Medquist (MEDQ) 10-Q 2002 Q3 Quarterly report

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q

_________________

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

For the quarterly period	Commission file number
ended September 30, 2002	0-19941

               MedQuist Inc.              
(Exact name of registrant as specified in its charter)

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

Five Greentree Centre, Suite 311, Marlton, NJ 08053
(Address of principal executive offices)      (Zip Code)

                            (856)810-8000                           
(Registrant’s telephone number, including area code)

(Former name, former address and former fiscal year,
if changed since last report.)

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    X       No   ___

Indicate the number of shares outstanding of each of the registrant’s classes of common stock, as of the latest practicable date: 37,078,036 shares of common stock, no par value, as of November 11, 2002.

MEDQUIST INC. AND SUBSIDIARIES

INDEX TO QUARTERLY REPORT ON FORM 10-Q

PART I.        FINANCIAL INFORMATION		PAGE NO.
Item 1.	Consolidated Financial Statements
	Consolidated Balance Sheets at September 30, 2002 (Unaudited) and
	December 31, 2001	1
	Consolidated Statements of Income for the Nine Months Ended September 30, 2002
	and 2001 (Unaudited)	2
	Consolidated Statements of Income for the Three Months Ended September 30, 2002
	and 2001 (Unaudited)	3
	Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2002
	and 2001 (Unaudited)	4
	Notes to Consolidated Financial Statements (Unaudited)	5
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	13
Item 3.	Quantitative and Qualitative Disclosure About Market Risk	18
Item 4.	Controls and Procedures	19
	Special Note Concerning Forward Looking Statements	19
PART II.     OTHER INFORMATION
Item 1.	Legal Proceedings	20
Item 2.	Changes in Securities and Use of Proceeds	20
Item 3.	Defaults upon Senior Securities	20
Item 4.	Submission of Matters to a Vote of Security Holders	20
Item 5.	Other Information	20
Item 6.	Exhibits and Reports on Form 8-K	20
SIGNATURE		21
SECTION 302 CERTIFICATIONS		22

MEDQUIST INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands)

	September 30,			December 31,
	2002			2001
	(Unaudited)			(Note 5)
Assets
Current assets:
Cash and cash equivalents	$	83,972		$	86,334
Accounts receivable, net of allowance of $5,691 and $5,148	87,736			78,429
Deferred income taxes	6,178				6,178
Prepaid expenses and other current assets	8,560				1,714
Total current assets		186,446		172,655
Property and equipment, net	38,602			34,167
Deferred income taxes	13,182			20,197
Other assets	7,586				7,292
Goodwill		136,927		110,584
Other intangible assets, net	75,539			57,219
	$	458,282		$	402,114
Liabilities and Shareholders’ Equity
Current liabilities:
Current portion of long-term debt	$	34		$	1,067
Accounts payable	9,630				4,562
Deferred revenue	15,863				333
Accrued expenses	30,660			30,990
Total current liabilities	56,187			36,952
Long-term debt		55			1,088
Other liabilities	1,342				1,187
Commitments and contingencies
Shareholders’ equity:
Common stock, no par value, 60,000 shares authorized,       37,077 and 36,889 issued and outstanding
		229,033		225,503
Retained earnings		171,204		137,361
Deferred compensation		(8	)		(31	)
Accumulated other comprehensive income		469			54
Total shareholders’ equity		400,698		362,887
	$	458,282		$	402,114

See Accompanying Notes to Consolidated Financial Statements.

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     MEDQUIST INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
(In thousands, except per share amounts)

	Nine Months Ended
	September 30,
	2002			2001
					(Note 5)
Revenue	$	357,355		$	295,772
Costs and expenses:
Cost of revenue, excluding depreciation	268,320			218,111
Selling, general and administrative		14,073			9,607
Research and development		1,426			—
Depreciation		13,697			12,265
Amortization of intangible assets		5,086			6,840
Restructuring (credits)		—			(600	)
Other (income)		—			(3,000	)
Total costs and expenses	302,602			243,223
Operating income		54,753			52,549
Equity in losses of investee		(674	)		(816	)
Interest income, net		950			3,327
Income before income taxes		55,029			55,060
Income taxes		21,186			21,511
Net income	$	33,843		$	33,549
Basic net income per common share	$	0.91		$	0.91
Diluted net income per common share	$	0.89		$	0.89

See Accompanying Notes to Consolidated Financial Statements.

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 MEDQUIST INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
(In thousands, except per share amounts)

	Three Months Ended
	September 30,
	2002			2001
					(Note 5)
Revenue	$	129,750		$	102,695
Costs and expenses:
Cost of revenue, excluding depreciation	99,056				75,435
Selling, general and administrative		6,891			3,328
Research and development		1,426			—
Depreciation		5,113			4,378
Amortization of intangible assets		1,772			2,559
Total costs and expenses	114,258				85,700
Operating income	15,492				16,995
Equity in losses of investee		(243	)		(248	)
Interest income, net		261			662
Income before income taxes	15,510				17,409
Income taxes		5,971			6,797
Net income	$	9,539		$	10,612
Basic net income per common share	$	0.26		$	0.29
Diluted net income per common share	$	0.25		$	0.28

See Accompanying Notes to Consolidated Financial Statements.

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MEDQUIST INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(In thousands)

	Nine Months Ended
	September 30,
	2002				2001
					(Note 5)
Operating activities:
Net income	$	33,843			$	33,549
Adjustments to reconcile net income to net cash provided by       operating activities, net of business acquisitions:
Depreciation and amortization		18,783			19,105
Equity in losses of investee		674				816
Pension contributions payable in Common Stock		277				667
Amortization of deferred compensation		23				72
Tax benefit for exercise of employee stock options		802				226
Changes in assets and liabilities, excluding effects of acquisitions
Accounts receivable, net		7,556			3,361
Prepaid expenses and other current assets		(611	)		5,279
Other assets		(72	)		(1,474		)
Accounts payable		794				138
Deferred revenue		(989	)			61
Accrued expenses		(2,428	)		(3,939		)
Other liabilities		155				385
Net cash provided by operating activities		58,807			58,185
Investing activities:
Purchases of property and equipment	(12,116		)		(9,713		)
Investment in A-Life Medical, Inc.		(892	)			—
Acquisitions, net of cash acquired	(48,518		)			(56,104	)
Net cash used in investing activities	(61,526		)	(65,817			)
Financing activities:
Repayments of long-term debt		(2,138	)			(561	)
Proceeds from the exercise of common stock options		488				632
Proceeds from issuance of Common Stock		1,864				—
Net cash provided by financing activities		214				71
Effect of exchange rate changes		143				—
Net decrease in cash and cash equivalents		(2,362	)		(7,561		)
Cash and cash equivalents, beginning of period		86,334			97,365
Cash and cash equivalents, end of period	$	83,972			$	89,804
Supplemental disclosure of cash flow information:
Cash paid during period for:
Interest expense	$	160			$	41
Income taxes	$	18,758			$	16,391

See Accompanying Notes to Consolidated Financial Statements.

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MedQuist Inc. and Subsidiaries
Notes to Consolidated Financial Statements
September 30, 2002
(Unaudited – amounts in thousands, except per share amounts)

Note 1. Business and Basis of Presentation

MedQuist Inc. is the leading national provider of medical transcription services to the healthcare industry in the United States. We entered this business in May 1994 through the acquisition of a medical transcription services company. Since this date we have completed an additional 49 acquisitions.

MedQuist Inc. is a majority owned subsidiary of Koninklijke Philips Electronics N.V. (Philips).

The information set forth in these statements is unaudited. The information reflects all adjustments that, in the opinion of management, are necessary to present a fair statement of operations of MedQuist Inc. and its consolidated subsidiaries for the periods indicated. Results of operations for the interim periods ended September 30, 2002 are not necessarily indicative of the results of operations for the full year. Certain information in footnote disclosures normally included in financial statements have been condensed or omitted in accordance with the rules and regulations of the Securities and Exchange Commission.

Note 2. Acquisitions

During 2001, we completed seven acquisitions accounted for using the purchase method. Pro forma information is not presented as the acquisitions were not material to the Company.

During the nine months ended September 30, 2002, we completed five acquisitions accounted for using the purchase method. A summary of the allocation of the purchase price to net assets acquired is as follows:

Accounts receivable	$	16,863
Prepaid and other		6,235
Property and equipment		6,016
Deposits		5
Goodwill		22,835
Other intangible assets		23,406
Accounts payable		(4,275	)
Deferred revenue	(16,519		)
Accrued expenses		(5,976	)
Debt		(72	)
Cash paid for acquisition
including transaction costs	$	48,518

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Included in the 2002 acquisitions was the acquisition of Lanier Healthcare, LLC (“Lanier”) on July 1, 2002, for $38.0 million in cash. The following unaudited proforma information is presented as if the Lanier acquisition had been completed on January 1, 2001. All other acquisitions in 2002 were not material to the Company.

	Nine Months Ended				Three Months Ended
	September 30,				September 30,
	2002		2001		2002			2001
Revenue	$	398,139	$	355,831	$	129,750	$	122,643
Net Income		33,764		33,540		9,539		10,459
Basic net income
per common share	$	0.91	$	0.91	$	0.26	$	0.28
Diluted net income
Per common share	$	0.89	$	0.89	$	0.25	$	0.28

In the nine months ended September 30, 2002, we adjusted goodwill and deferred income taxes by $3,509 relating to accounting for certain previously completed stock acquisitions.

Revenue is derived from the sale and implementation of voice-capture and document management solutions and maintenance service of these products. We recognize revenue and profit on sales and implementation utilizing the percentage of completion method. With regard to service contracts, which is arranged separate from the product sale, the typical arrangement spans twelve months. We recognize revenue on the service contracts on a straight line method over the term of the underlying service contract.

Note 3. Restructuring Charges

In December 2001, we approved a restructuring plan associated with the roll out of our new transcription platform. The plan includes the closure of several operating facilities in order to improve operating efficiencies. Costs associated with the plan of approximately $1,468 were recognized in 2001 in accordance with Emerging Issues Task Force (EITF) Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity." The components of the restructuring charge and associated activity is as follows:

	Non-Cancelable Leases			Severance			Total
2001 Restructuring charge	$	1,343		$	125		$	1,468
Payments against restructuring accrual in 2002		(440	)		(36	)		(476	)
Accrual at September 30, 2002	$	903		$	89		$	992

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In November 2001, we completed the purchase of a medical transcription company. In connection with this acquisition, we established a restructure reserve of $1,790. The components of the restructuring charge and associated activity is as follows:

	Non-Cancelable Leases			Severance			Total
2001 Restructuring charge	$	1,599		$	191		$	1,790
Payments against restructuring accrual:
2001		(85	)		—			(85	)
2002		(498	)	(181		)		(679	)
Accrual at September 30, 2002	$	1,016		$	10		$	1,026

In December 1998, the Company’s board of directors approved management’s restructuring plan associated with another entity. The components of the restructuring charge and associated activity is as follows:

	Non-Cancelable Leases			Severance			Non-Cancelable Contracts and Other Exit Costs			Total
1998 Restructuring Charge	$	3,835		$	1,618		$	1,086		$	6,539
Payments against Restructuring accrual:
1998		—			(567	)		(410	)		(977	)
1999		(437	)		(723	)		(17	)	(1,177		)
2000		(556	)		(20	)		—			(576	)
2001		(164	)		—			—			(164	)
2002		(135	)		—			—			(135	)
Revision to estimate recorded in 1999	(1,492		)		(182	)		(659	)	(2,333		)
Revision to estimate recorded in 2000		(471	)		—			—			(471	)
Revision to estimate recorded in 2001		(44	)		(126	)		—			(170	)
Accrual at September 30, 2002	$	536		$	—		$	—		$	536

In 1997, an acquired entity had approved a separate management plan to close and/or merge several redundant customer service centers in order to further reduce costs and improve operating efficiencies. The plan was completed during 1998 and included the cost of exiting certain facilities, primarily related to non-cancelable leases, the disposition of fixed assets and employee severance costs. During 2001, we revised our accrual estimates and $430 of the restructure accruals were reversed in connection with the revision. At December 31, 2001, the accrual had been fully utilized.

Note 4. Business Combinations and Intangibles

In June 2001, the Financial Accounting Standards Board issued SFAS No. 141, "Business Combinations" and SFAS No. 142, "Goodwill and Other Intangible Assets". SFAS No. 141 requires that all business combinations consummated after June 30, 2001 be accounted for under the purchase method of accounting. SFAS No. 142 requires that goodwill and intangible assets with indefinite lives will no longer be amortized, but are reviewed at least annually for impairment. The amortization provisions of SFAS No. 142 apply to goodwill and intangible

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assets acquired after June 30, 2001. With respect to goodwill and intangible assets acquired prior to July 1, 2001, we adopted SFAS No. 142 effective January 1, 2002.

The carrying amount of acquired intangible assets as of September 30, 2002 is as follows:

	Life	Gross Carrying Amount		Accumulated Amortization		Net Book Value
Goodwill	NA	$	151,469	$	14,542	$	136,927
Customer Lists	10-25 years		76,960		12,282		64,678
Noncompete Agreements	1.5-5 years		11,218		7,828		3,390
Other	3-5 years		13,504		6,033		7,471
		$	253,151	$	40,685	$	212,466

Reported net income for the nine and three months ended September 30, 2002 and September 30, 2001 exclusive of amortization expense related to goodwill is as follows:

	Nine Months Ended September 30,				Three Months Ended September 30,
	2002		2001		2002		2001
Net income, as reported	$	33,843	$	33,549	$	9,539	$	10,612
Add back:
Goodwill amortization, net of tax		—		1,536		—		538
Adjusted net income	$	33,843	$	35,085	$	9,539	$	11,150
Basic net income per common share:
Basic net income per share, as reported	$	0.91	$	0.91	$	0.26	$	0.29
Impact of goodwill amortization		—		0.04		—		0.01
Adjusted basic net income per share	$	0.91	$	0.95	$	0.26	$	0.30
Diluted net income per common share:
Diluted net income per share, as reported	$	0.89	$	0.89	$	0.25	$	0.28
Impact of goodwill amortization		—		0.04		—		0.01
Adjusted diluted net income per share	$	0.89	$	0.93	$	0.25	$	0.29

Pursuant to SFAS No. 142, we tested goodwill for impairment in the second quarter of 2002 and we have determined there has not been any impairment.

Note 5. Investment in A-Life Medical, Inc.

In January 2002, we increased our ownership in A-Life Medical, Inc. (A-Life) to 28.1 percent of the outstanding voting shares of A-Life. As such, effective January 2002 we began accounting for the investment under the equity method of accounting. In accordance with Accounting Principles Board Opinion (APB) No. 18, the prior year financial statements have been retroactively adjusted. The previously reported net income for the three and nine months ended September 30, 2001 has been decreased by $248 and $816, respectively, to reflect the equity in losses of A-Life during these periods. The impact of the retroactive adjustments is to decrease previously reported diluted net income per common share by $0.01 and $0.02 for the three and nine month periods ended September 30, 2001, respectively. The carrying amount of our investment in A-Life has also been adjusted to reflect our percentage ownership in the losses incurred by A-Life during the period we maintained the cost basis investment. Accordingly, we

8

reduced our investment by $1,923 with a corresponding offset to retained earnings. In addition, because A-Life had negative book value at the time of our change to the equity basis of accounting, the entire remaining adjusted investment was allocated to intangible assets, of which $1 million was allocated to acquired software. The acquired software is being amortized over three years. The remaining amount was recorded as goodwill, which was $3.8 million as of September 30, 2002.

On June 28, 2002, we further increased our ownership in A-Life to 31.6%.

Note 6. Net Income Per Common Share

Basic net income per share is calculated by dividing net income by the weighted average number of shares of Common Stock outstanding for the period. Diluted net income per share is calculated by dividing net income by the weighted average number of shares of Common Stock outstanding for the period, adjusted for the dilutive effective of Common Stock equivalents, which consist of stock options, using the treasury stock method.

The table below sets forth the reconciliation of the numerators and denominators of the basic and diluted net income per share computations:

	Nine Months Ended September 30,
	2002					2001
	Net Income		Shares	Per Share Amount		Net Income		Shares	Per Share Amount
Basic	$	33,843	36,987	$	0.91	$	33,549	36,831	$	0.91
Effect of dilutive securities		—	958				—	872
Diluted	$	33,843	37,945	$	0.89	$	33,549	37,703	$	0.89

For the nine months ended September 30, 2002 and 2001, options to acquire 3,203 and 2,320 shares of Common Stock, respectively, were outstanding but were not included in the computation of diluted net income per share. These shares were not included in the computation because the exercise prices of the options were greater than the average market prices for Common Stock during the periods.

	Three Months Ended June 30,
	2002					2001
	Net Income		Shares	Per Share Amount		Net Income		Shares	Per Share Amount
Basic	$	9,539	37,045	$	0.26	$	10,612	36,868	$	0.29
Effect of dilutive securities		—	872				—	1,002
Diluted	$	9,539	37,917	$	0.25	$	10,612	37,870	$	0.28

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For the three months ended September 30, 2002 and 2001, options to acquire 3,206 and 2,093 shares of Common Stock, respectively, were outstanding but were not included in the computation of diluted net income per share. These shares were not included in the computation because the exercise prices of the options were greater than the average market prices for Common Stock during the periods.

Note 7. Related Party Transactions

In the fourth quarter of 2000, the Company began participating in a deposit facility established by Philips which allowed investments up to $150 million to earn interest at LIBOR less 0.125 percent, for periods up to 365 days. The Company withdrew all funds invested in this related-party deposit facility in the second quarter of 2001 and, at December 31, 2001, the Company had no such investment. The facility terminated in February 2002. Interest income earned on cash deposited with Philips was $403 for the year ended December 31, 2001, all of which was earned in the six months ended June 30, 2001.

MedQuist incurred costs of $1,933 with Philips during the nine months ended September 30, 2001, related to a licensing agreement entered into to provide for the integration and use of certain Philips speech recognition technology into our business. This agreement was amended in January 2002, which required a $150 up front payment in addition to a fee based on a per payroll line basis. Through September 30, 2002, the $150 has been paid and there have been no fees incurred on a payroll line basis. The agreement expires on May 22, 2005.

In addition to the revision to the license agreement, MedQuist entered into a consulting agreement with Philips. This agreement calls for Philips to aid MedQuist with the integration of its speech and transcription technologies. Under this agreement, MedQuist has incurred costs of $190 for the nine months ended September 30, 2002.

Presently all business insurance coverages, with the exception of worker's compensation, are provided by Philips. For the nine months ended September 30, 2002, we have incurred $133 in premiums with Philips under these policies.

Philips also sells dictation related equipment to MedQuist and for the nine months ended September 30, 2002 we have incurred $706 in costs for such equipment.

Management believes that the transactions with Philips are on an arms-length basis.

Note 8. Commitments and Contingencies

During the nine months ended September 30, 2002 there have been no items that significantly impact the Company’s commitments and contingencies as disclosed in the notes to the 2001 annual financial statements as filed on Form 10-K.

Note 9. New Accounting Pronouncements

In August 2001, the Financial Accounting Standards Board issued SFAS No. 143, "Accounting for Asset Retirement Obligations" (effective for fiscal years beginning after June 15, 2002). SFAS No. 143 addresses accounting and reporting for obligations associated with the retirement of tangible long-lived assets and retirement of assets. We currently do not expect that the adoption of SFAS No. 143 will have a significant impact on our consolidated financial position and results of operations.

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In August 2001, the Financial Accounting Standards Board issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets", which establishes a single accounting model, based on the framework established in SFAS No. 121, "Accounting for the Impairment or Disposal of Long-Lived Assets", and resolves significant implementation issues related to SFAS No. 121. SFAS No. 144 superceded SFAS No. 121 and Accounting Principles Board Opinion No. 30, "Reporting the Results of Operations - Reporting the Effects of a Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions". We adopted SFAS No. 144 in 2002. The adoption of SFAS No. 144 did not have a material impact on our consolidated financial condition or results of operations.

In June 2002, the Financial Accounting Standards Board issued SFAS No. 146, “Accounting for Exit or Disposal Activities”. SFAS No. 146 addresses the recognition, measurement and reporting of costs associated with exit and disposal activities, including restructuring activities. SFAS No. 146 also addresses recognition of certain costs related to terminating a contract that is not a capital lease, costs to consolidate facilities or relocate employees and termination of benefits provided to employees that are involuntarily terminated under the terms of a one-time benefit arrangement that is not an ongoing benefit arrangement or an individual deferred compensation contract. SFAS No. 146 is effective for exit or disposal activities that are initiated after December 31, 2002. Adoption of SFAS No. 146 is not expected to have an impact on the financial position or results of operations of the Company.

Note 10. Segment Information

MedQuist manages its business in two segments; services and solutions. While the two segments are closely related, the services segment is largely comprised of transcription and coding services, while the solution segment is comprised of sale and service of voice products.

Segment information is presented in accordance with SFAS 131, “Disclosure about Segments of an Enterprise and Related Information”. This standard is based on a management approach, which requires segmentation based on the Company’s internal organization and disclosure of revenue and operating income based on internal accounting methods. The Company’s financial reporting systems present various data for management to run the business, including profit and loss statements. However, this standard does not require an enterprise to report information that is not prepared for internal use, if reporting it would be impractical.

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Nine Months Ended September 30,

2002		Services	Solutions		Intersegment Items			Consolidated
Revenue	$	339,810	$	17,633	$	(88	)	$	357,355
Cost of revenue,
excluding depreciation		256,277		12,131		(88	)	268,320
Gross profit	$	83,533	$	5,502	$	—		$	89,035

2001
Revenue	$	295,772	N/A	—	$	295,772
Cost of revenue,
excluding depreciation		218,111	—	—		218,111
Gross profit	$	77,661	N/A	—	$	77,661

Three Months Ended September 30,

2002		Services	Solutions		Intersegment Items			Consolidated
Revenue	$	112,205	$	17,633	$	(88	)	$	129,750
Cost of revenue,
excluding depreciation		87,013		12,131		(88	)		99,056
Gross profit	$	25,192	$	5,502	$	—		$	30,694

2001
Revenue	$	102,695	N/A	—	$	102,695
Cost of revenue,
excluding depreciation		75,435	—	—		75,435
Gross profit	$	27,260	N/A	—	$	27,260

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A reconciliation of MedQuist’s consolidated segment gross profit to consolidated income before income taxes is as follows:

	Nine Months Ended September 30,						Three Months Ended September 30,
	2002			2001			2002			2001
Consolidated segment gross profit	$	89,035		$	77,661		$	30,694		$	27,260
Selling, general and administrative	(14,073		)		(9,607	)		(6,891	)		(3,328	)
Research and development		(1,426	)		—			(1,426	)		—
Depreciation	(13,697		)	(12,265		)		(5,113	)		(4,378	)
Amortization of intangible assets		(5,086	)		(6,840	)		(1,772	)		(2,559	)
Restructuring credits		—			600			—			—
Other income, net		276			5,511			18			414
Income before income taxes	$	55,029		$	55,060		$	15,510		$	17,409

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

General

Critical Accounting Policies and Estimates

Management Discussion and Analysis of Financial Condition and Results of Operations are based on our Consolidated Financial Statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires management to make estimates and assumptions which affect the reported amounts of assets, liabilities, revenue, expense, and related disclosures. Management bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities.

Management believes the following critical accounting policies affect its more significant estimates and assumptions used in the preparation of its consolidated financial statements.

Revenue Recognition

A substantial portion of our revenue is derived from providing medical transcription services, which we recognize when services are rendered. These services are based primarily on contracted rates. A portion of our revenue is derived from the sale and implementation of voice-capture and document management solutions, and maintenance service of these products. We recognize revenue and profit on sales and implementation utilizing the percentage of completion method. With regard to service contracts, which is arranged separate from the product sale, the typical arrangement spans 12 months. We recognize revenue on the service contracts on a straight line method over the term of the underlying service contract.

Bad Debt

We estimate allowances for doubtful accounts receivables based on historical experience and evaluation of the financial condition of the customers. Historically, our estimates have been adequate to cover accounts receivable exposure. If circumstances related to our estimates change, we may need to record additional allowances.

13

Valuation of Goodwill, Other Intangible Assets and Other Long-Lived Assets

We assess goodwill, other intangible assets, and other long-lived assets for recoverability whenever events or changes in circumstances indicate their carrying value may not be recoverable through the estimated undiscounted future cash flows resulting from the use of the assets. When we determine that the carrying value of goodwill, other intangible assets, and other long-lived assets may not be recoverable, we measure impairment by using the projected discounted cash flow method to determine fair value with a discount rate we determine to be commensurate with the risk inherent in our current business. When impairment is determined, it is recorded as a charge against earnings in the period when recognized.

Deferred Taxes

We record a valuation allowance to reduce our deferred tax assets to the amount that is more likely than not to be realized. We have considered future taxable income and prudent and feasible tax planning strategies in determining the need for a valuation allowance. In the event we were to determine that we could not realize all or part of our net deferred tax assets in the future, an adjustment to the deferred tax assets would be charged to earnings in the period such determination is made. Likewise, if we later determine that it is more likely than not that the net deferred tax assets would be realized, the previously provided valuation reserve would be reversed.

Results of Operations

The following table sets forth for the periods indicated certain financial data in the Company’s Unaudited Consolidated Statements of Income as a percentage of net revenue:

	Nine Months Ended September 30,				Three Months Ended September 30,
	2002		2001		2002		2001
Revenue	100.0	%	100.0	%	100.0	%	100.0	%
Costs and expenses:
Cost of revenue, excluding depreciation	75.1		73.7		76.3		73.5
Selling, general and administrative	4.0		3.3		5.3		3.2
Research and development	0.4		—		1.1		—
Depreciation	3.8		4.1		4.0		4.3
Amortization of intangible assets	1.4		2.3		1.4		2.5
Restructuring (credits)	—		(0.2	)	—		—
Other (income)	—		(1.0	)	—		—
Operating income	15.3		17.8		11.9		16.5
Equity in losses of investee	(0.2	)	(0.3	)	(0.2	)	(0.2	)
Interest income, net	0.3		1.1		0.2		0.6
Income before income taxes	15.4		18.6		11.9		16.9
Income taxes	5.9		7.3		4.6		6.6
Net income	9.5	%	11.3	%	7.3	%	10.3	%

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Nine Months Ended September 30, 2002

Revenue.Revenue increased 20.8% from $295.8 million for the nine months ended September 30, 2001 to $357.4 million for the comparable 2002 period. Revenue from the services segment increased 14.9% from $295.8 million for the nine months ended September 30, 2001 to $339.8 million for the comparable 2002 period. The increase is the result of acquisitions made in 2001 and 2002. Revenue from the solutions segment were $17.6 million for the nine months ended September 30, 2002 and are the result of the acquisition of Lanier on July 1, 2002.

Cost of Revenue, excluding depreciation. Cost of revenue increased 23.0% from $218.1 million for the nine months ended September 30, 2001 to $268.3 million for the comparable 2002 period. As a percentage of revenue, cost of revenue increased from 73.7% for the nine months ended September 30, 2001 to 75.1% for the comparable 2002 period. Cost of revenue from the services segment increased from $218.1 million or 73.7% of revenue for the nine months ended September 30, 2001 to $256.3 million or 75.4% of revenue. The increase primarily resulted from payroll, transcription and benefit costs, in addition to costs associated with development of our new transcription platform. Cost of revenue for the solutions segment was $12.1 million or 68.8% of revenue for the nine months ended September 30, 2002. The cost of revenue for the solutions segment resulted from the acquisition of Lanier on July 1, 2002.

Selling, general and administrative.Selling, general and administrative expenses increased 46.5% from $9.6 million for the nine months ended September 30, 2001 to $14.1 million for the comparable 2002 period. As a percentage of revenues, selling, general and administrative expenses increased from 3.3% for the nine months ended September 30, 2001 to 3.9% for the comparable 2002 period. Of the increase in expense between comparable periods $3.3 million of the increase results from the Lanier acquisition and largely relates to the cost of the sales force. The remaining $1.2 million increase is the result of increased costs to support operations.

Research and development. Research and development costs were $1.4 million for the nine months ended September 30, 2002. These costs relate entirely to Lanier, which was acquired on July 1, 2002.

Depreciation. Depreciation expense increased 11.7% from $12.3 million for the nine months ended September 30, 2001 to $13.7 million for the comparable 2002 period. As a percentage of revenues, depreciation decreased from 4.1% for the nine months ended September 30, 2001 to 3.8% for the comparable period in 2002. The increase in expense was due to increased capital purchases to support the increased revenue base. As a percentage of revenue, depreciation decreased as a result of our ability to reduce certain voice capture component expenditures through our acquisition of Digital Voice, Inc. early in 2001.

Amortization of intangible assets. Amortization of intangible assets decreased from $6.8 million for the nine months ended September 30, 2001 to $5.1 million for the comparable 2002 period. The decrease is attributable to the elimination of goodwill amortization in accordance with SFAS 142 reflecting a $2.5 million reduction of amortization partially offset by $742,000 of amortization of other intangibles associated with the Company's acquisitions in 2001 and 2002, which were accounted for using the purchase method.

15

Equity in losses of investee. As a result of our increased ownership in A-Life to 28.1% of the outstanding voting shares of A-Life, we are required to reflect the investment under the equity method of accounting. As a result, for the nine months ended September 30, 2002, we recognized a loss on this investment of $674,000. This loss was the result of amortization of $250,000 related to $1 million of the investment being allocated to acquired software and $424,000 related to our share of A-Life's operating loss. Our equity in the losses of A-Life for the nine months ended September 30, 2001 was $816,000. On June 28, 2002, we further increased our ownership in A-Life to 31.6%.

Interest income, net. We had net interest income of $3.3 million for the nine months ended September 30, 2001 and net interest income of $950,000 for the comparable 2002 period. The decrease is due to decreased rates of return on cash and cash equivalents.

Income taxes. Income taxes decreased from $21.5 million for the nine months ended September 30, 2001 to $21.2 million for the comparable 2002 period. The decrease in income taxes resulted primarily from decreased pre-tax earnings in the nine months ended September 30, 2002.

Three Months Ended September 30, 2002

Revenue.Revenue increased 26.3% from $102.7 million for the three months ended September 30, 2001 to $129.8 million for the comparable 2002 period. Revenue from the services segment increased 9.3% from $102.7 million for the three months ended September 30, 2002 to $112.2 million for the comparable 2002 period. The increase is the result of the acquisitions made in late 2001 and 2002. Revenue from the solutions segment were $17.6 million for the three months ended September 30, 2002 and are the result of the acquisition of Lanier on July 1, 2002.

Cost of Revenue, excluding depreciation.Cost of revenue increased 31.3% from $75.4 million for the three months ended September 30, 2001 to $99.1 million for the comparable 2002 period. As a percentage of revenue, cost of revenue increased from 73.5% for the three months ended September 30, 2001 to 76.3% for the comparable 2002 period. Cost of revenue from the services segment increased from $75.4 million or 73.5% of revenue for the three months ended September 30, 2001 to $87.0 million or 77.5% of revenue for the comparable 2002 period. The increase primarily resulted from payroll, transcription and benefit costs in addition to costs associated with development of our new transcription platform. Cost of revenue for the solutions segment was $12.1 million or 68.8% of revenue for the three months ended September 30, 2002. The cost of revenue for the solutions segment resulted from the acquisition of Lanier on July 1, 2002.

Selling, general and administrative. Selling, general and administrative expenses increased 107.0% from $3.3 million for the three months ended September 30, 2001 to $6.9 million for the comparable 2002 period. As a percentage of revenues, selling, general and administrative expenses increased from 3.2% for the three months ended September 30, 2001 to 5.3% for the comparable 2002 period. Of the increase in expense between comparable periods, $3.3 million of the increase results from the Lanier acquisition and largely relates to the cost of the sales force. The remaining $600,000 increase is the result of increased costs to support the operations.

Research and development. Research and development costs were $1.4 million for the three months ended September 30, 2001. These costs relate entirely to Lanier, which was acquired on July 1, 2002.

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Depreciation. Depreciation expense increased 16.8% from $4.4 million for the three months ended September 30, 2001 to $5.1 million for the comparable 2002 period. As a percentage of revenues, depreciation decreased from 4.3% for the three months ended September 30, 2001 to 4.0% for the comparable period in 2002. The increase in expense was due to increased capital purchases to support the increased revenue base. As a percentage of revenue, depreciation decreased as a result of our ability to reduce certain voice capture component expenditures through our purchase of DVI early in 2001.

Amortization of intangible assets. Amortization of intangible assets decreased from $2.6 million for the three months ended September 30, 2001 to $1.8 million for the comparable 2002 period. The decrease is attributable to the elimination of goodwill amortization in accordance with SFAS 142 reflecting $874,000 reduction of amortization, partially offset by $87,000 of amortization of other intangibles associated with the Company's acquisitions in 2001 and 2002, which were accounted for using the purchase method.

Equity in losses of investee. As a result of our increased ownership in A-Life to 28.1% of the outstanding voting shares of A-Life, we are required under APB No. 18 to reflect the investment under the equity method of accounting. As a result, for the three months ended September 30, 2002, we recognized a loss in this investment of $243,000. This loss was the result of amortization of $83,000 related to $1 million of the investment being allocated to acquired software and $160,000 related to our share of A-Life's operating loss. Our equity in the losses of A-Life for the three months ended September 30, 2001 was $248,000. On June 28, 2002, we further increased our ownership in A-Life to 31.6%.

Interest income, net. We had net interest income of $662,000 for the three months ended September 30, 2001 and net interest income of $261,000 for the comparable 2002 period. The decrease is due to decreased rates of return on liquid investments.

Income taxes. Income taxes decreased from $6.8 million for the three months ended September 30, 2001 to $6.0 million for the comparable 2002 period. The decrease in income taxes resulted from decreased pre-tax earnings. .

Liquidity and Capital Resources

     At September 30, 2002, we had working capital of $130.3 million, including $84.0 million of cash and cash equivalents. During the nine months ended September 30, 2002, our operating activities provided cash of $58.8 million and during the nine months ended September 30, 2001 our operating activities provided cash of $58.2 million. The increase is primarily due to increased collections in accounts receivable, partially offset by decreases in our accrued expenses and an increase in prepaid expenses.

     During the nine months ended September 30, 2002, we used cash in investing activities of $61.5 million, consisting of $12.1 million of capital expenditures and $48.5 million for acquisitions accounted for under the purchase method and $892,000 of additional investments in A-Life. During the nine months ended September 30, 2001, we used cash for investing activities of $65.8 million, consisting of $9.7 million of capital expenditures and $56.1 million for acquisitions accounted for under the purchase method.

17

During the nine months ended September 30, 2002, net cash provided by financing activities was $214,000. During the nine months ended September 30, 2001, cash provided by financing activities was $71,000.

We believe that our cash and cash equivalents generated from operations and our borrowing capacity will be sufficient to meet our current working capital and capital expenditure requirements.

New Accounting Pronouncements

In August 2001, the Financial Accounting Standards Board issued SFAS No. 143, "Accounting for Asset Retirement Obligations" (effective for fiscal years beginning after June 15, 2002). SFAS No. 143 addresses accounting and reporting for obligations associated with the retirement of tangible long-lived assets and retirement of assets. We currently do not expect that the adoption of SFAS No. 143 will have a significant impact on our consolidated financial position and results of operations.

In August 2001, the Financial Accounting Standards Board issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets", which establishes a single accounting model, based on the framework established in SFAS No. 121, "Accounting for the Impairment or Disposal of Long-Lived Assets", and resolves significant implementation issues related to SFAS No. 121. SFAS No. 144 superceded SFAS No. 121 and Accounting Principles Board Opinion No. 30, "Reporting the Results of Operations - Reporting the Effects of a Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions". We adopted SFAS No. 144 in 2002. The adoption of SFAS No. 144 did not have a material impact on our consolidated financial condition or results of operations.

In June 2002, the Financial Accounting Standards Board issued SFAS No. 146, “Accounting for Exit or Disposal Activities”. SFAS No. 146 addresses the recognition, measurement and reporting of costs associated with exit and disposal activities, including restructuring activities. SFAS No. 146 also addresses recognition of certain costs related to terminating a contract that is not a capital lease, costs to consolidate facilities or relocate employees and termination of benefits provided to employees that are involuntarily terminated under the terms of a one-time benefit arrangement that is not an ongoing benefit arrangement or an individual deferred compensation contract. SFAS No. 146 is effective for exit or disposal activities that are initiated after December 31, 2002. Adoption of SFAS No. 146 is not expected to have an impact on the financial position or results of operations of the Company.

Item 3. Quantitative and Qualitative Disclosure About Market Risk

We generally do not use derivative financial instruments in our investment portfolio. We make investments in instruments that meet credit quality standards, as specified in our investment policy guidelines; the policy also limits the amount of credit exposure to any one issue, and type of instrument. We do not expect any material loss with respect to our investment portfolio.

The following table provides information about our investment portfolio at September 30, 2002. For investment securities, the table presents principal amounts and related weighted average interest rates (dollars in thousands).

Cash and cash equivalents	$	83,972
Average interest rate		1.4	%

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Item 4. Controls and Procedures

Within ninety days prior to the filing of this Report, the Company’s Chief Executive Officer and Chief Financial Officer evaluated the effectiveness of the design and operation of the Company’s disclosure controls and procedures, which are designed to insure that the Company records, processes, summarizes and reports in a timely and effective manner the information required to be disclosed in the reports filed with or submitted to the Securities and Exchange Commission. Based upon this evaluation, they concluded that, as of the date of the evaluation, the Company’s disclosure controls are effective. Since the date of this evaluation, there have been no significant changes in the Company’s internal controls or in other factors that could significantly affect those controls.

Special Note Concerning Forward Looking Statements

Some of the information in this Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act and Section 21E of the Securities Exchange Act. We also have referred you to this note in other written or oral disclosures we have made. These statements include forward-looking language such as “will likely result,” “may,” “are expected to,” “is anticipated,” “estimated,” “projected,” “intends to,” "consensus earnings estimates," or other similar words. Our actual results are likely to differ, and could differ materially, from the results expressed in, or implied by, these forward-looking statements. There are many factors that could cause these forward-looking statements to be incorrect, including but not limited to the following risks: risks associated with (1) our ability to recruit and retain qualified transcriptionists; (2) inability to complete and assimilate acquisitions of businesses; (3) dependence on our senior management team; (4) the impact of new services or products on the demand for our services; (5) our dependence on medical transcription for substantially all of our business; (6) our ability to expand our customer base; (7) our ability to maintain our current growth rate in revenue and earnings; (8) the volatility of our stock price; (9) our ability to compete with others; (10) changes in law, including without limitation, the impact of the Health Information Portability and Accountability Act ("HIPAA"); (11) infringement on the proprietary rights of others; (12) our failure to comply with confidentiality requirements; and (13) risks inherent in diversifying into other businesses, such as from the acquisitions of Lanier and DVI (digital dictation equipment), Speech Machines (ASP transcription platform and business) and entering into the medical record coding reimbursement business. When considering these forward-looking statements, you should keep in mind these risk factors and other cautionary statements in this report, and should recognize that those forward-looking statements speak only as of the date made. MedQuist does not undertake any obligation to update any forward-looking statement included in this Form 10-Q or elsewhere. Other risk factors and cautionary statements are set forth in our other filings with the SEC, and you are encouraged to read those.

19

Part II Other Information

Item 1. -	Legal Proceedings	- None
Item 2. -	Changes in 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 a) Section 202 Disclosure to Investors Pursuant to Section 202 of the Sarbanes-Oxley Act of 2002, the Company discloses that its audit committee has approved the performance of tax services by its auditor.
Item 6. -	Exhibits and Reports on Form 8-K a) Exhibits: Exhibit 10.29.1 – Employment Agreement, dated December 22, 2000 between Lanier Healthcare, LLC and Dennis M. Mahoney, filed herewith, and Amendment to Employment Agreement, dated July 1, 2002 between Lanier Healthcare, LLC and Dennis M. Mahoney, filed herewith. Exhibit 10.29.2 – Confidentiality and Non-Solicitation Agreement, dated as of July 1, 2002 between MedQuist Transcriptions, Ltd. and Dennis M. Mahoney, filed herewith. Exhibit 10.30 – Employment Agreement, dated as of August 19, 1998 between Signal Transcriptions Network, Inc., and Robin K. Stults, filed herewith. Exhibit 99.1 – Certification of CEO pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. Exhibit 99.2 – Certification of CFO pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. b) The Company filed the following Reports on Form 8-K

20

File Date	Item Reported
July 16, 2002	Change in Registrants Certified Public
	Accountant
July 25, 2002	Regulation FD Disclosure in connection
	with earnings release and conference call

SIGNATURE

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.
	Registrant
Date: November 14, 2002	By: /s/Brian J. Kearns
	Brian J. Kearns
	Chief Financial Officer

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I, David A. Cohen, President and Chief Executive Officer, certify that:
1.	I have reviewed this quarterly report on Form 10-Q of MedQuist Inc.;
2.	Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;
3.	Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;
4.	The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;
5.	The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and
6.	The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
Date: November 14, 2002

/s/David A. Cohen

David A. Cohen

President and Chief Executive Officer

22

I, Brian J. Kearns, Chief Financial Officer, certify that:
1.	I have reviewed this quarterly report on Form 10-Q of MedQuist Inc.;
2.	Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;
3.	Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;
4.	The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;
5.	The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and
6.	The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
Date: November 14, 2002

/s/Brian J. Kearns

Brian J. Kearns

Chief Financial Officer

23