% of his Target Incentive for 2006, regardless of our performance. Our board of directors awarded these cash incentives to (i) reward the achievement of individual objectives, (ii) recognize the efforts of our management team in light of the challenging circumstances facing our organization, and (iii) serve as a retention tool given the limitations placed upon us to award long-term equity incentives.
Nightingale continues to remain eligible for annual incentive compensation for 2006 related to Mr. Hoffmann’s services to us in accordance with the terms of our agreement with Nightingale as described below under the caption “Compensation of our President and Chief Executive Officer.”
2007 Management Incentive Plan
The Compensation Committee recommended, and our board of directors approved, our 2007 Management Incentive Plan (2007 Plan) in March 2007. Although we continue to use operating income and net revenues to measure corporate financial performance in 2007, the 2007 Plan varies significantly from the 2006 Plan in that the portion of the cash incentive under the 2007 Plan allocated for individual performance is not contingent upon the achievement of the operating income and net revenues targets established for 2007. Under the 2007 Plan, a named executive officer’s cash incentive award will be based upon the following criteria:
| • | 30% upon the achievement of such named executive officer’s 2007 individual performance objectives; | |
| • | 35% based upon a 2007 net revenues target; and | |
| • | 35% based upon an 2007 operating income target. |
Individual performance objectives for 2007 were set in the same manner as they were set in 2006.
Target Incentives under the 2007 Plan remain unchanged for all of our named executive officers, other than Mr. Hoffmann, who does not participate in the 2007 Plan, and Mr. Ivie. Based upon the results of the analysis performed by Compensation Resources as discussed above and our own internal review of Target Incentives for certain members of our senior management, the Compensation Committee recommended, and our board of directors subsequently determined, that Mr. Ivie’s Target Incentive should be increased from 40% to 45%.
Other than as described above, the actual operating income and net revenues targets under the 2007 Plan and the individual performance objectives for each named executive officer, other than Mr. Hoffmann, under the 2007 Plan are based on certain internal financial goals set in connection with our board of directors’ consideration and approval of our annual operating plan for 2007. These internal financial goals involve confidential strategic, commercial and financial information which, if disclosed, may result in competitive harm to us. However, we believe that the internal financial goals, although not guaranteed, are capable of being achieved if our named executive officers meet or exceed their individual objectives, if we perform according to our 2007 annual operating plan and if the assumptions in our 2007 annual operating plan are proven correct.
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Nightingale is eligible for incentive compensation for 2007 related to Mr. Hoffmann’s services to us in accordance with the terms of our agreement with Nightingale as described below under the caption “Compensation of our President and Chief Executive Officer.”
Discretionary Bonuses
Our employment agreement with our former President provided that he was eligible to receive an annual discretionary bonus of up to 50% of his base salary, payable at the discretion of our board of directors. This discretionary bonus would be in addition to any annual incentive award potentially payable under our Management Incentive Plan. Our board of directors determined that our former President would not receive any discretionary bonus for his service to us in 2006.
Sign-On Bonuses
Pursuant to the terms of her employment agreement, Ms. Donovan received $50,000 and $100,000 in June 2006 and June 2007, respectively, representing the portion of her sign-on bonus that became nonforfeitable during such calendar years. Our board of directors designed the staggered disbursement of Ms. Donovan’s sign-on bonus in order to incentivize her to remain with us through the second anniversary of her employment commencement date.
Long-Term Incentives
Equity-Based Incentives
As discussed earlier in this report, due to our inability to timely file periodic reports with the SEC and our continued failure to become current in our periodic reporting obligations with the SEC, we have not granted stock options since November 2003 nor have we permitted any outstanding stock options to be exercised since June 2004. We continue to believe, however, that equity compensation in the form of stock option grants may provide long-term upside to our named executive officers, and may align their interests with those of our shareholders and may serve as an effective retention device for executives. As a result, in connection with the recruitment of our named executive officers, other than Mr. Hoffmann and our former President, each such named executive officer has the right, pursuant to his or her employment agreement, to receive a grant of stock options to purchase shares of our common stock (Special Option Award) once we become current in our reporting obligations under the Exchange Act and ourForm S-8 registration statement for our 2002 Option Plan complies with the requirements of the SEC, and provided in each case that the recipient is still an employee on the grant date. Each Special Option Award will have an exercise price equal to the fair market value of our common stock on the date of grant and will expire on the 10th anniversary of the date of grant. Additionally, each Special Option Award will vest in equal annual installments over five years, subject to the named executive officer’s continued employment with us through the applicable vesting date.
The following table sets forth the number of shares of our common stock subject to each named executive officer’s Special Option Award.
| Number of Shares | ||||
Name | Subject to Award | |||
| Kathleen Donovan | 80,000 | |||
| R. Scott Bennett | 60,000 | |||
| Mark Ivie | 60,000 | |||
Annual Long-Term Incentive Awards
In addition to the Special Option Award described above, our named executive officers, other than Mr. Hoffmann and our former President, are entitled to receive, upon attainment of certain performance objectives, annual long-term incentive awards (Annual LTIP Awards) in the form of either:
| • | options to purchase shares of our common stock; | |
| • | restricted shares of our common stock; or | |
| • | cash through a long-term incentive program. |
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The following table sets forth the dollar value of the Annual LTIP Award each such named executive officer is eligible to receive as set forth in his or her respective employment agreement:
| Dollar Value of | ||||
Name | LTIP Award ($) | |||
| Kathleen Donovan | 60,000 | |||
| R. Scott Bennett | 120,000 | |||
| Mark Ivie | 60,000 | |||
Due to our inability to timely file periodic reports with the SEC and our continued failure to become current in our periodic reporting obligations with the SEC, we have not yet established a long-term incentive plan under which the Annual LTIP Awards will be granted. As such, no Annual LTIP Awards have been earned by or paid to the eligible named executive officers as of the date of this report. It is our intention to implement a formal long-term incentive plan and issue Annual LTIP Awards to our named executive officers, other than Mr. Hoffmann, prospectively, after we have become current in our periodic reporting obligations under the Exchange Act.
Under the terms of his employment agreement, our former President was eligible for annual grants of non-qualified stock options to purchase shares of our common stock with a target value of up to 100% of his base salary upon the achievement of certain pre-established annual financial and strategic initiatives proposed by management and approved by our board of directors. Our board of directors determined that such initiatives were not met and, as such, no award was earned for 2006.
Benefits and Perquisites
Benefits
We maintain broad-based benefits that are provided to all full-time employees, including health and dental insurance, life and disability insurance and our 401(k) plan. Certain of these benefits require employees to pay a portion of the premium. These benefits are offered to our named executive officers, other than Mr. Hoffmann and our former President, on the same basis as all other employees, except that we provide, and pay the premiums for, additional long term disability and life insurance coverage for those named executive officers. Mr. Hoffmann does not receive any of these benefits under the terms of our engagement with Nightingale. Our former President is no longer employed by us and therefore does not receive any of these benefits other than medical coverage as described below under “Separation Agreement with Mr. Lavelle.”
All full-time employees other than those who own 5% or more of our common stock are eligible to participate in our Employee Stock Purchase Plan. Our Employee Stock Purchase Plan provides that participants may authorize us to withhold up to 10% of their earnings (up to a maximum of $25,000) for the purchase of shares of our common stock. The purchase price of our common stock is determined by the Compensation Committee but shall not be less than 85% of the fair market value of our common stock on the date of purchase. Our board of directors indefinitely suspended participation in our Employee Stock Purchase Plan in June 2004.
Perquisites or Other Personal Benefits
With the exception of Mr. Hoffmann and our former President, our named executive officers are entitled to few perquisites or other personal benefits that are not otherwise available to all of our employees. In 2006, we provided premium payments for additional long term disability and life insurance coverage to our named executive officers other than Mr. Hoffmann.
Additional compensation provided to Nightingale for Mr. Hoffmann’s services (including certain travel and living expenses associated with his engagement by us) and our former President (including country club dues, automobile allowances and airline club memberships) are detailed below in our “Summary Compensation Table.”
These perquisites or other personal benefits represent a relatively modest portion of each named executive officer’s compensation. We do not anticipate any significant changes to the perquisites or other personal benefits levels of our named executive officers for 2007.
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Compensation of our President and Chief Executive Officer
As a result of the events giving rise to the Review, our board of directors appointed Howard Hoffmann as our Chief Executive Officer in July 2004. Our board of directors based its decision to retain Mr. Hoffmann’s services based upon Mr. Hoffmann’s extensive financial, operational and managerial experience, including financial and operational restructurings, in a wide range of industries. In connection with his appointment, we entered into a letter agreement with Nightingale, dated as of July 29, 2004 and amended as of December 16, 2004, September 25, 2006 and January 8, 2007, pursuant to which Nightingale assigns the services of Mr. Hoffmann to us to serve as our Chief Executive Officer. With the departure of our former President in May 2007, our board of directors appointed Mr. Hoffmann to the additional position of President in June 2007. Mr. Hoffmann continues to serve as our President and Chief Executive Officer pursuant to the terms of our agreement with Nightingale, which expired on June 30, 2007. We are currently negotiating the terms of an extension of this agreement. Our board of directors is responsible for monitoring and reviewing the performance of Mr. Hoffmann on an ongoing basis.
In structuring Nightingale’s compensation for Mr. Hoffmann’s services, our board of directors attempted to align Nightingale’s interests with the successful implementation and achievement of our corporate objectives, including achieving corporate operational improvements and bringing current our required reporting obligations with the SEC. Based on this objective, the compensation for Mr. Hoffmann’s services consists of fixed monthly cash payments and cash bonuses payable upon our achievement of certain corporate operational improvements and us becoming current in our required reporting obligations with the SEC. Our board of directors believes that the amount of these fixed and contingent cash payments are appropriate and reasonable in light of Mr. Hoffmann’s experience and the challenges associated with his role as our President and Chief Executive Officer.
We currently pay to Nightingale the sum of $120,000 per month for Mr. Hoffmann’s service as our President and Chief Executive Officer. In addition, we reimburse Nightingale for any out-of-pocket expenses incurred by Mr. Hoffmann in the course of his service as our President and Chief Executive Officer. Examples of such out-of-pocket expenses include transportation, meals, lodging, telephone, specifically assignable secretarial and office assistance, and report production. Upon the completion of his service as our President and Chief Executive Officer, if we decide to retain Mr. Hoffmann services as a consultant, we will pay Nightingale $525 per hour for his services.
Nightingale may be entitled to receive a discretionary bonus payment of up to $240,000 in connection with Mr. Hoffmann’s service in 2006 as our Chief Executive Officer (2006 Discretionary Bonus). The determination of whether to pay all or a portion of the 2006 Discretionary Bonus will be at the sole discretion of a committee composed of the Non-Executive Chairman of our board of directors, the Chairman of the Audit Committee and the Chairman of the Compensation Committee and will not be a function of the attainment of any particular objectives. This committee will inform Nightingale of the amount, if any, of the 2006 Discretionary Bonus that is to be paid by the date that is 14 days following completion of the filing of our periodic filings covering the years 2003, 2004 and 2005 and the first three quarters of 2006 with the SEC.
Nightingale may be entitled to an additional performance related bonus payment of up to $480,000 in connection with Mr. Hoffmann’s service from January 1, 2007 through June 30, 2007 as our President and Chief Executive Officer (2007 First Half Performance Bonus). The amount, if any, of the 2007 First Half Performance Bonus that Nightingale may be entitled to receive will be based on the achievement of eight key strategic operational objectives that had been established by our board of directors and Nightingale. Each objective shall be weighted equally (i.e., 1/8 of the $480,000) and will be evaluated individually by our board of directors in determining the amount of the 2007 First Half Performance Bonus. These operational objectives involved confidential strategic, commercial and financial information which, if disclosed, may result in competitive harm to us.
Tax and Accounting Considerations Affecting Executive Compensation
We structure our compensation program in a manner that is consistent with our compensation philosophy and objectives. However, while it is the Compensation Committee and our board of directors’ general intention to design the components of our executive compensation program in a manner that is tax efficient for both us and our executives, there can be no assurance that the Compensation Committee or our board of directors will always approve compensation that is tax advantageous for us.
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We endeavor to design our equity incentive awards conventionally, so that they are accounted for under standards governing equity-based arrangements and, more specifically, so that they are afforded fixed treatment under those standards.
Report of the Compensation Committee
We, the Compensation Committee of the Board of Directors of MedQuist Inc., have reviewed and discussed the “Compensation Discussion and Analysis” set forth above with management and, based on such review and discussions, we recommend to the board of directors that the “Compensation Discussion and Analysis” set forth above be included in this annual report onForm 10-K.
SUBMITTED BY THE COMPENSATION COMMITTEE
John H. Underwood, Chairman
N. John Simmons, Jr.
Richard H. Stowe
August 31, 2007
The foregoing Report of the Compensation Committee shall not be deemed to be incorporated by reference into any filing made by us under the Securities Act or the Exchange Act, notwithstanding any general statement contained in any such filing incorporating this report by reference, except to the extent we incorporate such report by specific reference.
Summary Compensation Table
The following table sets forth summary information concerning compensation of our named executive officers for the year ended December 31, 2006.
| Non-Equity | ||||||||||||||||||||||||
| Incentive Plan | All Other | |||||||||||||||||||||||
| Name and | Salary | Bonus | Compensation | Compensation | Total | |||||||||||||||||||
Principal Position | Year | ($) | ($)(3) | ($) | ($)(6) | ($) | ||||||||||||||||||
| Howard Hoffmann President and Chief Executive Officer | 2006 | — | — | — | 1,909,273 | 1,909,273 | ||||||||||||||||||
| Kathleen E. Donovan Senior Vice President and Chief Financial Officer | 2006 | 375,000 | 134,375 | (4) | — | 5,132 | 514,507 | |||||||||||||||||
| Frank Lavelle(2) Former President | 2006 | 500,000 | 125,000 | — | 30,617 | 655,617 | ||||||||||||||||||
| R. Scott Bennett Senior Vice President of Sales and Marketing | 2006 | 240,000 | 54,000 | (5) | — | 1,879 | 295,879 | |||||||||||||||||
| Mark Ivie Chief Technology Officer | 2006 | 225,000 | 45,000 | — | 3,427 | 273,427 | ||||||||||||||||||
| (1) | We named Mr. Hoffmann our Chief Executive Officer on July 30, 2004 and President on June 14, 2007. | |
| (2) | Mr. Lavelle left our employment on May 14, 2007. | |
| (3) | Except with regard to Ms. Donovan and Mr. Bennett, the amounts reported in this column represent bonuses awarded to each executive with respect to the executive’s performance during 2006 as determined in the discretion of our board of directors. Each bonus was paid in 2007. | |
| (4) | $50,000 of the amount reported represents a portion of Ms. Donovan’s signing bonuses earned and paid during 2006 pursuant to her employment agreement. The remaining $84,375 represents a bonus awarded to |
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| Ms. Donovan at the discretion of our board of directors related to her performance during 2006. This bonus was paid in 2007. | ||
| (5) | This amount represents the bonus paid to Mr. Bennett pursuant to his employment agreement for his performance during 2006. | |
| (6) | The amounts reported in this column represent the following: |
| Long Term | ||||||||||||||||||||
| Company | Group Life | Disability | Other | |||||||||||||||||
| Matching | Insurance | Insurance | Other | Contractual | ||||||||||||||||
| Name and | 401(k) | Premium Cost | Premium Cost | Perquisites | Payments | |||||||||||||||
Principal Position | Contributions ($) | ($) | ($) | ($) | ($)(c) | |||||||||||||||
| Howard Hoffmann President and Chief Executive Officer | — | — | — | 22,821 | (a) | 1,886,452 | (d) | |||||||||||||
| Kathleen E. Donovan Senior Vice President and Chief Financial Officer | 2,734 | 959 | 1,439 | — | — | |||||||||||||||
| Frank Lavelle Former President | 5,500 | 1,213 | 1,684 | 22,220 | (b) | — | ||||||||||||||
| R. Scott Bennett Senior Vice President of Sales and Marketing | — | 751 | 1,128 | — | — | |||||||||||||||
| Mark Ivie Chief Technology Officer | 1,641 | 728 | 1,058 | — | — | |||||||||||||||
| (a) | This amount consists of reimbursements paid to Nightingale for lodging expenses, mileage, toll and parking expenses, and certain other miscellaneous living expenses incurred by Mr. Hoffmann during his engagement as our Chief Executive Officer in 2006. |
| (b) | Mr. Lavelle’s other perquisites consist of automobile allowances, country club dues and airline club memberships. |
| (c) | For the year ended December 31, 2006, the amount shown as Other Contractual Payments made to Mr. Hoffmann consist of (i) payments of $1,870,000 to Nightingale, the primary purpose of which was to compensate Nightingale for Mr. Hoffmann’s services as our Chief Executive Officer and (ii) additional payments totaling $16,452 to Nightingale, which represents certain reimbursable business related expenses incurred by Mr. Hoffmann in his capacity as our Chief Executive Officer during 2006. |
| (d) | The amount shown does not include the 2006 Discretionary Bonus of up to $240,000 that Nightingale may be entitled to receive in connection with Mr. Hoffmann’s service in 2006 as our President and Chief Executive Officer, as described above under the heading “Compensation of our President and Chief Executive Officer,” as this amount is not yet calculable as of the filing of this report. The amount of the bonus that will be payable to Nightingale, if any, will be determined no later than 14 days following the filing of this report. |
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Grants of Plan-Based Awards
The following table sets forth each grant of an award made to each named executive officer for the year ended December 31, 2006.
| Estimated Possible Payouts Under | ||||||||||||||||||||||||
| Non-Equity Incentive Plan Awards | Estimated Possible Payouts Under | |||||||||||||||||||||||
| (1)(2) | Equity Incentive Plan Awards | |||||||||||||||||||||||
| Threshold | Target | Maximum | Threshold | Target | Maximum | |||||||||||||||||||
Name | ($) | ($) | ($) | (#) | (#) | (#) | ||||||||||||||||||
| Howard Hoffmann | — | — | — | — | — | — | ||||||||||||||||||
| Kathleen E. Donovan | 50,625 | 168,750 | 253,125 | — | — | — | ||||||||||||||||||
| Frank Lavelle | 75,000 | 250,000 | 375,000 | — | — | — | ||||||||||||||||||
| R. Scott Bennett | 32,400 | 108,000 | 162,000 | — | — | — | ||||||||||||||||||
| Mark Ivie | 27,000 | 90,000 | 135,000 | — | — | — | ||||||||||||||||||
| (1) | This table does not include the Annual LTIP Awards for Ms. Donovan and Messrs. Bennett and Ivie discussed above in the “Compensation Discussion and Analysis” section. As discussed in that section, no awards were made with respect to the 2006 calendar year. | |
| (2) | Includes the 2006 threshold, target and maximum payouts designated under the 2006 Plan discussed above in the “Compensation Discussion and Analysis” section. As discussed in that section, for a participant to receive his or her threshold annual incentive award, we had to achieve at least 95% of our operating income target and 98% of our net revenues target. We did not meet these minimum thresholds. Accordingly, no cash bonus was earned or paid under the 2006 Plan. |
Narrative Disclosure to Summary Compensation Table and Grants of Plan-Based Awards Table
Other than our agreement with Nightingale, we have written employment agreements with each of our named executive officers that provide for the payment of base salary and for each named executive officer’s participation in bonus programs and employee benefit plans. Our agreement with Nightingale contains unique terms as a result of the nature of its engagement by us, all of which are discussed in detail above. In addition, each agreement other than our agreement with Nightingale specifies payments and benefits that would be due to such named executive officer upon the termination of his or her employment with us. See “Potential Payments Upon Termination orChange-In-Control” below, for additional information regarding amounts payable upon termination to each of our named executive officers other than Mr. Hoffmann.
Outstanding Equity Awards at Fiscal Year-End; Option Exercises and Stock Vested During Last Fiscal Year
None of our named executive officers have ever been granted options to purchase our common stock.
Pension Benefits
None of our named executive officers participate in or have account balances in qualified or non-qualified defined benefit plans sponsored by us.
Nonqualified Deferred Compensation
None of our named executive officers participate in or have account balances in non-qualified defined contribution plans or other deferred compensation plans maintained by us.
Potential Payments Upon Termination orChange-In-Control
The following is a discussion of payments and benefits that would be due to each of our named executive officers, other than Mr. Hoffmann and our former President, upon the termination of his or her employment with us. The amounts in the table below assume that each termination was effective as of December 29, 2006 (the last business day of 2006) and are merely illustrative of the impact of a hypothetical termination of each executive’s
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employment. The amounts to be payable upon an actual termination of employment can only be determined at the time of such termination based on the facts and circumstances then prevailing.
Pursuant to the terms of the agreement between us and Nightingale, Nightingale is not entitled to receive any additional payments for Mr. Hoffmann’s service to us upon termination of Mr. Hoffmann’s services to us or in the event we experience a change in control.
The actual payments made, or to be made, to Mr. Lavelle as a result of his resignation as our President, effective May 14, 2007, are described below under the caption “Separation Agreement with Mr. Lavelle.”
Severance Payments
Under the terms of their respective employment agreements, Ms. Donovan and Messrs. Bennett and Ivie will be entitled to the following severance payments in the event he or she is terminated “without cause” (as defined below): (1) continuation of the named executive officer’s then current base salary for a period of 12 months and (2) a payment equal to the average of the last three annual bonuses received by the named executive officer under our annual Management Incentive Plan (provided that, in the event the named executive officer has not been employed by us for at least three full years at the time of termination of employment, then the average of the last two years will apply, and in the event the named executive officer has not been employed by us for at least two full years at the time of termination, then the named executive officer’s target bonus would be paid).
In order to receive the severance payments described above, each named executive officer is required to execute and deliver a general release of claims against us.
As used in their respective employment agreements, the term “cause” means the occurrence of any of the following: (1) the named executive officer’s refusal, willful failure or inability to perform (other than due to illness or disability) his or her employment duties or to follow the lawful directives of his or her superiors; (2) misconduct or gross negligence by the named executive officer in the course of employment; (3) conduct of the named executive officer involving fraud, embezzlement, theft or dishonesty in the course of employment; (4) a conviction of or the entry of a plea of guilty or nolo contendere to a crime involving moral turpitude or that otherwise could reasonably be expected to have an adverse effect on our operations, condition or reputation; (5) a material breach by the named executive officer of any agreement with or fiduciary duty owed to us or (6) alcohol abuse or use of controlled drugs other than in accordance with a physician’s prescription.
Applicable Restrictive Covenants
Each of Ms. Donovan and Mr. Ivie are bound by certain non-competition and non-solicitation covenants which extend for a period of 18 months following termination of employment for any reason. Mr. Bennett is bound by substantially similar covenants for a period of 12 months following termination of employment for any reason.
Change of Control
Upon a “change of control” (as defined below), any unvested options granted to Ms. Donovan and Messrs. Bennett and Ivie pursuant to the Special Option Awards will become fully vested and will become exercisable by the named executive officer following the six-month anniversary of the change of control.
Because the Special Option Awards have not, as of the date of this filing, been granted, the value of the acceleration of these options is not currently estimatable, and therefore, is not included in the table below.
For purposes of their respective employment agreements, the term “change of control” will be deemed to have occurred upon the following: (1) a change within a12-month period in the holders of more than 50% of our
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outstanding voting stock or (2) any other event deemed to constitute a “Change of Control” by our board of directors.
Assuming a termination “without cause” occurred on December 29, 2006 (the last business day of 2006), the payments to each of Ms. Donovan and Messrs. Bennett and Ivie had an estimated value of:
| Salary | Severance | |||||||||||
| Continuation | Bonus | Total | ||||||||||
Name | ($) | ($)(1) | ($) | |||||||||
| Kathleen E. Donovan | 375,000 | 168,750 | 543,750 | |||||||||
| R. Scott Bennett | 240,000 | 108,000 | 348,000 | |||||||||
| Mark Ivie | 225,000 | 90,000 | 315,000 | |||||||||
| (1) | As of December 29, 2006, none of these named executive officers would have completed two full years of employment with us, therefore, their severance is calculated using their target annual bonus amount rather than an average of prior years’ bonuses actually paid. |
Separation Agreement with Mr. Lavelle
We entered into a formal Separation and Release Agreement with Mr. Lavelle on June 28, 2007 (Separation Agreement). Pursuant to the terms of the Separation Agreement, Mr. Lavelle will be entitled to receive the following:
| • | monthly payments for a period of 18 months following the termination date in an amount equal to the quotient obtained by dividing (x) the sum of (A) 1.5 times the base salary paid in the12-month period preceding the termination date and (B) the total cash bonus paid in the12-month period preceding the termination date, by (y) 18; | |
| • | reimbursement for costs incurred in obtaining outplacement services, at a cost not to exceed $100,000; and | |
| • | medical coverage following the date of termination until the earlier to occur of (i) the expiration of 18 months and (ii) the date on which Mr. Lavelle is eligible for coverage under a plan maintained by a new employer or a plan maintained by his spouse’s employer, at the level in effect on the date of his termination (or generally comparable coverage) for himself and, where applicable, his spouse and dependents, as the same may be changed by us from time to time for employees generally, as if Mr. Lavelle had continued in employment during such period. |
The following table summarizes the payments Mr. Lavelle will be entitled to receive pursuant to the terms of the Separation Agreement.
| Payment Amount | ||||
| Severance Payment | $ | 875,000 | ||
| Outplacement Services | $ | 100,000 | (1) | |
| Medical (including dental and vision) | $ | 10,142 | (2) | |
| (1) | Represents the maximum amount that we are obligated to reimburse Mr. Lavelle for expenses incurred in obtaining outplacement services. | |
| (2) | This amount represents our portion of the premium payments for 18 months of medical coverage (includes dental and vision). |
In addition, the Separation Agreement provides that Mr. Lavelle will be bound by the non-competition and non-solicitation covenants set forth in his employment agreement for a period of 18 months following his termination of employment. The Separation Agreement also provides that Mr. Lavelle releases us from claims arising or occurring on or prior to the date of the Separation Agreement.
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Director Compensation
Philips Directors and Management Directors (as described in Item 10, Directors and Executive Officers of the Registrant — Identification of Directors above and in Item 13, Certain Relationships and Related Transactions, and Director Independence — Governance Agreement below) do not receive any compensation for their service on our board of directors. Independent Directors (as described in Item 10, Directors and Executive Officers of the Registrant — Identification of Directors above and in Item 13, Certain Relationships and Related Transactions, and Director Independence — Governance Agreement below) are entitled to compensation for their service on our board of directors and on any committees of our board of directors. All directors are reimbursed for all reasonable expenses incurred by them in connection with their service on our board of directors.
Our Independent Directors receive the following annual compensation:
| • | Pursuant to our board of directors Deferred Compensation Plan, the right to receive common stock having a fair market value of $50,000, determined as of the date of grant (January 1 of each year), at the time such Independent Director ceases to serve on our board (Deferred Stock Awards). Prior to the time of issuance, the Independent Director has no rights with respect to the shares of common stock subject to the award; and | |
| • | $25,000 in cash to cover all meetings, with committee chairs receiving an additional $2,000 in cash and the chair of the Audit Committee receiving and an additional $5,000 in cash. |
Our board of directors postponed the granting of Deferred Stock Awards for 2006 and 2005 until such time as we become current in our periodic reporting obligations with the SEC. Upon us becoming current in our periodic reporting obligations with the SEC, we will grant the postponed deferred compensation awards based on the then current price of our common stock. The cash component of the independent directors’ compensation was paid for service in 2005 and 2006.
The following table sets forth certain information regarding the compensation of our Independent Directors in 2006:
| Fees Earned | Deferred Stock | |||||||||||
| or Paid in | Awards | Total | ||||||||||
Name(1) | Cash ($) | ($)(2) | ($) | |||||||||
| N. John Simmons, Jr. | 30,000 | 50,000 | 80,000 | |||||||||
| Richard H. Stowe | 27,000 | 50,000 | 77,000 | |||||||||
| John H. Underwood | 27,000 | 50,000 | 77,000 | |||||||||
| (1) | All directors other than Messrs. Simmons, Stowe and Underwood are Philips Directors and, as such, do not receive any compensation for their service on our board of directors. However, all Philips Directors are reimbursed for all reasonable expenses incurred by them in connection with their service on our board of directors. | |
| (2) | The amounts listed in this column represent the dollar value of the Deferred Stock Awards each Independent Director was entitled to receive on January 1, 2006; however, our board of directors postponed the granting of Deferred Stock Awards for 2006 until such time as we become current in our periodic reporting obligations. Upon us becoming current in our periodic reporting obligations with the SEC we will grant the postponed deferred compensation awards based on the then current market price of our common stock. |
Committee Interlocks and Insider Participation
John H. Underwood, N. John Simmons, Jr. and Richard H. Stowe served as members of the Compensation Committee during 2006. None of Messrs. Underwood, Simmons, Jr. or Stowe has served as one of our executives. There are no compensation committee interlocks between us and any other entity involving our or such entity’s executive officers or board members.
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| Item 12. | Security Ownership of Certain Beneficial Owners and Management |
Principal Holders of Voting Securities
The following table sets forth information regarding the beneficial ownership of our common stock as of July 31, 2007, for:
| • | each person who is known by us to own beneficially more than 5% of the outstanding shares of our common stock; | |
| • | each of our directors; | |
| • | each of our named executive officers; and | |
| • | all of our directors and executive officers as a group. |
The percentages of shares outstanding provided in the table below are based on 37,483,723 shares of common stock outstanding as of July 31, 2007. Beneficial ownership is determined in accordance with SEC rules and regulations and generally includes voting or investment power with respect to securities. Unless otherwise indicated, each person or entity named in the table below has sole voting and investment power, or shares voting and investment power with his or her spouse, with respect to all shares of stock listed as owned by that person. Shares issuable upon the exercise of options that are exercisable within 60 days of July 31, 2007 are considered to be outstanding for the purpose of calculating the percentage of outstanding shares of our common stock held by the individual, but not for the purpose of calculating the percentage of outstanding shares held by any other individual. The address of our directors and executive officers isc/o MedQuist Inc., 1000 Bishops Gate Blvd., Suite 300, Mount Laurel, New Jersey, 08054.
| Shares Beneficially Owned | ||||||||
| Percentage of | ||||||||
Name of Beneficial Owner | Number of Shares | Class | ||||||
| Koninklijke Philips Electronics N.V. | 26,085,086 | 69.6 | % | |||||
| Rembrandt Tower | ||||||||
| Amstelplein 1 1096 HA Amsterdam, the Netherlands | ||||||||
| Newcastle Partners, L.P | 2,679,974 | (1) | 7.1 | % | ||||
| 300 Crescent Court, | ||||||||
| Suite 1110 | ||||||||
| Dallas, Texas 75201 | ||||||||
| Clement Revetti, Jr. | 26,085,086 | (2) | 69.6 | % | ||||
| Stephen H. Rusckowski | 26,085,086 | (2) | 69.6 | % | ||||
| Gregory M. Sebasky | 26,085,086 | (2) | 69.6 | % | ||||
| N. John Simmons, Jr. | — | — | ||||||
| Richard H. Stowe | 31,644 | (3) | * | |||||
| John H. Underwood | 37,930 | (4) | * | |||||
| Scott M. Weisenhoff | 26,085,086 | (2) | 69.6 | % | ||||
| Howard S. Hoffmann | — | — | ||||||
| Frank W. Lavelle | — | (5) | — | |||||
| Kathleen E. Donovan | — | — | ||||||
| Scott Bennett | — | — | ||||||
| Mark Ivie | — | — | ||||||
| All directors and executive officers as a group (14 persons)(3)(4)(6) | 26,183,961 | 69.7 | % | |||||
| * | Less than 1%. | |
| (1) | According to a Schedule 13D/A filed with the SEC on July 14, 2006: (i) Newcastle Partners, L.P. (NP) is a Texas limited partnership, the principal business of which is investing in securities; (ii) Newcastle Capital |
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| Management, L.P. (NCM) is a Texas limited partnership, the principal business of which is acting as the general partner of NP; (iii) Newcastle Capital Group, L.L.C. (NCG) is a Texas limited liability company, the principal business of which is acting as the general partner of NCM; (iv) Mark E. Schwarz (Schwarz) is an individual whose principal business is serving as the managing member of NCG and (v) by reason of such relationships, Schwartz, NDG and NCM may be deemed, pursuant to Rule 13d-3 of the Exchange Act, to be the beneficial owners of all shares of common stock held by NP. | ||
| (2) | According to a Schedule 13D/A filed with the SEC on July 6, 2007. Each Philips Director has disclaimed beneficial ownership of such shares. | |
| (3) | Includes options to purchase 6,529 shares of our common stock held by Mr. Stowe that may be exercised within 60 days of July 31, 2007, options to purchase 15,000 shares of our common stock held by Monashee Associates LLC, an entity controlled by Mr. Stowe, and 4,903 shares of our common stock to be issued to Mr. Stowe pursuant to the Board Deferred Stock Plan. | |
| (4) | Includes options to purchase 33,124 shares of our common stock held by Mr. Underwood that may be exercised within 60 days of July 31, 2007, 1,056 shares of our common stock indirectly owned in an Individual Retirement Account and 3,750 shares of our common stock to be issued to Mr. Underwood pursuant to the Board Deferred Stock Plan. | |
| (5) | According to a Form 3 filed with the SEC on March 18, 2005. This is the most current information we have for this individual. | |
| (6) | Includes our directors (Messrs. Revetti, Rusckowski, Sebasky, Simmons, Stowe, Underwood and Weisenhoff) and our executive officers (Ms. Donovan and Messrs. Hoffmann, Ivie, Bennett, Clark, Brennan and Sullivan). Includes options to purchase 27,200 and 2,000 shares of our common stock held by Mr. Clark and Mr. Sullivan, respectively, that may be exercised within 60 days of July 31, 2007. |
Securities Authorized for Issuance Under Equity Compensation Plans
The following table sets forth, as of December 31, 2006, information concerning equity compensation plans under which our securities are authorized for issuance. The table does not reflect grants, awards, exercises, terminations or expirations since that date. All share amounts and exercise prices have been adjusted to reflect stock splits that occurred after the date on which any particular underlying plan was adopted, to the extent applicable.
| (A) | (B) | (C) | ||||||||||
| Number of | ||||||||||||
| Securities | ||||||||||||
| Remaining Available | ||||||||||||
| Number of Securities | for Future Issuance | |||||||||||
| to be Issued Upon | Weighted Average | under Equity | ||||||||||
| Exercise of | Exercise Price of | Compensation Plans | ||||||||||
| Outstanding Options, | Outstanding Options, | (excluding securities | ||||||||||
Plan Category | Warrants and Rights | Warrants and Rights | reflected in column (A)) | |||||||||
| Plans Approved by Shareholders | 2,149,916 | $ | 31.86 | 1,758,260 | (1) | |||||||
| Plans Not Approved by Shareholders | — | — | — | |||||||||
| Total | 2,149,916 | $ | 31.86 | 1,758,260 | ||||||||
| (1) | This amount represents 1,133,050 shares of our common stock available for future issuance pursuant to stock options available for grant under our 2002 Equity Incentive Plan, 18,626 shares of our common stock available for future issuance pursuant to outstanding stock awards under our Board Deferred Stock Plan and 606,584 shares of our common stock available for future issuance pursuant to our Employee Stock Purchase Plan. |
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Employee Benefit Plans
Stock Option Plans
On July 23, 2004, our board of directors affirmed our June 16, 2004 decision to indefinitely suspend the exercise of options under our stock option plans. Notwithstanding the foregoing, the post-termination option exercise period for unexercised stock options held by certain of our executive officers that are no longer employed by us was frozen, such that the post-termination exercise period for those holders will not begin to run until we become current in our reporting obligations under the Exchange Act.
2002 Stock Option Plan
Our 2002 Stock Option Plan was adopted by our board of directors in December 2001 and our shareholders in May 2002. Our 2002 Stock Option Plan is administered by the Compensation Committee of our board of directors. The purpose of our 2002 Stock Option Plan is to provide additional incentives to our officers, other key employees and non-employee directors (and those officers, other key employees and non-employee directors of each of our present or future parent or subsidiary corporations), by encouraging them to invest in shares of our common stock, and to thereby acquire a proprietary interest in our equity ownership and an increased personal interest in our continued success and progress. Options may not be granted pursuant to our 2002 Stock Option Plan after December 2011.
Number of Shares and Adjustment. The aggregate number of shares which may presently be issued upon the exercise of options granted under our 2002 Stock Option Plan is 1,500,000 shares of our common stock. As of July 31, 2007, options to purchase 353,650 shares of our common stock were outstanding under our 2002 Stock Option Plan. The aggregate number and kind of shares issuable under our 2002 Stock Option Plan is subject to appropriate adjustment in the sole discretion of the Compensation Committee to reflect changes in the number of outstanding shares of our common stock by reason of a stock dividend, stock split, combination of shares, recapitalization, merger, consolidation, transfer of assets, reorganization, conversion, or other similar circumstances. Any shares of our common stock subject to options that terminate unexercised will be available for future grants under our 2002 Stock Option Plan.
Eligibility and Administration. All of our officers and key employees (or any officers and key employees of any of our current or future parent or subsidiary corporations), including all non-employee directors are eligible to receive options under our 2002 Stock Option Plan to purchase shares of our common stock. The Compensation Committee determines, among other things, which of our officers and key employees will be granted options under our 2002 Stock Option Plan, whether options granted will be incentive stock options meeting the requirements of Section 422 of the Internal Revenue Code of 1986, as amended (Code) or non-qualified stock options not intended to meet the requirements of Section 422 of the Code, the number of shares subject to an option, the time at which an option is granted and the duration of an option and the exercise price of an option. No individual may receive options under our 2002 Stock Option Plan for more than 80% of the total number of shares of our common stock authorized for issuance under our 2002 Stock Option Plan. Our 2002 Stock Option Plan also provides that each person who is a director of ours as of June 1 of each year and who is not an employee of ours shall automatically be granted an option to purchase 3,000 shares of our common stock, subject to such adjustment or modification as may be adopted by our board of directors. On October 14, 2004, our board of directors suspended indefinitely the annual grant of 3,000 options to each of our non-employee directors.
Amendment, Supplement, Suspension and Termination. Our board of directors reserves the right at any time, and from time to time, to modify or amend our 2002 Stock Option Plan in any way, or to suspend or terminate it, provided, however, that such action shall not affect options granted under our 2002 Stock Option Plan prior to the actual date on which such action occurred.
Exercise Price and Terms. The exercise price for options granted under our 2002 Stock Option Plan shall be equal to at least the fair market value of our common stock as of the date of the grant of the option, except that the option exercise price of incentive stock options granted to individuals owning shares our common stock possessing more than 10% of the total combined voting power of all classes of our equity securities must not be less than 110% of the fair market value as of the date of the grant of the option. Unless terminated earlier by the option’s terms,
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options granted under our 2002 Stock Option Plan will expire 10 years after the date they are granted, except that, with respect to incentive stock options granted to individuals owning shares of our common stock possessing more than 10% of the total combined voting power of all classes of our equity securities on the date of the grant, Section 422 of the Code requires that such options expire five years after the date they are granted.
Payment of Exercise Price. Payment of the option price on exercise of incentive stock options and non-qualified stock options may be made in cash, with shares of our common stock, or a combination of both.
Termination of Service; Death; Non-Transferability. All unexercised incentive stock options will terminate such number of days (not to exceed 90) as determined by the Compensation Committee after the date that either:
| • | the optionee ceases to perform services for us; or | |
| • | we deliver to or receive notice from the optionee of an intention to terminate his or her employment relationship, regardless of whether or not a different effective date of termination is provided in such notice; |
provided, however, that this termination date shall not apply in the case of disability or death of the optionee (but in no event shall the option expire later than the expiration date).
A holder of an incentive stock option under our 2002 Stock Option Plan who ceases to be an employee because of a disability must exercise any vested but unexercised options within one year after he or she ceases to be an employee (but in no event later than the expiration date). The heirs or personal representative of a deceased employee who could have exercised an option while alive may exercise such option within one-year following the employee’s death (but in no event later than the expiration date). No option is transferable except by will, the laws of descent and distribution or pursuant to a qualified domestic relations order.
1992 Stock Option Plan
Our 1992 Stock Option Plan was adopted by our board of directors and shareholders in January 1992. Our 1992 Stock Option Plan, which replaced our 1988 Stock Option Plan, is administered by the Compensation Committee. Options may no longer be issued under our 1992 Stock Option Plan.
Number of Options Outstanding. As of July 31, 2007, options to purchase 1,634,744 shares of our common stock were outstanding under our 1992 Stock Option Plan.
Option Term. Options issued under our 1992 Stock Option Plan have a maximum term of 10 years.
Termination of Service; Death. Options issued under our 1992 Stock Option Plan terminate one year after the termination of employment by reason of death or disability and 90 days after any other termination of employment (but in no event shall the option expire later than the expiration date).
Nonstatutory Stock Option Plan for Non-Employee Directors
Our Nonstatutory Stock Option Plan for Non-Employee Directors was adopted by our board of directors and our shareholders in January 1992. Our Nonstatutory Stock Option Plan for Non-Employee Directors is administered by our board of directors and was created to enhance our ability to attract, retain and motivate non-employee members of our board of directors and to provide additional incentives to non-employee members of our board of directors. Options may no longer be issued pursuant to our Nonstatutory Stock Option Plan for Non-Employee Directors.
Number of Options Outstanding. As of July 31, 2007, options to purchase 86,240 shares of our common stock were outstanding under our Nonstatutory Stock Option Plan for Non-Employee Directors.
Option Term. Options are exercisable in full from the grant date and terminate 30 days after the date the grantee ceases to be a member of our board of directors. Unless terminated earlier by the option’s terms, options granted under our Nonstatutory Stock Option Plan for Non-Employee Directors expire 10 years after the date of grant (but in no event shall the option expire later than the expiration date). Any options granted on or after June 1996, to the extent not exercised, terminate two years after the individual ceases to be a director (but in no event shall the option expire later than the expiration date).
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The MRC Group, Inc. 1992 Stock Option Plan
We assumed administration responsibility for The MRC Group, Inc. 1992 Stock Option Plan in connection with our acquisition of MRC in December 1998. Pursuant to the acquisition agreement, each outstanding unexpired option to purchase shares of MRC common stock was converted into an option to purchase shares of our common stock at the conversion rate set forth in the acquisition agreement. Otherwise, the terms of The MRC Group, Inc. 1992 Stock Option Plan still govern the outstanding options granted under the plan. Options may no longer be issued pursuant to The MRC Group, Inc. 1992 Stock Option Plan.
Number of Options Outstanding. As of July 31, 2007, options to purchase 14,586 shares of our common stock were issued and outstanding under The MRC Group, Inc. 1992 Stock Option Plan.
Option Terms. Each option under The MRC Group, Inc. 1992 Stock Option Plan expires no later than 10 years from the date on which the option was granted.
Termination of Service; Death. Options issued under The MRC Group, Inc. 1992 Stock Option Plan terminate one year after the termination of employment by reason of death or disability and 90 days after any other termination of employment; provided, however, if his or her employment relationship with us is terminated by us then the unexercised options will terminate not later than 30 days after the termination of employment of the optionee. In no event shall the option expire later than the expiration date.
Executive Deferred Compensation Plan
We established the MedQuist Inc. Executive Deferred Compensation Plan (EDCP) in 2001. The EDCP, which is administered by the Compensation Committee, allows certain members of management and highly compensated employees to defer a certain percentage of their income. Contributions may no longer be made to our EDCP. Under the EDCP, participants were able to defer compensation to an account in which proceeds would be available either during or after termination of employment. The Compensation Committee was permitted to match certain contributions made to a retirement distribution account with either shares of our common stock or cash. However, matching contributions were only made with cash. Participants were not entitled to receive matching contributions if they elected to make deferrals to an account in which proceeds would be available during employment. Participants were able to defer up to 15% of base salary (or such other maximum percentage as may be approved by the Compensation Committee) and 90% of bonus amounts (or such other maximum percentage as may be approved by the Compensation Committee). Distributions to a participant made pursuant to an account in which proceeds are available after termination of employment may be made to the participant upon the participant’s termination or attainment of age 65, as elected by the participant in his or her enrollment agreement. Distributions to a participant made pursuant to an account in which proceeds are available during employment may be made at the election of the participant in their enrollment agreement, subject to certain exceptions. The balances in the EDCP are not funded but are segregated, and participants in the plan are our general creditors. All amounts deferred in the EDCP increase or decrease based on hypothetical investment results of the executive’s selected investment alternatives, but plan distributions are paid out of our funds rather than from a dedicated investment portfolio.
Board of Directors Deferred Compensation Plan
2006 Compensation
Commencing on January 1, 2005, our Independent Directors receive the following annual compensation:
| • | deferred compensation in the form of common stock having a fair market value of $50,000 on the date of grant; and | |
| • | $25,000 in cash to cover all meetings, with committee chairs receiving an additional $2,000 in cash and the chair of the Audit Committee receiving and additional $5,000 in cash. |
Our board of directors postponed the granting of the deferred compensation awards for 2005 and 2006 until such time as we become current in our periodic reporting obligations with the SEC. Upon us becoming current in our periodic reporting obligations with the SEC, we will grant the postponed deferred compensation awards based
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on the then current market price of our common stock. The cash component of the independent directors’ compensation was paid in 2005 and 2006.
401(k) Plan
We maintain a tax-qualified retirement plan named the MedQuist 401(k) Plan (401(k) Plan) that provides eligible employees with an opportunity to save for retirement on a tax-advantaged basis. Our 401(k) Plan allows eligible employees to contribute up to 25% of their annual eligible compensation on a pre-tax basis, subject to applicable Code limits. Elective deferral contributions are allocated to each participant’s account according to their investment selection(s). Employee elective deferrals are 100% vested at all times. We have historically matched, in cash, 50% of a participant’s elective deferral contributions, up to 5% of the participant’s total annual eligible compensation. Beginning in April 2007, matching contributions are now based upon our operating results in the discretion of our executive officers. Matching contributions are 33% vested after one year of service, 67% vested after two years of service and 100% vested after three years of service. Our 401(k) Plan and its related trust are intended to qualify under Sections 401(a) and 501(a) of the Code. As a tax-qualified retirement plan, contributions to our 401(k) Plan and earnings on those contributions are not taxable to the employees until distributed from our 401(k) Plan, and all contributions are deductible by us when made.
Employee Stock Purchase Plan
All full-time employees other than those who own 5% or more of our common stock are eligible to participate in our Employee Stock Purchase Plan. Our Employee Stock Purchase Plan provides that participants may authorize us to withhold up to 10% of their earnings (up to a maximum of $25,000) for the purchase of shares of our common stock. The purchase price of our common stock is determined by the Compensation Committee but shall not be less than 85% of the fair market value of our common stock on the date of purchase. Our board of directors indefinitely suspended participation in our Employee Stock Purchase Plan on June 15, 2004.
2007 Management Incentive Plan
Under our 2007 Management Incentive Plan, all management level employees with influence on our financial results other than Mr. Hoffmann have the opportunity to earn an annual bonus in the event that weand/or such employee attain pre-established bonus plan target objectives. For those eligible employees who commenced employment with us during the first six months of 2007, the bonus payment will be calculated on a pro rata basis. Management-level employees hired on or after July 1, 2007 are not eligible to participate in our 2007 Management Incentive Plan. Bonuses pursuant to our 2007 Management Incentive Plan will be paid in a lump sum amount in 2008.
| Item 13. | Certain Relationships and Related Transactions, and Director Independence |
Majority Shareholder
On July 6, 2000, Philips completed a tender offer in which Philips acquired approximately 60% of our outstanding common stock. Subsequent to the completion of that tender offer, Philips increased its ownership position and currently owns approximately 69.6% of our outstanding common stock. As a result of Philips’ ownership position, we would be considered to be a “Controlled Company” if we were listed on an exchange, such as The NASDAQ Stock Market LLC.
Governance Agreement
Under the terms of the Governance Agreement, we agree to take any and all action necessary so that our board of directors consists of 11 persons, including:
| • | two Management Directors; | |
| • | six Philips Directors; and | |
| • | three Independent Directors. |
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Notwithstanding the preceding, our board of directors has the discretionary authority under the Governance Agreement to increase or decrease the size of our board of directors, provided that:
| • | there are at least two Management Directors and three Independent Directors; and | |
| • | the relative percentage of Management Directors, Independent Directors and Philips Directors is maintained. |
In addition, the number of directors that Philips is permitted to designate or nominate under the Governance Agreement, which is based upon Philips’ relative ownership of our equity securities having the right to vote generally in any election of our directors, is as follows:
| Philips’ Beneficial Ownership | Number of | |||
of Our Voting Stock | Philips Directors | |||
| More than 50% | 6 | |||
| 36%-50% | 4 | |||
| 27%-35% | 3 | |||
| 18%-26% | 2 | |||
| 5%-17% | 1 | |||
| Less than 5% | 0 | |||
If at any time Philips has the right to designate fewer than six directors under the terms of the Governance Agreement, the Nominating Committee of our board of directors will nominate a number of additional Independent Directors as is necessary to constitute the entire board of directors.
Philips has the right to designate a replacement Philips Director upon the termination of a Philips Director’s term or upon a Philips Director’s death, resignation, retirement, disqualification or removal from office. Our Chief Executive Officer has the right to designate a replacement Management Director upon the termination of a Management Director’s term or upon a Management Director’s death, resignation, retirement, disqualification or removal from office.
Notwithstanding the preceding, the composition of our current board of directors is as follows:
| • | three Independent Directors (Messrs. Simmons, Stowe and Underwood); and | |
| • | four Philips Directors designated by Philips (Messrs. Revetti, Rusckowski, Sebasky and Weisenhoff). |
The Governance Agreement also requires us to establish and maintain the following committees of our board of directors:
| • | Nominating Committee consisting solely of two Independent Directors, one Philips Director and one Management Director which is responsible, among other things, for the nomination of the Independent Directors. We currently maintain a Nominating Committee composed of one Independent Director (Mr. Stowe) and one Philips Director (Mr. Rusckowski); | |
| • | Compensation Committee consisting of two Independent directors and two Philips Directors which is responsible, among other things, for the adoption, amendment and administration of all of our employee benefit plans and arrangements and the compensation of all or our officers. We currently maintain a Compensation Committee composed of three Independent Directors (Messrs. Simmons, Stowe and Underwood); and | |
| • | Supervisory Committee consisting of at least three Independent directors which is responsible, among other things, for the general oversight, administration, amendment and enforcement of the Governance Agreement and all other material agreements or arrangements between Philips and us. We currently maintain a Supervisory Committee composed of three Independent Directors (Messrs. Simmons, Stowe and Underwood). |
The Governance Agreement will terminate on the first date that Philips is no longer the beneficial owner of at least 5% of our equity securities having the right to vote generally in any election of our directors. The provisions of
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the Governance Agreement relating to the establishment of committees of our board of directors will terminate on the first date that Philips is the beneficial owner of less than a majority of our equity securities having the right to vote generally in any election of our directors.
Nightingale
On July 30, 2004, our board of directors appointed Howard S. Hoffmann to serve as our Chief Executive Officer. On June 14, 2007, our board of directors appointed Mr. Hoffmann as our President. In connection with his appointment, we entered into a letter agreement with Nightingale, dated as of July 29, 2004 and amended as of December 16, 2004, September 25, 2006 and January 8, 2007, pursuant to which Nightingale assigns the services of Mr. Hoffmann to us to serve as our President and Chief Executive Officer. Mr. Hoffmann serves as the Managing Partner of Nightingale. Mr. Hoffmann continues to serve as our President and Chief Executive Officer pursuant to the terms of the agreement, which expired on June 30, 2007. We are currently negotiating the terms of an extension of this agreement. We currently pay to Nightingale the sum of $120,000 per month for Mr. Hoffmann’s service as our President and Chief Executive Officer. In addition, we reimburse Nightingale for any out-of-pocket expenses incurred by Mr. Hoffmann in the course of his service as our President and Chief Executive Officer. Examples of such out-of-pocket expenses include transportation, meals, lodging, telephone, specifically assignable secretarial and office assistance, and report production. Upon the completion of his service as our President and Chief Executive Officer, we will pay Nightingale $525 per hour for Mr. Hoffmann’s services as a consultant.
Our letter agreement with Nightingale also permits us to engage personnel employed by Nightingale in addition to Mr. Hoffmann to provide consulting services to us from time to time. Pursuant to this arrangement, we incurred the following costs (dollars in thousands):
| Six Months Ended | Year Ended | |||
June 30, 2007 | December 31, 2006 | |||
| $563 | $ | 976 | ||
Indemnification Agreements
On July 3, 2007, we entered into indemnification agreements with each of Richard H. Stowe and John H. Underwood. Each indemnification agreement is substantially similar to the indemnification agreement we entered into on July 15, 2005 with N. John Simmons, Jr. (Simmons Indemnification Agreement) and provides, among other things, that to the extent permitted by New Jersey law, we will indemnify the director against all expenses (including attorneys’ fees), judgments, fines and amounts paid in settlement actually and reasonably incurred by him in conjunction with any suit in which he is a party or otherwise involved as a result of his service as a member of our board of directors.
On August 23, 2007, we entered into indemnification agreements with Ms. Donovan and Messrs. Hoffmann, Brennan, Sullivan, Ivie, Clark and Bennett. Each indemnification agreement is substantially similar to the Simmons Indemnification Agreement and provides, among other things, that to the extent permitted by New Jersey law, we will indemnify the executive officer against all expenses (including attorneys’ fees), judgments, fines and amounts paid in settlement actually and reasonably incurred by him or her in conjunction with any suit in which he or she is a party or otherwise involved as a result of his or her service as an executive officer.
Licensing Agreement
In connection with Philips’ tender offer, we entered into a Licensing Agreement with PSRS on May 22, 2000 (Licensing Agreement). The Licensing Agreement was subsequently amended by the parties as of January 1, 2002, February 23, 2003, August 10, 2003, September 1, 2004, December 30, 2005 and February 13, 2007.
Under the Licensing Agreement, we license from PSRS its SpeechMagic speech recognition and processing software, including any updated versions of the software developed by PSRS during the term of the License Agreement (Licensed Product), for use by us anywhere in the world. We pay a fee for use of the Licensed Product based upon a per line fee for each transcribed line of text processed through the Licensed Product.
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Upon the expiration of its initial term on June 28, 2005, the Licensing Agreement was renewed for an additional five year term. PSRS may terminate the Licensing Agreement for cause immediately in the event that we:
| • | default in any payment due to PSRS and the default continues for a period of 30 business days after written notice to us; | |
| • | fail to perform any material obligation, duty or responsibility or are in default with any material term or condition of the Licensing Agreement and the default continues for a period of 30 business days after written notice to us; or | |
| • | become insolvent or file for bankruptcy. |
We may terminate the Licensing Agreement for cause immediately in the event that PSRS:
| • | fails to perform any material obligation, duty or responsibility or is in default with any material term or condition of the Licensing Agreement and the default continues for a period of 30 business days after written notice to PSRS; or | |
| • | becomes insolvent or files for bankruptcy. |
Either PSRS or we may terminate the Licensing Agreement for any reason upon at least two years prior written notice to the other party.
We may purchase, license or use a product competing with the Licensed Product during the term of the Licensing Agreement provided we give PSRS at least three months prior written notice and the opportunity to submit to us a commercially and technologically competitive offer. We, however, have no obligation to accept such an offer. PSRS is not prohibited from granting a license for the Licensed Product or any similar products to any of our competitors that provide outsourced medical transcription services in North America.
In connection with the Licensing Agreement, we have a consulting arrangement with PSRS whereby PSRS assists us with the integration of its speech and transcription technologies. We incurred the following aggregate costs under the Licensing Agreement and this consulting arrangement (dollars in thousands):
| Six Months Ended | Year Ended | |||
June 30, 2007 | December 31, 2006 | |||
| $1,102 | $ | 2,393 | ||
OEM Supply Agreement
We entered into an OEM Supply Agreement with PSRS on September 23, 2004 pursuant to which we obtained the exclusive right in North America to sell certain PSRS Products (as defined below) createdand/or developed by PSRS to third parties, to service such PSRS Products and to incorporate such PSRS Products into our own products (OEM Supply Agreement). Under the OEM Supply Agreement, “PSRS Products” is defined as:
| • | PSRS’ in-house solution for radiology products, together with all derivations and future versions thereof; and | |
| • | all multi-user solutions PSRS develops that include the core functionality of front-end speech recognition software for the medical market in North America. |
Upon the expiration of its initial term on June 30, 2007, the OEM Agreement was renewed for an additional three year term. PSRS may terminate the OEM Agreement:
| • | in the event of material breach by us which is not cured after 30 days written notice; | |
| • | if we assign the OEM Agreement without PSRS’ consent; or | |
| • | if we undergo a change of control and the control changes to a third party doing business in the dictation market or in the speech recognition market. |
We may terminate the OEM Supply Agreement in the event of material breach by PSRS that is not cured after 30 days written notice.
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PSRS may elect to convert the exclusive license under the OEM Supply Agreement to a non-exclusive license if we fail to meet the sales forecasts and commitments with respect to software purchases and payments set forth in the OEM Supply Agreement during its initial term. To exercise this right, PSRS must pay us a fixed amount for each month remaining in the initial term after the date exclusivity is terminated. In 2004, we made a payment to PSRS with respect to software purchases and payments under the OEM Supply Agreement in an amount equal to the sales forecast and commitment set forth in the OEM Supply Agreement for such year. We did not meet the sales forecast and commitment set forth in the OEM Supply Agreement for 2005 or 2006.
If PSRS decides to discontinue all business relating to the PSRS Products in North America, PSRS has the right to terminate the OEM Supply Agreement by giving us six months prior written notice, in which case PSRS agrees to negotiate in good faith with us the terms and conditions under which it will provide training and access to source code of the PSRS Products to the extent reasonably necessary for us to continue development and to support the installed base of PSRS Products in North America.
In consideration of PSRS’ development, maintenance and support for the first version of the PSRS Products, we paid PSRS a development fee in 2004. In addition, we pay monthly license fees to PSRS, subject to certain reductions based upon the level of purchases of PSRS Products by us under the OEM Supply Agreement relative to annual forecasted amounts.
Under the OEM Supply Agreement, we are required to use reasonable commercial efforts to sell end users a software maintenance agreement. The software maintenance agreement provides that the customer will obtain certain product releases and technical support directly from PSRS or from PSRS through us. We pay a fee to PSRS for each software maintenance agreement contract sold by us.
In connection with the OEM Supply Agreement, we incurred the following costs (dollars in thousands):
| Six Months Ended | Year Ended | |||
June 30, 2007 | December 31, 2006 | |||
| $301 | $ | 1,429 | ||
Equipment Sales
We purchase dictation related equipment from Philips. We incurred the following costs for such equipment (dollars in thousands):
| Six Months Ended | Year Ended | |||
June 30, 2007 | December 31, 2006 | |||
| $321 | $ | 878 | ||
Insurance Coverage through Philips
We obtain all of our business insurance coverage (other than workers’ compensation) through Philips. We incurred the following costs for business insurance coverage (dollars in thousands):
| Six Months Ended | Year Ended | |||
June 30, 2007 | December 31, 2006 | |||
| $1,454 | $ | 1,601 | ||
Purchasing Agreements
We enter into annual letter agreements with Philips Electronics North America Corporation (PENAC), an affiliate of Philips, to purchase products and services from certain suppliers under the terms of the prevailing agreements between such suppliers and PENAC (Philips Supply Agreements). We incurred the following service fees for use of the Philips Supply Agreements (dollars in thousands):
| Six Months Ended | Year Ended | |||
June 30, 2007 | December 31, 2006 | |||
| $40 | $ | 30 | ||
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Purchases of Products and Implementation Services
From time to time Philips purchases certain products and implementation services from us. We have recorded net revenues from Philips in the following amounts pursuant to this arrangement (dollars in thousands):
| Six Months Ended | Year Ended | |||
June 30, 2007 | December 31, 2006 | |||
| $0 | $ | 26 | ||
Our Policies Regarding Related Party Transactions
Transactions with Philips
Pursuant to the Governance Agreement, our board of directors established the Supervisory Committee, which is responsible, among other things, for (i) the general oversight, administration, amendment and enforcement, on behalf of us, of the Governance Agreement and the Licensing Agreement, and (ii) the entry into, general oversight, administration, amendment and enforcement, on behalf of us, of any other agreements or arrangements between us or any of our subsidiaries, on the one hand, and Philips and any of its subsidiaries (as defined in the Governance Agreement) on the other hand, which would be required pursuant toRegulation S-K promulgated by the SEC to be disclosed in a registration statement filed under the Securities Act or in a proxy statement or other report filed under the Exchange Act. All transactions with Philips referenced above have been approved by the Supervisory Committee.
Transactions with Other Related Parties
In August 2007 our board of directors adopted a written policy which charges the Audit Committee with the responsibility of approving or ratifying all related party transactions other than those between us and Philips. According to the policy, a “related party transaction” is a transaction between us and any related party other than (i) transactions available to all of our employees generally, (ii) transactions involving less than $5,000 when aggregated with all similar transactions and (iii) transactions with Philips that are subject to the approval of the Supervisory Committee as described above. A “related party,” according to the policy, is any one of the following:
| • | Any of our executive officers or directors; | |
| • | Any shareholder owning more than 5% of our stock; | |
| • | Any person who is an immediate family member of our executive officers or directors; or | |
| • | Any entity in which any of the above has a substantial ownership interest or control. |
To date the Audit Committee has not approved any related party transactions pursuant to the policy.
| Item 14. | Principal Accountant Fees and Services |
The Audit Committee of our board of directors is responsible for the appointment, compensation, oversight and replacement, if necessary, of our independent registered public accounting firm. In accordance with the charter of the Audit Committee, the Audit Committee must approve, in advance of the service, all audit, internal control-related and permissible non-audit services provided by our independent registered public accounting firm, subject to a de minimis exception for non-audit services. In its review of non-audit service fees, the Audit Committee considers, among other things, the possible effect of the performance of such services on the independence of our independent registered public accounting firm. Our independent registered public accounting firm may not be retained to perform any of the non-audit services specified in Section 10A(g) of the Exchange Act.
All services provided by KPMG LLP, our independent registered accounting firm, for the years ended December 31, 2006 and 2005 were preapproved by the Audit Committee.
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Fees Paid to the Principal Accountant — 2006 and 2005
The following table sets forth the aggregate fees billed to us for the years ended December 31, 2006 and 2005 by KPMG LLP (dollars in thousands):
Fees | 2006 | 2005 | ||||||
| Audit Fees(1) | $ | 5,977 | $ | 1,014 | ||||
| Audit-Related Fees | — | — | ||||||
| Tax Fees(2) | 254 | 240 | ||||||
| All Other Fees | 198 | — | ||||||
| Total Fees | $ | 6,429 | $ | 1,254 | ||||
| (1) | Audit Fees — represents aggregate fees paid or accrued for the audit of management’s assessment of, and the effective operation of, our internal control over financial reporting as required by Section 404, the audit of our annual financial statements and review of our interim financial statements, and fees for services that are normally provided by our independent registered public accounting firm in connection with statutory and regulatory filings. | |
| (2) | Tax Fees — represents fees for all professional services rendered by our independent registered public accounting firm’s tax professionals, except those related to the audit of our financial statements, including tax compliance, tax advice and tax planning. | |
| (3) | All Other Fees — represents fees for professional services rendered in connection with a potential acquisition. |
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PART IV
| Item 15. | Exhibits and Financial Statement Schedules |
| (a) | Documents filed as part of this report: |
(1) Financial Statements.The consolidated financial statements filed as part of this report are listed on the Index to Consolidated Financial Statements onpage F-1.
(2) Financial Statement Schedules.All financial statement schedules have been omitted here because they are not applicable, not required, or the information is shown in the consolidated financial statements or notes thereto.
(3) Exhibits.See (b) below.
| (b) | Exhibits: |
No. | Description | |
| 3.1(1) | Certificate of Incorporation of MedQuist Inc. (as amended) | |
| 3.2(1) | By-Laws of MedQuist Inc. (as amended) | |
| 4.1(1) | Specimen Stock Certificate | |
| 10.1*(1) | The MRC Group, Inc. Amended and Restated 1992 Stock Option Plan | |
| 10.2*(1) | 1992 Stock Option Plan of MedQuist Inc., as amended | |
| 10.3*(1) | Nonstatutory Stock Option Plan for Non-Employee Directors of MedQuist Inc. | |
| 10.4*(1) | MedQuist Inc. 2002 Stock Option Plan | |
| 10.5*(1) | Form of Award Agreement under the MedQuist Inc. 2002 Stock Option Plan | |
| 10.6*(1) | 1996 Employee Stock Purchase Plan | |
| 10.7*(1) | MedQuist Inc. Executive Deferred Compensation Plan | |
| 10.8*(1) | Separation Agreement, dated as of December 10, 2004, between MedQuist Inc. and John W. Quaintance | |
| 10.9*(1) | Separation Agreement, dated as of December 20, 2004, between MedQuist Inc. and Ethan Cohen | |
| 10.10*(1) | Separation Agreement, dated as of October 24, 2005, between MedQuist Inc. and Terry Cameron | |
| 10.11*(1) | Separation Agreement, dated as of October 27, 2005, between MedQuist Inc. and James Weiland | |
| 10.12*(1) | Employment Agreement, dated as of February 9, 2005, between MedQuist Inc. and Adele Barbato | |
| 10.13*(1) | Separation Agreement and General Release dated June 28, 2007 by and between MedQuist Inc. and Frank Lavelle | |
| 10.14*(1) | Separation Agreement and General Release dated June 28, 2007 by and between MedQuist Inc. and Linda Reino | |
| 10.15*(1) | Relocation Letter Agreement, dated as of April 26, 2006, between MedQuist Inc. and Adele T. Barbato | |
| 10.16*(1) | Employment Agreement, dated as of February 24, 2005, between MedQuist Inc. and Frank Lavelle | |
| 10.16.1*(1) | Amendment to Employment Agreement, dated as of February 16, 2007, between MedQuist Inc. and Frank Lavelle | |
| 10.17*(1) | Letter Agreement, dated as of April 21, 2005, between MedQuist Inc. and Michael Clark | |
| 10.18*(1) | Letter Agreement, dated as of April 21, 2005, between MedQuist Inc. and Mark Sullivan | |
| 10.19*(1) | Employment Agreement, dated as of May 27, 2005, between MedQuist Inc. and Mark Ivie | |
| 10.20*(1) | Employment Agreement, dated as of June 2, 2005, between MedQuist Inc. and Kathleen Donovan | |
| 10.21*(1) | Employment Agreement, dated as of October 26, 2005, between MedQuist Inc. and R. Scott Bennett | |
| 10.22*(1) | Employment Agreement, dated as of August 10, 2006, between MedQuist Inc. and Linda Reino | |
| 10.23*(1) | Letter Agreement, dated as of November 10, 2006, by and between MedQuist Inc. and James Brennan |
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Table of Contents
No. | Description | |
| 10.24*(1) | Engagement Letter, dated as of July 30, 2004, between MedQuist Inc. and Nightingale & Associates, LLC | |
| 10.24.1*(1) | Amendment to Engagement Letter, dated as of January 7, 2005, between MedQuist Inc. and Nightingale & Associates, LLC | |
| 10.24.2*(1) | Amendment to Engagement Letter, dated as of September 25, 2006 between MedQuist Inc. and Nightingale & Associates, LLC | |
| 10.24.3*(1) | Amendment to Engagement Letter, dated as of January 8, 2007, between MedQuist Inc. and Nightingale & Associates, LLC | |
| 10.25(1) | Governance Agreement, dated as of May 22, 2000, between MedQuist Inc. and Koninklijke Philips Electronics N.V. | |
| 10.26(1) | Licensing Agreement, dated as of May 22, 2000, between MedQuist Inc. and Philips Speech Processing GmbH | |
| 10.26.1(1) | Amendment No. 1 to Licensing Agreement, dated as of January 1, 2002, between MedQuist Inc. and Philips Speech Processing GmbH | |
| 10.26.2#(1) | Amendment No. 2 to Licensing Agreement, dated as of December 10, 2002, between MedQuist Inc. and Philips Speech Processing GmbH | |
| 10.26.3#(1) | Amendment No. 3 to Licensing Agreement, dated as of August 10, 2003, between MedQuist Inc. and Philips Speech Processing GmbH | |
| 10.26.4#(1) | Amendment No. 4 to Licensing Agreement, dated as of September 1, 2004, between MedQuist Inc. and Philips Speech Processing GmbH | |
| 10.26.5#(1) | Amendment No. 5 to Licensing Agreement, dated as of December 30, 2005, between MedQuist Transcriptions, Ltd. and Philips Speech Recognition Systems GmbH f/k/a Philips Speech Processing GmbH | |
| 10.26.6#(1) | Amendment No. 6 to Licensing Agreement, dated as of February 13, 2007, between MedQuist Inc. and Philips Speech Recognition Systems GmbH f/k/a Philips Speech Processing GmbH | |
| 10.27#(1) | OEM Supply Agreement, dated as of September 23, 2004, between MedQuist Inc. and Philips Speech Processing GmbH | |
| 10.28*(1) | Indemnification Agreement, dated as of July 15, 2005, between MedQuist Inc. and John Simmons | |
| 10.29(1) | Norcross, Georgia Office Lease Agreement dated as of September 6, 2002 | |
| 10.30(1) | Mt. Laurel, New Jersey Office Lease Agreement dated as of June 17, 2003 | |
| 10.31(1) | First Amendment to Mt. Laurel, New Jersey Office Lease Agreement dated as of August 26, 2003 | |
| 10.32(1) | Second Amendment to Mt. Laurel, New Jersey Office Lease Agreement dated as of November 30, 2003 | |
| 10.33(1) | Third Amendment to Mt. Laurel, New Jersey Office Lease Agreement dated as of November 30, 2003 | |
| 10.34(1) | Confirmation of Lease Term regarding Mt. Laurel, New Jersey Office Lease dated as of August 10, 2006 | |
| 10.35(1) | Marietta, Georgia Office Lease Agreement dated as of September 6, 2002 | |
| 10.36(1) | First Amendment to Marietta, Georgia Office Lease Agreement dated March 24, 2006 | |
| 10.37.1(1) | Memorandum of Understanding dated March 23, 2007 by and among (i) MedQuist, Inc., Brian J. Kearns, David A. Cohen, John A. Donohoe, Ethan Cohen, John W. Quaintance, and Ronald F. Scarpone, and (ii) Greater Pennsylvania Carpenters Pension Fund | |
| 10.37.2(2) | Stipulation of Settlement dated March 23, 2007 by and among (i) MedQuist, Inc., Brian J. Kearns, David A. Cohen, John A. Donohoe, Ethan Cohen, John W. Quaintance, and Ronald F. Scarpone, and (ii) Greater Pennsylvania Carpenters Pension Fund | |
| 10.38*(1) | MedQuist Inc. Board of Directors Deferred Compensation Plan | |
| 10.39*(1) | Indemnification Agreement, dated as of July 3, 2007 between MedQuist Inc. and John H. Underwood | |
| 10.40*(1) | Indemnification Agreement, dated as of July 3, 2007 between MedQuist Inc. and Richard H. Stowe |
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Table of Contents
No. | Description | |
| 10.41*(3) | Form of Management Indemnification Agreement by and between MedQuist Inc. and Certain Officers | |
| 21(1) | Subsidiaries of MedQuist Inc. | |
| 23 | Consent of KPMG LLP | |
| 24 | Power of Attorney (included on the signature page hereto) | |
| 31.1 | Certification of Chief Executive Officer required byRule 13a-14(a) orRule 15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | |
| 31.2 | Certification of Chief Financial Officer required byRule 13a-14(a) orRule 15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | |
| 32.1 | Certification of Chief Executive Officer pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 | |
| 32.2 | Certification of Chief Financial Officer pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |
| * | Management contract or compensatory plan or arrangement. | |
| # | Portions of this Exhibit were omitted and filed separately with the Secretary of the SEC pursuant to a request for confidential treatment that has been filed with the SEC. | |
| (1) | Incorporated by reference to our Annual Report onForm 10-K for the year ended December 31, 2005 filed on July 5, 2007. | |
| (2) | Incorporated by reference to our Current Report onForm 8-K/A filed on August 24, 2007. | |
| (3) | Incorporated by reference to our Current Report onForm 8-K filed on August 28, 2007. |
| (c) | Financial Statement Schedules. |
None.
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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Exchange Act, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Medquist Inc.
| By: | /s/ Howard S. Hoffmann |
Howard S. Hoffmann
President and Chief Executive Officer
President and Chief Executive Officer
Date: August 31, 2007
Pursuant to the requirements of the Exchange Act, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Each person, in so signing also makes, constitutes, and appoints Howard S. Hoffmann and Kathleen E. Donovan, and each of them acting alone, as his or her true and lawful attorneys-in-fact, with full power of substitution, in his or her name, place, and stead, to execute and cause to be filed with the SEC any or all amendments to this report.
Signature | Capacity | Date | ||||
/s/ Howard S. Hoffmann Howard S. Hoffmann | President and Chief Executive Officer (Principal Executive Officer) | August 31, 2007 | ||||
/s/ Kathleen E. Donovan Kathleen E. Donovan | Senior Vice President and Chief Financial Officer (Principal Financial Officer) | August 31, 2007 | ||||
/s/ James Brennan James Brennan | Principal Accounting Officer, Controller and Vice President | August 31, 2007 | ||||
/s/ Stephen H. Rusckowski Stephen H. Rusckowski | Non-Executive Chairman of the Board of Directors | August 31, 2007 | ||||
/s/ Clement Revetti, Jr. Clement Revetti, Jr. | Director | August 31, 2007 | ||||
/s/ Gregory M. Sebasky Gregory M. Sebasky | Director | August 31, 2007 | ||||
/s/ N. John Simmons, Jr. N. John Simmons, Jr. | Director | August 31, 2007 | ||||
/s/ Richard H. Stowe Richard H. Stowe | Director | August 31, 2007 | ||||
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Signature | Capacity | Date | ||||
/s/ John H. Underwood John H. Underwood | Director | August 31, 2007 | ||||
/s/ Scott M. Weisenhoff Scott M. Weisenhoff | Director | August 31, 2007 | ||||
84
Index to Consolidated Financial Statements
| F-2 | ||||||||
| F-4 | ||||||||
| F-5 | ||||||||
| F-6 | ||||||||
| F-7 | ||||||||
| F-8 | ||||||||
| F-9 | ||||||||
| Financial Statement Schedule — Valuation and Qualifying Accounts — December 31, 2006, 2005 and 2004 | F-37 | |||||||
| Consent of KPMG LLP | ||||||||
| Certification of Chief Executive Officer | ||||||||
| Certification of Chief Financial Officer | ||||||||
| Certification of Chief Executive Officer, pursuant to Section 906 | ||||||||
| Certification of Chief Financial Officer, pursuant to Section 906 | ||||||||
F-1
Table of Contents
Report of Independent Registered Public Accounting Firm
The Board of Directors and Shareholders
MedQuist Inc.:
We have audited management’s assessment, included in the accompanying Management’s Report on Internal Control Over Financial Reporting as of December 31, 2006 (Item 9A(b)), that MedQuist Inc. (the Company) did not maintain effective internal control over financial reporting as of December 31, 2006, because of the effect of material weaknesses identified in management’s assessment, based on criteria established inInternal Control — Integrated Frameworkissued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). MedQuist Inc.’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the Company’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
A material weakness is a control deficiency, or combination of control deficiencies, that results in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected. The following material weaknesses have been identified and included in management’s assessment as of December 31, 2006:
Entity Level Controls
| • | The Company did not have adequate procedures to ensure the timely communication of information that involves complex, non-recurring accounting and other matters that impact its financial reporting process. Specifically, the communication of information between senior management and accounting personnel was not adequate to ensure the timely and accurate accounting and reporting of such information in the Company’s consolidated financial statements. | |
| • | The Company did not maintain a sufficient complement of accounting and finance personnel that were adequately trained and that possessed the appropriate level of knowledge in generally accepted accounting principles (GAAP) to properly account for complex accounting transactions. |
F-2
Table of Contents
| • | The Company did not have sufficient processes, controls and management oversight to ensure that its books and records were appropriately maintained and that complex accounting transactions were effectively researched and recorded in accordance with GAAP. There was a lack of appropriate processes and controls within the financial close process, insufficient review of complex accounting transactions as well as inadequate training and expertise within the accounting and finance organization. |
These material weaknesses resulted in more than a remote likelihood that a material misstatement of the Company’s annual or interim consolidated financial statements would not be prevented or detected. These material weaknesses also contributed to the other material weakness identified below.
Revenue Recognition
| • | The Company did not have adequate policies and procedures to ensure the proper recognition of post-contract customer support and related hardware, software and implementation services in accordance with GAAP. In addition, individuals responsible for recording such revenues in the Company’s consolidated financial statements did not fully comprehend the criteria for revenue recognition. This material weakness resulted in errors in calculating the proper amount of revenues to defer in the Company’s 2006 consolidated financial statements. |
This material weakness resulted in more than a remote likelihood that a material misstatement of the Company’s annual or interim consolidated financial statements would not be prevented or detected.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of MedQuist Inc. and subsidiaries as of December 31, 2006, 2005 and 2004 and the related consolidated statements of operations, shareholders’ equity and other comprehensive income and cash flows for each of the years in the three-year period ended December 31, 2006. These material weaknesses were considered in determining the nature, timing, and extent of audit tests applied in our audit of the 2006 consolidated financial statements, and this report does not affect our report dated August 31, 2007, which expressed an unqualified opinion on those consolidated financial statements.
In our opinion, management’s assessment that MedQuist Inc. did not maintain effective internal control over financial reporting as of December 31, 2006, is fairly stated, in all material respects, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Also, in our opinion, because of the effect of the material weaknesses described above on the achievement of the objectives of the control criteria, MedQuist Inc. has not maintained effective internal control over financial reporting as of December 31, 2006, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
/s/ KPMG LLP
Philadelphia, Pennsylvania
August 31, 2007
F-3
Table of Contents
The Board of Directors and Shareholders of MedQuist Inc.:
We have audited the accompanying consolidated balance sheets of MedQuist Inc. and subsidiaries as of December 31, 2006 and 2005, and the related consolidated statements of operations, shareholders’ equity and other comprehensive income, and cash flows for each of the years in the three-year period ended December 31, 2006. In connection with our audits of the consolidated financial statements, we also have audited financial statement Schedule II. These consolidated financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedule based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of MedQuist Inc. and subsidiaries as of December 31, 2006 and 2005, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2006, in conformity with U.S. generally accepted accounting principles. Also in our opinion, the related financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.
As discussed in Notes 3 and 14 to the consolidated financial statements, effective January 1, 2006, MedQuist Inc. and subsidiaries adopted the fair value method of accounting for stock-based compensation as required by Statement of Financial Accounting Standards No. 123(R),Share-Based Payment.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of MedQuist Inc. and subsidiaries’ internal control over financial reporting as of December 31, 2006, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated August 31, 2007 expressed an unqualified opinion on management’s assessment of, and an adverse opinion on the effective operation of, internal control over financial reporting.
/s/ KPMG LLP
Philadelphia, Pennsylvania
August 31, 2007
F-4
Table of Contents
(In thousands, except per share amounts)
| Years Ended December 31, | ||||||||||||
| 2006 | 2005 | 2004 | ||||||||||
| Net revenues | $ | 358,091 | $ | 353,005 | $ | 451,894 | ||||||
| Operating costs and expenses: | ||||||||||||
| Cost of revenues | 280,273 | 315,399 | 336,232 | |||||||||
| Selling, general and administrative | 53,675 | 54,558 | 46,436 | |||||||||
| Research and development | 13,219 | 9,784 | 10,539 | |||||||||
| Depreciation | 11,802 | 17,099 | 18,521 | |||||||||
| Amortization of intangible assets | 5,829 | 8,193 | 8,888 | |||||||||
| Cost of investigation and legal proceedings | 13,001 | 34,127 | 10,253 | |||||||||
| Shareholder securities litigation settlement | — | 7,750 | — | |||||||||
| Impairment charges | — | 148 | 15,078 | |||||||||
| Restructuring charges | 3,442 | 3,257 | — | |||||||||
| Total operating costs and expenses | 381,241 | 450,315 | 445,947 | |||||||||
| Operating (loss) income | (23,150 | ) | (97,310 | ) | 5,947 | |||||||
| Equity in income of affiliated company | 874 | 500 | 188 | |||||||||
| Interest income, net | 7,628 | 5,940 | 1,840 | |||||||||
| (Loss) income before income taxes | (14,648 | ) | (90,870 | ) | 7,975 | |||||||
| Income tax provision | 2,294 | 20,762 | 4,233 | |||||||||
| Net (loss) income | $ | (16,942 | ) | $ | (111,632 | ) | $ | 3,742 | ||||
| Net (loss) income per share: | ||||||||||||
| Basic | $ | (0.45 | ) | $ | (2.98 | ) | $ | 0.10 | ||||
| Diluted | $ | (0.45 | ) | $ | (2.98 | ) | $ | 0.10 | ||||
| Weighted average shares outstanding: | ||||||||||||
| Basic | 37,484 | 37,484 | 37,451 | |||||||||
| Diluted | 37,484 | 37,484 | 37,636 | |||||||||
The accompanying notes are an integral part of these consolidated financial statements.
F-5
Table of Contents
(In thousands)
| As of December 31, | ||||||||
| 2006 | 2005 | |||||||
Assets | ||||||||
| Current assets: | ||||||||
| Cash and cash equivalents | $ | 175,412 | $ | 178,271 | ||||
| Accounts receivable, net | 54,778 | 71,761 | ||||||
| Income tax receivable | 1,772 | 21,708 | ||||||
| Deferred income taxes | 298 | 2,385 | ||||||
| Other current assets | 8,352 | 9,973 | ||||||
| Total current assets | 240,612 | 284,098 | ||||||
| Property and equipment, net | 20,969 | 23,961 | ||||||
| Goodwill | 124,826 | 123,849 | ||||||
| Other intangible assets, net | 45,448 | 51,278 | ||||||
| Deferred income taxes | 2,378 | 2,756 | ||||||
| Other assets | 6,906 | 7,249 | ||||||
| Total assets | $ | 441,139 | $ | 493,191 | ||||
Liabilities and Shareholders’ Equity | ||||||||
| Current liabilities: | ||||||||
| Accounts payable | $ | 10,779 | $ | 10,046 | ||||
| Accrued expenses | 28,812 | 37,401 | ||||||
| Accrued compensation | 15,558 | 21,073 | ||||||
| Customer accommodation and quantification | 24,777 | 46,878 | ||||||
| Deferred revenue | 15,202 | 18,039 | ||||||
| Total current liabilities | 95,128 | 133,437 | ||||||
| Deferred income tax liability | 18,034 | 15,482 | ||||||
| Other non-current liabilities | 458 | 3,052 | ||||||
| Commitments and contingencies (Note 13) | ||||||||
| Shareholders’ equity: | ||||||||
| Common stock — no par value; authorized 60,000 shares; 37,484 and 37,484 shares issued and outstanding, respectively | 235,080 | 232,963 | ||||||
| Retained earnings | 87,693 | 104,635 | ||||||
| Deferred compensation | 332 | 332 | ||||||
| Accumulated other comprehensive income | 4,414 | 3,290 | ||||||
| Total shareholders’ equity | 327,519 | 341,220 | ||||||
| Total liabilities and shareholders’ equity | $ | 441,139 | $ | 493,191 | ||||
The accompanying notes are an integral part of these consolidated financial statements.
F-6
Table of Contents
(In thousands)
| Years Ended December 31, | ||||||||||||
| 2006 | 2005 | 2004 | ||||||||||
Operating activities: | ||||||||||||
| Net (loss) income | $ | (16,942 | ) | $ | (111,632 | ) | $ | 3,742 | ||||
| Adjustments to reconcile net (loss) income to cash provided by (used in) operating activities: | ||||||||||||
| Depreciation and amortization | 17,631 | 25,292 | 27,409 | |||||||||
| Equity in (income) loss of affiliated company | (874 | ) | (500 | ) | (188 | ) | ||||||
| Write-off and impairment of intangible assets | — | 148 | 15,078 | |||||||||
| Deferred income tax provision (benefit) | 5,225 | 36,655 | (2,203 | ) | ||||||||
| Stock option expense | 2,117 | 37 | 209 | |||||||||
| Stock based compensation — Board Members | — | — | 54 | |||||||||
| Tax benefit from exercise of employee stock options | — | — | 319 | |||||||||
| Provision for doubtful accounts | 4,955 | 8,111 | 5,992 | |||||||||
| Asset writeoff charges | 767 | 4,096 | 99 | |||||||||
| Changes in operating assets and liabilities excluding effects of acquisitions: | ||||||||||||
| Accounts receivable | 11,066 | (2,749 | ) | (4,253 | ) | |||||||
| Income tax receivable | 19,889 | (15,981 | ) | (1,824 | ) | |||||||
| Other current assets | 1,666 | 1,132 | (3,041 | ) | ||||||||
| Other non-current assets | 1,216 | 600 | 277 | |||||||||
| Accounts payable | 92 | (2,583 | ) | (2,005 | ) | |||||||
| Accrued expenses | (9,366 | ) | 16,799 | 5,327 | ||||||||
| Accrued compensation | (5,537 | ) | 527 | 30 | ||||||||
| Customer accommodation and quantification | (21,121 | ) | 37,176 | 931 | ||||||||
| Deferred revenue | (3,343 | ) | (3,737 | ) | 1,140 | |||||||
| Other non-current liabilities | (2,090 | ) | (1,142 | ) | 409 | |||||||
| Net cash provided by (used in) operating activities | 5,351 | (7,751 | ) | 47,502 | ||||||||
Investing activities: | ||||||||||||
| Purchase of property and equipment | (8,191 | ) | (9,535 | ) | (14,754 | ) | ||||||
| Capitalized software | (58 | ) | (638 | ) | (22 | ) | ||||||
| Net cash used in investing activities | (8,249 | ) | (10,173 | ) | (14,776 | ) | ||||||
Financing activities: | ||||||||||||
| Repayment of debt | — | (25 | ) | (29 | ) | |||||||
| Proceeds from issuance of stock | — | — | 216 | |||||||||
| Proceeds from exercise of stock options | — | — | 814 | |||||||||
| Net cash (used in) provided by financing activities | — | (25 | ) | 1,001 | ||||||||
| Effect of exchange rate changes | 39 | 1 | 72 | |||||||||
| Net (decrease) increase in cash and cash equivalents | (2,859 | ) | (17,948 | ) | 33,799 | |||||||
| Cash and cash equivalents — beginning of year | 178,271 | 196,219 | 162,420 | |||||||||
| Cash and cash equivalents — end of year | $ | 175,412 | $ | 178,271 | $ | 196,219 | ||||||
Supplemental cash flow information: | ||||||||||||
| Cash paid for interest | $ | — | $ | — | $ | 3 | ||||||
| Cash (recovered) paid for income taxes | $ | (22,381 | ) | $ | 162 | $ | 9,609 | |||||
| Accommodation payments paid with credits | $ | 980 | $ | — | $ | — | ||||||
The accompanying notes are an integral part of these consolidated financial statements.
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Table of Contents
MedQuist Inc. and Subsidiaries
Years Ended December 31, 2006, 2005 and 2004
| Accumulated | ||||||||||||||||||||||||
| Other | Total | |||||||||||||||||||||||
| Common Stock | Retained | Deferred | Comprehensive | Shareholders’ | ||||||||||||||||||||
| Shares | Amount | Earnings | Compensation | Income | Equity | |||||||||||||||||||
| (In thousands) | ||||||||||||||||||||||||
Balance, January 1, 2004 | 37,259 | $ | 231,368 | $ | 212,525 | $ | 278 | $ | 3,321 | $ | 447,492 | |||||||||||||
| Comprehensive income: | ||||||||||||||||||||||||
| Net income | — | — | 3,742 | — | — | 3,742 | ||||||||||||||||||
| Foreign currency translation adjustments | — | — | — | — | 1,104 | 1,104 | ||||||||||||||||||
| Total comprehensive income | 4,846 | |||||||||||||||||||||||
| Exercise of stock options, including tax benefit of $319 | 210 | 1,133 | — | — | — | 1,133 | ||||||||||||||||||
| Employee stock compensation | — | 209 | — | — | — | 209 | ||||||||||||||||||
| Deferred compensation — stock grants | — | — | — | 54 | — | 54 | ||||||||||||||||||
| Issuance of common stock | 15 | 216 | — | — | — | 216 | ||||||||||||||||||
Balance, December 31, 2004 | 37,484 | 232,926 | 216,267 | 332 | 4,425 | 453,950 | ||||||||||||||||||
| Comprehensive income: | ||||||||||||||||||||||||
| Net loss | — | — | (111,632 | ) | — | — | (111,632 | ) | ||||||||||||||||
| Foreign currency translation adjustments | — | — | — | — | (1,135 | ) | (1,135 | ) | ||||||||||||||||
| Total comprehensive loss | (112,767 | ) | ||||||||||||||||||||||
| Employee stock compensation | 37 | — | — | — | 37 | |||||||||||||||||||
Balance, December 31, 2005 | 37,484 | 232,963 | 104,635 | 332 | 3,290 | 341,220 | ||||||||||||||||||
| — | — | — | — | — | ||||||||||||||||||||
| Comprehensive loss: | ||||||||||||||||||||||||
| Net loss | — | — | (16,942 | ) | — | — | (16,942 | ) | ||||||||||||||||
| Foreign currency translation adjustments | — | — | — | — | 1,124 | 1,124 | ||||||||||||||||||
| Total comprehensive loss | (15,818 | ) | ||||||||||||||||||||||
| Stock-based compensation expense | — | 2,117 | — | — | — | 2,117 | ||||||||||||||||||
Balance, December 31, 2006 | 37,484 | $ | 235,080 | $ | 87,693 | $ | 332 | $ | 4,414 | $ | 327,519 | |||||||||||||
The accompanying notes are an integral part of these consolidated financial statements.
F-8
Table of Contents
MedQuist Inc. and Subsidiaries
(In thousands, except per share amounts)
| 1. | Description of Business |
We are a provider of medical transcription technology and services which are integral to the clinical documentation workflow. We service health systems, hospitals and large group medical practices throughout the U.S. In the clinical documentation workflow, we provide, in addition to medical transcription technology and services, digital dictation, speech recognition, electronic signature and medical coding technology and services. We are a member of the Philips Group of Companies and collaborate with Philips Medical Systems in marketing and product development.
| 2. | Introductory Note |
In November 2003, one of our employees raised allegations that we had engaged in improper billing practices. In response, our board of directors undertook an independent review of these allegations and engaged the law firm of Debevoise and Plimpton LLP, who in turn retained PricewaterhouseCoopers LLP, to assist in the review (Review). On March 16, 2004, we announced that we had delayed the filing of our 2003 annual report onForm 10-K pending completion of the Review. Subsequently, on March 25, 2004, we filed aForm 8-K detailing our determination that the Review would not be completed by the March 30, 2004 filing deadline for our 2003Form 10-K. As a result of our noncompliance with the U.S. Securities and Exchange Commission’s (SEC) periodic disclosure requirements, our common stock was delisted from the NASDAQ National Market on June 16, 2004.
On July 30, 2004, we issued a press release entitled “MedQuist Announces Key Findings Of Independent Review Of Client Billing,” which announced certain findings in the Review regarding our billing practices (July 2004 Press Release). The Review found, among other things, that with respect to our medical transcription services contracts that called for billing based on the “AAMT line” billing unit of measure, we used ratios and formulae to help calculate the number of AAMT transcription lines for which our customers (AAMT Customers) were billed rather than counting each of the relevant characters to determine a billable line as provided for in the contracts. With respect to these contracts, our use of ratios and formulae to arrive at AAMT line counts was generally not disclosed to our AAMT Customers.
The AAMT line unit of measure was developed in 1993 by three medical transcription industry groups, including the American Association for Medical Transcription (AAMT), in an attempt to standardize industry billing practices for medical transcription services. Following the development of the AAMT line unit of measure, customers increasingly began to request AAMT line billing. Accordingly, we, along with other vendors in the medical transcription industry, began to incorporate the AAMT line unit of measure into certain customer contracts. The AAMT line definition provides that a “line” consists of 65 characters and defined the term “character” to include such things as macros and function keys as well as other information necessary for the final appearance and content of a document. However, these definitions turned out to be inherently ambiguous and difficult to apply in practice. As a result, the AAMT line was applied inconsistently throughout the medical transcription industry. In fact, no single set of AAMT characters was ever defined or agreed upon for this unit of measure, and it was eventually renounced by the groups responsible for its development.
The Review concluded that our rationale for using ratios and formulae to determine the number of AAMT transcription lines for billing was premised on a good faith attempt to adopt a consistent and commercially reasonable billing method given the lack of common standards in the industry and ambiguities inherent in the AAMT line definition. The Review concluded that the use of ratios and formulae within the medical transcription platform setups may have resulted in over billing and under billing of some customers. In addition, in some instances, customers’ ratios and formulae were adjusted without disclosure to the AAMT Customers. However, the Review found no evidence that the amounts we billed AAMT Customers were, in general, commercially unfair or inconsistent with what competitors would have charged. Moreover, it was noted in the Review that we have been able to attract and retain customers in a competitive market.
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Table of Contents
MedQuist Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(In thousands, except per share amounts)
Following the issuance of the July 2004 Press Release, we began an extensive review of our historical AAMT line billing (Management’s Billing Assessment) and in August 2004 informed our current and former customers that we would be contacting them to discuss how they might have been impacted. In response, several former and current customers, including some of our largest customers, contacted us requesting, among other things, (i) an explanation of the billing methods employed by us for the customer’s account; (ii) an individualized review of the customer’s past billings,and/or (iii) a meeting with a member of our management team to discuss the July 2004 Press Release as it pertained to the customer’s particular account. Some customers demanded an immediate refund or credit to their account; others threatened to withhold payment on invoicesand/or take their business elsewhere unless we timely responded to their informationand/or audit requests.
In response to our customers’ concern over the July 2004 Press Release, we made the decision to take action to try to avoid litigation and preserve and solidify our customer business relationships by offering a financial accommodation to our AAMT Customers. See Note 4.
Disclosure of the findings of the Review, along with the delisting of our common stock, precipitated a number of governmental investigations and civil lawsuits. See Note 13.
| 3. | Significant Accounting Policies |
Principles of Consolidation
Our consolidated financial statements include the accounts of MedQuist Inc. and its subsidiary companies. All intercompany balances and transactions have been eliminated in consolidation.
Use of Estimates and Assumptions in the Preparation of Consolidated Financial Statements
The preparation of our consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect amounts reported in our consolidated financial statements. Significant items subject to such estimates and assumptions include the carrying amount of property and equipment, valuation of long-lived and intangible assets and goodwill, valuation allowances for receivables, inventories and deferred income taxes, revenue recognition, stock-based compensation and commitments and contingencies. Actual results could differ from those estimates.
Revenue Recognition
We follow revenue recognition criteria outlined in Staff Accounting Bulletin (SAB) 101,Revenue Recognition in Financial Statements,as amended by SAB 104. The majority of our revenues are derived from providing medical transcription services. Revenues for medical transcription services and medical records coding are recognized when the services are rendered. These services are based on contracted rates. The remainder of our revenues are derived from the sale of voice-capture and document management products including software, hardware and implementation, training and maintenance service related to these products.
We recognize software and software-related revenues pursuant to the requirements of American Institute of Certified Public Accountants (AICPA) Statement of Position (SOP)97-2Software Revenue Recognition(SOP 97-2), as amended bySOP 98-9,Software Revenue Recognition, With Respect to Certain Transactions,SOP 81-1,Accounting for Performance of Construction-type and Certain Production-type Contracts, Emerging Issues Task Force (EITF)00-03Application of AICPA Statement of Position97-2 to Arrangements That Include the Right to Use Software Stored on Another Entity’s Hardware,EITF 03-05Applicability of AICPA Statement of Position97-2 to Non-Software Deliverables in an Arrangement Containing More-Than-Incidental Softwareand other authoritative accounting guidance.
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Table of Contents
MedQuist Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(In thousands, except per share amounts)
We recognize software-related revenues using the residual method when vendor-specific objective evidence (VSOE) of fair value exists for all of the undelivered elements in the arrangement, but does not exist for one or more delivered elements. We allocate revenues to each undelivered element based on its respective fair value determined by the price charged when that element is sold separately or, for elements not yet sold separately, the price established by management if it is probable that the price will not change before the element is sold separately. We defer revenues for the undelivered elements and recognize the residual amount of the arrangement fee, if any, when the basic criteria inSOP 97-2 have been met.
UnderSOP 97-2, provided that the arrangement does not involve significant production, modification, or customization of the software, revenues are recognized when all of the following four criteria have been met; persuasive evidence of an arrangement exists, delivery has occurred, the fee is fixed or determinable and collectibility is probable.
If at the outset of an arrangement, we determine that the arrangement fee is not fixed or determinable, revenues are deferred until the arrangement fee becomes due and payable by the customer. If at the outset of an arrangement we determine that collectibility is not probable, revenues are deferred until payment is received. Our license agreements typically do not provide for a right of return other than during the standard warranty period. If an arrangement allows for customer acceptance of the software or services, we defer revenues until the earlier of customer acceptance or when the acceptance rights lapse.
We separately market and sell hardware and software post contract customer support (PCS). PCS covers phone support, hardware parts and labor, software bug fixes and limited upgrades, if and when available. We do not commit to specific future software upgrades or releases. The contract period for PCS is generally one year. We recognize both hardware and software PCS on a straight line basis over the life of the underlying PCS contract. In some of our PCS contracts, we bill the customer prior to performing the services. As of December 31, 2006 and 2005, deferred PCS revenues of $12,235 and $13,895, respectively, are included in deferred revenues and $450 and $956, respectively, are included in non-current liabilities in the accompanying consolidated balance sheets.
Certain arrangements include multiple elements involving software, hardware and implementation, training, or other services that are not essential to the functionality of the software. VSOE for services does not exist. Since the undelivered elements are typically services, we recognize the entire arrangement fee ratably over the period during which the services are expected to be performed or the PCS period, whichever is longer, beginning with delivery of the software, provided that all other revenue recognition criteria inSOP 97-2 are met. The services are typically completed before the PCS term expires. As such, upon completion of the services, the difference between the VSOE of fair value for the remaining PCS period and the remaining unrecognized portion of the arrangement fee is recognized as revenue (i.e. the residual method), and the remaining deferred revenue is recognized ratably over the remaining PCS period, provided that all other revenue recognition criteria inSOP 97-2 are met.
Accounting for Consideration Given to a Customer
As a result of the Accommodation Analysis (which is described in Note 4), we offered financial accommodations to our customers. Pursuant to EITF Issue01-9,Accounting for Consideration Given by a Vendor to a Customer (Including a Reseller of the Vendor’s Products)(EITF 01-9), consideration given by a vendor to a customer is presumed to be a reduction of the selling price of the vendor’s services and, therefore, should be characterized as a reduction of revenues when recognized in the vendor’s income statement. For the years ended December 31, 2006 and 2005, $10,402 and $57,678 was recorded as a reduction of revenues. See Note 4.
Litigation and Settlement Costs
From time to time, we are involved in litigation, claims, contingencies and other legal matters. We record a charge equal to at least the minimum estimated liability for a loss contingency when both of the following
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Table of Contents
MedQuist Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(In thousands, except per share amounts)
conditions are met: (i) information available prior to issuance of the financial statements indicates that it is probable that an asset had been impaired or a liability had been incurred at the date of the financial statements and (ii) the range of the loss can be reasonably estimated. We expense legal costs, including those legal costs expected to be incurred in connection with a loss contingency, as incurred.
Services Provided by Independent Registered Public Accountant
Services provided by our independent registered public accounting firm are expensed as the services are provided and were $6,429, $1,254, and $1,171 for the years ended December 31, 2006, 2005 and 2004, respectively.
Restructuring Costs
A liability for restructuring costs associated with an exit or disposal activity is recognized and measured initially at fair value when the liability is incurred. We record a liability for severance costs when employees are notified that they are to be terminated and for future, non-cancellable operating lease costs when we vacate a facility.
Our estimates of future liabilities may change, requiring us to record additional restructuring charges or reduce the amount of liabilities recorded. At the end of each reporting period, we evaluate the remaining accrued restructuring charges to ensure their adequacy, that no excess accruals are retained and the utilization of the provisions are for their intended purposes in accordance with developed exit plans. We periodically evaluate currently available information and adjust our accrued restructuring charges as necessary. Changes in estimates are accounted for as restructuring costs or credits in the period identified.
Research and Development Costs
Research and development costs are expensed as incurred.
Income Taxes
Deferred tax assets and liabilities are recorded for temporary differences between the tax basis of assets and liabilities and their reported amounts in the consolidated financial statements, using statutory tax rates in effect for the year in which the differences are expected to reverse. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in our statements of operations in the period that includes the enactment date. A valuation allowance is recorded to reduce the carrying amounts of deferred tax assets unless it is more likely than not that such assets will be realized. Management considers various sources of future taxable income including projected book earnings, the reversal of deferred tax liabilities, and prudent and feasible tax planning strategies in determining the need for a valuation allowance.
Stock-Based Compensation
On January 1, 2006, we adopted the fair value recognition provisions of Financial Accounting Standards Board (FASB) Statement 123 (revised 2004),Share-Based Payment, (Statement 123(R)), using the modified prospective transition method which requires application of Statement 123(R) on the date of adoption and, therefore, we have not retroactively adjusted results from periods prior to 2006. Under the modified prospective transition method, compensation costs associated with share-based awards recognized in 2006 includes compensation costs for all share-based payments granted prior to, but not yet vested as of January 1, 2006, based on the grant-date fair value previously estimated in accordance with the provisions of FASB Statement 123,Accounting for Stock-Based Compensation(Statement 123). Had we granted options in 2006, the compensation costs for those options would have been based on the grant-date fair value estimated in accordance with the provisions of Statement 123(R). In
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Table of Contents
MedQuist Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(In thousands, except per share amounts)
March 2005, the SEC issued SAB 107 (SAB 107) which provided supplemental guidance related to Statement 123(R). We have applied the provisions of SAB 107 in our adoption of Statement 123(R).
Statement 123(R) requires companies to estimate the fair value of stock options on the date of grant using an option pricing model. The value of the portion of the award that is ultimately expected to vest is recognized as compensation expense over the requisite service periods.
Stock-based compensation expense related to employee stock options recognized under Statement 123(R) for 2006 was $2,117 which was charged to selling, general and administrative expenses ($562), research and development expenses ($240) and cost of revenues ($1,315). Included in the $2,117 is $194 of expense related to options that will be issued to certain executive officers when we become current in our periodic reporting obligations with the SEC (see Note 4). As of December 31, 2006, total unamortized stock-based compensation cost related to non-vested stock options, net of expected forfeitures, was $1,517 which is expected to be recognized over a weighted-average period of 3.8 years.
Prior to the adoption of Statement 123(R), we accounted for stock-based awards to employees and directors using the intrinsic value method in accordance with Accounting Principles Board (APB) Opinion 25,Accounting for Stock Issued to Employees(APB 25), as allowed under Statement 123. Under the intrinsic value method, no compensation expense for employee stock options was recognized in our consolidated statements of operations because the exercise price of the stock options granted to employees was greater than or equal to the fair market value of the underlying stock at the date of grant.
The following table illustrates the pro forma effect on net (loss) income and per share amounts for 2005 and 2004 as if we had applied the fair-value recognition provisions of Statement 123 to stock-based employee compensation.
| Years Ended December 31, | ||||||||
| 2005 | 2004 | |||||||
| Net (loss) income | $ | (111,632 | ) | $ | 3,742 | |||
| Add: Stock-based employee compensation expense included in reported net (loss) income | 37 | 209 | ||||||
| Deduct: Total stock-based employee compensation expense determined under fair-value based method for all awards | (3,487 | ) | (3,771 | ) | ||||
| Pro forma net (loss) income | $ | (115,082 | ) | $ | 180 | |||
| Basic net (loss) income per share: | ||||||||
| As reported | $ | (2.98 | ) | $ | 0.10 | |||
| Pro forma | $ | (3.07 | ) | $ | 0.00 | |||
| Diluted net (loss) income per share: | ||||||||
| As reported | $ | (2.98 | ) | $ | 0.10 | |||
| Pro forma | $ | (3.07 | ) | $ | 0.00 | |||
We did not grant any options for the years ended December 31, 2006, 2005 and 2004.
Net (Loss) Income per Share
Basic net (loss) income per share is computed by dividing net (loss) income by the weighted average number of shares outstanding during each period. Diluted net (loss) income per share is computed by dividing net (loss) income by the weighted average shares outstanding, as adjusted for the dilutive effect of common stock equivalents, which consist only of stock options, using the treasury stock method.
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Table of Contents
MedQuist Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(In thousands, except per share amounts)
The table below reflects the basic and diluted net (loss) income per share for the years ended December 31:
| 2006 | 2005 | 2004 | ||||||||||
| Net (loss) income | $ | (16,942 | ) | $ | (111,632 | ) | $ | 3,742 | ||||
| Weighted average shares outstanding: | ||||||||||||
| Basic | 37,484 | 37,484 | 37,451 | |||||||||
| Effect of dilutive stock | — | — | 185 | |||||||||
| Diluted | 37,484 | 37,484 | 37,636 | |||||||||
| Net (loss) income per share: | ||||||||||||
| Basic | $ | (0.45 | ) | $ | (2.98 | ) | $ | 0.10 | ||||
| Diluted | $ | (0.45 | ) | $ | (2.98 | ) | $ | 0.10 | ||||
The computation of diluted net (loss) income per share does not assume conversion, exercise or issuance of shares that would have an anti-dilutive effect on diluted net (loss) income per share. During 2006 and 2005, we had a net loss; as a result, any assumed conversions would result in reducing the net loss per share and, therefore, are not included in the calculation. Shares having an anti-dilutive effect on net (loss) income per share and, therefore, excluded from the calculation of diluted net (loss) income per share, totaled 2,150 shares, 3,432 shares and 3,619 shares for the years ended December 31, 2006, 2005 and 2004, respectively.
Advertising Costs
Advertising costs are expensed as incurred and for the years ended December 31, 2006, 2005 and 2004 were $1,903, $2,098 and $1,881, respectively.
Cash and Cash Equivalents
We consider all highly liquid instruments with original maturities of three months or less to be cash equivalents. Our cash management and investment policies dictate that cash equivalents be limited to investment grade, highly liquid securities. We place our temporary cash investments with high-credit rated, quality financial institutions. Deposits held with banks may exceed the amount of insurance provided on such deposits. Consequently, our cash equivalents are subject to potential credit risk. As of December 31, 2006 and 2005, cash equivalents consisted of securities and obligations of the United States Treasury and money market investments. The carrying value of cash and cash equivalents approximates fair value.
Accounts Receivable and Allowance for Doubtful Accounts
Accounts receivable are recorded at the invoiced amount and do not bear interest. The carrying value of accounts receivable approximates fair value. The allowance for doubtful accounts is our best estimate for losses inherent in our accounts receivable portfolio. The sales return and allowance reserve is our best estimate of sales credits that will be issued related to our accounts receivable portfolio. These allowances are used to state trade receivables at estimated net realizable value.
We estimate uncollectible amounts based upon our historical write-off experience, current customer receivable balances, age of customer receivable balances, the customer’s financial condition and current economic conditions. Historically, these estimates have been adequate to cover our accounts receivable exposure.
We enter into medical transcription service arrangements which contain provisions for performance penalties in the event certain service levels, primarily related to turnaround time on transcribed reports, are not achieved. We reduce revenues for any performance penalties incurred and have included an estimate of such credits in our allowance for uncollectible accounts.
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Table of Contents
MedQuist Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(In thousands, except per share amounts)
Product revenues for sales to end-user customers and resellers is recognized upon passage of title if all other revenue recognition criteria have been met. End-user customers generally do not have a right of return. We provide certain of our resellers and distributors with limited rights of return of our products. We reduce revenues for rights to return our product based upon our historical experience and have included an estimate of such credits in our allowance for doubtful accounts.
Inventories
Inventories, which are primarily comprised of finished goods, are stated at the lower of cost or market, with cost determined on afirst-in, first-out basis. Inventories in excess of anticipated future demand or for obsolete products are reserved. As of December 31, 2006 and 2005, the net inventory balances were $2,608 and $4,200, respectively, and are included in other current assets in the accompanying consolidated balance sheets.
Property and Equipment
Property and equipment are stated at cost less accumulated depreciation. Depreciation is calculated on a straight-line basis over the estimated useful lives of the assets which range from three to seven years for furniture, equipment and software, and the lesser of the lease term or estimated useful life for leasehold improvements. Repairs and maintenance costs are charged to expense as incurred while additions and betterments are capitalized. Gains or losses on disposals are charged to operations. Upon retirement, sale or other disposition, the related cost and accumulated depreciation are eliminated from the accounts and any gain or loss is included in operations.
Goodwill
Goodwill represents the excess of the aggregate purchase price over the fair value of the net assets acquired in a purchase business combination. Goodwill is reviewed for impairment on December 1 of each year.
The goodwill impairment test is a two-step test. Under the first step, the fair value of the reporting unit is compared with its carrying value (including goodwill). We consider three methods when determining fair value; the discounted cash flow method, the quoted price method and the public company method. Of these three methods, we assign the most significant weighting to the discounted cash flow method. If the fair value of the reporting unit is less than its carrying value, an indication of goodwill impairment exists for the reporting unit and the enterprise must perform step two of the impairment test. Under step two, an impairment loss is recognized for any excess of the carrying amount of the reporting unit’s goodwill over the implied fair value of that goodwill. The implied fair value of goodwill is determined by allocating the fair value of the reporting unit in a manner similar to a purchase price allocation, in accordance with FASB Statement 141,Business Combinations. The residual fair value after this allocation is the implied fair value of the reporting unit’s goodwill.
Software Development
We capitalize software development costs pursuant to the requirements of FASB Statement 86,Accounting for the Costs of Computer Software to be Sold, Leased, or Otherwise Marketed(Statement 86), for our software developed for sale and AICPASOP 98-1,Accounting for the Costs of Computer Software Developed or Obtained for internal Use(SOP 98-1), for our software developed for internal use.
Statement 86 specifies that costs incurred in creating a computer software product shall be charged to expense when incurred as research and development until technical feasibility has been established. Technical feasibility is established upon completion of a detail program design or, in its absence, completion of a working model. Thereafter, all software production costs shall be capitalized until the product is available for release to customers.
SOP 98-1 specifies that software costs incurred in the preliminary project stage should be expensed as incurred. Capitalization of costs should begin when the preliminary project stage is completed and management,
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Table of Contents
MedQuist Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(In thousands, except per share amounts)
with the relevant authority, authorizes and commits funding of the project and it is probable that the project will be completed and the software will be used to perform the function intended. Capitalization should cease no later than the point at which the project is substantially complete and ready for its intended use.
Capitalized software is reported at the lower of unamortized cost or net realizable value and is amortized over the product’s estimated economic life which is generally three years. As of December 31, 2006 and 2005, $485 and $689, respectively, of unamortized software development costs are included in other intangible assets in the accompanying consolidated balance sheets. For the years ended December 31, 2006, 2005 and 2004, software amortization expense was $262, $336 and $633, respectively.
Long-Lived and Other Intangible Assets
Long-lived assets, including property and equipment and purchased intangible assets subject to amortization, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. To determine the recoverability of long-lived assets, the estimated future undiscounted cash flows expected to be generated by an asset is compared to the carrying value of the asset. If the carrying value of the long-lived asset exceeds its estimated future undiscounted cash flows, an impairment charge is recognized in the amount by which the carrying value of the asset exceeds its fair value. Annually we evaluate the reasonableness of the useful lives of these assets.
Intangible assets include certain assets (primarily customer lists) obtained from business acquisitions and are being amortized using the straight-line method over their estimated useful lives which range from three to 20 years.
Foreign Currency Translation
Our operating subsidiaries in the United Kingdom and Canada use the local currency as their functional currency. We translate the assets and liabilities of those entities into U.S. dollars using the month-end exchange rate. We translate revenues and expenses using the average exchange rates prevailing during the reporting period. The resulting translation adjustments are recorded in accumulated other comprehensive income within shareholders’ equity. Gains and losses from foreign currency transactions are included in net (loss) income and were not material for the years ended December 31, 2006, 2005 and 2004, respectively.
Business Enterprise Segments
We operate in one reportable operating segment which is medical transcription technology and services.
Concentration of Risk, Geographic Data and Enterprise-wide Disclosures
No single customer accounted for more than 10% of our net revenues in any period. There is no single geographic area of significant concentration other than the United States.
The following table summarizes the net revenues by the categories of our products and services as a percentage of our total net revenues.
| 2006 | 2005 | 2004 | ||||||||||
| Medical transcription | 83.8% | 79.5% | 83.0% | |||||||||
| Products and related services | 4.6% | 8.1% | 7.1% | |||||||||
| PCS | 8.5% | 9.3% | 7.6% | |||||||||
| Other | 3.1% | 3.1% | 2.3% | |||||||||
| Total | 100.0% | 100.0% | 100.0% | |||||||||
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Table of Contents
MedQuist Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(In thousands, except per share amounts)
Other includes medical coding, application service provider and time and material revenues.
Fair Value of Financial Instruments
Cash and cash equivalents, accounts receivable, accounts payable and accrued expenses are reflected in the accompanying consolidated balance sheets at carrying values which approximate fair value due to the short-term nature of these instruments and the variability of the respective interest rates where applicable.
Recent Accounting Pronouncements
In June 2006, the EITF reached a consensus on IssueNo. 06-3,How Taxes Collected from Customers and Remitted to Government Authorities Should be Presented in the Income Statement (That Is, Gross versus Net Presentation). The consensus allows companies to choose between two acceptable alternatives based on their accounting policies for transactions in which the company collects taxes on behalf of a governmental authority, such as sales taxes. Under the gross method, taxes collected are accounted for as a component of sales revenue with an offsetting expense. Conversely, the net method allows a reduction to sales revenue. If such taxes are reported gross and are significant, companies should disclose the amount of those taxes. The guidance should be applied to financial reports through retrospective application for all periods presented, if amounts are significant, for interim and annual reporting beginning after December 31, 2006. We have historically presented taxes on a net basis and we do not intend to change our policy.
In July 2006, the FASB issued Interpretation 48,Accounting for Uncertainty in Income Taxes(FIN 48). FIN 48 prescribes a comprehensive model for the financial statement recognition, measurement, presentation and disclosure of uncertain tax positions taken or expected to be taken in income tax returns. FIN 48 is effective for fiscal years beginning after December 15, 2006. The cumulative effect, if any, of applying FIN 48 will be recorded as an adjustment to retained earnings as of the beginning of the period of adoption. We are still evaluating the adoption of FIN 48 and have not yet determined the impact, if any, on our consolidated financial statements.
In September 2006, the SEC issued SAB 108,Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements(SAB 108), which addresses how the effects of prior-year uncorrected misstatements should be considered when quantifying misstatements in current-year financial statements. SAB 108 will require registrants to quantify misstatements using both the balance sheet and income-statement approaches and to evaluate whether either approach results in quantifying an error that is material in light of relevant quantitative and qualitative factors. When the effect of initial adoption is determined to be material, SAB 108 allows for a cumulative effect adjustment to beginning retained earnings. The requirements are effective for annual financial statements covering the first fiscal year ending after November 15, 2006. The adoption of SAB 108 did not have any impact on our consolidated financial statements.
In September 2006, the FASB issued Statement 157,Fair Value Measurements, (Statement 157) which defines fair value, establishes guidelines for measuring fair value and expands disclosures regarding fair value measurements. Statement 157 does not require any new fair value measurements. The provisions of this statement are effective for fiscal years beginning after November 15, 2007. We do not expect the adoption of Statement 157 to have a material impact on our consolidated financial statements.
In February 2007, the FASB issued Statement 159,The Fair Value Option for Financial Assets and Financial Liabilities, including an amendment of FASB Statement 115(Statement 159) which permits entities to choose to measure eligible items at fair value at specified election dates. Unrealized gains and losses on items for which the fair value option has been elected will be reported in earnings at each subsequent reporting date. The following balance sheet items are within the scope of Statement 159:
| • | Recognized financial assets and financial liabilities unless a special exception applies; |
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Notes to Consolidated Financial Statements
(In thousands, except per share amounts)
| • | Firm commitments that would otherwise not be recognized at inception and that involve only financial instruments; | |
| • | Non-financial insurance contracts; and | |
| • | Host financial instruments resulting from separation of an embedded non-financial derivative instrument from a non-financial hybrid instrument |
Statement 159 will be effective for fiscal years beginning after November 2007 with early adoption possible but subject to certain requirements. We do not expect the adoption of Statement 159 to have a material impact on our consolidated financial statements.
| 4. | Customer Accommodation and Quantification |
As discussed in Note 2, in connection with our decision to offer financial accommodations to our AAMT Customers, we analyzed our historical billing information and the available report-level data to develop individualized accommodation offers to be made to our AAMT Customers (Accommodation Analysis). This analysis took approximately one year to complete. The methodology utilized to develop the individual accommodation offers was designed to generate positive accommodation outcomes for our AAMT Customers. As such, the methodology was not a calculation of potential over billing nor was it intended as a measure of damages or a reflection of any admission of liability due and owed to our AAMT Customers. Instead, the Accommodation Analysis was a methodology that was developed to arrive at commercially reasonable and fair accommodation offers that would be acceptable to our AAMT Customers without negotiation.
In the fourth quarter of 2005, based on the Accommodation Analysis, our board of directors authorized management to make cash accommodation offers to AAMT customers in the aggregate amount of $65,413. In 2006, this amount was adjusted by a net additional amount of $1,157 based on a refinement of the Accommodation Analysis resulting in an aggregate amount of $66,570. By accepting our accommodation offer, an AAMT Customer must agree, among other things, to release us from any and all claims and liability regarding AAMT line and other billing related issues.
As part of this process, we also conducted an analysis in an attempt to quantify the economic consequences of potentially unauthorized adjustments to AAMT Customers’ ratios and formulae within the transcription platform setups (Quantification). This Quantification was calculated to be $9,835.
Of the authorized cash accommodation amount of $66,570, $1,157 and $57,678 were treated as consideration given by a vendor to a customer and accordingly recorded as a reduction in revenues in 2006 and 2005, respectively. The balance of $7,735 plus an additional $2,100 has been accounted for as a billing error associated with the Quantification resulting in a reduction of revenues in various reporting periods from 1999 to 2005.
The goal of our customer accommodation was to reach a settlement with our AAMT Customers. However, the Accommodation Analysis for certain AAMT Customers did not result in positive accommodation outcomes. For certain other customers, the Accommodation Analysis resulted in calculated cash accommodation offers that we believed were insufficient as a percentage of their historical AAMT line billing to motivate such customers to resolve their billing disputes with us. Therefore, in 2006 we modified our customer accommodation to enable us to offer this group of AAMT Customers credits for the purchase of future productsand/or services from us over a defined period of time. On July 21, 2006, our board of directors authorized management to make credit accommodation offers up to an additional $8,676 beyond amounts previously authorized. During 2006, this amount was adjusted by a net additional amount of $569 based on a refinement of the Accommodation Analysis, resulting in an aggregate amount of $9,245. In connection with the credit accommodation offers we recorded a reduction in revenues and corresponding increase in accrued expenses of $9,245 in 2006.
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Notes to Consolidated Financial Statements
(In thousands, except per share amounts)
The following is a summary of the financial statement activity related to the customer accommodation and the Quantification which is included as a separate line item in the accompanying consolidated balance sheets as of December 31, 2006 and 2005:
| 2006 | 2005 | |||||||
| Beginning balance | $ | 46,878 | $ | 9,702 | ||||
| Quantification | — | 133 | ||||||
| Customer accommodation | 10,402 | 57,678 | ||||||
| Payments and other adjustments | (31,523 | ) | (20,635 | ) | ||||
| Credits | (980 | ) | — | |||||
| Ending balance | $ | 24,777 | $ | 46,878 | ||||
| 5. | Cost of Investigation and Legal Proceedings |
For the years ended December 31, 2006, 2005 and 2004, we recorded a charge of $13,001, $34,127 and $10,253, respectively, for costs associated with the Review, Management’s Billing Assessment as well as defense and other costs associated with the SEC and U.S. Department of Justice (DOJ) investigations and civil litigation that we deemed to be unusual in nature. The following is a summary of the amounts recorded in the accompanying consolidated statements of operations:
| 2006 | 2005 | 2004 | ||||||||||
| Legal fees | $ | 14,427 | $ | 20,858 | $ | 8,408 | ||||||
| Other professional fees | 4,787 | 9,789 | 471 | |||||||||
| Nightingale and Associates, LLC (Nightingale) services | 3,005 | 3,207 | 1,371 | |||||||||
| Insurance recoveries and claims | (9,409 | ) | — | — | ||||||||
| Other | 191 | 273 | 3 | |||||||||
| Total | $ | 13,001 | $ | 34,127 | $ | 10,253 | ||||||
Other professional fees represent accounting and dispute analysis costs and document search and retrieval costs. Insurance recoveries and claims represent insurance recoveries ($8,702) and insurance claims ($707). The insurance claims were recorded in other current assets in the accompanying consolidated balance sheet as of December 31, 2006 and payment related to these claims was received in the first quarter of 2007.
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Notes to Consolidated Financial Statements
(In thousands, except per share amounts)
6. 2005 Restructuring Plan
During 2005, we implemented a restructuring plan (2005 Plan) based on the implementation of a centralized national service delivery model. The plan involved the consolidation of operating facilities and a related reduction in workforce. The table below reflects the financial statement activity related to the 2005 Plan which is included in accrued expenses in the accompanying consolidated balance sheets as of December 31, 2006 and 2005:
| Non-Cancelable | ||||||||||||||||
| Total | Leases | Severance | Equipment | |||||||||||||
| Initial charge | $ | 3,257 | $ | 2,334 | $ | 704 | $ | 219 | ||||||||
| Usage | (1,207 | ) | (641 | ) | (347 | ) | (219 | ) | ||||||||
| Balance as of December 31, 2005 | 2,050 | 1,693 | 357 | — | ||||||||||||
| Additional charge | 3,442 | 1,653 | 1,447 | 342 | ||||||||||||
| Usage | (4,780 | ) | (2,698 | ) | (1,740 | ) | (342 | ) | ||||||||
| Balance as of December 31, 2006 | $ | 712 | $ | 648 | $ | 64 | $ | — | ||||||||
The 2005 Plan will be completed in 2007 for severance and 2009 for non-cancelable leases.
| 7. | Accounts Receivable |
Accounts receivable consisted of the following as of December 31:
| 2006 | 2005 | |||||||
| Trade accounts receivable | $ | 59,272 | $ | 76,150 | ||||
| Less: Allowance for doubtful accounts | (4,494 | ) | (4,389 | ) | ||||
| Accounts receivable, net | $ | 54,778 | $ | 71,761 | ||||
| 8. | Property and Equipment |
Property and equipment consisted of the following as of December 31:
| 2006 | 2005 | |||||||
| Computer equipment | $ | 31,162 | $ | 36,640 | ||||
| Communication equipment | 6,602 | 11,466 | ||||||
| Software | 16,802 | 13,067 | ||||||
| Furniture and office equipment | 1,586 | 2,165 | ||||||
| Leasehold improvements | 2,655 | 2,760 | ||||||
| Total property and equipment | 58,807 | 66,098 | ||||||
| Less: accumulated depreciation | (37,838 | ) | (42,137 | ) | ||||
| Property and equipment, net | $ | 20,969 | $ | 23,961 | ||||
During 2006, we recorded a write-off of $767 which was allocated between cost of revenues ($425) and restructuring charges related to the 2005 Plan ($342). In the fourth quarter of 2005, based upon an inventory of fixed assets, we recorded a write-off of $4,070 (original cost $29,116 less accumulated depreciation $25,046). This expense was allocated between cost of revenues ($3,851) and restructuring charges related to the 2005 Plan ($219). In addition, during 2005 approximately $50,832 in fully depreciated assets no longer in use were written off which had no impact on net loss.
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Notes to Consolidated Financial Statements
(In thousands, except per share amounts)
| 9. | Goodwill and Other Intangible Assets |
Goodwill
In December 2004, we changed our organization structure from two reporting units (Services and Solutions) to one reporting unit. At that time, we tested the goodwill valuation of each reporting unit for impairment. Due to reduced sales and margins experienced in the Solutions reporting unit, expected operating profits and cash flows were forecast lower than previously anticipated. Accordingly, in December 2004, a goodwill impairment charge of $14,603 was recorded related to the Solutions reporting unit. The impairment charge is included in the separate line item in the accompanying consolidated statements of operations.
The following table reflects the financial statement activity related to the carrying amount of goodwill as of December 31, 2006 and 2005:
| Balance as of January 1, 2005 | $ | 124,826 | ||
| Foreign currency adjustments | (696 | ) | ||
| Tax adjustment | (281 | ) | ||
| Balance as of December 31, 2005 | 123,849 | |||
| Foreign currency adjustments | 977 | |||
| Balance as of December 31, 2006 | $ | 124,826 | ||
The foreign currency adjustments reflect changes in the period-end currency rates of our foreign subsidiaries. The tax adjustment is due to book/tax differences related to two acquisitions in which tax goodwill exceeded the book value of the goodwill, resulting in a permanent favorable difference that reduces goodwill as it is recognized on our tax returns.
Other Intangible Assets
As of December 31, other intangible asset balances were:
| 2006 | ||||||||||||
| Accumulated | Net book | |||||||||||
| Cost | Amortization | Value | ||||||||||
| Customer lists | $ | 77,185 | $ | (32,654 | ) | $ | 44,531 | |||||
| Noncompete agreements | 4,559 | (4,559 | ) | — | ||||||||
| Tradenames | 5,325 | (4,893 | ) | 432 | ||||||||
| Capitalized software | 2,597 | (2,112 | ) | 485 | ||||||||
| Total | $ | 89,666 | $ | (44,218 | ) | $ | 45,448 | |||||
| 2005 | ||||||||||||
| Accumulated | Net book | |||||||||||
| Cost | Amortization | Value | ||||||||||
| Customer lists | $ | 77,185 | $ | (27,920 | ) | $ | 49,265 | |||||
| Noncompete agreements | 4,559 | (4,095 | ) | 464 | ||||||||
| Tradenames | 5,325 | (4,465 | ) | 860 | ||||||||
| Capitalized software | 2,539 | (1,850 | ) | 689 | ||||||||
| Total | $ | 89,608 | $ | (38,330 | ) | $ | 51,278 | |||||
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Notes to Consolidated Financial Statements
(In thousands, except per share amounts)
The estimated useful life and the weighted average remaining lives of the intangible assets as of December 31, 2006 are as follows:
| Estimated | Weighted Average | |||||||
| Useful Life | Remaining Lives | |||||||
| Customer lists | 10 - 20 years | 11.5 years | ||||||
| Noncompete agreements | 4 - 5 years | 0 years | ||||||
| Tradenames | 3 years | 1.0 years | ||||||
| Capitalized software | 3 years | 2.2 years | ||||||
As part of our acquisition of Lanier Healthcare, LLC (Lanier) in 2002, we acquired a tradename used on Lanier products. In December 2004, our plans to continue selling this product changed and we determined that the tradename would be disposed of before its previously established useful life. In accordance with FASB Statement 144,Accounting for the Impairment or Disposal of Long-Lived Assets(Statement 144), we compared the carrying value to its fair value. An impairment charge of $475 was recorded in December 2004 representing the excess of carrying value over fair value and is included in the separate line item in the accompanying consolidated statements of operations.
Estimated annual amortization expense for intangible assets is as follows:
| 2007 | $ | 5,368 | ||
| 2008 | 4,936 | |||
| 2009 | 4,725 | |||
| 2010 | 4,704 | |||
| 2011 | 4,568 | |||
| Thereafter | 21,147 | |||
| Total | $ | 45,448 | ||
| 10. | Contractual Obligations |
Leases
Minimum rental payments under operating leases are recognized on a straight-line basis over the term of the lease, including any periods of free rent and landlord incentives. Rental expense for operating leases for the years ended December 31, 2006, 2005 and 2004 was $4,089, $5,710 and $7,139, respectively. Future minimum lease payments under non-cancelable operating leases (with initial or remaining lease terms in excess of one year) as of December 31, 2006 are:
| Total | Continuing | Restructuring | ||||||||||
| 2007 | $ | 2,531 | $ | 2,001 | $ | 530 | ||||||
| 2008 | 1,467 | 1,388 | 79 | |||||||||
| 2009 | 1,061 | 1,020 | 41 | |||||||||
| 2010 | 874 | 874 | — | |||||||||
| 2011 and thereafter | 672 | 672 | — | |||||||||
| Total minimum lease payments | $ | 6,605 | $ | 5,955 | $ | 650 | ||||||
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Notes to Consolidated Financial Statements
(In thousands, except per share amounts)
Other Contractual Obligations
The following summarizes our other contractual obligations as of December 31, 2006:
| Severance and Other | ||||||||||||
| Total | Purchase | Guaranteed Payments | ||||||||||
| 2007 | $ | 8,470 | $ | 7,753 | $ | 717 | ||||||
| 2008 | 6,908 | 6,100 | 808 | |||||||||
| 2009 | 6,100 | 6,100 | — | |||||||||
| 2010 | 6,100 | 6,100 | — | |||||||||
| 2011 and thereafter | 1,685 | 1,685 | — | |||||||||
| Total | $ | 29,263 | $ | 27,738 | $ | 1,525 | ||||||
Purchase obligations represent telecommunication contracts ($26,085), a software purchase ($1,046) and other recurring purchase obligations ($607). Severance and other guaranteed payments are comprised of severance payments ($1,425) and other guaranteed payments ($100).
As of December 31, 2006, we had agreements with certain of our senior management that provided for severance payments in the event these individuals were terminated without cause. The maximum cost exposure related to these agreements was $1,207 as of December 31, 2006.
| 11. | Investment in A-Life Medical, Inc. (A-Life) |
We have an investment in A-Life, a privately held entity which provides advanced natural language processing technology for the medical industry. Our investment is recorded under the equity method of accounting since we owned 33.6% of A-Life’s outstanding voting shares as of December 31, 2006 and 2005. The table below reflects the financial statement activity related to A-Life as of December 31, 2006 and 2005 that is recorded in other assets in the accompanying consolidated balance sheets.
| Balance as of January 1, 2005 | $ | 4,515 | ||
| Share in income | 500 | |||
| Balance as of December 31, 2005 | 5,015 | |||
| Share in income | 874 | |||
| Balance as of December 31, 2006 | $ | 5,889 | ||
In August 2001, we entered into an Advance Agreement with A-Life (Advance Agreement). The Advance Agreement required a prepayment of $1,000 for $1,600 in services to be provided by A-Life to us. The Advance Agreement had an expiration date of December 31, 2005. Due to significantly lower than expected revenues as well as a determination that services to be provided by A-Life over the remaining life of the contract would not utilize the prepaid balance as of December 31, 2004, we recorded an impairment charge of $706 in the fourth quarter of 2004 in cost of revenues. The Advance Agreement terminated on December 31, 2005.
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Notes to Consolidated Financial Statements
(In thousands, except per share amounts)
| 12. | Accrued Expenses |
Accrued expenses consisted of the following as of December 31:
| 2006 | 2005 | |||||||
| Professional services | $ | 4,938 | $ | 11,294 | ||||
| Shareholder litigation settlement | 7,750 | 7,750 | ||||||
| Other | 16,124 | 18,357 | ||||||
| Total accrued expenses | $ | 28,812 | $ | 37,401 | ||||
No other individual accrued expense is in excess of 5% of total current liabilities.
| 13. | Commitments and Contingencies |
Governmental Investigations
The SEC is currently conducting a formal investigation of us relating to our billing practices. We have been fully cooperating with the SEC since it opened its investigation in 2004. We have complied and are continuing to comply with information and document requests by the SEC.
We also received an administrative HIPAA subpoena for documents from the DOJ on December 17, 2004. The subpoena sought information primarily about our provision of medical transcription services to governmental and non-governmental customers. The information was requested in connection with a government investigation into whether we and others violated federal laws in connection with the provision of medical transcription services. We have complied and are continuing to comply with information and document requests by the DOJ.
The DOL is currently conducting a formal investigation into the administration of our 401(k) plan. We have been fully cooperating with the DOL since it opened its investigation in 2004. We have complied and are continuing to comply with information and document requests by the DOL.
Developments relating to the SEC, DOJand/or DOL investigations will continue to create various risks and uncertainties that could materially and adversely affect our business and our historical and future financial condition, results of operations, and cash flows.
Shareholder Securities Litigation
A shareholder putative class action lawsuit was filed against us in the United States District Court District of New Jersey on November 8, 2004. The action, entitledWilliam Steiner v. MedQuist, Inc., et al., CaseNo. 1:04-cv-05487-FLW (Shareholder Putative Action), was filed against us and certain of our former officers, purportedly on behalf of an alleged class of all persons who purchased our common stock during the period from April 23, 2002 through November 2, 2004, inclusive (Securities Class Period). The complaint specifically alleged that defendants violated federal securities laws by purportedly issuing a series of false and misleading statements to the market throughout the Securities Class Period, which statements allegedly had the effect of artificially inflating the market price of our securities. The complaint asserts claims under Section 10(b) and 20(a) of the Exchange Act andRule 10b-5, thereunder. Named as defendants, in addition to us, were our former President and Chief Executive Officer and our former Executive Vice President and Chief Financial Officer.
On August 16, 2005, a First Amended Complaint in the Shareholder Putative Class Action was filed against us in the United States District Court District of New Jersey. The First Amended Complaint named additional defendants, including certain current and former directors, certain of our former officers, our former and current external auditors and Philips. Like the original complaint, the First Amended Complaint asserted claims under Sections 10(b) and 20(a) of the Exchange Act andRule 10b-5 thereunder. The Securities Class Period of the original
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(In thousands, except per share amounts)
complaint was expanded 20 months to include the period from March 29, 2000 through June 14, 2004. Pursuant to an October 17, 2005 consent order approved by the Court, lead plaintiff Greater Pennsylvania Pension Fund filed a Second Amended Complaint on November 15, 2005. The Second Amended Complaint dropped Philips as a defendant, but alleged the same claims and the same purported class period as the First Amended Complaint. Plaintiffs sought unspecified damages. Pursuant to the provisions of the Private Securities Litigation Reform Act, discovery in the action was stayed pending the filing and resolution of the defendants’ motions to dismiss, which were filed on January 17, 2006, and which were fully briefed as of June 16, 2006. On September 29, 2006, the Court denied our motions to dismiss and the motion to dismiss of the individual defendants. In the same order, the Court granted the motion to dismiss filed by our former and current external auditors. On November 3, 2006, we filed our Answer denying the material allegations contained in the Second Amended Complaint. On March 23, 2007, we entered into a memorandum of understanding and a stipulation of settlement with the lead plaintiff in which we agreed to pay $7.75 million to settle all claims, throughout the class period, against all defendants in the action. On May 16, 2007, the Court issued an Order Preliminarily Approving Settlement and Providing for Notice. The Court conducted a final approval hearing and approved the settlement on August 15, 2007. Neither we nor any of the individuals named in the action has admitted to liability or any wrongdoing in connection with the settlement.
Customer Litigation
A putative class action was filed in the United States District Court for the Central District of California. The action, entitled South Broward Hospital District, d/b/a Memorial Regional Hospital, et al. v. MedQuist, Inc. et al., CaseNo. CV-04-7520-TJH-VBKx, was filed on September 9, 2004 against us and certain of our present and former officials, purportedly on behalf of an alleged class of non-Federal governmental hospitals and medical centers that the complaint claims were wrongfully and fraudulently overcharged for transcription services by defendants based primarily on our use of the AAMT line billing unit of measure. The complaint charged fraud, violation of the California Business and Professions Code, unjust enrichment, conversion, negligent supervision and violation of RICO. Plaintiffs seek damages in an unspecified amount, plus costs and interest, an injunction against alleged continuing illegal activities, an accounting, punitive damages and attorneys’ fees. Named as defendants, in addition to us, were one of our senior vice presidents, our former executive vice president of marketing and new business development, our former executive vice president and chief legal officer, and our former executive vice president and chief financial officer.
On December 20, 2004, we and the individual defendants filed motions to dismiss for lack of personal jurisdiction and improper venue, or in the alternative, to transfer the putative action to the United States District Court for the District of New Jersey. On February 2, 2005, plaintiffs filed a Second Amended Complaint both adding and deleting named plaintiffs in an attempt to keep the putative action in the United States District Court for the Central District of California. On March 30, 2005, the United States District Court for the Central District of California issued an order transferring the putative action to the United States District Court District of New Jersey.
On August 1, 2005, we and the individual defendants filed their respective Answers denying the material allegations contained in the Second Amended Complaint. On August 31, 2005, we and the individual defendants filed motions to dismiss the Second Amended Complaint for failure to state a claim and a motion to dismiss in favor of arbitration, or in the alternative, to stay pending arbitration. On December 12, 2005, the plaintiffs filed an Amendment to the Second Amended Complaint. On December 13, 2005, the Court issued an order requiring plaintiffs to file a Third Amended Complaint.
Plaintiffs filed the Third Amended Complaint on January 4, 2006. The Third Amended Complaint expands the claims made beyond issues arising from contracts based on AAMT line billing and beyond customers billed based on an AAMT line, alleging that we engaged in a scheme to inflate customers’ invoices without regard to the terms of individual contracts and even in the absence of any written contract. The Third Amended Complaint also limits plaintiffs’ claim for fraud in the inducement of the agreement to arbitrate to the three named plaintiffs whose
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Notes to Consolidated Financial Statements
(In thousands, except per share amounts)
contracts contain an arbitration provision and a subclass of similarly situated customers. On January 20, 2006 we and the individual defendants filed motions to dismiss the Third Amended Complaint for failure to state a claim and a motion to compel arbitration of all claims by the arbitration subclass and to stay the case in its entirety pending arbitration. On March 8, 2006 the Court held a hearing on these motions, and took the matter under submission. On March 30, 2007, the Court issued an order holding that plaintiffs could not make out a claim that we had violated the federal RICO statute, thus eliminating any claim against us for treble damages. The Court also found that plaintiffs could not make out a claim that we had engaged in any unfair or deceptive acts or practices in violation of state law, or that we had made any negligent misrepresentations to plaintiffs. In its ruling, the Court, without reaching a decision of whether any wrongdoing had occurred, allowed plaintiffs to proceed with their claims against us for fraud, unjust enrichment and an accounting. In its order, the Court denied our motion to compel arbitration regarding those customers whose contracts contained an agreement to arbitrate. We have appealed that decision to the Third Circuit Court of Appeals, and we moved the district court to stay the matter pending that appeal. The district court heard oral argument on our motion to stay on May 30, 2007 and took the motion under submission. On June 8, 2007, plaintiffs filed a Motion for Summary Action with the Third Circuit Court of Appeals, asking the Court to dismiss plaintiffs who did not enter into arbitration agreements with us from the appeal. We filed our opposition to this motion on June 25, 2007. The Court has referred the motion to the merits panel for decision after full briefing. In addition, on July 18, 2007, the Third Circuit Court of Appeals issued notice that the case had been assigned to mediation in the Court’s mediation program. On August 1, 2007, plaintiffs filed a motion for expedited review on appeal. We do not oppose this motion, and the parties have agreed to a schedule pursuant to which the appeal will be fully briefed by November 16, 2007. On August 21, 2007, the Third Circuit granted the motion for expedited review. Under the Court’s order, briefing is scheduled to be completed by November 16, 2007. The Third Circuit also has ordered the parties to telephonic mediation, which is scheduled to proceed on September 12, 2007. We believe that the claims asserted have no merit and intend to defend the case vigorously.
Medical Transcriptionist Litigation
Hoffmann Putative Class Action
A putative class action lawsuit was filed against us in the United States District Court for the Northern District of Georgia. The action, entitled Brigitte Hoffmann, et al. v. MedQuist, Inc., et al., CaseNo. 1:04-CV-3452, was filed with the Court on November 29, 2004 against us and certain current and former officials, purportedly on behalf of an alleged class of current and former employees and statutory workers, who are or were compensated on a “per line” basis for medical transcription services (Class Members) from January 1, 1998 to the time of the filing of the complaint (Class Period). The complaint specifically alleged that defendants systematically and wrongfully underpaid the Class Members during the Class Period. The complaint asserted the following causes of action: fraud, breach of contract, demand for accounting, quantum meruit, unjust enrichment, conversion, negligence, negligent supervision, and RICO violations. Plaintiffs sought unspecified compensatory damages, punitive damages, disgorgement and restitution. On December 1, 2005, the Hoffmann matter was transferred to the United States District Court for the District of New Jersey. On January 12, 2006, the Court ordered this case consolidated with the Myers Putative Class Action discussed below. As set forth below, we believe that the claims asserted in the consolidated Myers Putative Class Action have no merit and intend to vigorously defend that action.
Force Putative Class Action
A putative class action entitled Force v. MedQuist Inc. and MedQuist Transcriptions, Ltd., CaseNo. 05-cv-2608-WSD, was filed against us on October 11, 2005, in the United States District Court for the Northern District of Georgia. The action was brought on behalf of a putative class of current and former employees who claim they are or were compensated on a “per line” basis for medical transcription services but were allegedly underpaid due to the actions of defendants. The named plaintiff asserted claims for breach of contract, quantum meruit, unjust enrichment, and for an accounting. Upon stipulation and consent of the parties, on February 17, 2006, the Force
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Notes to Consolidated Financial Statements
(In thousands, except per share amounts)
matter was ordered transferred to the United States District Court for the District of New Jersey. Subsequently, on April 4, 2006, the parties entered into a stipulation and consent order whereby the Force matter was consolidated with the Myers Putative Class Action discussed below, and the consolidated amended complaint filed in the Myers action on January 31, 2006 was deemed to supersede the original complaint filed in the Force matter. As set forth below, we believe that the claims asserted in the consolidated Myers Putative Class Action have no merit and intend to vigorously defend that action.
Myers Putative Class Action
A putative class action entitled, Myers, et al. v. MedQuist Inc. and MedQuist Transcriptions, Ltd., CaseNo. 05-cv-4608 (JBS), was filed against us on September 22, 2005 in the United States District Court for the District of New Jersey. The action was brought on behalf of a putative class of our employee and independent contractor transcriptionists who claim that they contracted with us to be paid on a 65 character line, but were allegedly underpaid due to intentional miscounting of the number of characters and lines transcribed. The named plaintiffs asserted claims for breach of contract, unjust enrichment, and request an accounting.
The allegations contained in the Myers case are substantially similar to those contained in the Hoffmann and Force putative class actions and, as detailed above, the three actions have now been consolidated. A consolidated amended complaint was filed on January 31, 2006. In the consolidated amended complaint, the named plaintiffs assert claims for breach of contract, breach of the covenant of good faith and fair dealing, unjust enrichment and demand an accounting. On March 7, 2006 we filed a motion to dismiss all claims in the consolidated amended complaint. The motion was fully briefed and argued on August 7, 2006. The Court denied the motion on December 21, 2006. On January 19, 2007, we filed our answer denying the mutual allegations pleaded in the consolidated amended complaint. The parties are now proceeding with discovery. The deadline to complete pretrial fact discovery is October 30, 2007. No date has been set for a class certification hearing or trial. We believe that the claims asserted in the consolidated actions have no merit and intend to vigorously defend the suit.
Shareholder Derivative Litigation
On October 4, 2005, we announced the dismissal with prejudice of a shareholder derivative action filed in United States District Court for the District of New Jersey. The suit, Rhoda Kanter (Plaintiff) v. Hans M. Barella et al. (Defendants), was filed on November 12, 2004 against Philips and 10 current and former members of our board of directors. We were named as a nominal defendant.
In a ruling dated September 21, 2005, the Court found plaintiff’s allegations that our board of directors breached their fiduciary duties to us to be insufficient. The plaintiff had alleged that for a period from 2001 through 2004, the Defendants violated their fiduciary duties by permitting artificial inflation of billing figures; failing to adequately ensure accurate and lawful billing practices; and failing to accurately report our true financial condition in its published financial statements. On October 3, 2005, plaintiff filed a motion for reconsideration of the Court’s order dismissing the action with prejudice. On November 16, 2005, the Court denied plaintiff’s motion for reconsideration. On December 13, 2005, plaintiff filed a Notice of Appeal with the United States Court of Appeals for the Third Circuit. Plaintiff’s appeal was fully briefed as of May 2006, and the Court of Appeals heard oral argument on the appeal on March 1, 2007. Plaintiff’s appeal was denied by the Court of Appeals on May 25, 2007.
Other than the shareholder securities litigation discussed above, at this time, based on the stage of litigation, and a review of the current facts and circumstances, no amount is probable and no amount within a range of possible outcomes is a better amount within the range that might result from an adverse judgment or a settlement of the matters discussed above.
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MedQuist Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(In thousands, except per share amounts)
Developments relating to third party litigation and governmental investigations will continue to create various risks and uncertainties that could materially and adversely affect our business, financial condition, results of operations and cash flows.
Other Matters
From time to time, we have been involved in various claims and legal actions arising in the ordinary course of business. In our opinion, the outcome of such actions will not have a material adverse effect on our consolidated financial position, results of operations, liquidity or cash flows.
We provide certain indemnification provisions within our standard agreement for the sale of software and hardware (collectively, Products) to protect our customers from any liabilities or damages resulting from a claim of U.S. patent, copyright or trademark infringement by third parties relating to our Products. We believe that the likelihood of any future payout relating to these provisions is remote. Accordingly, we have not recorded any liability in our consolidated financial statements as of December 31, 2006 or 2005 related to these indemnification provisions.
We have insurance policies which provide coverage for certain of the matters related to the legal actions described herein. As of December 31, 2006, we have received insurance recoveries of $8,702 and have filed claims for an additional $707 both of which have been recorded as a reduction of our cost of investigation and legal proceedings in the accompanying consolidated statements of operations. The receivables for insurance claims were recorded in other current assets in the accompanying consolidated balance sheet as of December 31, 2006 and payment related to these claims was received in the first quarter of 2007. Subsequent to December 31, 2006, we received payment on the $707 claim noted above as well as additional insurance recoveries of $15,386.
| 14. | Stock Option Plans |
Our stock option plans provide for the granting of options to purchase shares of common stock to eligible employees (including officers) as well as to our non-employee directors. Options may be issued with the exercise prices equal to the fair market value of the common stock on the date of grant or at a price determined by a committee of our board of directors. Stock options vest and are exercisable over periods determined by the committee, generally five years, and expire no more than 10 years after the grant.
In July 2004, our board of directors affirmed our June 2004 decision to indefinitely suspend the exercise and future grant of options under our stock option plans. Ten former executives separated from us in 2005 and 2004. Notwithstanding the suspension, to the extent such executives held options that were vested as of their resignation date, such options remain exercisable for the post-termination period, generally 90 days, commencing on the date that the suspension is lifted for the exercise of options. There are 580 shares that have qualified for this post-termination exercise period. A summary of these post-termination options as of December 31, 2006 is as follows:
| Options Exercisable | ||||||||||||
| Average | ||||||||||||
| Number of | Intrinsic | Exercise | ||||||||||
Range of Exercise Prices | Shares | Value | Price | |||||||||
| $ 2.71-$10.00 | 34 | $ | 280 | $ | 5.39 | |||||||
| $10.01-$20.00 | 123 | — | $ | 15.59 | ||||||||
| $20.01-$70.00 | 423 | — | $ | 46.59 | ||||||||
| 580 | $ | 280 | ||||||||||
The extension of the life of the awards was recorded as a modification of the grants. Under APB 25, the modification created intrinsic value for vested stock if the market value of the stock on the date of termination
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Notes to Consolidated Financial Statements
(In thousands, except per share amounts)
exceeded the exercise price. Therefore, these grants required an immediate recognition of the compensation expense with an offsetting credit to common stock. We recorded a charge of $0, $37 and $209 for the years ended December 31, 2006, 2005 and 2004, respectively.
Information with respect to our common stock options is as follows:
| Weighted | ||||||||||||||||
| Weighted | Average | |||||||||||||||
| Shares | Average | Remaining | Aggregate | |||||||||||||
| Subject to | Exercise | Contractual | Intrinsic | |||||||||||||
| Options | Price | Life in Years | Value | |||||||||||||
| Outstanding, January 1, 2004 | 5,428 | $ | 29.42 | |||||||||||||
| Exercised | (210 | ) | $ | 3.87 | ||||||||||||
| Forefeited | (562 | ) | $ | 35.18 | ||||||||||||
| Canceled | (607 | ) | $ | 37.39 | ||||||||||||
| Outstanding, December 31, 2004 | 4,049 | $ | 28.76 | |||||||||||||
| Forefeited | (216 | ) | $ | 34.25 | ||||||||||||
| Canceled | (401 | ) | $ | 27.77 | ||||||||||||
| Outstanding, December 31, 2005 | 3,432 | $ | 28.18 | |||||||||||||
| Forefeited | (75 | ) | $ | 22.11 | ||||||||||||
| Canceled | (1,207 | ) | $ | 22.00 | ||||||||||||
| Outstanding, December 31, 2006 | 2,150 | $ | 31.86 | 4.1 | $ | 365 | ||||||||||
| Exercisable, December 31, 2006 | 1,930 | $ | 32.92 | 3.9 | $ | 365 | ||||||||||
| Options vested and expected to vest as of December 31, 2006 | 1,996 | $ | 32.57 | 3.9 | $ | 365 | ||||||||||
The aggregate intrinsic value is calculated using the difference between the closing stock price on the last trading day of 2006 and the option exercise price, multiplied by the number of in-the-money options.
A summary of outstanding and exercisable options as of December 31, 2006 is as follows:
| Options Outstanding | Options Exercisable | |||||||||||||||||||
| Weighted | ||||||||||||||||||||
| Average | Weighted | Weighted | ||||||||||||||||||
| Remaining | Average | Average | ||||||||||||||||||
| Range of | Number | Contractual Life | Exercise | Number | Exercise | |||||||||||||||
Exercise Prices | of Shares | (in years) | Price | of Shares | Price | |||||||||||||||
| $ 2.71-$10.00 | 46 | 2.3 | $ | 6.00 | 46 | $ | 6.00 | |||||||||||||
| $10.01-$20.00 | 553 | 4.8 | $ | 16.70 | 429 | $ | 16.49 | |||||||||||||
| $20.01-$30.00 | 851 | 4.4 | $ | 26.74 | 755 | $ | 26.43 | |||||||||||||
| $30.01-$40.00 | 194 | 3.1 | $ | 32.41 | 194 | $ | 32.41 | |||||||||||||
| $40.01-$70.00 | 506 | 3.2 | $ | 59.18 | 506 | $ | 59.18 | |||||||||||||
| 2,150 | 4.1 | $ | 31.86 | 1,930 | $ | 32.92 | ||||||||||||||
There were no options granted during 2006, 2005 and 2004. There were no shares exercised in 2006 and 2005. The total intrinsic value of options exercised in 2004 was $2,738. The total fair value of shares vested during 2006 was $1,923.
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MedQuist Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(In thousands, except per share amounts)
As of December 31, 2006, there were 1,133 additional options available for grant under our stock option plans. When we become up to date in our reporting to the SEC, certain executive officers, in accordance with their employment agreements, will receive an aggregate of 200 options with an exercise price equal to the then market value of our common stock on the date of grant. In 2005, $78 is included in the pro forma stock-based compensation amount depicted in Note 3 related to these options. In 2006, $136 is included as selling, general and administrative expenses and $58 is included in research and development expenses in the accompanying consolidated statement of operations related to these options with the total of $194 included in common stock in the accompanying consolidated balance sheet as of December 31, 2006. Since the exercise price of these options is not yet known, the fair value of such awards will be remeasured as of each balance sheet date until such time as the exercise price is determined.
| 15. | Income Taxes |
The sources of (loss) income before income taxes and the income tax provision for the years ended December 31, 2006, 2005 and 2004 are as follows:
| 2006 | 2005 | 2004 | ||||||||||
| (Loss) income before income taxes: | ||||||||||||
| Domestic | $ | (15,302 | ) | $ | (93,021 | ) | $ | 6,394 | ||||
| Foreign | 654 | 2,151 | 1,581 | |||||||||
| (Loss) income before income taxes | $ | (14,648 | ) | $ | (90,870 | ) | $ | 7,975 | ||||
| Current income tax (benefit) provision: | ||||||||||||
| Federal | $ | (3,615 | ) | $ | (16,171 | ) | $ | 5,501 | ||||
| State and local | 291 | (151 | ) | 529 | ||||||||
| Foreign | 393 | 429 | 406 | |||||||||
| Current income tax (benefit) provision | (2,931 | ) | (15,893 | ) | 6,436 | |||||||
| Deferred income tax provision (benefit): | ||||||||||||
| Federal | 4,825 | 28,702 | (3,506 | ) | ||||||||
| State and local | (259 | ) | 7,830 | (1,036 | ) | |||||||
| Foreign | 659 | 123 | 2,339 | |||||||||
| Deferred income tax provision (benefit) | 5,225 | 36,655 | (2,203 | ) | ||||||||
| Income tax provision | $ | 2,294 | $ | 20,762 | $ | 4,233 | ||||||
The reconciliation of the statutory federal income tax rate to our effective income tax rate is as follows:
| Statutory federal income tax rate | 35.0 | 35.0 | 35.0 | |||||||||
| State income taxes, net of federal tax effect | (2.5 | ) | 5.0 | (3.9 | ) | |||||||
| Valuation allowance | (40.4 | ) | (62.5 | ) | 17.8 | |||||||
| Impact of foreign operations | (1.1 | ) | (0.5 | ) | 2.0 | |||||||
| Adjustments to tax reserves | 1.7 | 0.5 | 1.1 | |||||||||
| Permanent differences | (7.1 | ) | (0.7 | ) | 1.8 | |||||||
| Other | (1.3 | ) | 0.4 | (0.7 | ) | |||||||
| Effective income tax rate | (15.7 | ) | (22.8 | ) | 53.1 | |||||||
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MedQuist Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(In thousands, except per share amounts)
Deferred income taxes reflect the net tax effect of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of our deferred tax assets and liabilities as of December 31, 2006, 2005 and 2004 were as follows:
| 2006 | 2005 | 2004 | ||||||||||
Deferred tax assets: | ||||||||||||
| Foreign net operating loss carryforwards | $ | 3,349 | $ | 3,022 | $ | 3,628 | ||||||
| Domestic net operating loss carryforwards | 18,492 | 2,687 | 101 | |||||||||
| Accounts receivable | 1,846 | 1,964 | 2,040 | |||||||||
| Property and equipment | 1,975 | 1,285 | — | |||||||||
| Intangibles | 22,285 | 24,192 | 25,145 | |||||||||
| Employee compensation and benefit plans | 1,250 | 2,136 | 1,799 | |||||||||
| Deferred compensation | 446 | 954 | 1,332 | |||||||||
| Customer accommodation and quantification | 6,374 | 18,485 | 3,832 | |||||||||
| Accruals and reserves | 10,556 | 8,078 | 4,187 | |||||||||
| Other | 2,113 | 1,761 | 1,851 | |||||||||
| Total gross deferred tax assets | 68,686 | 64,564 | 43,915 | |||||||||
| Less: Valuation allowance | (64,601 | ) | (58,039 | ) | (1,476 | ) | ||||||
| Total deferred tax assets | 4,085 | 6,525 | 42,439 | |||||||||
Deferred tax liabilities: | ||||||||||||
| Property and equipment | — | — | (1,922 | ) | ||||||||
| Intangibles | (18,704 | ) | (15,947 | ) | (13,110 | ) | ||||||
| Other | (739 | ) | (919 | ) | (903 | ) | ||||||
| Total deferred tax liabilities | (19,443 | ) | (16,866 | ) | (15,935 | ) | ||||||
| Net deferred tax (liability) asset | $ | (15,358 | ) | $ | (10,341 | ) | $ | 26,504 | ||||
As of December 31, 2006, we had federal net operating loss carry forwards of approximately $37,382 which will expire in 2026.
As of December 31, 2006 and 2005, we had state net operating loss carry forwards of approximately $115,632 and $60,378, respectively, which will expire between 2007 and 2026. In addition, we have foreign net operating loss carry forwards of approximately $16,369, which do not expire. Utilization of the net operating loss carry forwards may be subject to an annual limitation in the event of a change in ownership in future years as defined by Section 382 of the Internal Revenue Code and similar state provisions.
In assessing the future realization of deferred taxes, we consider whether it is more likely than not that some portion or all of the deferred income tax assets will not be realized based on projections of our future taxable earnings. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible.
During 2006, we increased our valuation allowance against our deferred income tax assets generated in foreign tax jurisdictions from $1,231 to $1,803 since management felt it was more likely than not that these deferred income tax assets would not be utilized.
In the fourth quarter of 2005, a valuation allowance of $56,808 was established against various domestic deferred income tax assets. After consideration of all evidence, both positive and negative, management concluded
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MedQuist Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(In thousands, except per share amounts)
that it was more likely than not that a majority of the domestic deferred income tax assets would not be realized. In 2006, we increased this valuation allowance to $62,798.
Domestic deferred income tax assets were recognized to the extent that objective positive evidence existed with respect to their future utilization. The objective positive evidence included the potential to carry back any losses generated by the deferred income tax assets in the future as well as income expected to be recognized due to the reversal of deferred income tax liabilities as of December 31, 2006. In analyzing deferred income tax liabilities as a source for potential income for purposes of recognizing deferred income tax assets, the deferred income tax liabilities related to excess book basis in goodwill over tax basis in goodwill were considered a source of future income for benefiting deferred income tax assets with indefinite lives only due to the indefinite life and uncertainty of reversal of these liabilities during the same period as thenon-indefinite life deferred income tax assets.
| 16. | Employee Benefit Plans |
401(k) Plan
We maintain a tax-qualified retirement plan named the MedQuist 401(k) Plan (401(k) Plan) that provides eligible employees with an opportunity to save for retirement on a tax advantaged basis. Our 401(k) Plan allows eligible employees to contribute up to 25% of their annual eligible compensation on a pre-tax basis, subject to applicable Internal Revenue Code limits. Elective deferral contributions are allocated to each participant’s individual account and are then invested in selected investment alternatives according to the participant’s directives. Employee elective deferrals are 100% vested at all times. We match 50% of each participant’s contribution, up to a maximum of 5% of each participant’s total annual eligible compensation. Matching contributions are 20% vested after two years of service, 40% after three years of service, 60% after four years of service and 100% vested after five years of service. A matching contribution was made on a per pay basis semi-monthly, using our common stock until April 2004. Subsequent to April 2004, our match was made in cash. The charge to operations for our matching contributions for the years ended December 31, 2006, 2005 and 2004 was $1,432, $1,380 and $1,511, respectively.
Employee Stock Purchase Plan
In 2003, all full-time employees except those who owned 5% or more of our common stock were eligible to participate in our Employee Stock Purchase Plan (ESPP). The ESPP provided that participants could authorize us to withhold up to 10% of their earnings for the purchase of shares of our common stock. The purchase price of the common stock was determined by the compensation committee of our board of directors, but could not be less than 85% of the fair market value of our common stock on the date of purchase. For the year ended December 31, 2004, the ESPP purchased from us 15 shares of common stock at a total purchase price of $216. Effective June 15, 2004, we suspended the ESPP indefinitely and no purchases have been made since the plan was suspended.
Executive Deferred Compensation Plan
We established the MedQuist Inc. Executive Deferred Compensation Plan (EDCP) in 2001. The EDCP, which is administered by the compensation committee of our board of directors, allowed certain members of management and highly compensated employees to defer a certain percentage of their income. Participants were permitted to defer compensation into an account in which proceeds were available either during or after termination of employment. The compensation committee authorized that certain contributions made to a retirement distribution account be matched with either shares of our common stock or cash. Participants were not entitled to receive matching contributions if they elected to make deferrals to an account into which proceeds are available during employment. Participants were able to defer up to 15% of their base salary (or such other maximum percentage as may be approved by the compensation committee) and 90% of their bonus (or such other maximum percentage as may be approved by the compensation committee). Distributions to a participant made pursuant to a retirement distribution account may be made to the participant upon the participant’s termination or attainment of age 65, as
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MedQuist Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(In thousands, except per share amounts)
elected by the participant in their enrollment agreement. Distributions to a participant made pursuant to an in-service distribution account may be made at the election of the participant in their enrollment agreement, subject to certain exceptions. The balances in the EDCP are not funded, but are segregated, and participants in the EDCP are our general creditors. All amounts deferred in the EDCP increase or decrease based on hypothetical investment results of the participant’s selected investment alternatives. However, EDCP distributions are paid out of our funds rather than from a dedicated investment portfolio. As of December 31, 2006 and 2005, the value of the assets held, managed and invested pursuant to the EDCP was $1,120 and $1,096, respectively, and is included in other current assets in the accompanying consolidated balance sheets. As of December 31, 2006 and 2005, the corresponding deferred compensation liability reflecting amounts due to employees was $827 and $1,017, respectively, and is included in accrued expenses in the accompanying consolidated balance sheets.
Effective January 1, 2005, the EDCP was suspended and no further contributions have been made.
Board of Directors Deferred Compensation Plan
Under our Board of Directors Deferred Compensation Plan (BDDCP) in effect through 2004, each independent director had the right to receive an annual grant of deferred compensation in the form of our common stock having a fair market value of $18 on the date of grant. Under the BDDCP, common stock will not be issued until the date a director leaves our board of directors. For purposes of valuing common stock granted under the plan, fair market value equaled the closing price of the common stock on the date of grant. Grants were automatically made on January 1 of each year. In addition to the deferred compensation discussed above, our independent directors each received $54 as the cash portion of their compensation for a two year period (2003 and 2004) for their services as independent directors.
Commencing on January 1, 2005, a portion of the compensation paid to our independent directors was deferred compensation in the form of common stock having a fair market value of $50 on the date of grant. Our board of directors postponed the granting of the deferred compensation awards for 2006 and 2005 until such time as we become up to date with our periodic reporting obligations with the SEC. As of December 31, 2006, 2005 and 2004, $332, $332 and $332, respectively, related to deferred compensation is included in the accompanying consolidated statements of shareholders’ equity and other comprehensive income.
17. Related-Party Transactions
From time to time, we enter into transactions in the normal course of business with related parties. The audit committee of our board of directors has been charged with the responsibility of approving or satisfying all related party transactions other than those between us and Philips.
In connection with Philips’ investment in us, we have entered into various agreements with Philips. All material transactions between Philips and us are reviewed and approved by the supervisory committee of our board of directors. The supervisory committee is comprised of directors’ independent from Philips. Listed below is a summary of our material agreements with Philips.
Licensing Agreement
In connection with Philips’ tender offer, we entered into a Licensing Agreement with Philips Speech Processing GmbH, an affiliate of Philips which is now known as Philips Speech Recognition Systems GmbH (PSRS), on May 22, 2000 (Licensing Agreement). The Licensing Agreement was subsequently amended by the parties as of January 1, 2002, February 23, 2003, August 10, 2003, September 1, 2004, December 30, 2005 and February 13, 2007.
Under the Licensing Agreement, we license from PSRS its SpeechMagic speech recognition and processing software, including any updated versions of the software developed by PSRS during the term of the License
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Notes to Consolidated Financial Statements
(In thousands, except per share amounts)
Agreement (Licensed Product), for use by us anywhere in the world. We pay a fee for use of this license based upon a per line fee for each transcribed line of text processed through the Licensed Product.
Upon the expiration of its initial term on June 28, 2005, the Licensing Agreement was renewed for an additional five year term.
In connection with the Licensing Agreement, we have a consulting arrangement with PSRS whereby PSRS assists us with the integration of its speech and transcription technologies.
OEM Supply Agreement
We entered into an OEM Supply Agreement with PSRS on September 23, 2004 pursuant to which we obtained the exclusive right in North America to sell certain PSRS Products (as defined below) createdand/or developed by PSRS to third parties, to service such PSRS Products and to incorporate such PSRS Products into our own products (OEM Supply Agreement).
Upon the expiration of its initial term on June 30, 2007, the OEM Supply Agreement was renewed for an additional three year term. Unless earlier terminated, the OEM Supply Agreement automatically renews for one additional three year term, provided that we are in compliance with the OEM Supply Agreement at the end of the initial term and each renewal term.
In 2004, we made a payment to PSRS with respect to software purchases and payments under the OEM Supply Agreement in an amount equal to the sales forecast and commitment set forth in the OEM Supply Agreement for such year. We did not meet the sales forecast and commitment set forth in the OEM Supply Agreement for 2005.
If PSRS decides to discontinue all business relating to the PSRS Products in North America, PSRS has the right to terminate the OEM Supply Agreement by giving us six months prior written notice, in which case PSRS agrees to negotiate in good faith with us the terms and conditions under which it will provide training and access to source code of the PSRS Products to the extent reasonably necessary for us to continue development and to support the installed base of PSRS Products in North America.
In consideration of PSRS’s development, maintenance and support for the first version of the PSRS Products, we paid PSRS a development fee in 2004. In addition, we pay monthly license fees to PSRS, subject to certain reductions based upon the level of purchases of PSRS Products by us under the OEM Supply Agreement relative to annual forecasted amounts.
Under the OEM Supply Agreement, we are required to use reasonable commercial efforts to sell end users a software maintenance agreement. The software maintenance agreement provides that the customer will obtain certain product releases and technical support directly from PSRS or from PSRS through us. We pay a fee to PSRS for each software maintenance agreement contract sold by us.
Equipment Sales
We purchase dictation related equipment from Philips.
Insurance Coverage through Philips
We obtain all of our business insurance coverage (other than workers’ compensation) through Philips.
Purchasing Agreements
We enter into annual letter agreements with Philips Electronics North America Corporation (PENAC), an affiliate of Philips, to purchase products and services from certain suppliers under the terms of the prevailing agreements between such suppliers and PENAC.
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MedQuist Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(In thousands, except per share amounts)
From time to time, we enter into other miscellaneous transactions with Philips including Philips purchasing certain products and implementation services from us. We recorded net revenues from sales to Philips of $26, $754 and $650 for the years ended December 31, 2006, 2005 and 2004, respectively.
Our consolidated balance sheets as of December 31, 2006 and 2005 reflect other current assets related to Philips of $0 and $1,786, respectively, and accrued expenses related to Philips of $2,030 and $987, respectively.
Listed below is a summary of the expenses incurred by us in connection with the various Philips agreements noted above for the years ended December 31, 2006, 2005 and 2004. Charges related to these agreements are included in cost of revenues and selling, general and administrative expenses in the accompanying consolidated statements of operations.
| Years Ended December 31, | ||||||||||||
| 2006 | 2005 | 2004 | ||||||||||
| PSRS licensing | $ | 2,390 | $ | 1,216 | $ | — | ||||||
| PSRS consulting | 3 | 162 | 435 | |||||||||
| OEM agreement | 1,429 | 1,521 | 1,851 | |||||||||
| Dictation equipment | 878 | 1,238 | 720 | |||||||||
| Insurance | 1,601 | 957 | 696 | |||||||||
| PENAC | 30 | 54 | 50 | |||||||||
| Other | 42 | 248 | 589 | |||||||||
| Total | $ | 6,373 | $ | 5,396 | $ | 4,341 | ||||||
On July 29, 2004, we entered into an agreement with Nightingale under which Nightingale agreed to provide interim chief executive services to us. On July 30, 2004, our board of directors appointed Howard S. Hoffmann to serve as our Chief Executive Officer (CEO). In June 2004, our board of directors appointed Mr. Hoffmann to serve as our President. Mr. Hoffmann serves as the Managing Partner of Nightingale. Mr. Hoffmann continues to serve as our President and Chief Executive Officer pursuant to the terms of the agreement, which expired on June 30, 2007. We are currently negotiating the terms of an extension of this agreement. Our board of directors is responsible for monitoring and reviewing the performance of Mr. Hoffmann on an ongoing basis. Our agreement with Nightingale also permits us to engage additional personnel employed by Nightingale to provide consulting services to us from time to time.
For the years ended December 31, 2006, 2005 and 2004, we incurred charges of $3,005, $3,207 and $1,371, respectively, for Nightingale services. As of December 31, 2006 and 2005, accrued expenses included $548 and $487, respectively, for amounts due to Nightingale for services performed.
See Note 11 for a discussion of our agreements with A-Life.
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Notes to Consolidated Financial Statements
(In thousands, except per share amounts)
| 18. | Quarterly Data (unaudited) |
| 1st | 2nd | 3rd | 4th | |||||||||||||
| Quarter | Quarter | Quarter | Quarter | |||||||||||||
2004 | ||||||||||||||||
| Net revenues | $ | 116,789 | $ | 112,845 | $ | 112,605 | $ | 109,655 | ||||||||
| Net income (loss) | $ | 7,239 | $ | 4,461 | $ | 3,450 | $ | (11,408 | ) | |||||||
| Net income (loss) per share: | ||||||||||||||||
| Basic | $ | 0.19 | $ | 0.12 | $ | 0.09 | $ | (0.30 | ) | |||||||
| Diluted | $ | 0.19 | $ | 0.12 | $ | 0.09 | $ | (0.30 | ) | |||||||
| Weighted average shares outstanding: | ||||||||||||||||
| Basic | 37,387 | 37,473 | 37,484 | 37,484 | ||||||||||||
| Diluted | 37,709 | 37,656 | 37,595 | 37,484 | ||||||||||||
2005 | ||||||||||||||||
| Net revenues | $ | 108,449 | $ | 103,364 | $ | 97,084 | $ | 44,108 | (1) | |||||||
| Net loss | $ | (1,160 | ) | $ | (3,248 | ) | $ | (4,722 | ) | $ | (102,502 | )(2) | ||||
| Net loss per share: | ||||||||||||||||
| Basic | $ | (0.03 | ) | $ | (0.09 | ) | $ | (0.13 | ) | $ | (2.73 | ) | ||||
| Diluted | $ | (0.03 | ) | $ | (0.09 | ) | $ | (0.13 | ) | $ | (2.73 | ) | ||||
| Weighted average shares outstanding: | ||||||||||||||||
| Basic | 37,484 | 37,484 | 37,484 | 37,484 | ||||||||||||
| Diluted | 37,484 | 37,484 | 37,484 | 37,484 | ||||||||||||
2006 | ||||||||||||||||
| Net revenues | $ | 96,014 | $ | 93,359 | $ | 82,096 | $ | 86,622 | ||||||||
| Net loss | $ | (8,471 | ) | $ | (2,416 | ) | $ | (2,104 | ) | $ | (3,951 | ) | ||||
| Net loss per share: | ||||||||||||||||
| Basic | $ | (0.23 | ) | $ | (0.06 | ) | $ | (0.06 | ) | $ | (0.11 | ) | ||||
| Diluted | $ | (0.23 | ) | $ | (0.06 | ) | $ | (0.06 | ) | $ | (0.11 | ) | ||||
| Weighted average shares outstanding: | ||||||||||||||||
| Basic | 37,484 | 37,484 | 37,484 | 37,484 | ||||||||||||
| Diluted | 37,484 | 37,484 | 37,484 | 37,484 | ||||||||||||
| (1) | Reflects a reduction in net revenues related to the Accommodation Analysis of $51,939. | |
| (2) | The fourth quarter 2005 net loss reflects the aforementioned reduction in net revenues as well as the establishment of a valuation allowance of $56,808 against various domestic deferred income tax assets. After consideration of all evidence, both positive and negative, management concluded that it was more likely than not that a majority of the domestic deferred income tax assets would not be realized. |
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Table of Contents
MedQuist Inc. and Subsidiaries
Schedule II — Valuation and Qualifying Accounts
(In thousands)
Allowance for Doubtful Accounts and Returns
| Balance at | Charges to | Doubtful | Balance at | |||||||||||||
| Beginning | Revenues and | Accounts | End of | |||||||||||||
| of Period | and Expenses | Written Off | Period | |||||||||||||
| December 31, 2004 | $ | 5,254 | 5,992 | (6,603 | ) | $ | 4,643 | |||||||||
| December 31, 2005 | $ | 4,643 | 8,111 | (8,365 | ) | $ | 4,389 | |||||||||
| December 31, 2006 | $ | 4,389 | 4,955 | (4,850 | ) | $ | 4,494 | |||||||||
Includes amounts written off to costs and expenses for bad debts of $552, $540, and ($519) for the years ended December 31, 2006, 2005 and 2004, respectively, and amounts charged to revenues for customer credits of $4,403, $7,571 and $6,511 for the years ended December 31, 2006, 2005 and 2004, respectively.
F-37
Table of Contents
EXHIBIT INDEX
No. | Description | |||
| 23 | Consent of KPMG LLP | |||
| 24 | Power of Attorney (included on the signature page hereto) | |||
| 31 | .1 | Certification of Chief Executive Officer required byRule 13a-14(a) orRule 15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | ||
| 31 | .2 | Certification of Chief Financial Officer required byRule 13a-14(a) orRule 15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | ||
| 32 | .1 | Certification of Chief Executive Officer pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 | ||
| 32 | .2 | Certification of Chief Financial Officer pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 | ||