Medquist 10Q 2008 Q3 Quarterly report

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q

(Mark One)


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

For the quarterly period ended September 30, 2008.


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

For the transition period from to

Commission file number: 001-13326

MEDQUIST INC.

(Exact name of registrant as specified in its charter)


New Jersey (State or other jurisdiction of incorporation or organization)		22-2531298 (I.R.S. Employer Identification No.)

1000 BISHOPS GATE BOULEVARD
SUITE 300
MOUNT LAUREL, NEW JERSEY		08054-4632
(Address of principal executive offices)		(Zip Code)

(856) 206-4000
(Registrant’s telephone number, including area code)

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

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

Large accelerated filer o

Accelerated filer þ

Non-accelerated filer o
(Do not check if a smaller reporting company)

Smaller reporting company o

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

The number of registrant’s shares of common stock, no par value, outstanding as of October 31, 2008 was 37,555,893.

MEDQUIST INC.
INDEX


		Page
PART I.	FINANCIAL INFORMATION		3
Item 1.	Financial Statements		3
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		22
Item 4.	Controls and Procedures		29
PART II.	OTHER INFORMATION		30

Item 1.	Legal Proceedings		30
Item 1A.	Risk Factors		34
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds		35
Item 3.	Defaults Upon Senior Securities		35
Item 4.	Submission of Matters to a Vote of Security Holders		35
Item 5.	Other Information		35
Item 6.	Exhibits		35

	Transcription Services Agreement

	Certification of Chief Executive Officer

	Certification of Chief Financial Officer

	Certification of Chief Executive Officer

	Certification of Chief Financial Officer

PART I. FINANCIAL INFORMATION

Item 1.Financial Statements

MedQuist Inc. and Subsidiaries
Consolidated Statements of Operations
(In thousands, except per share amounts)
Unaudited


	Three months ended						Nine months ended
	September 30,						September 30,
	2008			2007			2008			2007

Net revenues	$	81,287		$	82,518		$	247,466		$	260,276


Operating costs and expenses:
Cost of revenues		57,235			64,290			176,508			198,918
Selling, general and administrative		13,148			15,548			39,047			48,158
Research and development		4,648			3,808			12,502			10,073
Depreciation		2,977			2,861			8,901			8,040
Amortization of intangible assets		1,411			1,361			4,145			4,065
Cost of investigation and legal proceedings, net		7,181			4,441			15,307			(456	)
Restructuring charges		(37	)		554			(82	)		935


Total operating costs and expenses		86,563			92,863			256,328			269,733


Operating loss		(5,276	)		(10,345	)		(8,862	)		(9,457	)

Equity in income of affiliated company		159			124			200			447
Other income		—			—			438			—
Interest income, net		418			2,302			2,601			6,477


Loss before income taxes		(4,699	)		(7,919	)		(5,623	)		(2,533	)

Income tax provision		1,063			1,016			2,721			2,402


Net loss	$	(5,762	)	$	(8,935	)	$	(8,344	)	$	(4,935	)


Net loss per share:
Basic	$	(0.15	)	$	(0.24	)	$	(0.22	)	$	(0.13	)

Diluted	$	(0.15	)	$	(0.24	)	$	(0.22	)	$	(0.13	)


Weighted average shares outstanding:
Basic		37,554			37,484			37,547			37,484

Diluted		37,554			37,484			37,547			37,484

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

MedQuist Inc. and Subsidiaries
Consolidated Balance Sheets
(In thousands)
Unaudited


	September 30,			December 31,
	2008			2007
Assets
Current assets:
Cash and cash equivalents	$	47,297		$	161,582
Accounts receivable, net of allowance of $4,565 and $4,359, respectively		47,815			48,725
Income tax receivable		631			815
Other current assets		9,349			7,920

Total current assets		105,092			219,042

Property and equipment, net		17,926			21,366
Goodwill		124,510			125,505
Other intangible assets, net		40,631			42,262
Deferred income taxes		2,225			2,712
Other assets		6,745			6,885


Total assets	$	297,129		$	417,772


Liabilities and Shareholders’ Equity
Current liabilities:
Accounts payable	$	8,684		$	12,754
Accrued expenses		18,377			18,989
Accrued compensation		14,750			14,826
Customer accommodation and quantification		12,136			18,459
Deferred income tax liability — current		4,783			4,783
Deferred revenue		15,926			16,023

Total current liabilities		74,656			85,834

Deferred income taxes		17,248			15,151

Other non-current liabilities		2,079			2,143


Commitments and contingencies

Shareholders’ equity:
Common stock — no par value; authorized 60,000 shares; 37,556 and 37,544 shares issued and outstanding, respectively		237,842			236,412
Retained earnings (deficit)		(38,746	)		72,876
Accumulated other comprehensive income		4,050			5,356


Total shareholders’ equity		203,146			314,644


Total liabilities and shareholders’ equity	$	297,129		$	417,772

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

MedQuist Inc. and Subsidiaries
Consolidated Statements of Cash Flows
(In thousands)
Unaudited


	Nine months ended
	September 30,
	2008			2007
Operating activities:
Net loss	$	(8,344	)	$	(4,935	)
Adjustments to reconcile net loss to cash provided by (used in) operating activities:
Depreciation and amortization		13,046			12,105
Equity in income of affiliated company		(200	)		(447	)
Deferred income tax provision		2,425			1,848
Stock option expense		1,361			446
Provision for doubtful accounts		2,065			3,649
Loss on disposal of property and equipment		47			78

Changes in operating assets and liabilities:
Accounts receivable		(1,917	)		(4,707	)
Income tax receivable		184			(151	)
Insurance receivable		—			707
Other current assets		(1,437	)		(954	)
Other non-current assets		117			(219	)
Accounts payable		(4,393	)		3,156
Accrued expenses		(984	)		(9,341	)
Accrued compensation		(53	)		929
Customer accommodation and quantification		(5,651	)		(4,048	)
Deferred revenue		(57	)		(84	)
Other non-current liabilities		(92	)		1,938

Net cash used in operating activities	$	(3,883	)	$	(30	)


Investing activities:
Purchase of property and equipment		(5,015	)		(8,337	)
Capitalized software		(2,712	)		(1,218	)
Proceeds from sale of investments		692			—

Net cash used in investing activities		(7,035	)		(9,555	)


Financing activities:
Dividends paid		(103,279	)		—
Proceeds from exercise of stock options		68			—

Net cash used in financing activities		(103,211	)		—


Effect of exchange rate changes		(156	)		115


Net decrease in cash and cash equivalents		(114,285	)		(9,470	)


Cash and cash equivalents — beginning of period		161,582			175,412


Cash and cash equivalents — end of period	$	47,297		$	165,942


Supplemental cash flow information:

Cash paid for income taxes	$	249		$	167

Accommodation payments paid with credits	$	659		$	1,961

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

MedQuist Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(In thousands, except for per share amounts)
Unaudited

1. Description of Business

MedQuist is the largest Medical Transcription Service Organization (MTSO) in the world, and a leader in technology enabled clinical documentation workflow. We service health systems, hospitals and large group medical practices throughout the U.S., and we employ approximately 5,400 skilled medical transcriptionists (MTs), making us the largest employer of MTs in the U.S. We believe our services and enterprise technology solutions — including mobile voice capture devices, speech recognition technologies, Web-based workflow platforms, and global network of MTs and editors — enable healthcare facilities to improve patient care, increase physician satisfaction, and lower operational costs.

Change in Majority Owner

On August 6, 2008, CBaySystems Holdings Limited (CBaySystems Holdings), a company that is publicly traded on the AIM market of the London Stock Exchange with a portfolio of investments in medical transcription, which includes a company that competes in the medical transcription market, healthcare technology, and healthcare financial services, acquired a 69.5% ownership interest in us from Koninklijke Philips Electronics N.V. (Philips) for $11.00 per share (CBaySystems Holdings Purchase). Immediately prior to the closing of the CBaySystems Holdings Purchase, four of our directors affiliated with Philips resigned from our board of directors and four individuals affiliated with CBaySystems Holdings were appointed to our board of directors.

Other Matters

The Company’s stock began trading on the Global Market of The NASDAQ Stock Market LLC under the ticker symbol “MEDQ” effective on July 17, 2008. On August 4, 2008, we announced the payment of a dividend of $2.75 per share of our common stock to shareholders of record as of the close of business on July 25, 2008. On September 4, 2008, we announced that our board of directors had named Peter Masanotti as Chief Executive Officer, and he joined the Company on September 16, 2008.

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 (Review). On March 16, 2004, we announced that we had delayed the filing of our Form 10-K for the year ended December 31, 2003 pending the completion of the Review. 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.

In response to our customers’ concern over the public disclosure of certain findings from the Review, we made the decision in the fourth quarter of 2005 to take action to try to avoid litigation and preserve and solidify our customer business relationships by offering a financial accommodation to certain of our customers. See Note 7.

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 11.

On July 5, 2007, we filed our Form 10-K for the year ended December 31, 2005 (2005 Form 10-K). The 2005 Form 10-K was our first periodic report covering the period after September 30, 2003. On August 31, 2007, we filed our Forms 10-Q for the quarters ended March 31, 2006, June 30, 2006 and September 30, 2006 as well as our Form 10-K for the year ended December 31, 2006. On October 4, 2007, we filed our Forms 10-Q for the quarters ended March 31, 2007 and June 30, 2007. On November 9, 2007, we timely filed our Form 10-Q for the quarter ended September 30, 2007 and we have timely filed all periodic reports since that date.

3. Basis of Presentation

The consolidated financial statements included herein are unaudited and have been prepared by us pursuant to the rules and regulations of the SEC. Certain information and footnote disclosures normally included in financial statements prepared in accordance with U.S. generally accepted accounting principles (GAAP) have been omitted pursuant to such rules and regulations although we believe that the disclosures are adequate to make the information presented not misleading. The consolidated financial statements include our accounts and the accounts of all of our wholly-owned subsidiaries. All significant inter-company accounts and transactions have been eliminated in consolidation.

These statements reflect all normal recurring adjustments that, in the opinion of management, are necessary for the fair presentation of the information contained herein. These consolidated financial statements should be read in conjunction with Management’s

MedQuist Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(In thousands, except for per share amounts)
Unaudited

Discussion and Analysis of Financial Condition and Results of Operations. As permitted under GAAP, interim accounting for certain expenses is based upon full year assumptions. Such amounts are expensed in full in the year incurred. For interim financial reporting purposes, income taxes are recorded based upon actual year to date income tax rates as permitted by Financial Accounting Standards Board (FASB) Interpretation 18, Accounting for Income Taxes in Interim Periods.

Our accounting policies are set forth in detail in Note 3 to the consolidated financial statements in our Annual Report on Form 10-K for the year ended December 31, 2007 filed with the SEC on March 17, 2008.

In September 2006, FASB issued Statement of Financial Accounting Standards (SFAS) No. 157, “Fair Value” (SFAS 157). SFAS 157 defines fair value, creates a framework within GAAP for measuring fair value, and expands disclosures about fair value measurements. In defining fair value, SFAS 157 emphasizes a market-based measurement approach that is based on the assumptions that market participants would use in pricing an asset or liability. SFAS 157 does not require any new fair value measurements, but does generally apply to other accounting pronouncements that require or permit fair value measurements. In February 2008, the FASB issued FSP FAS 157-2, “Effective Date of FASB Statement No. 157,” which delays for one year the effective date of SFAS 157 for most nonfinancial assets and nonfinancial liabilities. Nonfinancial instruments affected by this deferral include assets and liabilities such as reporting units measured at fair value in a goodwill impairment test and nonfinancial assets acquired and liabilities assumed in a business combination. Effective January 1, 2008, we adopted SFAS 157 for financial assets and financial liabilities recognized at fair value on a recurring basis. The partial adoption of SFAS 157 for these items did not have a material impact on our financial position, results of operations and cash flows. The statement establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into three broad categories. Level 1: Quoted market prices in active markets for identical assets or liabilities that the company has the ability to access. Level 2: Observable market based inputs or unobservable inputs that are corroborated by market data such as quoted prices, interest rates and yield curves. Level 3: Inputs are unobservable data points that are not corroborated by market data. At September 30, 2008, we held two financial assets, cash and cash equivalents (Level 1) and our Executive Deferred Compensation Plan (EDCP) included in other current assets with a fair value of $896. We measure the fair value of our EDCP on a recurring basis using Level 2 (significant other observable) inputs as defined by SFAS 157. The adoption of SFAS 157 did not have a material impact on the basis for measuring the fair value of these items.

In February 2007, FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities — including an amendment of FASB Statement No .115.” This statement permits entities to choose to measure many financial instruments and certain other items at fair value. This statement is effective for financial statements issued for fiscal years beginning after November 15, 2007, including interim periods within that fiscal year. We did not elect the fair value option for any of our existing financial instruments as of September 30, 2008 and we have not determined whether or not we will elect this option for financial instruments we may acquire in the future.

In December 2007, FASB issued SFAS No. 141 (revised 2007), “Business Combinations” (SFAS 141R). SFAS 141R defines a business combination as a transaction or other event in which an acquirer obtains control of one or more businesses. Under SFAS 141R, all business combinations are accounted for by applying the acquisition method (previously referred to as the purchase method), under which the acquirer measures all identified assets acquired, liabilities assumed, and noncontrolling interests in the acquiree at their acquisition date fair values. Certain forms of contingent consideration and certain acquired contingencies are also recorded at their acquisition date fair values. SFAS 141R also requires that most acquisition related costs be expensed in the period incurred. SFAS 141R is effective for us in January 2009. SFAS 141R will change our accounting for business combinations on a prospective basis.

In December 2007, FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements — an amendment of ARB No. 51” (SFAS 160). SFAS 160 requires a company to recognize noncontrolling interests (previously referred to as “minority interests”) as a separate component in the equity section of the consolidated statement of financial position. It also requires the amount of consolidated net income specifically attributable to the noncontrolling interest be identified in the consolidated statement of income. SFAS 160 also requires changes in ownership interest to be accounted for similarly, as equity transactions; and when a subsidiary is deconsolidated, any retained noncontrolling equity investment in the former subsidiary and the gain or loss on the deconsolidation of the subsidiary be measured at fair value. SFAS 160 is effective for us in January 2009. We are currently evaluating the impact, if any, SFAS 160 will have on our financial position, results of operations or cash flows.

In March 2008, FASB issued SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities” (SFAS 161). SFAS 161 requires a company with derivative instruments to disclose information that should enable financial statement users to understand how and why a company uses derivative instruments, how derivative instruments and related hedged items are accounted for under SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” and how derivative instruments and related

MedQuist Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(In thousands, except for per share amounts)
Unaudited

hedged items affect a company’s financial position, financial performance, and cash flows. SFAS 161 is effective for us in January 2009.

In May 2008, FASB issued SFAS No. 162, “The Hierarchy of Generally Accepted Accounting Principles” (SFAS 162). SFAS 162 identifies the sources of accounting principles and the framework for selecting the principles used in the preparation of financial statements. SFAS No. 162 is effective 60 days following the SEC’s approval of the Public Company Accounting Oversight Board amendments to AU Section 411, “The Meaning of Present Fairly in Conformity with Generally Accepted Accounting Principles.” We are currently evaluating the impact, if any, SFAS 162 will have on our financial position, results of operations or cash flows.

The FASB recently issued a Staff Position (FSP) No. FAS 142-3, “Determination of the Useful Life of Intangible Assets” (FSP 142-3) which amends the factors a company should consider when developing renewal assumptions used to determine the useful life of an intangible asset under SFAS No. 142, “Goodwill and Other Intangible Assets” (SFAS 142). Paragraph 11 of SFAS 142 requires companies to consider whether renewal can be completed without substantial cost or material modification of the existing terms and conditions associated with the asset. FSP 142-3 replaces the previous useful life criteria with a new requirement — that an entity consider its own historical experience in renewing similar arrangements. If historical experience does not exist then the company would consider market participant assumptions regarding renewal including highest and best use of the asset by a market participant, and adjustments for other entity-specific factors included in paragraph 11 of SFAS 142. We are currently evaluating the impact, if any, SFAS 142-3 will have on our financial position, results of operations or cash flows.

4. Stock-Based Compensation

The following table summarizes our stock-based compensation expense related to employee stock options recognized under SFAS No. 123R, “Share Based Payment,” (SFAS 123R).


	Three months ended September 30,				Nine months ended September 30,
	2008		2007		2008		2007
Selling, general and administrative	$	840	$	130	$	944	$	188
Research and development		359		39		405		62
Cost of revenues		—		70		12		196

Total	$	1,199	$	239	$	1,361	$	446

As of September 30, 2008, total unamortized stock-based compensation cost related to non-vested stock options, net of expected forfeitures, was $775 which is expected to be recognized over a period of 3.0 years.

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 generally 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. For 10 of our former executives (who separated from us in 2005 and 2004) who held options that were vested as of their resignation date, our board of directors allowed their options to remain exercisable for the post-termination period commencing on the date that the suspension was lifted for the exercise of options. There were 704 options that qualified for this post-termination exercise period. The suspension was lifted on October 4, 2007 and all but 154 of these options terminated on February 1, 2008. In July 2008, 12 of the 154 options were exercised for an aggregate exercise amount of $68.

A summary of these remaining options as of September 30, 2008 is as follows:

MedQuist Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(In thousands, except for per share amounts)
Unaudited


	Options exercisable
					Average
	Number of		Intrinsic		Exercise
Range of Exercise Prices	Shares		Value		Price

$ 2.71 — $10.00		19	$	—	$	5.71
$10.01 — $20.00		47		—	$	14.38
$20.01 — $70.00		76		—	$	33.28

		142	$	—

The extension of the life of the awards was recorded as a modification of the grants in 2005 and 2004. Under Accounting Principles Board Opinion No 25, “Accounting for Stock Issued to Employees,” (APB 25), the modification created intrinsic value for vested stock if the market value of the stock on the date of termination exceeded the exercise price. Therefore, these grants required an immediate recognition of the compensation expense with an offsetting credit to common stock. No charges were incurred for the three and nine month periods ended September 30, 2008 and 2007.

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, December 31, 2007		2,359		$	31.08
Granted		296			4.85
Exercised		(12	)		5.71
Forefeited		(2	)		17.45
Canceled		(807	)		39.30

Outstanding, September 30, 2008		1,834		$	23.41		4.5	$	—

Exercisable, September 30, 2008		1,538		$	26.98		3.5	$	—


Options vested and expected to vest as of September 30, 2008		1,834		$	23.41		4.5	$	—

The aggregate intrinsic value is calculated using the difference between the closing stock price on the last trading day of the quarter and the option exercise price, multiplied by the number of in-the-money options.

There were 296 options granted and 12 options exercised during the nine months ended September 30, 2008 There were no options granted or exercised during the nine months ended September 30, 2007. We estimated fair value for the option granted as of the date of the grant by applying the Black-Scholes pricing valuation model. The application of this model involves assumptions that are judgmental and sensitive in the determination of compensation expense. The key assumptions used in determining the fair value of the options granted during the nine months ended September 30, 2008 were:


Expected term (years)	5.92
Expected volatility	54.46	%
Dividend yield	0	%
Expected risk free interest rate	3.25	%

The change in ownership on August 6, 2008 was a change in control as defined in the employment agreements for certain option holders. This resulted in the immediate vesting of previously unvested stock options. All previously unamortized stock compensation expense related to such stock options was recognized as of August 6, 2008 resulting in a charge of approximately $1.2 million.

A summary of outstanding and exercisable common stock options as of September 30, 2008 is as follows:

MedQuist Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(In thousands, except for per share amounts)
Unaudited


Options outstanding					Options exercisable
		Weighted
		Average		Weighted				Weighted
		Remaining		Average				Average
	Number	Contractual Life		Exercise		Number		Exercise
Range of Exercise Prices	of Shares	(in years)		Price		of Shares		Price
$ 2.71 — $10.00	314	9.5	$	4.90		18	$	5.71
$10.01 — $20.00	560	5.4	$	14.76		560	$	14.76
$20.01 — $30.00	628	2.9	$	26.48		628	$	26.48
$30.01 — $40.00	117	1.3	$	32.94		117	$	32.94
$40.01 — $70.00	215	1.7	$	58.86		215	$	58.86

	1,834	4.5	$	23.41		1,538	$	26.98

As of September 30, 2008, there were 732 additional options available for grant under our stock option plans. When we became current in our reporting obligations with the SEC on October 4, 2007, certain executive officers, in accordance with their employment agreements, received a grant of an aggregate of 200 options with an exercise price equal to the grant date market value of our common stock on October 4, 2007. In September 2008, an officer received a grant of 296 options with an exercise price equal to the grant date market value of our common stock.

5. Other Comprehensive Loss

Other comprehensive loss was as follows:


	Three months ended September 30,						Nine months ended September 30,
	2008			2007			2008			2007
Net loss	$	(5,762	)	$	(8,935	)	$	(8,344	)	$	(4,935	)
Foreign currency translation adjustment		(1,266	)		587			(1,305	)		989

Comprehensive loss	$	(7,028	)	$	(8,348	)	$	(9,649	)	$	(3,946	)

6. Net Loss per Share

Basic net loss per share is computed by dividing net loss by the weighted average number of shares outstanding during each period. Diluted net loss per share is computed by dividing net loss 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.

The following table reflects the weighted average shares outstanding used to compute basic and diluted net loss per share:


	Three months ended September 30,						Nine months ended September 30,
	2008			2007			2008			2007
Net loss	$	(5,762	)	$	(8,935	)	$	(8,344	)	$	(4,935	)


Weighted average shares outstanding:
Basic		37,554			37,484			37,547			37,484
Effect of dilutive shares		—			—			—			—

Diluted		37,554			37,484			37,547			37,484

Net loss per share:
Basic	$	(0.15	)	$	(0.24	)	$	(0.22	)	$	(0.13	)
Diluted	$	(0.15	)	$	(0.24	)	$	(0.22	)	$	(0.13	)

The computation of diluted net loss per share does not assume conversion, exercise or issuance of shares that would have

MedQuist Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(In thousands, except for per share amounts)
Unaudited

an anti-dilutive effect on diluted net loss per share. For each period presented, 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 per share and, therefore, excluded from the calculation of diluted net loss per share, totaled 1,520 for the three and nine months ended September 30, 2008 and 2,168 shares for the three and nine months ended September 30, 2007.

7. Customer Accommodation and Quantification

As noted in Note 2, in connection with our decision to offer financial accommodations to certain of our customers (Accommodation Customers), we analyzed our historical billing information and the available report-level data (Management’s Billing Assessment) to develop individualized accommodation offers to be made to Accommodation Customers (Accommodation Analysis). The Accommodation Analysis took approximately one year to complete. The methodology utilized to develop the individual accommodation offers was designed to generate positive accommodation outcomes for Accommodation 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 Accommodation 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 Accommodation 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 Accommodation 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 Accommodation Customer must agree, among other things, to release us from any and all claims and liability regarding certain 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 Accommodation 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 certain of our customers. However, the Accommodation Analysis for certain customers did not result in positive accommodation outcomes. For certain other Accommodation Customers, the Accommodation Analysis resulted in calculated cash accommodation offers that we believed were insufficient as a percentage of their historical 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 Accommodation Customers credits for the purchase of future products and/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.

The following is a summary of the financial statement activity for the periods indicated related to the customer accommodation and the Quantification which is included as a separate line item in the accompanying consolidated balance sheets as of September 30, 2008 and December 31, 2007:


	Nine months ended			Year ended
	September 30, 2008			December 31, 2007
Beginning balance	$	18,459		$	24,777
Payments and other adjustments		(5,664	)		(3,723	)
Credits		(659	)		(2,595	)

Ending balance	$	12,136		$	18,459

8. Cost of Investigation and Legal Proceedings, Net

MedQuist Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(In thousands, except for per share amounts)
Unaudited

For the three months ended September 30, 2008 and 2007, we recorded charges of $7,181 and $4,441, respectively, and for the nine months ended September 30, 2008 and 2007, we recorded a charge of $15,307 and a credit of ($456), respectively for costs associated with the Review and Management’s Billing Assessment, as well as defense and other costs associated with governmental investigations and civil litigation, including, in 2007, $197 of consulting services provided by Nightingale and Associates, LLC (Nightingale), a management consulting company specializing in turnarounds and crisis management, that we deemed to be unusual in nature. Howard Hoffmann, our former President and Chief Executive Officer, provided services to us pursuant to the terms of an agreement between us and Nightingale. Nightingale also provided certain consulting services to us related to the Review and Management’s Billing Assessment. The agreement with Nightingale was terminated consensually on June 10, 2008, which was also the date that Mr. Hoffmann ceased being our President and Chief Executive Officer. These costs are net of insurance claim reimbursements. We record insurance claims when the realization of the claim is probable. The following is a summary of the amounts recorded as Cost of investigation and legal proceedings, net, in the accompanying consolidated statements of operations:


	Three months ended September 30,				Nine months ended September 30,
	2008		2007		2008		2007
Legal fees	$	1,125	$	3,937	$	7,392	$	12,783
Other professional fees		131		504		490		1,948
Nightingale services		—		—		—		197
Insurance recoveries and claims		—		—		—		(15,386	)
Other		5,925		—		7,425		2

Total	$	7,181	$	4,441	$	15,307	$	(456	)

Other professional fees represent accounting and dispute analysis costs and document search and retrieval costs. In 2007, insurance recoveries and claims represent insurance recoveries ($4,243) and insurance claims ($11,143). The insurance claims were recorded in other current assets and payment related to these claims was received in the third quarter of 2007. We do not expect to receive any additional insurance recoveries related to these claims in the future. The 2008 Other amount of $7,425 is for the proposed settlements of all claims related to the consolidated medical transcriptionists putative class action and the U.S. Department of Justice (DOJ) investigation. (See Note 11).

9. Restructuring Plans

2007 Restructuring Plans

During the third quarter of 2007, we implemented a restructuring plan related to a reduction in workforce of 104 employees as a result of the refinement of our centralized national services delivery model. In addition, during the fourth quarter of 2007, we implemented a restructuring plan related to an additional reduction in workforce of 183 employees attributable to our efforts to reduce costs. All of the restructuring costs incurred are severance related. The table below reflects the financial statement activity related to the 2007 Plan which is included in accrued expenses in the accompanying consolidated balance sheets:


	Nine Months Ended			Year Ended
	September 30, 2008			December 31, 2007
	Total Severance			Total Severance
Beginning balance	$	1,493		$	—
Charge (Reversal)		(76	)		2,263
Cash paid		(1,417	)		(770	)

Ending balance	$	0		$	1,493

During the nine months ended September 30, 2008, we reversed $76 related to the 2007 restructuring plan because certain employee severance expenses will not be incurred. The remainder of payments related to the 2007 restructuring plan were made by September 30, 2008.

2005 Restructuring Plan

During 2005, we implemented a restructuring plan (2005 Plan) based on the implementation of a centralized national service

MedQuist Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(In thousands, except for per share amounts)
Unaudited

delivery model. The 2005 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:


	Nine Months Ended			Year Ended
	September 30, 2008			December 31, 2007
	Total Non-Cancelable			Total Non-Cancelable
	Leases			Leases
Beginning balance	$	126		$	648
Charge (Reversal)		(6	)		322
Cash paid		(90	)		(844	)

Ending balance	$	30		$	126

The remainder of payments related to the 2005 Plan will be made through 2009 for non-cancelable leases.

10. Income Taxes

Our consolidated income tax expense consists principally of an increase in deferred tax liabilities related to goodwill amortization deductions for income tax purposes during the applicable period as well as state and foreign income taxes offset by the reversal of certain state tax reserves due to the expiration of the statutes of limitations. We have recorded a valuation allowance to reduce our net deferred tax assets to an amount that is more likely than not to be realized in future years.

Under FASB Interpretation 48,Accounting for Uncertainty in Income Taxes — an interpretation of FASB Statement 109(FIN 48), we classify penalties and interest related to uncertain tax positions as part of income tax expense. There were no material changes to our uncertain tax positions, including penalties and interest for the three and nine months ended September 30, 2008.

11. 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 and we have complied with information and document requests by the SEC.

We also received an administrative subpoena under Health Insurance Portability and Accountability Act of 1996 (HIPAA) 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. On September 26, 2008, the DOJ gave notice to intervene in part in twoqui tamactions filed against us for matters purportedly related to the DOJ’s investigation. We have reached a settlement-in-principle to resolve the DOJ’s civil claims and the twoqui tam litigation matters for payment of $6.6 million to the DOJ, which has been accrued as of September 30, 2008. The settlement-in-principle has been disclosed to the court in thequi tamactions, and the twoqui tamrelators have accepted the settlement payment as fair and reasonable. The parties have exchanged a draft settlement agreement and have provided comments thereto and are presently negotiating final settlement terms. We must separately negotiate payment of the relators’ legal fees which are not covered by the settlement-in-principle with the DOJ.

The U.S. Department of Labor (DOL) conducted a formal investigation into the administration of our 401(k) plan. We fully cooperated with the DOL from the inception of its investigation in 2004 and we complied with information and document requests by the DOL. In April 2008, we made an additional contribution of approximately $41 to our 401(k) plan and certain current or former plan participants in an attempt to resolve the DOL investigation. In July 2008, we received written confirmation from the DOL that it concluded its investigation.

Developments relating to the SEC and/or DOJ investigations may continue to represent 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.

MedQuist Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(In thousands, except for per share amounts)
Unaudited

Customer Litigation

Kaiser Litigation

On June 6, 2008, plaintiffs Kaiser Foundation Health Plan, Inc., Kaiser Foundation Hospitals, The Permanente Medical Group, Inc., Kaiser Foundation Health Plan of the Mid-Atlantic States, Inc., and Kaiser Foundation Health Plan of Colorado (collectively, Kaiser) filed suit against MedQuist Inc. and MedQuist Transcriptions, Ltd. (collectively, MedQuist) in the Superior Court of the State of California in and for the County of Alameda. The action is entitled Foundation Health Plan Inc., et al v. MedQuist Inc. et al., Case No. CV-078-03425 PJH. The complaint asserts five causes of action, for common law fraud, breach of contract, violation of California Business and Professions Code section 17200, unjust enrichment, and a demand for an accounting. More specifically, Kaiser alleges that MedQuist fraudulently inflated the payable units of measure in medical transcription reports generated by MedQuist for Kaiser pursuant to the contracts between the parties. The damages alleged in the complaint include an estimated $7 million in compensatory damages, as well as punitive damages, attorneys’ fees and costs, and injunctive relief. MedQuist contends that it did not breach the contracts with Kaiser, or commit the fraud alleged, and it intends to defend the suit vigorously. MedQuist removed the case to the United States District Court for the Northern District of California, and filed motions to dismiss Kaiser’s complaint and to transfer venue of the case to the United Stated District Court for the District of New Jersey. Kaiser stipulated to transfer, and the case was transferred to the United States District Court for the District of New Jersey on or about August 26, 2008. The parties participated in mediation on July 24, 2008, but the case was not settled. MedQuist’s motion to dismiss has been fully briefed and is currently pending before the Court. No hearing date has been scheduled for the motion. No pretrial schedule or trial date has been set. We believe that the claims asserted have no merit and intend to vigorously defend the action.

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., Case No. 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, the parties have reached an agreement in principle to settle all claims.

Force Putative Class Action

A putative class action entitled Force v. MedQuist Inc. and MedQuist Transcriptions, Ltd., Case No. 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, the parties have reached an agreement in principle to settle all claims.

Myers Putative Class Action

MedQuist Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(In thousands, except for per share amounts)
Unaudited

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 requested 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 material allegations pleaded in the consolidated amended complaint.

On May 17, 2007, the Court issued a Scheduling Order, ordering all pretrial fact discovery completed by October 30, 2007. The Court subsequently ordered plaintiffs to file their motion for class certification by December 14, 2007 and continued the date to complete fact discovery to January 14, 2008. On October 18, 2007, the Court heard oral argument on plaintiffs’ motion to compel further responses to written discovery regarding our billing practices. At the conclusion of the hearing, the Court denied plaintiffs’ motion, finding plaintiffs had not established that the billing discovery sought was relevant to the claims or defenses regarding transcriptionist pay alleged in their case. On December 14, 2007, plaintiffs filed their motion for class certification, identifying a proposed class of all of our transcriptionists who were compensated on a per line basis for work completed on MedRite, MTS or DEP transcription platforms from November 29, 1998 to the present and alleging that the proposed class was underpaid by more than $80 million, not including interest.

On January 4, 2008, the Court entered a Consent Order ordering our opposition to the motion for class certification to be filed by March 14, 2008, plaintiffs’ reply brief to be filed by May 14, 2008 and setting oral argument for June 2, 2008. No date has been set for trial. On January 9, 2008, the Court entered a Consent Order extending the deadline for the parties to complete depositions of identified witnesses through February 15, 2008. We have now deposed each of the named plaintiffs and all witnesses who offered declarations in support of plaintiffs’ motion for class certification, and plaintiffs have deposed numerous MedQuist present and former employees. On February 8, 2008, plaintiffs indicated that they would seek leave to file an amended class certification brief to narrow their claims. On February 19, 2008, the parties exchanged their Initial Disclosures. Plaintiffs’ disclosures limited their damages estimate to $41.0 million related to alleged underpayment on the MedRite transcription platform; however, plaintiffs stated that they were continuing to analyze potential undercounting and would supplement their damages claim. On March 10, 2008, plaintiffs moved for leave to file an amended motion for class certification dropping all allegations involving our DEP transcription platform and narrowing the claims asserted regarding the legacy MTS transcription platform. We did not oppose plaintiffs’ motion for leave. On March 11, 2008, the Court granted plaintiffs’ motion, ordering us to file our opposition to plaintiffs’ amended motion for class certification by April 4, 2008 and ordering plaintiffs to file their reply by May 23, 2008. On April 4, 2008, we filed our opposition to plaintiffs’ amended motion for class certification.

The parties have reached an agreement to settle all claims in exchange for payment of $1.5 million plus certain injunctive relief. The settlement contemplates notice to a settlement class consisting of all medical transcriptionists paid by the line for the period from November 29, 1998 through execution of the stipulation of settlement and is conditioned on final approval by the court. Neither MedQuist, nor any other party, has admitted or will admit liability or any wrongdoing in connection with the settlement. Plaintiffs have executed the stipulation of settlement, and motion for preliminary approval of the settlement has been filed. We have accrued $1.5 million at September 30, 2008 related to this matter.

Shareholder Litigation

Costa Brava Partnership III, L.P. Shareholder Litigation

Claim for Preliminary and Injunctive Relief

MedQuist Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(In thousands, except for per share amounts)
Unaudited

plaintiff also sought an ex parte temporary restraining order and entry of an order to show cause requiring the defendants to appear and show cause why a preliminary injunction should not be issued enjoining certain of the complained of actions. A hearing was held on the preliminary injunction motion on August 5, 2008. At the conclusion of the hearing, the Court denied the request for a temporary restraining order and denied the request to enter an order to show cause. The Court found that Costa Brava had not met the standards for injunctive relief, including a showing of likelihood of success on the merits of its underlying claims or the presence of immediate irreparable harm. The Court allowed the plaintiff two weeks to file a further amended complaint, and directed the parties to engage in discovery on an expedited schedule. On August 19, 2008, Costa Brava filed a notice of withdrawal with the Court that dismissed without prejudice Costa Brava’s claims against MedQuist and the other defendants.

Kahn Putative Class Action

On January 22, 2008, MedQuist shareholder Alan R. Kahn filed a shareholder putative class action lawsuit against us, Philips and four of our former non-independent directors, Clement Revetti, Jr., Stephen H. Rusckowski, Gregory M. Sebasky and Scott Weisenhoff. The action, entitled Alan R. Kahn v. Stephen H. Rusckowski, et al., Docket No. BUR-C-000007-08, is pending in the Superior Court of New Jersey, Chancery Division, Burlington County. In the action, plaintiff purports to bring the action on his own behalf and on behalf of all current holders of our common stock. The complaint alleged that defendants breached their fiduciary duties of good faith, fair dealing, loyalty, and due care by purportedly agreeing to and initiating a process for our sale or a change of control transaction which will allegedly cause harm to plaintiff and the putative class. Plaintiff sought damages in an unspecified amount, plus costs and interest, a judgment declaring that defendants breached their fiduciary duties and that any proposed transactions regarding our sale or change of control are void, an injunction preventing our sale or any change of control transaction that is not entirely fair to the class, an order directing us to appoint three independent directors to our board of directors, and attorneys’ fees and expenses.

On June 12, 2008, plaintiff filed an amended class action complaint against us, eight of our current and former directors, and Philips in the Superior Court of New Jersey, Chancery Division. In the amended complaint, plaintiff alleges that our current and former directors breached their fiduciary duties of good faith, fair dealing, loyalty, and due care by not permitting our public shareholders the opportunity to decide whether they wanted to participate in a share purchase offer with non-party CBaySystems Holdings that would have allowed the public shareholders to sell their shares of our common stock for an amount above market price. Plaintiff further alleges that CBaySystems Holdings also made the share purchase offer to our majority shareholder, Philips, and that Philips breached its fiduciary duties by accepting CBaySystems Holdings’ offer. Based on these allegations, plaintiff seeks declaratory, injunctive, and monetary relief from all defendants.

On July 14, 2008, we moved to dismiss plaintiff’s amended class action complaint, arguing (1) that plaintiff’s amended class action complaint did not allege that we engaged in any wrongdoing which supported a breach of fiduciary duty claim and (2) that a breach of fiduciary duty claim is not legally cognizable against a corporation. Plaintiff filed an opposition to our motion to dismiss on July 21, 2008.

On October 14, 2008, plaintiff filed a motion to consolidate this action with the Newcastle shareholder litigation matter described immediately below. On October 30, 2008, we filed opposition to the motion to consolidate. The motion to consolidate and the motion to dismiss the amended class action complaint will be heard on November 7, 2008.

We deny any liability and intend to defend this action vigorously.

Newcastle Shareholder Litigation

On June 30, 2008, Newcastle Partners, L.P. (Newcastle), a shareholder affiliated with one of our directors, derivatively on our behalf, filed an action against Philips, CBaySystems Holdings, Cbay Inc., five of our former non-independent directors, Stephen H. Rusckowski, Clement Revetti, Jr., Greg Sebasky, Jr., Scott M. Weisenhoff and Edward H. Siegel, in the Superior Court of New Jersey, Chancery Division, Burlington County. The complaint also named us as a “Nominal Defendant,” meaning that no monetary relief is being sought against us.

MedQuist Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(In thousands, except for per share amounts)
Unaudited

together, aided and abetted the Philips Directors’ breach of their fiduciary duties. In light of the first two counts, plaintiffs sought injunctive relief (including an order enjoining the CBaySystems Holdings Purchase), declaratory relief and attorneys’ fees and costs. Third, as an alternative form of relief, plaintiffs allege that in the event that Philips sells its stake in MedQuist, plaintiffs demand a declaration that a certain agreement related to the governance of the Company remain in full force and effect. Fourth, plaintiffs assert that CBay breached the standstill provision contained in an April 2008 confidentiality agreement between us and CBay and demand an injunction to prevent CBay from violating that agreement (Confidentiality Agreement).

On July 9, 2008, Newcastle filed an application for an Order to Show Cause (OSC) to (i) preliminarily enjoin Philips and CBay from consummating the CBaySystems Holdings Purchase ; (ii) preliminarily enjoin the Philips Directors from taking any action to consummate the CBaySystems Holdings Purchase; and (iii) preliminarily enjoin CBay from violating the Confidentiality Agreement. As part of the relief requested in the OSC, plaintiffs sought a Temporary Restraining Order (TRO) that would restrain all defendants from taking any action in violation of the proposed OSC until a preliminary injunction hearing could be held.

On July 9, 2008, counsel for MedQuist, Philips, the Philips Directors, CBay, Newcastle and Arklow appeared before Judge Michael Hogan of the Superior Court of New Jersey, Burlington County, for a hearing on the TRO application. After entertaining argument from the parties, Judge Hogan denied the TRO application. Judge Hogan scheduled a preliminary injunction hearing for July 31, 2008 and ordered expedited discovery. The parties subsequently agreed to an expedited discovery schedule, as well as a briefing schedule on the OSC for a preliminary injunction. The preliminary injunction hearing was held on July 31, 2008, and on August 1, 2008, the Court issued an order denying plaintiffs’ motion seeking preliminary injunctive relief. The Court found, among other things, that the plaintiffs failed to establish by clear and convincing evidence a reasonable probability of success on their underlying claims, or that absent injunctive relief they would suffer immediate irreparable harm. A status conference originally scheduled for September 29, 2008 was rescheduled to October 15, 2008. Subsequently, Newcastle’s counsel requested an additional postponement and the Court agreed to schedule the status conference for November 7, 2008.

Reseller Arbitration Demand

On October 1, 2007, we received from counsel to nine current and former resellers of our products (Claimants), a copy of an arbitration demand filed by the Claimants, initiating an arbitration proceeding styled Diskriter, Inc., Electronic Office Systems, Inc., Milner Voice & Data, Inc., Nelson Systems, Inc., NEO Voice and Communications, Inc., Office Business Systems, Inc., Roach-Reid Office Systems, Inc., Stiles Office Systems, Inc., and Travis Voice and Data, Inc. v. MedQuist Inc. and MedQuist Transcriptions, Ltd. (collectively MedQuist) (filed on September 27, 2007, AAA, 30-118-Y-00839-07). The arbitration demand purports to set forth claims for breach of contract; breach of covenant of good faith and fair dealing; promissory estoppel; misrepresentation; and tortious interference with contractual relations. The Claimants allege that we breached our written agreements with the Claimants by: (i) failing to provide reasonable training, technical support, and other services; (ii) using the Claimants’ confidential information to compete against the Claimants; (iii) directly competing with the Claimants’ territories; and (iv) failing to make new products available to the Claimants. In addition, the Claimants allege that we made false oral representations that we: (i) would provide new product, opportunities and support to the Claimants; (ii) were committed to continuing to use Claimants; (iii) did not intend to create our own sales force with respect to the Claimants’ territory; and (iv) would stay out of Claimants’ territories and would not attempt to take over the Claimants business and relationships with the Claimants’ customers and end-users. The Claimants assert that they are seeking damages in excess of $24.3 million. We also moved to dismiss MedQuist Inc. as a party to the arbitration since MedQuist Inc. is not a party to the Claimants’ agreements, and accordingly, has never agreed to arbitration. The AAA initially agreed to rule on these matters, but then decided to defer a ruling to the panel of arbitrators selected pursuant to the parties’ agreements (Panel). In response, we informed the Panel that a court, not the Panel, should rule on these issues. When it appeared that the Panel would rule on these issues, we initiated a lawsuit in the Superior Court of DeKalb County (the Court) and requested an injunction enjoining the Panel from deciding these issues. The Court denied the request, and indicated that a new motion could be filed if the Panel’s ruling was adverse to MedQuist Inc. or MedQuist Transcriptions, Ltd. On May 6, 2008, the Panel dismissed MedQuist Inc. as a party, but ruled against our opposition to a consolidated arbitration. We asked the Court to stay the arbitration in order to review that decision. The Court initially granted the stay, but later lifted the stay. The Court did not make any substantive rulings regarding consolidation, and in fact, left that decision and others to the assigned judge, who was unable to hear those motions. Accordingly, until further order of the Court, the arbitration will proceed forward.

We filed an answer and counterclaim in the arbitration, which generally denied liability. In the lawsuit, the defendants filed a motion to dismiss alleging that the our complaint failed to state an actionable claim for relief. On July 25, 2008, we filed our response which opposed the motion to dismiss in all respects. Discovery has now commenced in both the arbitration and the lawsuit. We deny all wrongdoing and intend to defend ourselves vigorously including asserting counterclaims against the Claimants as appropriate.

MedQuist Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(In thousands, except for per share amounts)
Unaudited

Anthurium Patent Litigation

On November 6, 2007, Anthurium Solutions, Inc. filed an action entitled Anthurium Solutions, Inc. v. MedQuist Inc., et al., Civil Action No. 2-07CV-484, in the United States District Court for the Eastern District of Texas, alleging that we infringed and continue to infringe United States Patent No. 7,031,998 through our DEP transcription platform. The complaint also alleges patent infringement claims against Spheris, Inc. and Arrendale Associates, Inc. The complaint seeks injunctive relief and unspecified damages, including enhanced damages and attorneys’ fees. We filed our answer on January 15, 2008 and counterclaimed seeking a declaratory judgment of non-infringement and invalidity. Plaintiff filed its preliminary infringement contentions on May 2, 2008. Our investigation of the claims is ongoing. We believe that the claims asserted have no merit and intend to vigorously defend the suit.

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 September 30, 2008 or December 31, 2007 related to these indemnification provisions.

We had insurance policies which provided coverage for certain of the matters related to the legal actions described herein and certain other legal actions that were previously settled or dismissed. To date, we have received total insurance recoveries of $24,795 related to these policies (See Note 8).

12. Related Party Transactions

From time to time, we enter into transactions in the normal course of business with related parties. Prior to August 6, 2008, Philips owned approximately 69.5% ownership interest in MedQuist. This ownership interest was sold to CBaySystems Holdings on August 6, 2008. Accordingly Philips ceased to be a related party on that date and CBaySystems Holdings (and affiliated entities) commenced to be a related party on that date. The Audit Committee of our board of directors has been charged with the responsibility of approving or ratifying all related party transactions other than those which were previously entered into between us and Philips prior to August 6, 2008. In any situation where the Audit Committee sees fit to do so, any related party transaction, other than those previously entered into between us and Philips prior to August 6, 2008, are presented to disinterested members of our board of directors for approval or ratification.

We are a party to various agreements with Philips, our former majority shareholder. All material transactions between Philips and us were reviewed and approved by the former supervisory committee of our board of directors. The supervisory committee was comprised of directors independent from Philips. On August 6, 2008, the supervisory committee of our board of directors was eliminated by our board of directors after the consummation of the CBaySystems Holdings Purchase.

On September 15, 2008, our wholly-owned subsidiary, MedQuist Transcriptions, Ltd., entered into a transcription services agreement with CBay Systems & Services, Inc. (CBay Systems), a wholly-owned subsidiary of CBaySystems Holdings, pursuant to which we outsource certain medical transcription services to CBay Systems. As this agreement constitutes a related party transaction, it was reviewed and approved by the Audit Committee of our board of directors. Except for the agreement, neither we nor any of our subsidiaries is a party to any agreement with CBaySystems Holdings, CBay, Inc. or any other affiliate of CBay or CBay, Inc.

Listed below is a summary of our material agreements with Philips.

Licensing Agreement

We are a party to 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.

MedQuist Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(In thousands, except for per share amounts)
Unaudited

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 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. As part of the CBaySystems Holdings Purchase, Philips waived, through June 30, 2011, its right to provide prior to June 30, 2011 a two year advance notice to terminate the Licensing Agreement. This waiver was conditioned upon a similar waiver from us which we have provided.

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

On September 21, 2007, we entered into an Amended and Restated OEM Supply Agreement (Amended OEM Agreement) with PSRS. The Amended OEM Agreement amends and restates a previous OEM Supply Agreement with PSRS dated September 23, 2004. In connection with the Amended OEM Agreement certain amounts paid to PSRS were capitalized in fixed assets and are being amortized over a three-year period.

Pursuant to the Amended OEM Agreement, we purchased a co-ownership interest in all rights and interests in and to SpeechQ for Radiology together with its components, including object and source code for the SpeechQ for Radiology application and the SpeechQ for Radiology integration SDK (collectively, the Product), but excluding the SpeechMagic speech recognition and processing software, which we separately license from PSRS for a fee under the Licensing Agreement. Additionally, the Amended OEM Agreement provides that we shall receive, in exchange for a fee, the exclusive right in the United States, Canada and certain islands of the Caribbean (collectively the Exclusive Territory) to sell, service and deliver the Product. In addition, PSRS has agreed that for the term of the Amended OEM Agreement it will not release a front-end multi-user reporting solution (including one similar to the Product) in the medical market in the Exclusive Territory nor will it directly authorize or assist any of its affiliates to do so either; provided that the restriction does not prevent PSRS’s affiliates from integrating SpeechMagic within their general medical application products. The Amended OEM Agreement further provides that we shall make payments to PSRS for PSRS’s development of an interim version of the software included in the Product (Interim Version). Except for the Interim Version which we and PSRS will co-own, the Amended OEM Agreement provides that any improvements, developments or other enhancements either we or PSRS makes to the Product (collectively, Improvements) shall be owned exclusively by the party that developed such Improvement. Each party has the right to seek patent or other protection of the Improvements it owns independent of the other party.

The term of the Amended OEM Agreement extends through June 30, 2010 and will automatically renew for an additional three year term provided that we are in material compliance with the Amended OEM Agreement as of such date. If PSRS decides to discontinue all business relating to the Product in the Exclusive Territory on or after June 30, 2010, PSRS can effect such discontinuation by terminating the Amended OEM Agreement by providing us with six months’ prior written notice of such discontinuation, provided the earliest such notice can be delivered is June 30, 2010. Either party may terminate the Amended OEM Agreement for cause immediately in the event that a material breach by the other party remains uncured for more than 30 days following delivery of written notice or in the event that the other party becomes insolvent or files for bankruptcy.

Equipment Purchases

We purchased certain dictation related equipment from Philips.

Insurance Coverage

Prior to the closing of the CBaySystems Holdings Purchase on August 6, 2008, we obtained all of our business insurance coverage (other than workers’ compensation) through Philips. As of August 7, 2008, we have insurance policies through CBaySystems Holdings.

Purchasing Agreements

MedQuist Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(In thousands, except for per share amounts)
Unaudited

For each of the three years ended December 31, 2007 we entered 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. As of January 1, 2008, we are no longer a party to an agreement with PENAC to purchase the products and services.

CBaySystems Holdings Purchase Incremental Costs

Philips will reimburse us for certain incremental and direct costs incurred by us in connection with the CBaySystems Holdings Purchase. These costs totaled $0 and $172 for the three and nine months ended September 30, 2008 and $0 for the three and nine months ended September 30, 2007.

From time to time prior to the CBaySystems Holdings Purchase, we entered 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 $0 for the three months ended September 30, 2008 and 2007, respectively, and $39 and $0 for the nine months ended September 30, 2008 and 2007, respectively.

Our consolidated balance sheets as December 31, 2007 reflect other assets related to Philips of $1,003 and accrued expenses due to Philips of $1,534.

Listed below is a summary of the expenses incurred by us in connection with the various Philips agreements noted above for the three and nine months ended September 30, 2008 and 2007. Philips ceased being a related party on August 6, 2008. Charges related to these agreements are included in cost of revenues and selling, general and administrative expenses in the accompanying consolidated statements of operations.


	Three months ended September 30,					Nine months ended September 30,
	2008 *		2007			2008 *			2007
Licensing agreement	$	355	$	645		$	2,070		$	1,747
OEM supply agreement		36		1,564			1,645			1,865
Equipment purchases		97		292			586			613
Insurance coverage		65		121			399			1,682
Purchasing agreement		—		(10	)		—			30
CBay Transaction		—		—			(172	)		—
Other		—		—			(39	)		—

Total	$	553	$	2,612		$	4,489		$	5,937


*		Philips ceased being a related party on August 6, 2008.

On July 29, 2004, we entered into an agreement with Nightingale under which Nightingale agreed to provide interim chief executive officer services to us. On July 30, 2004, our board of directors appointed Howard S. Hoffmann to serve as our non-employee chief executive officer. Mr. Hoffmann served as the Managing Partner of Nightingale. 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 served as our president and chief executive officer pursuant to the terms of the agreement between us and Nightingale which was amended on March 14, 2008 (Amendment). The Amendment, among other things, extended the term of Mr. Hoffmann’s role as our president and chief executive officer through August 1, 2008. Our agreement with Nightingale also permitted us to engage additional personnel employed by Nightingale to provide consulting services to us from time to time. Mr. Hoffman’s service as president and chief executive officer and the related engagement of Nightingale terminated consensually on June 10, 2008.

For the three months ended September 30, 2008 and 2007, we incurred charges of $0 and $792 respectively, and for the nine months ended September 30, 2008 and 2007, we incurred charges of $1,073 and $2,279, respectively for Nightingale services. From February 1, 2007 through June 10, 2008, the Nightingale charges were recorded in selling, general and administrative expenses in the accompanying consolidated statements of operations due to Nightingale’s focus on operational matters instead of the Review and Management’s Billing Assessment. Prior to February 1, 2007, charges related to Nightingale were recorded in cost of investigation and legal proceedings, net (see Note 8). As of September 30, 2008 and December 31, 2007, accrued expenses included $0 and $400,

MedQuist Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(In thousands, except for per share amounts)
Unaudited

respectively, for amounts due to Nightingale for services performed.

13. Investment in A-Life Medical, Inc. (A-Life)

As of September 30, 2008 and December 31, 2007, we had an investment of $6,215 and $6,016, respectively, 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 September 30, 2008 and December 31, 2007. Our investment in A-Life is recorded in other assets in the accompanying consolidated balance sheets.

Our investment in A-Life included a note receivable plus accrued interest due from A-Life which matured on December 31, 2003. Prior to 2007, this note receivable and accrued interest had been recorded in other assets. In January 2008, A-Life paid us $1,250 to satisfy this note receivable and accrued interest in full, as well as all other disputes and claims between A-Life and us. Accordingly, we reclassified the note receivable and accrued interest balances to other current assets in the accompanying December 31, 2007 consolidated balance sheet.

In January 2008, we recorded $438 of other income related to this transaction.

Item 2.Management’s Discussion and Analysis of Financial Condition and Results of Operations

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 Securities Exchange Act of 1934 (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 in our Annual Report on Form 10-K for the year ended December 31, 2007, as well as risks discussed elsewhere in this report;

	•		each of the matters discussed in Part II, Item 1, Legal Proceedings;

	•		difficulties relating to our significant management turnover;

	•		our ability to recruit and retain qualified medical transcriptionists (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 expand our customer base;

	•		changes in law, including, without limitation, the impact Health Insurance Portability and Accountability Act of 1996 (HIPAA) will have on our business;

	•		infringement on the proprietary rights of others;

	•		our ability to diversify into other businesses;

	•		our ability to effectively integrate newly-acquired operations, if any;

	•		competitive pricing pressures in the medical transcription industry and our response to those pressures; and

	•		general conditions in the economy and capital markets.

These and other risks and uncertainties that could affect our actual results are discussed in this report and in our other filings with the SEC.

Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, events, levels of activity, performance, or achievements. We do not assume responsibility for the accuracy and completeness of the forward-looking statements other than as required by applicable law. We do not undertake any duty to update any of the forward-looking statements after the date of this report to conform them to actual results, except as required by the federal securities laws.

You should read this section in combination with the section entitled Management’s Discussion and Analysis of Financial Condition and Results of Operations for the year ended December 31, 2007, included in our Annual Report on Form 10-K for the year ended December 31, 2007.

Executive Overview

We are the largest Medical Transcription Service Organization (MTSO) in the world, and a leader in technology enabled clinical documentation workflow. We service health systems, hospitals and large group medical practices throughout the U.S., and we employ approximately 5,400 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 and electronic signature services.

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.

On August 6, 2008, CBaySystems Holdings Limited (CBaySystems Holdings) purchased Koninklijke Philips Electronics N.V.’s

(Philips) 69.5% interest in MedQuist. CBaySystems Holdings is a company that is publicly traded on the AIM market of the London Stock Exchange with a portfolio of investments in medical transcription, which includes a company that competes in the medical transcription market, healthcare technology, and healthcare financial services.

In 2001, we acquired Speech Machines, a company based in the United Kingdom, whose technology has since developed into our DocQment™ Enterprise Platform (DEP). In 2002, we began the process of migrating our customers to our DEP from our many disparate transcription platforms and completed this process in the first quarter of 2007. As a result of this process, we encountered customer attrition.

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. In addition, during this period we also devoted a significant portion of our time and attention to matters outside the ordinary course of business such as cooperating with federal investigations, responding to ongoing legal proceedings and reviewing past allegations of improper billing practices. 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 by U.S.-based healthcare providers. This demand for qualified MTs, as well as budgetary pressures experienced by healthcare providers, has also caused many more U.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. One of these low cost providers is owned by CBaySystems Holdings. 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 which have reduced the length of time required to transcribe medical reports, in turn reducing the overall cost of medical transcription services; and

	•		Increasing requirements for electronic medical records, driving up demand for transcription services in some cases where records used to be paper based, and driving down demand in other cases as customers attempt to implement electronic medical records.

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;

	•		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 electronic health record 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

Our discussion and analysis of our financial condition and consolidated results of operations are based upon our consolidated financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles (GAAP). The preparation of our consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, net revenues and expenses and related disclosure of contingent assets and liabilities. On an on-going basis, we evaluate our estimates based upon historical experience and various other assumptions that we believe to be reasonable under the circumstances, 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. Our actual results may differ from these estimates. These critical accounting policies and estimates have been discussed with the Audit Committee of our board of directors.

We believe that our critical accounting policies affect our more significant estimates and judgments used in the preparation of our consolidated financial statements. Our Annual Report on Form 10-K for the year ended December 31, 2007 contains a discussion of these critical accounting policies. There have been no significant changes in our critical accounting policies from those disclosed in our Annual Report on Form 10-K for the year ended December 31, 2007 other than as described in Note 3 of the “Notes to Consolidated Financial Statements” included in Part I, Item 1 of this Quarterly Report on Form 10-Q.

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 and electronic signature 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 revenues from new products have not replaced the lost revenues.

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 two 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, net

Cost of investigation and legal proceedings, net include legal fees incurred in connection with investigations by the U.S. Securities and Exchange Commission (SEC) and the U.S. Department of Justice (DOJ) and proceedings and the defense of civil litigation matters described in Part II, Item 1, Legal Proceedings in this report, litigation support consulting, and consulting services provided by Nightingale and Associates, LLC (Nightingale) prior to February 1, 2007, net of insurance claims reimbursement.

Consolidated Results of Operations

The following tables set forth our consolidated results of operations for the periods indicated below:

Comparison of Three Months Ended September 30, 2008 and 2007


	Three months ended September 30,
	2008						2007
				% of Net						% of Net
($ in thousands)	Amount			Revenues			Amount			Revenues			$ Change			% Change

Net revenues	$	81,287			100.0	%	$	82,518			100.0	%	$	(1,231	)		(1.5	%)


Operating costs and expenses:
Cost of revenues		57,235			70.4	%		64,290			77.9	%		(7,055	)		(11.0	%)
Selling, general and administrative		13,148			16.2	%		15,548			18.8	%		(2,400	)		(15.4	%)
Research and development		4,648			5.7	%		3,808			4.6	%		840			22.1	%
Depreciation		2,977			3.7	%		2,861			3.5	%		116			4.1	%
Amortization of intangible assets		1,411			1.7	%		1,361			1.6	%		50			3.7	%
Cost of investigation and legal proceedings, net		7,181			8.8	%		4,441			5.4	%		2,740			61.7	%
Restructuring charges		(37	)		(0.0	%)		554			0.7	%		(591	)		(106.7	%)


Total operating costs and expenses		86,563			106.5	%		92,863			112.5	%		(6,300	)		(6.8	%)


Operating loss		(5,276	)		(6.5	%)		(10,345	)		(12.5	%)		5,069			(49.0	%)

Equity in income of affiliated company		159			0.2	%		124			0.2	%		35			28.2	%
Other income		—			—			—			—			—			n.a.
Interest income, net		418			0.5	%		2,302			2.8	%		(1,884	)		(81.8	%)


Loss before income taxes		(4,699	)		(5.8	%)		(7,919	)		(9.6	%)		3,220			(40.7	%)

Income tax provision		1,063			1.3	%		1,016			1.2	%		47			4.6	%


Net loss	$	(5,762	)		(7.1	%)	$	(8,935	)		(10.8	%)	$	3,173			(35.5	%)

Net revenues

Net revenues decreased $1.2 million, or 1.5%, to $81.3 million for the three months ended September 30, 2008 compared with $82.5 million for the three months ended September 30, 2007. This decrease was attributable primarily to reduced service revenues of $1.3 million resulting primarily from lower medical transcription pricing. Transcription volume was steady compared to the same period in 2007. Other revenues were up $0.1 million.

Cost of revenues

Cost of revenues decreased $7.1 million, or 11.0%, to $57.2 million for the three months ended September 30, 2008 compared with $64.3 million for the three months ended September 30, 2007. This decrease was attributable primarily to:

	•		reduced medical transcription payroll costs of $3.4 million related directly to our increased use of speech recognition technology, which reduces the payroll costs associated with the production of revenues;

	•		reduced technology product costs of $1.0 million; and

	•		reduced costs of $2.7 million resulting from headcount reductions taken in 2007 to better align our overhead costs with our lower revenues levels.

As a percentage of net revenues, cost of revenues decreased to 70.4% for the three months ended September 30, 2008 from 77.9% for the same period in 2007, as a result largely of our increased use of speech recognition technology and actions taken to better align our fixed costs with our lower revenue levels.

Selling, general and administrative

SG&A expenses decreased $2.4 million, or 15.4%, to $13.1 million for the three months ended September 30, 2008 compared with $15.5 million for the three months ended September 30, 2007. This decrease was attributable to a decrease of $1.4 million in audit fees and a reduction of $1.0 million in all other SG&A costs primarily professional fees related to our evaluation of strategic alternatives which began in 2007. SG&A expense in the three month period ended September 30, 2008 as a percentage of net revenues was 16.2% compared with 18.8% for the same period in 2007.

Research & development

R&D expenses increased $0.8 million, or 22.1%, to $4.6 million for the three months ended September 30, 2008 compared with $3.8 million for the three months ended September 30, 2007. This increase was due to employee related costs including $0.4 million of stock option compensation as a result of the immediate vesting of previously unvested stock options due to the change in control. R&D expenses as a percentage of net revenues were 5.7% for the three months ended September 30, 2008 compared with 4.6% for the three months ended September 30, 2007.

Depreciation

Depreciation expense increased $0.1 million, or 4.1%, to $3.0 million for the three months ended September 30, 2008 compared with $2.9 million for the three months ended September 30, 2007. This increase was the result primarily of several assets being purchased in the latter part of 2007. Depreciation expense as a percentage of net revenues was 3.7% for the three months ended September 30, 2008 compared with 3.5% for the same period in 2007.

Cost of investigation and legal proceedings, net

Interest income, net

Interest income, net reflects interest earned on cash and cash equivalent balances. Interest income, net decreased $1.9 million, or 81.8%, to $0.4 million for the three months ended September 30, 2008 compared with $2.3 million for the three months ended September 30, 2007. This decrease was attributable to the dividend payout of $103.3 million in August 2008, combined with lower weighted average interest rates earned in the 2008 period (2.0%) compared with the 2007 period (5.6%).

Income tax provision

The effective income tax rate for the three months ended September 30, 2008 was 22.6% compared with an effective income tax rate of 12.8% for the three months ended September 30, 2007. The rates consists primarily of provisions for the deferred tax liability

related to the current year tax goodwill amortization which is indefinite in nature as well as the valuation allowance provided against a majority of U.S. deferred tax assets created in the quarter. The provisions also include state and foreign income taxes. The higher 2008 rate is due primarily to a lower pretax loss in 2008.

Comparison of Nine Months Ended September 30, 2008 and 2007


	Nine months ended September 30,
	2008						2007
				% of Net						% of Net
($ in thousands)	Amount			Revenues			Amount			Revenues			$ Change			% Change

Net revenues	$	247,466			100.0	%	$	260,276			100.0	%	$	(12,810	)		(4.9	%)


Operating costs and expenses:
Cost of revenues		176,508			71.3	%		198,918			76.4	%		(22,410	)		(11.3	%)
Selling, general and administrative		39,047			15.8	%		48,158			18.5	%		(9,111	)		(18.9	%)
Research and development		12,502			5.1	%		10,073			3.9	%		2,429			24.1	%
Depreciation		8,901			3.6	%		8,040			3.1	%		861			10.7	%
Amortization of intangible assets		4,145			1.7	%		4,065			1.6	%		80			2.0	%
Cost of investigation and legal proceedings, net		15,307			6.2	%		(456	)		(0.2	%)		15,763			(3,456.8	%)
Restructuring charges		(82	)		(0.0	%)		935			0.4	%		(1,017	)		(108.8	%)


Total operating costs and expenses		256,328			103.6	%		269,733			103.6	%		(13,405	)		(5.0	%)


Operating loss		(8,862	)		(3.6	%)		(9,457	)		(3.6	%)		595			(6.3	%)

Equity in income of affiliated company		200			0.1	%		447			0.2	%		(247	)		(55.3	%)
Other income		438			0.2	%		—			—			438			n.a.
Interest income, net		2,601			1.1	%		6,477			2.5	%		(3,876	)		(59.8	%)


Loss before income taxes		(5,623	)		(2.3	%)		(2,533	)		(1.0	%)		(3,090	)		122.0	%

Income tax provision		2,721			1.1	%		2,402			0.9	%		319			13.3	%


Net loss	$	(8,344	)		(3.4	%)	$	(4,935	)		(1.9	%)	$	(3,409	)		69.1	%

Net revenues

Net revenues decreased $12.8 million, or 4.9% to $247.5 million for the nine months ended September 30, 2008 compared with $260.3 million for the nine months ended September 30, 2007. This decrease was attributable primarily to:

	•		reduced service revenues of $9.2 million resulting primarily from lower medical transcription volume. We believe the reduction in volume was the result primarily of customer losses to other outsourced medical transcription providers; and

	•		reduced revenues from our technology products of $3.6 million due primarily to reduced maintenance contracts.

Cost of revenues

Cost of revenues decreased $22.4 million, or 11.3%, to $176.5 million for the nine months ended September 30, 2008 compared with $198.9 million for the nine months ended September 30, 2007. This decrease was attributable primarily to:

	•		reduced medical transcription payroll costs of $9.8 million related directly to the decrease in our service revenues as well as our increased use of speech recognition technology, which reduces the payroll costs associated with the production of revenues;

	•		reduced technology product cost of goods sold of $2.8 million; and

	•		reduced employee related costs of $9.8 million resulting from headcount reductions taken in 2007 to better align our overhead costs with our lower revenues.

As a percentage of net revenues, cost of revenues decreased to 71.3% for the nine months ended September 30, 2008 from 76.4%

for the same period in 2007 as a result of the reductions described above.

Selling, general and administrative

SG&A expenses decreased $9.1 million, or 18.9%, to $39.0 million for the nine months ended September 30, 2008 compared with $48.2 million for the nine months ended September 30, 2007. This decrease was attributable to expenses in 2007 which did not repeat in 2008 including audit fees of $4.4 million related to the consolidated financial statements and the internal control over financial reporting for years 2003 through 2007; $1.4 million associated with the separation of certain members of our executive management; and $1.0 million for insurance premiums in the second quarter of 2007 triggered by our receipt of certain levels of insurance recovery; and a reduction of compensation expense of $4.1 million as a result of reductions in workforce. These decreases were offset by an increase in all other SG&A costs of $1.8 million primarily related to higher legal cost unrelated to the billing investigation. SG&A expenses as a percentage of net revenues were 15.8% for the nine months ended September 30, 2008 compared with 18.5% for the same period in 2007.

Research & development

R&D expenses increased $2.4 million, or 24.1%, to $12.5 million for the nine months ended September 30, 2008 compared with $10.1 million for the nine months ended September 30, 2007. This increase was due to higher recruiting and staffing costs associated with additional investments in our industry leading DEP technology of $2.0 million and $0.4 million of stock option compensation as a result of the immediate vesting of previously unvested stock options due to the change in control. R&D expenses as a percentage of net revenues were 5.1% for the nine months ended September 30, 2008 compared with 3.9% for the nine months ended September 30, 2007.

Depreciation

Depreciation expense increased $0.9 million, or 10.7%, to $8.9 million for the nine months ended September 30, 2008 compared with $8.0 million for the nine months ended September 30, 2007. This increase was the result primarily of several assets being purchased in the latter part of 2007. Depreciation expense as a percentage of net revenues was 3.6% for the nine months ended September 30, 2008 compared with 3.1% for the same period in 2007.

Cost of investigation and legal proceedings, net

Costs and expenses associated with the Review and Management’s Billing Assessment are being reported as cost of investigation and legal proceedings, net. These costs and expenses increased $15.8 million, or 3,456.8%, to $15.3 million for the nine months ended September 30, 2008 compared with ($0.5) million for the nine months ended September 30, 2007. This increase in costs was due to the recognition of $15.3 million of insurance claims in 2007 that did not occur in 2008; as well as a charge of $1.5 million recorded during the first quarter of 2008 for the proposed settlement of all claims related to the consolidated medical transcriptionist putative class action; and the tentative agreement with the DOJ investigation for $5.9 million in the three months ended September 30, 2008, offset by a decrease in legal fees $6.9 million.

Interest income, net

Interest income, net reflects interest earned on cash and cash equivalent balances. Interest income, net decreased $3.9 million, or 59.8%, to $2.6 million for the nine months ended September 30, 2008 compared with $6.5 million for the nine months ended September 30, 2007. This decrease was attributable to lower average cash balances and lower interest rates in the 2008 period (2.0%) compared with the 2007 period (5.0%).

Income tax provision

The effective income tax rate for the nine months ended September 30, 2008 was 48.4% compared with an effective income tax rate of 94.8% for the nine months ended September 30, 2007. The rates consists primarily of provisions for the deferred tax liability related to the current year tax goodwill amortization which is indefinite in nature as well as the valuation allowance provided against a majority of U.S. deferred tax assets created in the quarter. The provisions also include state and foreign income taxes. The lower 2008 rate is due primarily to a higher pretax loss in 2008.

Liquidity and Capital Resources

As of September 30, 2008, we had working capital of $30.4 million compared with $133.2 million as of December 31, 2007. Our principal source of liquidity was available cash on hand. Cash and cash equivalents decreased $114.3 million for the nine months ended September 30, 2008 to $47.3 million as of September 30, 2008 from $161.6 million as of December 31, 2007. This decrease

was driven primarily by cash used in financing activities of $103.3 million for the dividend payment, accommodation payments of $5.6 million, the payment of the additional accrual related to the settlement of all claims related to the South Broward customer class action matter of $2.3 million, cash used to purchase of property and equipment of $5.0 million, offset by cash generated from all other activity of $1.9 million.

On July 14, 2008, we announced a dividend of $2.75 per share of our common stock which was paid on August 4, 2008 to shareholders of record as of the close of business on July 25, 2008. This resulted in the use of approximately $103.3 million of cash. Any future determination to pay dividends will be at the discretion of our board of directors and will depend on our financial condition, results of operations, capital requirements, and other factors that our board of directors may deem relevant.

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 will have increased cash expenditures relating to:

	•		the SEC and DOJ 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.

Item 4.Controls and Procedures

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 under Rule 13a-15(e) promulgated under the Exchange Act, as of the last day of the fiscal period covered by this report, September 30, 2008. 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, as of September 30, 2008, our disclosure controls and procedures were effective at a reasonable assurance level.

Changes in Internal Control Over Financial Reporting

There have been no changes in our internal control over financial reporting during the fiscal quarter ended September 30, 2008 that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II. OTHER INFORMATION

Item 1.Legal Proceedings

Governmental Investigations

We also received an administrative subpoena under Health Insurance Portability and Accountability Act of 1996 (HIPAA) 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. On September 26, 2008, the DOJ gave notice to intervene in part in twoqui tamactions filed against us for matters purportedly related to the DOJ’s investigation. We have reached a settlement-in-principle to resolve the DOJ’s civil claims and the twoqui tam litigation matter for payment of $6.6 million to the DOJ, which has been accrued as of September 30, 2008. The settlement-in-principle has been disclosed to the court in thequi tamactions, and the twoqui tamrelators have accepted the settlement payment as fair and reasonable. The parties have exchanged a draft settlement agreement and have exchanged comments thereto and are presently negotiating final settlement terms. We must separately negotiate payment of the relators’ legal fees which are not covered by the settlement in principal with the DOJ.

Customer Litigation

Kaiser Litigation

Medical Transcriptionist Litigation

Hoffmann Putative Class Action

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, the parties have reached an agreement in principle to settle all claims.

Force Putative Class Action

Myers Putative Class Action

A putative class action entitled Myers, et al. v. MedQuist Inc. and MedQuist Transcriptions, Ltd., Case No. 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 requested an accounting.

Shareholder Litigation

Costa Brava Partnership III, L.P. Shareholder Litigation

Claim for Preliminary and Injunctive Relief

On July 30, 2008, Costa Brava Partnership III, L.P. (Costa Brava) filed a verified complaint and jury demand in the United States District Court District of New Jersey against MedQuist Inc., Philips, CBay Inc., CBaySystems Holdings, SAC Capital Management, LLC, SAC Private Capital Group, LLC, SAC PEI CB Investment, L.P., and four of our former, non-independent directors, Clement Revetti, Jr., Gregory M. Sebasky and Scott M. Weisenhoff and Edward H. Siegel. It subsequently filed a first amended complaint on August 1, 2008. The amended complaint alleged that the defendants violated the Clayton Act, the New Jersey Shareholder Protection Act, and federal securities laws, by engaging in certain actions that were anti-competitive, harmful to us and in furtherance of the CBaySystems Holdings Purchase. Certain of the claims were purportedly asserted derivatively on our behalf. On August 1, 2008, plaintiff also sought an ex parte temporary restraining order and entry of an order to show cause requiring the defendants to appear and show cause why a preliminary injunction should not be issued enjoining certain of the complained of actions. A hearing was held on the preliminary injunction motion on August 5, 2008. At the conclusion of the hearing, the Court denied the request for a temporary restraining order and denied the request to enter an order to show cause. The Court found that Costa Brava had not met the standards for injunctive relief, including a showing of likelihood of success on the merits of its underlying claims or the presence of immediate irreparable harm. The Court allowed the plaintiff two weeks to file a further amended complaint, and directed the parties to engage in discovery on an expedited schedule. On August 19, 2008, Costa Brava filed a notice of withdrawal with the Court that dismissed without prejudice Costa Brava’s claims against MedQuist and the other defendants.

Kahn Putative Class Action

We deny any liability and intend to defend this action vigorously.

Newcastle Shareholder Litigation

On July 9, 2008, Newcastle amended the complaint to add Arklow Master Fund, Ltd. (Arklow), one of our shareholders and affiliated with one of our directors, as an additional plaintiff. Plaintiffs allege that defendants took steps to sell Philips’ entire interest in MedQuist (i.e., 69.5% of our outstanding shares) to CBaySystems Holdings and CBay Inc. (collectively, CBay). Plaintiffs assert four counts in the amended complaint. First, plaintiffs contend that Rusckowski, Revetti, Sebasky, Weisenhoff and Siegel (collectively, the Philips Directors), who are also senior officers of Philips, breached their fiduciary duties, to us by taking steps to consummate the CBaySystems Holdings Purchase that will adversely affect us. Second, plaintiffs aver that all of the defendants, individually and together, aided and abetted the Philips Directors’ breach of their fiduciary duties. In light of the first two counts, plaintiffs sought injunctive relief (including an order enjoining the CBaySystems Holdings Purchase), declaratory relief and attorneys’ fees and costs. Third, as an alternative form of relief, plaintiffs allege that in the event that Philips sells its stake in MedQuist, plaintiffs demand a declaration that a certain agreement related to the governance of the Company remain in full force and effect. Fourth, plaintiffs assert that CBay breached the standstill provision contained in an April 2008 confidentiality agreement between us and CBay and demand an injunction to prevent CBay from violating that agreement (Confidentiality Agreement).

Reseller Arbitration Demand

On October 1, 2007, we received from counsel to nine current and former resellers of our products (Claimants), a copy of an arbitration demand filed by the Claimants, initiating an arbitration proceeding styled Diskriter, Inc., Electronic Office Systems, Inc., Milner Voice & Data, Inc., Nelson Systems, Inc., NEO Voice and Communications, Inc., Office Business Systems, Inc., Roach-Reid Office Systems, Inc., Stiles Office Systems, Inc., and Travis Voice and Data, Inc. v. MedQuist Inc. and MedQuist Transcriptions, Ltd. (collectively, MedQuist) (filed on September 27, 2007, AAA, 30-118-Y-00839-07). The arbitration demand purports to set forth claims for breach of contract; breach of covenant of good faith and fair dealing; promissory estoppel; misrepresentation; and tortious interference with contractual relations. The Claimants allege that we breached our written agreements with the Claimants by: (i) failing to provide reasonable training, technical support, and other services; (ii) using the Claimants’ confidential information to compete against the Claimants; (iii) directly competing with the Claimants’ territories; and (iv) failing to make new products available to the Claimants. In addition, the Claimants’ allege that we made false oral representations that we: (i) would provide new product, opportunities and support to the Claimants; (ii) were committed to continuing to use Claimants; (iii) did not intend to create our own sales force with respect to the Claimants’ territory; and (iv) would stay out of Claimants’ territories and would not attempt to take over the Claimants business and relationships with the Claimants’ customers and end-users. The Claimants assert that they are seeking damages in excess of $24.3 million. We also moved to dismiss MedQuist Inc. as a party to the arbitration since MedQuist Inc. is not a party to the Claimants’ agreements, and accordingly, has never agreed to arbitration. The AAA initially agreed to rule on these matters, but then decided to defer a ruling to the panel of arbitrators selected pursuant to the parties’ agreements (Panel). In response, we informed the Panel that a court, not the Panel, should rule on these issues. When it appeared that the Panel would rule on these

issues, we initiated a lawsuit in the Superior Court of DeKalb County (the Court) and requested an injunction enjoining the Panel from deciding these issues. The Court denied the request, and indicated that a new motion could be filed if the Panel’s ruling was adverse to MedQuist Inc. or MedQuist Transcriptions, Ltd. On May 6, 2008, the Panel dismissed MedQuist Inc. as a party, but ruled against our opposition to a consolidated arbitration. We asked the Court to stay the arbitration in order to review that decision. The Court initially granted the stay, but later lifted the stay. The Court did not make any substantive rulings regarding consolidation, and in fact, left that decision and others to the assigned judge, who was unable to hear those motions. Accordingly, until further order of the Court, the arbitration will proceed forward.

We filed an answer and counterclaim in the arbitration, which generally denied liability. In the lawsuit, the defendants filed a motion to dismiss alleging that our complaint failed to state an actionable claim for relief. On July 25, 2008, we filed our response which opposed the motion to dismiss in all respects. Discovery has now commenced in both the arbitration and the lawsuit. We deny all wrongdoing and intend to defend ourselves vigorously including asserting counterclaims against the Claimants as appropriate.

Anthurium Patent Litigation

On November 6, 2007, Anthurium Solutions, Inc. filed an action entitledAnthurium Solutions, Inc. v. MedQuist Inc., et al.,Civil Action No. 2-07CV-484, in the United States District Court for the Eastern District of Texas, alleging that we infringed and continue to infringe United States Patent No. 7,031,998 through our DEP transcription platform. The complaint also alleges patent infringement claims against Spheris, Inc. and Arrendale Associates, Inc. The complaint seeks injunctive relief and unspecified damages, including enhanced damages and attorneys’ fees. We filed our answer on January 15, 2008 and counterclaimed seeking a declaratory judgment of non-infringement and invalidity. Plaintiff filed its preliminary infringement contentions on May 2, 2008. Our investigation of the claims is ongoing. We believe that the claims asserted have no merit and intend to vigorously defend the suit.

Other Matters

We had insurance policies which provided coverage for certain of the matters related to the legal actions described herein and certain other legal actions that were previously settled or dismissed. We received total insurance recoveries of $24,795 related to these policies (See Note 8). We do not expect to receive any additional insurance recoveries related to these legal actions.

Item 1A.Risk Factors

We have reviewed the risk factors previously disclosed in our Annual Report on Form 10-K for the year ended December 31, 2007 and have added the following additional risk factor:

As of August 6, 2008, CBaySystems Holdings owns approximately 69.5% of our outstanding common stock, and its interests may conflict with the interests of MedQuist and the interests of our other shareholders.

CBaySystems Holdings beneficially owns approximately 69.5% of our outstanding common stock. CBaySystems Holdings 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 CBaySystems Holdings will be able to make decisions affecting our capital structure, including decisions to issue additional capital stock, implement stock repurchase programs and declare dividends. Our interests and the interests of our affiliates, including CBaySystems Holdings, could conflict with the interest of our other shareholders.

In addition, CBaySystems Holdings beneficially owns 100% of a company, CBay Systems & Services, Inc., that competes in the medical transcription market. Decisions made by CBaySystems Holdings regarding us and CBay Systems & Services, Inc. could benefit CBay Systems & Services, Inc. at our expense and CBaySystems Holdings has the ability to divert resources from us to CBay Systems & Services, Inc., both of which could cause our competitive position vis-à-vis CBay Systems & Services, Inc. to be diminished.

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

None.

Item 3.Defaults Upon Senior Securities

None.

Item 4.Submission of Matters to a Vote of Security Holders

None.

Item 5.Other Information

None.

Item 6.Exhibits

(a) Exhibits


No.		Description

3.1⁽¹⁾		Second Amended and Restated By-Laws of MedQuist Inc., as amended

10.1^(*)		Transcription Services Agreement by and between MedQuist Transcriptions, Ltd. and CBay Systems & Services, Inc. dated September 15, 2008

10.2⁽²⁾		Form of Amendment of Indemnification Agreement for Executive Officers

10.3⁽³⁾		Employment Agreement by and between Peter Masanotti and MedQuist Inc., dated September 3, 2008

31.1		Certification of Chief Executive Officer required by Rule 13a-14(a) or Rule 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 by Rule 13a-14(a) or Rule 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


(1)		Incorporated by reference to our Current Report on Form 8-K filed with the SEC on July 15, 2008

(2)		Incorporated by reference to our Current Report on Form 8-K filed with the SEC on August 25, 2008

(3)		Incorporated by reference to our Current Report on Form 8-K filed with the SEC on September 9, 2008

(*)		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.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.


	MEDQUIST INC.
Date: November 4, 2008	/s/ Peter Masanotti
	Peter Masanotti
	President and Chief Executive Officer (Principal Executive Officer)



Date: November 4, 2008	/s/ Kathleen E. Donovan
	Kathleen E. Donovan
	Senior Vice President and Chief Financial Officer (Principal Financial Officer)

Exhibit Index


No.		Description
10.1^(*)		Transcription Services Agreement by and between MedQuist Transcriptions, Ltd. and CBay Systems & Services, Inc. dated September 15, 2008

31.1		Certification of Chief Executive Officer required by Rule 13a-14(a) or Rule 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 by Rule 13a-14(a) or Rule 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


(*)		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.

Positive
Negative
Uncertain
Constraining
Legalese
Litigous
Readability	8th grade Good

Medquist (MEDQ) Inactive 10-Q2008 Q3 Quarterly report

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