Medquist 10Q 2009 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, 2009.


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 (Address of principal executive offices)		08054-4632 (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. Yesþ Noo

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yeso Noo

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 filero	Accelerated filerþ	Non-accelerated filero	Smaller reporting companyo
		(Do not check if a smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yeso Noþ

The number of registrant’s shares of common stock, no par value, outstanding as of November 4, 2009 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		17
Item 4. Controls and Procedures		25

PART II. OTHER INFORMATION		26

Item 1. Legal Proceedings		26
Item 1A. Risk Factors		28
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds		29
Item 3. Defaults Upon Senior Securities		29
Item 4. Submission of Matters to a Vote of Security Holders		29
Item 5. Other Information		29
Item 6. Exhibits		29

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,
	2009			2008			2009		2008
Net revenues	$	76,836		$	81,287		$	233,251	$	247,466


Operating costs and expenses:
Cost of revenues		52,768			57,235			157,993		176,508
Selling, general and administrative		7,930			11,496			25,819		36,446
Research and development		2,439			4,648			7,235		12,502
Depreciation		2,197			2,977			7,418		8,901
Amortization of intangible assets		1,518			1,411			4,533		4,145
Cost of legal proceedings and settlements, net		1,382			8,833			13,440		17,908
Restructuring charges		481			(37	)		481		(82	)


Total operating costs and expenses		68,715			86,563			216,919		256,328


Operating income (loss)		8,121			(5,276	)		16,332		(8,862	)

Equity in income of affiliated company		2,154			159			2,582		200
Other income		—			—			—		438
Interest income (expense), net		(29	)		418			36		2,601


Income (loss) before income taxes		10,246			(4,699	)		18,950		(5,623	)

Income tax provision		542			1,063			1,556		2,721


Net income (loss)	$	9,704		$	(5,762	)	$	17,394	$	(8,344	)


Net income (loss) per share:
Basic	$	0.26		$	(0.15	)	$	0.46	$	(0.22	)

Diluted	$	0.26		$	(0.15	)	$	0.46	$	(0.22	)


Weighted average shares outstanding:
Basic		37,556			37,554			37,556		37,547

Diluted		37,560			37,554			37,556		37,547

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,
	2009			2008
Assets
Current assets:
Cash and cash equivalents	$	15,677		$	39,918
Accounts receivable, net of allowance of $3,927 and $4,802, respectively		43,352			50,374
Income tax receivable		204			154
Other current assets		4,849			8,053

Total current assets		64,082			98,499

Property and equipment, net		11,860			15,785
Goodwill		40,763			40,545
Other intangible assets, net		37,357			39,877
Deferred income taxes		1,298			1,204
Other assets		10,430			6,295


Total assets	$	165,790		$	202,205


Liabilities and Shareholders’ Equity
Current liabilities:
Accounts payable	$	6,549		$	7,487
Accrued expenses		8,799			11,994
Accrued compensation		14,192			11,204
Customer accommodation		11,634			12,055
Deferred income taxes		652			651
Deferred revenue		11,679			15,630

Total current liabilities		53,505			59,021

Deferred income taxes		1,458			799
Other non-current liabilities		2,322			2,033


Commitments and contingencies

Shareholders’ equity:
Common stock — no par value; authorized 60,000 shares; 37,556 and 37,556 shares issued and outstanding, respectively		237,800			237,907
Accumulated deficit		(131,751	)		(99,198	)
Accumulated other comprehensive income		2,456			1,643


Total shareholders’ equity		108,505			140,352


Total liabilities and shareholders’ equity	$	165,790		$	202,205

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,
	2009			2008
Operating activities:
Net income (loss)	$	17,394		$	(8,344	)
Adjustments to reconcile net income (loss) to cash provided by (used in) operating activities:
Depreciation and amortization		11,951			13,046
Equity in income of affiliated company		(2,582	)		(200	)
Deferred income taxes		662			2,425
Stock option expense		144			1,361
Provision for doubtful accounts		230			2,065
Loss on disposal of property and equipment		27			47
Changes in operating assets and liabilities:
Accounts receivable		6,847			(1,917	)
Income tax receivable		(50	)		184
Other current assets		3,467			(1,437	)
Other non-current assets		(34	)		117
Accounts payable		(351	)		(4,393	)
Accrued expenses		(3,427	)		(984	)
Accrued compensation		2,959			(53	)
Customer accommodation		(317	)		(5,651	)
Deferred revenue		(4,107	)		(57	)
Other non-current liabilities		168			(92	)

Net cash provided by (used in) operating activities	$	32,981		$	(3,883	)


Investing activities:
Purchase of property and equipment		(3,603	)		(5,015	)
Capitalized software		(1,846	)		(2,712	)
Proceeds from sale of investments		—			692
Investment in affiliated company		(852	)		—

Net cash used in investing activities		(6,301	)		(7,035	)


Financing activities:
Dividends paid		(49,949	)		(103,279	)
Debt issuance costs		(1,171	)		—
Proceeds from exercise of stock options		—			68

Net cash used in financing activities		(51,120	)		(103,211	)


Effect of exchange rate changes		199			(156	)


Net decrease in cash and cash equivalents		(24,241	)		(114,285	)


Cash and cash equivalents — beginning of period		39,918			161,582


Cash and cash equivalents — end of period	$	15,677		$	47,297


Supplemental cash flow information:

Cash paid for income taxes	$	241		$	249

Accommodation payments paid with credits	$	103		$	659

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

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

1. 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 Securities and Exchange Commission (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 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. Our accounting policies are set forth in detail in Note 2 to the consolidated financial statements in our Annual Report on Form 10-K for the year ended December 31, 2008 filed with the SEC on March 11, 2009. These interim consolidated financial statements should be read in conjunction with the consolidated financial statements and related notes included in our annual report on Form 10-K for the year ended December 31, 2008.

In May 2009, the Financial Accounting Standards Board (FASB) issued guidance which requires management to evaluate subsequent events through the date the financial statements were issued or the date the financial statements were available to be issued. This guidance was effective for annual and interim periods ending after June 15, 2009. We evaluated subsequent events through November 9, 2009.

In June 2009, the FASB issued guidance to require an enterprise to perform an analysis to determine whether the enterprise’s variable interest or interests give it a controlling financial interest in a variable interest entity (which would result in the enterprise being deemed the primary beneficiary of that entity and, therefore, obligated to consolidate the variable interest entity in its financial statements); to require ongoing reassessments of whether an enterprise is the primary beneficiary of a variable interest entity; to revise guidance for determining whether an entity is a variable interest entity; and to require enhanced disclosures that will provide more transparent information about an enterprise’s involvement with a variable interest entity. This is effective for interim periods as of the beginning of the first annual reporting period beginning after November 15, 2009. The Company is currently evaluating the provisions of such guidance to determine the impact on the Company’s results of operations, cash flows or financial position.

In June 2009, the FASB issued “The FASB Accounting Standards Codification^TM and the Hierarchy of Generally Accepted Accounting Principles”. This establishes the Codification as the source of authoritative GAAP recognized by the FASB to be applied by nongovernmental entities. Rules and interpretive releases of the SEC under federal securities laws are also sources of authoritative GAAP for SEC registrants. All guidance contained in the Codification carries an equal level of authority. This is effective for financial statements issued for interim and annual periods ending after September 15, 2009.

In September 2009, the FASB ratified two consensuses affecting revenue recognition:

The first consensus,Revenue Recognition—Multiple-Element Arrangements, sets forth requirements that must be met for an entity to recognize revenue from the sale of a delivered item that is part of a multiple-element arrangement when other items have not yet been delivered. One of those current requirements is that there be objective and reliable evidence of the standalone selling price of the undelivered items, which must be supported by either vendor-specific objective evidence (VSOE) or third-party evidence (TPE).

This consensus eliminates the requirement that all undelivered elements have VSOE or TPE before an entity can recognize the portion of an overall arrangement fee that is attributable to items that already have been delivered. In the absence of VSOE or TPE of the standalone selling price for one or more delivered or undelivered elements in a multiple-element arrangement, entities will be required to estimate the selling prices of those elements. The overall arrangement fee will be allocated to each element (both delivered and undelivered items) based on their relative selling prices, regardless of whether those selling prices are evidenced by VSOE or TPE or are based on the entity’s estimated selling price. Application of the “residual method” of allocating an overall arrangement fee between delivered and undelivered elements will no longer be permitted.

The second consensus,Software-Revenue Recognition,addresses the accounting for transaction involving software to exclude from its scope tangible products that contain both software and non-software and not-software components that function together to deliver a products functionality.

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

The Consensuses are effective prospectively for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010. We are evaluating the potential impact of these requirements on our financial statements.

Certain reclassifications were made to prior period financial statements to conform to the current presentation. Expenses and charges of $1,652 for the three months ended September 30, 2008 and $2,601 for the nine months ended September 30, 2008 related to the Anthurium, Reseller and Shareholder lawsuits (Note 6) had previously been included in Selling, General and Administrative expenses. Due to the significant amount of such expenses in 2009, such costs are now included in the line item Cost of legal proceedings and settlements, net.

2. Stock-Based Compensation and Long-Term Incentive Plan

The following table summarizes our stock-based compensation expense related to employee stock options:


	Three months ended September 30,				Nine months ended September 30,
	2009		2008		2009		2008
Selling, general and administrative	$	48	$	840	$	144	$	944
Research and development		—		359		—		405
Cost of revenues		—		—		—		12

Total	$	48	$	1,199	$	144	$	1,361

As of September 30, 2009, total unamortized stock-based compensation cost related to non-vested stock options, net of expected forfeitures, was $389, which is expected to be recognized over a period of 2.0 years.

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, 2008		1,816		$	23.34
Granted		—			—
Exercised		—			—
Forfeited		—			—
Canceled		(303	)		22.01

Outstanding, September 30, 2009		1,513			24.27		3.0	$	—

Exercisable, September 30, 2009		1,315			26.67		2.1	$	—


Options vested and expected to vest as of September 30, 2009		1,513		$	24.27		3.0	$	—

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. As of September 30, 2009 19 options were in the money.

There were no options granted or exercised during the nine months ended September 30, 2009. There were 296 options granted and 12 options exercised during the nine months ended September 30, 2008. In the first quarter of 2009, we modified the stock options previously granted in the third quarter of 2008 to our Chief Executive Officer. The grant price was increased from $4.85 per share to $8.25 per share by a committee of our board of directors. There was no incremental cost of the modification. We estimated fair value for the modified option granted as of the date of the modification by applying the Black-Scholes option 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 modified in the first quarter of 2009 were:


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

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

A summary of outstanding and exercisable common stock options as of September 30, 2009 is as follows:


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		8.5	$	8.10		117	$	7.85
$10.01 — $20.00		376		2.0	$	15.83		376	$	15.83
$20.01 — $30.00		556		1.8	$	26.39		556	$	26.39
$30.01 — $40.00		80		0.6	$	32.71		80	$	32.71
$40.01 — $70.00		187		0.7	$	58.61		186	$	58.61

		1,513		3.0	$	24.27		1,315	$	26.67

As of September 30, 2009, there were 903 additional options available for grant under our stock option plans.

On August 27, 2009, our board of directors upon the recommendation of its compensation committee approved the MedQuist Inc. Long-Term Incentive Plan. The Incentive Plan is designed to encourage and reward the creation of long-term equity value by certain members of our senior management team. The executives and key employees will be selected by the Compensation Committee and will be eligible to participate in the Incentive Plan.

No amounts have been accrued under the Incentive Plan as no awards have been made as of September 30, 2009.

3. Comprehensive income (loss)

Comprehensive income (loss) was as follows:


	Three months ended September 30,					Nine months ended September 30,
	2009		2008			2009		2008
Net income (loss)	$	9,704	$	(5,762	)	$	17,394	$	(8,344	)
Foreign currency translation adjustment		138		(1,266	)		813		(1,305	)

Comprehensive income (loss)	$	9,842	$	(7,028	)	$	18,207	$	(9,649	)

4. Net Income (Loss) per Share

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


	Three months ended September 30,					Nine months ended September 30,
	2009		2008			2009		2008
Net income (loss)	$	9,704	$	(5,762	)	$	17,394	$	(8,344	)

Weighted average shares outstanding:
Basic		37,556		37,544			37,556		37,547
Effect of dilutive shares		4		—			—		—

Diluted		37,560		37,554			37,556		37,547

Net income (loss) per share:
Basic	$	0.26	$	(0.15	)	$	0.46	$	(0.22	)
Diluted	$	0.26	$	(0.15	)	$	0.46	$	(0.22	)

The computation of diluted net income (loss) per share does not assume conversion, exercise or issuance of options that would have an anti-dilutive effect on diluted net income (loss) per share. Options having an anti-dilutive effect on net income (loss) per share and, therefore, excluded from the calculation of diluted net income (loss) per share, totaled 1,494 and 1,513, respectively, for the three and nine months ended September 30, 2009 and 2,168 for the three and nine months ended September 30, 2008.

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

5. Customer Accommodation

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). 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.

We are unable to predict how many customers, if any, may accept the outstanding accommodation offers on the terms proposed by us, nor are we able to predict the timing of the acceptance (or rejection) of any outstanding accommodation offers. Until any offers are accepted, we may withdraw or modify the accommodation program or any outstanding offers at any time. In addition, we are unable to predict how many future offers, if made, will be accepted on the terms proposed by us. We regularly evaluate whether to proceed with, modify or withdraw the accommodation program or any outstanding offers.

The following is a summary of the financial statement activity related to the customer accommodation which is included as a separate line item in the accompanying consolidated balance sheets as of September 30, 2009 and December 31, 2008:


	Nine months ended			Year ended
	September 30, 2009			December 31, 2008
Beginning balance	$	12,055		$	18,459
Payments and other adjustments		(318	)		(5,664	)
Credits		(103	)		(740	)

Ending balance	$	11,634		$	12,055

6. Cost of Legal Proceedings and Settlements, Net

The following is a summary of the amounts recorded as Cost of legal proceedings and settlements, net, in the accompanying consolidated statements of operations:


	Three months ended September 30,				Nine months ended September 30,
	2009		2008		2009		2008
Legal fees	$	1,352	$	2,777	$	7,630	$	9,993
Other professional fees		30		131		60		490
Settlements		—		5,925		5,750		7,425

Total	$	1,382	$	8,833	$	13,440	$	17,908

Other professional fees represent accounting and dispute analysis costs and document search and retrieval costs. The 2008 Settlements of $7,425 are for the settlements of all claims related to the consolidated medical transcriptionists putative class action and the U.S. Department of Justice (DOJ) investigation. The 2009 settlement amount of $5,750 is for the settlement related to the Anthurium patent claim which was settled and paid in June 2009.

7. Restructuring Plans

2009 Restructuring Plans

During the third quarter of 2009, we implemented a restructuring plan related to a reduction in workforce of 47 employees in order to better align costs with revenues (2009 Plan). The table below reflects the financial statement activity related to the 2009 Plan which is included in accrued expenses in the accompanying consolidated balance sheets:


	Nine Months Ended
	September 30, 2009
Beginning balance	$	—
Charge		497
Cash paid		(229	)

Ending balance	$	268

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

2008 Restructuring Plans

During the fourth quarter of 2008, we implemented a restructuring plan related to a reduction in workforce of 189 employees in order to better align costs with revenues (2008 Plan). The table below reflects the financial statement activity related to the 2008 Plan which is included in accrued expenses in the accompanying consolidated balance sheets:


	Nine Months Ended			Year Ended
	September 30, 2009			December 31, 2008
Beginning balance	$	1,323		$	—
Charge		(16	)		2,135
Cash paid		(1,222	)		(812	)

Ending balance	$	85		$	1,323

8. 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. We 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.

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, 2009.

9. Credit Agreement

In August 2009, we entered into a five-year $25 million revolving credit agreement (the “Credit Agreement”) with Wells Fargo Foothill, LLC, pursuant to a credit agreement (the “Credit Agreement”). Subject to certain terms and conditions of the Credit Agreement, the Credit Agreement provides committed revolving funding through August 2014 and includes an option whereby we can increase its maximum credit to $40 million, based upon certain terms and conditions. The amount available for borrowings is based upon a percentage of eligible accounts receivable. Under the agreement, there are reserves established which limit the amounts that can be available. At September 30, 2009, $21.0 million was available under the Credit Agreement. The Credit Agreement is a working capital facility that may be used for general corporate purposes. The Credit Agreement enables us to borrow funds in U.S. dollars, at variable interest rates. The Credit Agreement provides the lender a security interest in and against significantly all of our assets. Under the Credit Agreement we agreed to certain covenants customarily found in such agreements including, but not limited to, financial covenants requiring us to maintain certain minimum levels of EBITDA and a minimum fixed charge coverage ratio. At September 30, 2009, we were in compliance with the financial covenants of the agreement. At September 30, 2009 there were no borrowings outstanding under the Credit Agreement.

10. Commitments and Contingencies

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 we fraudulently inflated the payable units of measure in medical transcription reports generated by us 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. We contend that we did not breach the contracts with Kaiser, or commit the fraud alleged, and we intend to defend the suit vigorously. The parties participated in private mediation on July 24, 2008, but the case was not settled. We removed the case to the United States District Court for the Northern District of California, and we 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 exchanged initial disclosures on October 6, 2008 and appeared before the court for an initial scheduling conference on October 14, 2008. Kaiser’s initial disclosures claim damages, including compensatory damages, punitive damages, and prejudgment interest, in excess of $12 million. Following the scheduling conference, the court ordered the parties to appear in person for mediation. The parties exchanged mediation statements on February 13, 2009, and mediation was held on February 27, 2009 but the case was not settled. The court heard argument on our motion to dismiss on March 19, 2009. On April 8, 2009, the court entered an order denying our motion to dismiss, except that our motion to dismiss plaintiffs’ claim under the fraudulent prong of the California Unfair Competition Law was granted. The court issued a scheduling order on April 17, 2009, setting a pretrial schedule. We filed our answer to plaintiff’s complaint on April 23, 2009.

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

Kaiser served an initial set of discovery requests on May 7, 2009. On May 20, 2009, the court temporarily stayed discovery to address allegations of ethical misconduct by Kaiser’s trial counsel, Greenberg Traurig, LLP. On July 1, 2009, the court granted us leave to conduct limited written discovery regarding Greenberg Traurig’s alleged ethical misconduct and continued the temporary stay of all other discovery. On July 14, 2009, we moved for sanctions against Greenberg Traurig for breach of the New Jersey Rules of Professional Conduct, and we moved to stay the litigation pending resolution of the motion for sanctions. These motions are fully briefed and pending before the court. Discovery is presently stayed pending resolution of our motion to stay.

Shareholder Litigation

Kahn Putative Class Action

On January 22, 2008, Alan R. Kahn, one of our shareholders, filed a shareholder putative class action lawsuit against us, Koninklijke Philips Electronics N.V. (Philips), our former majority shareholder, 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, was venued 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 original 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 members of 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 alleged that our current and former directors breached their fiduciary duties of good faith, fair dealing, loyalty, and due care by not providing our public shareholders with the opportunity to decide whether they wanted to participate in a share purchase offer with non-party CBaySystems Holdings Ltd. (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 alleged that CBaySystems Holdings made the share purchase offer to Philips and that Philips breached its fiduciary duties by accepting CBaySystems Holdings’ offer. Based on these allegations, plaintiff sought declaratory, injunctive, and monetary relief from all defendants. Plaintiff claimed that we were only named as a party to the litigation for purposes of injunctive relief.

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 November 21, 2008, the Court granted our motion and the motions filed by the other defendants and dismissed plaintiff’s amended class action complaint with prejudice. On December 31, 2008, plaintiff filed an appeal of the trial court’s dismissal order with the New Jersey Appellate Division. Thereafter, the parties briefed all the issues raised in plaintiff’s appeal. In our opposition brief, we opposed all the arguments plaintiff raised with respect to the dismissal of the claims against us.

On September 24, 2009, the Appellate Division held oral argument on the issues that are the subject of plaintiff’s appeal. We are now waiting for the Appellate Division to issue a decision.

Reseller Arbitration Demand

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

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. 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. On September 10, 2008, the Court heard argument on defendants’ motion to dismiss. The Court did not issue a decision, but rather, took the matter under advisement.

During discovery in the arbitration, Claimants have repeatedly modified the individual damage claims and now allege that they are asserting two alternative damage theories. Claimants have not specified what the two alternative damage theories are, but have stated that they are seeking alternative damage amounts for each Claimant. The Panel issued a Revised Scheduling Order, which tentatively scheduled the arbitration to begin in February of 2010.

On July 13, 2009, we filed our first of two motions for summary judgment arguing that (i) the contracts at issue bar the type of damages sought by Claimants with respect to their breach of contract and good faith and fair dealing claims; (ii) Claimants cannot recover damages under any theory beyond the expiration of their agreements; (iii) Claimants alleged contract damages are not recoverable under applicable law; (iv) Georgia does not recognize a claim for the violation of the covenant of good faith and fair dealing; (v) Claimants’ fraud and promissory estoppel claims fail given the presence of agreements requiring amendments in writing; and (vi) the releases signed by the Claimants bar any claims or damages sought prior to the date the respective releases were executed.

On September 24, 2009, Claimants served their expert report which changed their damage theories and calculations.

On September 30, 2009, the Panel granted in part and denied in part our initial motion for summary judgment. The Panel held that (i) the damage limitation clause in the Claimant’s contracts was enforceable and would bar any damages subject to the clause, including lost profits, with respect to Claimant’s breach of contract claim; (ii) the claim for violation of the covenant of good faith and fair dealing should be dismissed and (iii) the releases executed by Claimants were enforceable, and they bar any claims or damages sought by Claimants prior to the date of the respective releases. The Panel denied the remainder of our initial motion for summary judgment at this stage of the proceedings.

On September 30, 2009, we filed our second motion for summary judgment. In that motion, we argued that we are entitled to summary judgment with respect to (i) Claimants’ fraud claim, and that any alleged damages were not caused by our alleged fraud, (ii) Claimant’s promissory estoppel claim, and that lost profits are not recoverable for such a claim, (iii) Claimant’s breach of contract claim, and that any alleged breach of contract damages are barred by the Panel’s prior ruling, and (iv) Claimant’s tortious interference claim, and that any alleged damages are not recoverable. Oral argument on this motion is scheduled for November 10, 2009.

We deny all wrongdoing and intend to defend ourselves vigorously.

SEC Investigations of Former Officers

With respect to our historical billing practices, the SEC is pursuing civil litigation against one of our current employees, who was our former controller but who does not currently serve in a senior management or financial reporting oversight role, and our former chief financial officer, whose employment with us ended in July 2004. Pursuant to our bylaws, we have indemnification obligations for the legal fees for these former officers.

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.

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

is remote. Accordingly, we have not recorded any liability in our consolidated financial statements as of September 30, 2009 or December 31, 2008 related to these indemnification provisions.

We have 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.

Network and information systems, the Internet and other technologies are critical to our business activities. Substantially all of our transcription services are dependent upon the use of network and information systems, including the use of our DEP and our license to use speech recognition software which is licensed from a third party. If information systems including the Internet or our DEP are disrupted, or if the third party does not renew our license to use speech recognition software, we could face a significant disruption of services. We have periodically experienced short term outages with our DEP, which have not significantly disrupted our business.

11. 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 (CBaySystems Holdings Purchase). 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 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 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.

On September 15, 2008, we entered into a transcription services agreement (the 2008 TSA) 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. The 2008 TSA was terminated by mutual written agreement on October 26, 2009. For the three months ended September 30, 2009 and 2008 we incurred expenses of $0 and $0, respectively, and for the nine months ended September 30, 2009 and 2008, we incurred expenses of $958 and $0, respectively, which were recorded in Cost of revenues.

On April 3, 2009, we entered into a transcription services agreement (Transcription Services Agreement) with CBay Systems, pursuant to which we outsource certain medical transcription services to CBay Systems. The Transcription Services Agreement will expire on April 16, 2012 unless sooner terminated by either party. Under the Transcription Services Agreement, we pay CBay Systems a per line fee based on each transcribed line of text processed and the specific type of service provided. CBay Systems will perform its services using our DocQment Enterprise Platform and will be held to certain performance standards and quality guidelines set forth in the agreement. The specific services to be performed will be set forth in order forms delivered by us to CBay Systems from time to time during the term of the Transcription Services Agreement. For the three and nine months ended September 30, 2009 we incurred expenses of $1,793 and $3,334, respectively, which were recorded in Cost of revenues.

On March 31, 2009, we entered into a transcription services subcontracting agreement (Subcontracting Agreement) with CBay Systems, pursuant to which CBay Systems will subcontract certain medical transcription, editing and related services to us. Under the Subcontracting Agreement, we will provide the medical transcription, editing and related services to CBay Systems using labor located within the United States using our DocQment Enterprise Platform. The specific services to be performed will be set forth in order forms delivered by CBay Systems to us from time to time during the term of the Subcontracting Agreement. We will receive 98% of the net monthly fees collected by CBay Systems from its customers for the services provided by us. For the three and nine months ended September 30, 2009, we recorded revenue of $506 and $975 under the terms of the Subcontracting agreement.

On September 19, 2009, we entered into a services agreement (Management Services Agreement) with CBay Inc. (CBay), pursuant to which certain senior executives and directors of CBay render to us, upon the request of our Chief Executive Officer, certain advisory and consulting services in relation to the affairs of us and our subsidiaries. The Management Services Agreement will remain in effect until the earliest to occur of (i) December 31, 2009, if either party gives notice of termination of the Services Agreement to the other party no later than December 1, 2009, (ii) the end of any calendar quarter subsequent to December 31, 2009, if either party gives notice of termination of the Services Agreement to the other party no later than thirty (30) days prior to the end of such calendar quarter, (iii) such time as CBay or its affiliates (other than the us and our subsidiaries) control, directly or indirectly, the power to vote less than thirty percent (30%) of the issued and outstanding common equity of the MedQuist, and (iv) such earlier date as we and CBay may mutually agree upon in writing. The Management Services Agreement provides that, in consideration of the management services rendered by CBay to us since July 1, 2009 and to be rendered by CBay to us pursuant to the Management Services Agreement, we will pay CBay a quarterly services fee equal to $350, which shall be payable in arrears. For the three months ended September 30, 2009 and 2008, we incurred services expenses with CBay Inc. of $350 and $0, respectively, and for the nine months ended September 30, 2009 and 2008, we incurred services expenses with CBay Inc. of $1,049 and $0, respectively, which has been recorded in Selling, general and administrative expense.

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

As of September 30, 2009 and December 31, 2008, Accounts payable and Accrued expenses included $1,049 and $665, respectively for amounts due to CBay Systems. As of September 30, 2009 and December 31, 2008, Accounts receivable included $369 and $0, respectively, for amounts due from CBay Systems.

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.

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 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. During 2008, our competitor, Nuance Communications, Inc. (Nuance) purchased PSRS. PSRS is now a business unit of Nuance.

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. During 2008, our competitor, Nuance purchased PSRS. PSRS is now a business unit of Nuance.

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.

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

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.

Other

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 $39 for the nine months ended September 30, 2008.

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. 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		Nine Months Ended
	September 30, 2008		September 30, 2008
Licensing agreement	$	355	$	2,070
OEM supply agreement		36		1,645
Equipment purchases		97		586
Insurance coverage		65		399
CBay Transaction				(172	)
Other		—		(39	)

Ending balance	$	553	$	4,489

On July 29, 2004, we entered into an agreement with Nightingale and Associates, LLC (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. 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 nine months ended September 30, 2008 we incurred charges of $1,073 for Nightingale services, which were recorded in Selling, general and administrative expenses in the accompanying consolidated statements of operations.

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

As of September 30, 2009 and December 31, 2008, we have an investment of $9,431 and $6,252 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. For the three months ended September 30, 2009, our investment increased by $2,154 related to our share of A-Life’s net income offset by $255 for a distribution which was recorded as Shareholders’ equity in our consolidated balance sheet. For the nine months ended September 30, 2009, our investment increased by $2,582 related to our share of A-Life’s net income, additional cash investments in A-Life of $852 offset by $255 for a distribution which was recorded as Shareholders’ equity in our consolidated balance sheet. Our investment in A-Life is recorded in Other assets in the accompanying consolidated balance sheets.

13. Financial Instruments

Effective January 1, 2008, we adopted Fair Value accounting for financial assets and financial liabilities. This 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

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

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 December 31, 2008, we held one financial asset, our Executive Deferred Compensation Plan assets (EDCP) included in Other current assets. We measured the fair value of our EDCP on a recurring basis using Level 2 (significant other observable) inputs. The adoption did not have an impact on the basis for measuring the fair value of these items. In the third quarter of 2009 we terminated the plan and distributed plan assets to members and liquidated the plan assets. Accordingly there were no financial instruments as defined as of September 30, 2009.

The following table presents our fair value hierarchy for those financial assets measured at fair value on a recurring basis in our consolidated balance sheets as of December 31, 2008:

Quoted Prices In

Active Markets for

Significant Other

Significant

December 31,

Identical

Observable

Unobservable

2008

Assets (Level 1)

Inputs (Level 2)

Inputs (Level 3)

Assets

Executive Deferred Compensation Plan assets

787

—

787

—


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 Item 1A, Risk Factors, of this report as well as risks discussed elsewhere in this report;

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

	•		our ability to recruit and retain qualified medical transcriptionists (MTs) and other employees;

	•		changes in law, including, without limitation, the impact HIPAA will have on our business;

	•		the impact of our new services and products on the demand for our existing services and products;

	•		our increased dependence on speech recognition technology, which we license, but do not own;

	•		our current dependence on medical transcription for substantially all of our business;

	•		our ability to expand our customer base;

	•		infringement on the proprietary rights of others;

	•		our ability to diversify into other businesses;

	•		our increased dependence on offshore medical transcription subcontractors;

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

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

	•		Our ability to operate the business given our restrictions under the Credit Agreement;

	•		difficulties relating to our significant management turnover; 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, 2008, included in our Annual Report on Form 10-K for the year ended December 31, 2008.

Executive Overview

We are a leading provider of integrated clinical documentation and healthcare information management technology and services. We offer health systems, hospitals, and physician practices integrated solutions for voice capture, speech recognition, medical transcription, document management, natural language processing and clinical documentation improvement, as well as coding services. Our solutions are designed to facilitate electronic access to clinical information by healthcare providers and to improve overall efficiency in the area of revenue cycle and cash flow performance by facilitating timely coding services.

We are one of the world’s largest medical transcription service organization (MTSO) and one of the leading technology-enabled clinical documentation workflow providers. We service our nationwide customer base 24 hours a day, seven days a week, using skilled, English-speaking medical transcriptionists located primarily in the United States and India. We believe our transcriptionist workforce, which includes employees as well as subcontractors, is one of the largest of any medical transcription company.

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 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 with us 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).

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 a 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, driven by current and projected U.S. economic conditions;

	•		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 (EHR) initiatives.

Although we believe the outsourced portion of the medical transcription services market continues to grow, in order to benefit from this trend we must overcome the following challenges: reduce costs, increase profit margins and continue to benefit from technological advances.

We evaluate our performance based upon the following factors:

	•		revenues;

	•		operating income;

	•		adjusted EBITDA;

	•		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, adjusted EBITDA 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, 2008 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, 2008 other than as described in Note 1 of the “Notes to Consolidated Financial Statements” included in Part I, Item 1 of this Quarterly Report on Form 10-Q.

In May 2009, the FASB issued guidance which requires management to evaluate subsequent events through the date the financial statements were issued or the date the financial statements were available to be issued. This is effective for annual and interim periods ending after June 15, 2009 and should be applied prospectively. We evaluated subsequent events through November 9, 2009.

In June 2009, the FASB issued guidance to require an enterprise to perform an analysis to determine whether the enterprise’s variable interest or interests give it a controlling financial interest in a variable interest entity (which would result in the enterprise being deemed the primary beneficiary of that entity and, therefore, obligated to consolidate the variable interest entity in its financial statements); to require ongoing reassessments of whether an enterprise is the primary beneficiary of a variable interest entity; to revise guidance for determining whether an entity is a variable interest entity; and to require enhanced disclosures that will provide more transparent information about an enterprise’s involvement with a variable interest entity. This guidance is effective for interim periods as of the beginning of the first annual reporting period beginning after November 15, 2009. The Company is currently evaluating the provisions to determine the impact on the Company’s results of operations, cash flows or financial position.

In June 2009, the FASB issued, “The FASB Accounting Standards Codification^TM and the Hierarchy of Generally Accepted Accounting Principles. This establishes the Codification as the source of authoritative GAAP recognized by the FASB to be applied by nongovernmental entities. Rules and interpretive releases of the SEC under federal securities laws are also sources of authoritative GAAP for SEC registrants. All guidance contained in the Codification carries an equal level of authority. This is effective for financial statements issued for interim and annual periods ending after September 15, 2009.

In September 2009, the FASB ratified two consensuses affecting revenue recognition:

One of those current requirements is that there be objective and reliable evidence of the standalone selling price of the undelivered items, which must be supported by either vendor-specific objective evidence (VSOE) or third-party evidence (TPE).

The second consensus,Software-Revenue Recognitionaddresses the accounting for transaction involving software to exclude from its scope tangible products that contain both software and non-software and not-software components that function together to deliver a products functionality.

Certain reclassifications were made to prior period financial statements to conform to the current presentation. Expenses and charges of $1.7 million for the three months ended September 30, 2008 and $2.6 million for the nine months ended September 30, 2008 related to the Anthurium, Reseller and Shareholder lawsuits had previously been included in Selling, general and administrative expenses. Due to the significant amount of such expenses in 2009, such costs are now included in Cost of legal proceedings and settlements, net.

On August 27, 2009, our board of directors upon the recommendation of its compensation committee, approved the MedQuist Inc. Long-Term Incentive Plan. The Incentive Plan is designed to encourage and reward the creation of long-term equity value by certain members of our senior management team. The executives and key employees will be selected by the Compensation Committee and will be eligible to participate in the Incentive Plan.

No amounts have been accrued under the Incentive Plan as no awards have been made as of September 30, 2009.

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.

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 benefit administration 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 legal proceedings and settlements, net

Cost of legal proceedings and settlements, 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), both of which were settled in 2008, indemnification of former officers, and proceedings and the defense of civil litigation matters and the Anthurium, Reseller and Shareholder matters.

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, 2009 and 2008


	Three Months Ended September 30,
	2009						2008
				% of Net						% of Net
($ in thousands)	Amount			Revenues			Amount			Revenues			$ Change			% Change
Net revenues	$	76,836			100.0	%	$	81,287			100.0	%	$	(4,451	)		(5.5	%)


Operating costs and expenses:
Cost of revenues		52,768			68.7	%		57,235			70.4	%		(4,467	)		(7.8	%)
Selling, general and administrative		7,930			10.3	%		11,496			14.1	%		(3,566	)		(31.0	%)
Research and development		2,439			3.2	%		4,648			5.7	%		(2,209	)		(47.5	%)
Depreciation		2,197			2.9	%		2,977			3.7	%		(780	)		(26.2	%)
Amortization of intangible assets		1,518			2.0	%		1,411			1.7	%		107			7.6	%
Cost of legal proceedings and settlements, net		1,382			1.8	%		8,833			10.9	%		(7,451	)		(84.4	%)
Restructuring charges		481			0.6	%		37			0.0	%		518			1,400.0	%


Total operating costs and expenses		68,715			89.4	%		86,563			106.5	%		(17,848	)		(20.6	%)


Operating income (loss)		8,121			10.6	%		(5,276	)		(6.5	%)		13,397			253.9	%

Equity in income of affiliated company		2,154			2.8	%		159			0.2	%		1,995			1,254.7	%
Other income		—			—			—			—			—			n.a.
Interest income (expense), net		(29	)		(0.0	%)		418			0.5	%		(447	)		(106.9	%)


Income (loss) before income taxes		10,246			13.3	%		(4,699	)		(5.8	%)		14,945			318.0	%

Income tax provision (benefit)		542			0.7	%		1,063			1.3	%		(521	)		(49.0	%)


Net income (loss)	$	9,704			12.6	%	$	(5,762	)		(7.1	%)	$	15,466			268.4	%

Net revenues

Net revenues decreased $4.5 million, or 5.5%, to $76.8 million for the three months ended September 30, 2009 compared with $81.3 million for the three months ended September 30, 2008. Transcription volumes increased during the third quarter relative to the prior period, while average prices for transcription declined and the migration from legacy products reduced services revenues.

Cost of revenues

Cost of revenues decreased $4.5 million, or 7.8% to $52.7 million for the three months ended September 30, 2009 compared with $57.2 million for the three months ended September 30, 2008. This decrease was attributable primarily to:

	•		reduced medical transcription payroll costs of $1.5 million related to our increased use of speech recognition technology, which reduces the payroll costs associated with the production of revenues;

	•		reduced medical transcription costs of $1.5 million related to the increase in our outsourced medical transcription volumes to our international labor partners;

	•		reduced costs of $1.5 million resulting from headcount reductions taken in 2008 to better align our overhead costs with our lower revenues levels and;

	•		reduced employee retention costs of $0.2 million resulting from the change in control of our majority shareholder:

	•		a decrease in other costs of $0.2 million; offset by

	•		an increase in technology product costs of $0.4 million:

As a percentage of net revenues, cost of revenues decreased to 68.7% for the three months ended September 30, 2009 from 70.4% for the same period in 2008, largely as a result 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 $3.6 million, or 31.0% to $7.9 million for the three months ended September 30, 2009 compared with $11.5 million for the three months ended September 30, 2008. This decrease was attributable to a decrease of $0.9 million of compensation expense as a result of reductions in workforce; a decrease of $0.8 million due to the acceleration of stock option awards given to certain members of our senior management team which vested following the change in control of our majority shareholder, a decrease of $0.4 million of legal fees, a reduction in employee retention costs of $0.3 million, resulting from the change in control of our majority shareholder, reduced audit fees of $0.3 million, a decrease of $0.2 million due to reduced professional fees related to our evaluation of strategic alternatives, a decrease of $0.2 million for building rent, and a decrease in all other SG$A expense of $0.5 million. SG&A expense in the three month period ended September 30, 2009 as a percentage of net revenues was 10.3% compared with 14.1% for the same period in 2008.

Research & development

R&D expenses decreased $2.2 million, or 47.5%, to $2.4 million for the three months ended September 30, 2009 compared with $4.6 million for the three months ended September 30, 2008. This decrease was related to a decrease of $1.2 million related to compensation expense as a result of reductions in workforce; a decrease of $0.4 million due to the acceleration of stock option awards given to certain members of our senior management team which vested following the change in control of our majority shareholder, a reduction in employee retention costs of $0.3 million resulting from the change in control of our majority shareholder, and a decrease in other costs of $0.3 million. R&D expenses as a percentage of net revenues were 3.2% for the three months ended September 30, 2009 compared with 5.7% for the three months ended September 30, 2008.

Depreciation

Depreciation expense decreased $0.8 million, or 26.2% to $2.2 million for the three months ended September 30, 2009 compared with $3.0 million for the three months ended September 30, 2008. This decrease was primarily the result of reduced capital spending in 2008. Depreciation expense as a percentage of net revenues was 2.9% for the three months ended September 30, 2009 compared with 3.7% for the same period in 2008.

Amortization

Amortization expense increased $0.1 million, or 7.6%, to $1.5 million for the three months ended September 30, 2009 compared with $1.4 million for the three months ended September 30, 2008. This increase was primarily the result of amortization expense associated with software development projects which were completed in 2008. Amortization expense as a percentage of net revenues was 2.0% for the three months ended September 30, 2009 compared with 1.7% for the same period in 2008.

Cost of legal proceedings and settlements, net

Costs of legal proceedings and settlements, net decreased $7.5 million, or 84.4%, to $1.3 million for the three months ended September 30, 2009 compared with $8.8 million for the three months ended September 30, 2008. This decrease in costs was due primarily to the DOJ settlement of $5.9 million; a decrease in legal fees related to the shareholder matter of $0.9 million: a decrease if $0.8 million related to the Anthurium patent claim; offset by an increase in all other legal fees of $0.1 million.

Equity in income of affiliated company

Equity in income of affiliated company increased $2.0 million, or 1,255%, to $2.2 million for the three months ended September 30, 2009 compared with $0.2 million for the three months ended September 30, 2008. This increase was primarily due to a gain recognized by our affiliate. Our affiliate obtained control of a previously unconsolidated joint venture and recorded a gain on its previously held interest in the joint venture.

Income tax provision

The effective income tax rate for the three months ended September 30, 2009 was 5.3% compared with an effective income tax rate of (22.6%) for the three months ended September 30, 2008. The income tax provisions consists of the increase in the deferred tax liability related to the current year tax goodwill amortization which is indefinite in nature as well as a decrease in the valuation allowance related to deferred tax assets utilized to offset earnings. The provisions also include state and foreign income taxes.

Comparison of Nine Months Ended September 30, 2009 and 2008


	Nine Months Ended September 30,
	2009					2008
			% of Net						% of Net
($ in thousands)	Amount		Revenues			Amount			Revenues			$ Change			% Change
Net revenues	$	233,251		100.0	%	$	247,466			100.0	%	$	(14,215	)		(5.7	%)


Operating costs and expenses:
Cost of revenues		157,993		67.7	%		176,508			71.3	%		(18,515	)		(10.5	%)
Selling, general and administrative		25,819		11.1	%		36,446			14.7	%		(10,627	)		(29.2	%)
Research and development		7,235		3.1	%		12,502			5.1	%		(5,267	)		(42.1	%)
Depreciation		7,418		3.2	%		8,901			3.6	%		(1,483	)		(16.7	%)
Amortization of intangible assets		4,533		1.9	%		4,145			1.7	%		388			9.4	%
Cost of legal proceedings and settlements, net		13,440		5.8	%		17,908			7.2	%		(4,468	)		(24.9	%)
Restructuring charges		481		0.2	%		82			0.0	%		563			686.6	%


Total operating costs and expenses		216,919		93.0	%		256,328			103.6	%		(39,409	)		(15.4	%)


Operating income (loss)		16,332		7.0	%		(8,862	)		(3.6	%)		25,194			284.3	%

Equity in income of affiliated company		2,582		1.1	%		200			0.1	%		2,382			1,191.0	%
Other income		—		—			438			0.2	%		(438	)		(100.0	%)
Interest income (expense), net		36		0.0	%		2,601			1.1	%		(2,565	)		(98.6	%)


Income (loss) before income taxes		18,950		8.1	%		(5,623	)		(2.3	%)		24,573			437.0	%

Income tax provision (benefit)		1,556		0.7	%		2,721			1.1	%		(1,165	)		(42.8	%)


Net income (loss)	$	17,394		7.5	%	$	(8,344	)		(3.4	%)	$	25,738			308.5	%

Net revenues

Net revenues decreased $14.2 million, or 5.7% to $233.3 million for the nine months ended September 30, 2009 compared with $247.5 million for the nine months ended September 30, 2008. Although growth in transcription volumes increased during the nine months relative to the prior year, the volume was not sufficient to offset the impact of lower average prices for transcription and the planned migration from legacy products which reduce services revenues.

Cost of revenues

Cost of revenues decreased $18.5 million, or 10.5% to $158.0 million for the nine months ended September 30, 2009 compared with $176.5 million for the nine months ended September 30, 2008. This decrease was attributable primarily to:

	•		reduced medical transcription payroll costs of $6.6 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 $0.8 million;

	•		reduced medical transcription costs of $3.0 million related to the increase in our outsourced medical transcription volumes to our international labor partners;

	•		reduced medical transcription payroll costs of $1.8 million related to the increase in our outsourced medical transcription cost controls;

	•		reduced costs of $4.9 million resulting from headcount reductions taken in 2008;

	•		a one time benefit of $1.2 million related to the release of a reserve for prior period medical claims.

As a percentage of net revenues, cost of revenues decreased to 67.7% for the nine months ended September 30, 2009 from 71.3% for the same period in 2008, largely as a result 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 $10.6 million, or 29.2%, to $25.8 million for the nine months ended September 30, 2009 compared with $36.4 million for the nine months ended September 30, 2008. This decrease was attributable to a decrease of $2.9 million related to compensation expense as a result of reductions in workforce, a decrease of $2.7 million of legal fees; a decrease of $1.6 million due to reduced professional fees related to our evaluation of strategic alternatives, a decrease of $1.0 million related to the expiration of our contract with Nightingale, a decrease of $0.8 million due to the acceleration of stock option awards given to certain members of our senior management team which vested following the change in control of our majority shareholder, reduced audit fees of $0.8 million, a reduction in employee retention costs of $0.3 million resulting from the change in control of our majority shareholder, a decrease of advertising and marketing costs of $0.4 million, and a decrease in all other SG&A costs of $0.1 million. SG&A expense in the nine month period ended September 30, 2009 as a percentage of net revenues was 11.1% compared with 14.7% for the same period in 2008.

Research & development

R&D expenses decreased $5.3 million, or 42.1%, to $7.2 million for the nine months ended September 30, 2009 compared with $12.5 million for the nine months ended September 30, 2008. This decrease was attributable to a decrease of $2.8 million related to compensation expense as a result of reductions in workforce; a decrease in the amounts we capitalized for software development of $0.6 million; a decrease in consulting expense of $0.8 million; a decrease of $0.4 million due to the acceleration of stock option awards given to certain members of our senior management team which vested following the change in control of our majority shareholder, a reduction in employee retention costs of $0.3 million resulting from the change in control of our majority shareholder; and a decrease in other costs of $0.4 million. R&D expenses as a percentage of net revenues were 3.1% for the nine months ended September 30, 2009 compared with 5.1% for the nine months ended September 30, 2008.

Depreciation

Depreciation expense decreased $1.5 million, or 16.7%, to $7.4 million for the nine months ended September 30, 2009 compared with $8.9 million for the nine months ended September 30, 2008. This decrease was primarily the result of reduced capital spending in 2008. Depreciation expense as a percentage of net revenues was 3.2% for the nine months ended September 30, 2009 compared with 3.6% for the same period in 2008.

Amortization

Amortization expense increased $0.4 million, or 9.4%, to $4.5 million for the nine months ended September 30, 2009 compared with $4.1 million for the nine months ended September 30, 2008. This increase was primarily the result of amortization expense associated with software development projects which were completed in 2008. Amortization expense as a percentage of net revenues was 1.9% for the nine months ended September 30, 2009 compared with 1.7% for the same period in 2008.

Cost of legal proceedings and settlements, net

Costs of legal proceedings and settlements, net decreased $4.5 million, or 24.9%, to $13.4 million for the nine months ended September 30, 2009 compared with $17.9 million for the nine months ended September 30, 2008. This decrease in costs was due primarily to the DOJ and medical transcriptionists putative class action settlements which in 2008 for $5.9 million and $1.5 million, respectively, which did not recur in the 2009 period; and a reduction in legal fees of $2.9 million: offset by the Anthurium patent claim of $5.8 million.

Equity in income of affiliated company

Equity in income of affiliated company increased $2.4 million, or 1,191%, to $2.6 million for the nine months ended September 30, 2009 compared with $0.2 million for the nine months ended September 30, 2008. This increase was primarily due to a

gain recognized by our affiliate. Our affiliate obtained control of a previously unconsolidated joint venture and recorded a gain on its previously held interest in the joint venture.

Income tax provision

The effective income tax rate for the nine months ended September 30, 2009 was 8.2% compared with an effective income tax rate of (48.3%) for the nine months ended September 30, 2008. The income tax provisions consists of the increase in the deferred tax liability related to the current year tax goodwill amortization which is indefinite in nature as well as a decrease in the valuation allowance related to deferred tax assets utilized to offset earnings in the current period. The provisions also include state and foreign income taxes.

Liquidity and Capital Resources

As of September 30, 2009, we had working capital of $10.6 million compared with $39.5 million as of December 31, 2008. Our principal sources of liquidity are cash from operations, available cash on hand and our access to a credit facility. Cash and cash equivalents decreased $24.2 million in the nine months ended September 30, 2009 to $15.7 million from $39.9 million as of December 31, 2008. This decrease was driven primarily by cash provided by operating activities of $33.0 million offset by cash used to purchase property and equipment of $3.6 million, cash used for software development activities and other investments of $2.7 million, cash dividend of $49.9 million, and cash used of $1.2 million for fees and expenses related to the Credit Agreement described below.

In August 2009 we entered into a five-year $25 million revolving credit agreement (the “Credit Agreement”) with Wells Fargo Foothill, LLC, pursuant to a credit agreement (the “Credit Agreement”). Subject to certain terms and conditions of the Credit Agreement, the Credit Agreement provides committed revolving funding through August 2014 and includes an option whereby we can increase its maximum credit to $40 million, based upon certain terms and conditions. The amount available for borrowings is based upon a percentage of eligible accounts receivable. Under the agreement, there are reserves established which limit the amounts that can be available. At September 30, 2009, $21.0 million was available under the Credit Agreement. The Credit Agreement is a working capital facility that may be used for general corporate purposes. The Credit Agreement enables us to borrow funds in U.S. dollars, at variable interest rates. The Credit Agreement provides the lender a security interest in and against significantly all of our assets. Under the Credit Agreement we agreed to certain covenants customarily found in such agreements including, but not limited to, financial covenants requiring us to maintain certain minimum levels of EBITDA and a minimum fixed charge coverage ratio. At September 30, 2009 we were in compliance with the financial covenants of the agreement. At September 30, 2009 there were no borrowings outstanding under the Credit Agreement.

We believe our existing cash and cash equivalents combined with cash expected to be generated from operations and cash available under the Credit Agreement 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.

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, 2009. 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, 2009, 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, 2009 that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II. OTHER INFORMATION


Item 1.		*Legal Proceedings*

Customer Litigation

Kaiser Litigation

Shareholder Litigation

Kahn Putative Class Action

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 September 24, 2009, the Appellate Division held oral argument on the issues that are the subject of plaintiff’s appeal. We are now waiting for the Appellate Division to issue a decision.

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.

On September 24, 2009, Claimants served their expert report which changed their damage theories and calculations.

We deny all wrongdoing and intend to defend ourselves vigorously.

SEC Investigations of Former Officers

Other Matters

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, 2009 or December 31, 2008 related to these indemnification provisions.

We have 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.


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, 2008 and have added the following additional risk factor: Our debt obligations include restrictive covenants which may restrict our operations or otherwise adversely affect us.

Under the Credit Agreement which we entered into in August 2009, we must abide by certain financial and other restrictive covenants that, among other things, require us to maintain certain minimum levels of EBITDA and a minimum fixed charge coverage ratio.

Upon a breach of any of the covenants in the Credit Agreement the lender could declare us to be in default of the Credit Agreement and could further require any outstanding borrowings under the Credit Agreement to be immediately due and payable, and terminate all commitments to extend further credit. We currently do not have any borrowings outstanding under the Credit Agreement.


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*

The following information was required to be disclosed under Item 2.05 of a Current Report on Form 8-K during the fiscal quarter ended September 30, 2009:

On July 8, 2009, our senior management team approved and we implemented a restructuring plan related to a reduction in workforce of 47 employees in order to better align costs with revenues. We recorded $497,000 in severance charges related to this restructuring plan, of which, as of September 30, 2009, $229,000 has been paid out in cash expenditures and $268,000 has been recorded on our consolidated balance sheet as accrued expenses in anticipation of future expenditures. In connection with this restructuring plan, we do not anticipate any additional expenditures beyond the $497,000 in severance charges already accrued.


Item 6.		*Exhibits*

(a)Exhibits


No.		Description

10.1		MedQuist Inc. Long-Term Incentive Plan adopted on August 27, 2009

10.2		Credit Agreement dated August 31, 2009 by and among MedQuist Inc. and its subsidiaries, and Wells Fargo Foothill, LLC as the arranger and administrative agent and lender.

10.3⁽¹⁾		Services Agreement by and between MedQuist Inc. and CBay Inc. dated September 19, 2009

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 September 24, 2009

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 9, 2009	/s/ Peter Masanotti
	Peter Masanotti
	President and Chief Executive Officer (Principal Executive Officer)


Date: November 9, 2009	/s/ Dominick Golio
	Dominick Golio
	Chief Financial Officer (Principal Financial Officer)

Exhibit Index


No.		Description

10.1		MedQuist Inc. Long-Term Incentive Plan adopted on August 27, 2009

10.2		Credit Agreement dated August 31, 2009 by and among MedQuist Inc. and its subsidiaries, and Wells Fargo Foothill, LLC as the arranger and administrative agent and lender.

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

Positive
Negative
Uncertain
Constraining
Legalese
Litigous
Readability	8th grade Good

Medquist (MEDQ) Inactive 10-Q2009 Q3 Quarterly report

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