e10vq

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 March 31, 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		22-2531298
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

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

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

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

Indicate by check mark whether the registrant 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). Yes o No o

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


Large accelerated filer o	Accelerated filer þ	Non-accelerated filer o	Smaller reporting company o
		(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). Yes o No þ

The number of registrant’s shares of common stock, no par value, outstanding as of April 30, 2009 was 37,555,893.

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


	March 31,			December 31,
	2009			2008
Assets
Current assets:
Cash and cash equivalents	$	51,854		$	39,918
Accounts receivable, net of allowance of $4,148 and $4,802, respectively		46,465			50,374
Income tax receivable		174			154
Other current assets		7,133			8,053

Total current assets		105,626			98,499

Property and equipment, net		13,916			15,785
Goodwill		40,372			40,545
Other intangible assets, net		39,053			39,877
Deferred income taxes		1,178			1,204
Other assets		6,385			6,295


Total assets	$	206,530		$	202,205


Liabilities and Shareholders’ Equity
Current liabilities:
Accounts payable	$	7,129		$	7,487
Accrued expenses		10,238			11,994
Accrued compensation		12,126			11,204
Customer accommodation		11,994			12,055
Deferred income taxes		651			651
Deferred revenue		14,207			15,630

Total current liabilities		56,345			59,021

Deferred income taxes		1,104			799
Other non-current liabilities		2,090			2,033


Commitments and contingencies (Note 9)

Shareholders’ equity:
Common stock — no par value; authorized 60,000 shares; 37,556 and 37,556 shares issued and outstanding, respectively		237,955			237,907
Accumulated deficit		(92,342	)		(99,198	)
Accumulated other comprehensive income		1,378			1,643


Total shareholders’ equity		146,991			140,352


Total liabilities and shareholders’ equity	$	206,530		$	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


	Three months ended
	March 31,
	2009			2008
Operating activities:
Net income (loss)	$	6,854		$	(4,417	)
Adjustments to reconcile net income (loss) to cash provided by (used in) operating activities:
Depreciation and amortization		4,063			4,289
Equity in income of affiliated company		(72	)		(16	)
Deferred income tax provision		309			719
Stock option expense		48			92
Provision for (recovery of) doubtful accounts		(105	)		263
Loss on disposal of property and equipment		24			26

Changes in operating assets and liabilities:
Accounts receivable		3,920			(3,700	)
Income tax receivable		(20	)		78
Other current assets		923			(189	)
Other non-current assets		(18	)		70
Accounts payable		392			(2,773	)
Accrued expenses		(1,739	)		(746	)
Accrued compensation		930			(999	)
Customer accommodation		—			(459	)
Deferred revenue		(1,424	)		1,441
Other non-current liabilities		63			(70	)

Net cash provided by (used in) operating activities	$	14,148		$	(6,391	)


Investing activities:
Purchase of property and equipment		(1,393	)		(1,837	)
Capitalized software		(766	)		(611	)

Net cash used in investing activities		(2,159	)		(2,448	)


Financing activities:
Net cash provided by financing activities		—			—


Effect of exchange rate changes		(53	)		(32	)


Net increase (decrease) in cash and cash equivalents		11,936			(8,871	)


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


Cash and cash equivalents — end of period	$	51,854		$	152,711



Supplemental cash flow information:

Cash paid (recovered) for income taxes	$	(131	)	$	95

Accommodation payments paid with credits	$	61		$	404

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

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 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 as permitted by Financial Accounting Standards Board (FASB) Interpretation 18, “Accounting for Income Taxes in Interim Periods”.

Our accounting policies are set forth in detail in Note 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.

2. Stock-Based Compensation

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


	Three months ended March 31,
	2009		2008
Selling, general and administrative	$	48	$	56
Research and development		—		24
Cost of revenues		—		12

Total	$	48	$	92

As of March 31, 2009, total unamortized stock-based compensation cost related to non-vested stock options, net of expected forfeitures, was $486 which is expected to be recognized over a period of 2.5 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		(234	)		19.48

Outstanding, March 31, 2009		1,582			24.54		3.7	$	—

Exercisable, March 31, 2009		1,286			28.29		2.4	$	—


Options vested and expected to vest as of March 31, 2009		1,582		$	24.54		3.7	$	—

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

There were no options granted or exercised during the three months ended March 31, 2009 and 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 the 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 granted during the three months ended March 31, 2009 were:


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

A summary of outstanding and exercisable common stock options as of March 31, 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		9.0	$	8.10		18	$	5.71
$10.01 – $20.00		397		3.6	$	15.89		397	$	15.89
$20.01 – $30.00		580		2.2	$	26.47		580	$	26.47
$30.01 – $40.00		96		1.0	$	33.31		96	$	33.31
$40.01 – $70.00		195		1.2	$	58.69		195	$	58.69

		1,582		3.7	$	24.54		1,286	$	28.29

As of March 31, 2009, there were 887 additional options available for grant under our stock option plans.

3. Other Comprehensive Income (Loss)

Other comprehensive income (loss) was as follows:


	Three months ended March 31,
	2009			2008
Net income (loss)	$	6,854		$	(4,417	)
Foreign currency translation adjustment		(265	)		(104	)

Comprehensive income (loss)	$	6,589		$	(4,521	)

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 March 31,
	2009		2008
Net income (loss)	$	6,854	$	(4,417	)


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

Diluted		37,556		37,544

Net income (loss) per share:
Basic	$	0.18	$	(0.12	)
Diluted	$	0.18	$	(0.12	)

The computation of diluted net income (loss) per share does not assume conversion, exercise or issuance of shares that would have an anti-dilutive effect on diluted net income (loss) per share. Shares 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 1,582 and 1,651 for the three months ended March 31, 2009 and 2008, respectively.

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 March 31, 2009 and December 31, 2008:


	Three months ended			Year ended
	March 31, 2009			December 31, 2008
Beginning balance	$	12,055		$	18,459
Payments and other adjustments		—			(5,664	)
Credits		(61	)		(740	)

Ending balance	$	11,994		$	12,055

6. Cost of Investigation and Legal Proceedings, Net

For the three months ended March 31, 2009 and 2008, we recorded charges of $785 and $6,398, respectively, for costs associated with the Review as well as defense and other costs associated with governmental investigations and civil litigation. The following is a summary of the amounts recorded as Cost of investigation and legal proceedings, net, in the accompanying consolidated statements of operations:


	Three months ended March 31,
	2009		2008
Legal fees	$	755	$	4,661
Other professional fees		30		237
Other		—		1,500

Total	$	785	$	6,398

Other professional fees represent accounting and dispute analysis costs and document search and retrieval costs. The 2008 Other amount of $1,500 is for the settlement of all claims related to the consolidated medical transcriptionists putative class action. (See Note 9).

7. Restructuring Plans

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. We recorded $2,135 in severance charges related to the 2008 restructuring plan. The remaining restructuring costs are included in accrued expenses in the accompanying consolidated balance sheet as of March 31, 2009. 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:


	Three Months Ended			Year Ended
	March 31, 2009			December 31, 2008
Beginning balance	$	1,323		$	—
Charge		—			2,135
Cash paid		(873	)		(812	)

Ending balance	$	450		$	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 have recorded a valuation allowance to reduce our net deferred tax assets to an amount that is more likely than not to be realized in future years.

Under FASB Interpretation 48, Accounting for Uncertainty in Income Taxes — an interpretation of FASB Statement 109 (FIN 48), we classify penalties and interest related to uncertain tax positions as part of income tax expense. There were no material changes to our uncertain tax positions, including penalties and interest for the three months ended March 31, 2009.

9. Commitments and Contingencies

SEC Investigations

Of the Company

In 2004, the SEC commenced an investigation of us relating to our billing practices. We fully cooperated with the SEC from the beginning of its investigation and we complied with information and document requests by the SEC. We resolved the investigation against us by entering into a settlement with the SEC on March 6, 2009 pursuant to which we agreed to the entry of final judgment in prospective litigation by the SEC, including an injunction against us from violating federal securities laws. The court entered the final judgment and consent on March 13, 2009. Under the settlement, we did not pay any fines or penalties to the SEC, and we did not admit to or deny any liability or wrongdoing.

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.

Customer Litigation

Kaiser Litigation

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.

Medical Transcriptionist Litigation

Hoffmann Putative Class Action

A putative class action lawsuit was filed against us in the United States District Court for the Northern District of Georgia. The action, entitled Brigitte Hoffmann, et al. v. MedQuist Inc., et al., Case No. 1:04-CV-3452, was filed with the Court on November 29, 2004 against us and certain current and former officials, purportedly on behalf of an alleged class of current and former employees and statutory workers, who are or were compensated on a “per line” basis for medical transcription services (Class Members) from January 1, 1998 to the time of the filing of the complaint (Class Period). The complaint specifically alleged that defendants systematically and wrongfully underpaid the Class Members during the Class Period. The complaint asserted the following causes of action: fraud, breach of contract, demand for accounting, quantum meruit, unjust enrichment, conversion, negligence, negligent supervision, and RICO violations. Plaintiffs sought unspecified compensatory damages, punitive damages, disgorgement and restitution. On December 1, 2005, the Hoffmann matter was transferred to the United States District Court for the District of New Jersey. On January 12, 2006, the Court ordered this case consolidated with the Myers Putative Class Action discussed below. As set forth below, the parties have reached an agreement in principle to settle all claims.

Force Putative Class Action

A putative class action entitled Force v. MedQuist Inc. and MedQuist Transcriptions, Ltd., Case No. 05-cv-2608-WSD, was filed against us on October 11, 2005 in the United States District Court for the Northern District of Georgia. The action was brought on behalf of a putative class of current and former employees who claim they are or were compensated on a “per line” basis for medical transcription services but were allegedly underpaid due to the actions of defendants. The named plaintiff asserted claims for breach of contract, quantum meruit, unjust enrichment, and for an accounting. Upon stipulation and consent of the parties, on February 17, 2006, the Force matter was ordered transferred to the United States District Court for the District of New Jersey. Subsequently, on April 4, 2006, the parties entered into a stipulation and consent order whereby the Force matter was consolidated with the Myers Putative Class Action discussed below, and the consolidated amended complaint filed in the Myers action on January 31, 2006 was deemed to supersede the original complaint filed in the Force matter. As set forth below, the parties have reached an agreement in principle to settle all claims.

Myers Putative Class Action

A putative class action entitled Myers, et al. v. MedQuist Inc. and MedQuist Transcriptions, Ltd., Case No. 05-cv-4608 (JBS), was filed against us on September 22, 2005 in the United States District Court for the District of New Jersey. The action was brought on behalf of a putative class of our employee and independent contractor transcriptionists who claim that they contracted with us to be paid on a 65 character line, but were allegedly underpaid due to intentional miscounting of the number of characters and lines transcribed. The named plaintiffs asserted claims for breach of contract, unjust enrichment, and requested an accounting.

The allegations contained in the Myers case are substantially similar to those contained in the Hoffmann and Force putative class actions and, as detailed above, the three actions were consolidated.

published. The deadlines to object to or request exclusion from the settlement class have passed, and the Court issued a final judgment and order of dismissal with prejudice on March 31, 2009. Neither we, nor any other party, has admitted or will admit liability or any wrongdoing in connection with the settlement.

Shareholder Litigation

Kahn Putative Class Action

On January 22, 2008, MedQuist shareholder Alan R. Kahn filed a shareholder putative class action lawsuit against us, Koninklijke Philips Electronics N.V. (Philips) and four of our former non-independent directors, Clement Revetti, Jr., Stephen H. Rusckowski, Gregory M. Sebasky and Scott Weisenhoff. The action, entitled Alan R. Kahn v. Stephen H. Rusckowski, et al., Docket No. BUR-C-000007-08, 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 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 our majority shareholder, 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 order with the New Jersey Appellate Division. The matter is now pending before the Appellate Division. We will vigorously oppose any issues that plaintiff raises on appeal.

Reseller Arbitration Demand

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

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

We filed an answer and counterclaim in the arbitration, which generally denied liability. In the lawsuit, the defendants filed a motion to dismiss alleging that our complaint failed to state an actionable claim for relief. On July 25, 2008, we filed our response which opposed the motion to dismiss in all respects. 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 has tentatively scheduled the arbitration to begin in October 2009. We deny all wrongdoing and intend to defend ourselves vigorously including asserting counterclaims against the Claimants as appropriate.

Anthurium Patent Litigation

On November 6, 2007, Anthurium Solutions, Inc. filed an action entitled Anthurium Solutions, Inc. v. MedQuist Inc., et al., Civil Action No. 2-07CV-484, in the United States District Court for the Eastern District of Texas, alleging that we infringed and continue to infringe United States Patent No. 7,031,998 through our DEP transcription platform. The complaint also alleges patent infringement claims against Spheris, Inc. and Arrendale Associates, Inc. The complaint seeks injunctive relief and unspecified damages, including enhanced damages and attorneys’ fees. We filed our answer on January 15, 2008 and counterclaimed seeking a declaratory judgment that the patent is invalid and has not been and is not being infringed by us. Our answer denied all of plaintiff’s allegations of patent infringement and all of plaintiff’s claims for damages, injunctive relief and/or other relief, including attorneys’ fees. Plaintiff filed its preliminary infringement contentions on May 2, 2008. On February 9, 2009, the courts issued a memorandum opinion and order in which it construed certain disputed words (“claim terms”) in the patent at issue. The entry of that order also finalized certain deadlines for the case, including (a) the completion of fact discovery by April 30, 2009, (b) the completion of expert witness discovery by June 30, 2009, and (c) the filing of dispositive motions by July 8, 2009. The trial is scheduled to commence on October 6, 2009. We believe that the claims asserted have no merit and intend to vigorously defend the suit.

Other Matters

From time to time, we have been involved in various claims and legal actions arising in the ordinary course of business. In our opinion, the outcome of such actions will not have a material adverse effect on our consolidated financial position, results of operations, liquidity or cash flows.

We provide certain indemnification provisions within our standard agreement for the sale of software and hardware (collectively, Products) to protect our customers from any liabilities or damages resulting from a claim of U.S. patent, copyright or trademark infringement by third parties relating to our Products. We believe that the likelihood of any future payout relating to these provisions is remote. Accordingly, we have not recorded any liability in our consolidated financial statements as of March 31, 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 an active disaster recovery program in place for our information systems and DEP. We believe there are alternative speech recognition software vendors that could replace the current vendor. MedQuist has periodically experienced short term outages with its DEP, which have not significantly disrupted our business

10. Related Party Transactions

From time to time, we enter into transactions in the normal course of business with related parties. Prior to August 6, 2008, Philips owned approximately 69.5% ownership interest in MedQuist. This ownership interest was sold to CBaySystems Holdings on

August 6, 2008. Accordingly Philips ceased to be a related party on that date and CBaySystems Holdings (and affiliated entities) commenced to be a related party on that date. The Audit Committee of our board of directors has been charged with the responsibility of approving or ratifying all related party transactions other than those which were previously entered into between us and Philips prior to August 6, 2008. In any situation where the Audit Committee sees fit to do so, any related party transaction, other than those previously entered into between us and Philips prior to August 6, 2008, are presented to disinterested members of our board of directors for approval or ratification.

On September 15, 2008, our wholly-owned subsidiary, MedQuist Transcriptions, Ltd., 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 will expire on September 15, 2010 unless sooner terminated by either party. For the three months ended March 31, 2009, we incurred expenses of $958 which were recorded in Cost of Revenues. As of March 31, 2009 and December 31, 2008, accounts payable included $414 and $283, respectively, for amounts due to CBay Systems for services performed.

On April 3, 2009, MedQuist Transcriptions, Ltd. entered into a transcription services agreement (Transcription Services Agreement) with CBay Systems, pursuant to which we outsource certain medical transcription services to CBay. The Transcription Services Agreement will expire on April 3, 2012 unless sooner terminated by either party. Under the Transcription Services Agreement, we pay CBay a per line fee based on each transcribed line of text processed and the specific type of service provided. CBay will perform its services using our DocQment Enterprise Platform and will be held to certain performance standards and quality guidelines set forth in the Transcription Services Agreement. The specific services to be performed will be set forth in order forms delivered by us to CBay from time to time during the term of the Transcription Services Agreement.

On March 31, 2009, MedQuist Transcriptions, Ltd. entered into a transcription services subcontracting agreement (Subcontracting Agreement) with CBay Systems, pursuant to which CBay 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 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 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 from its customers for the services provided us.

For the three months ended March 31, 2009, we incurred services expenses with CBaySystems Holdings of $350 which has been recorded in Selling, General and Administrative expense. As of March 31, 2009 and December 31, 2008, accrued expenses included $350 and $342, respectively, for amounts due to CBaySystems Holdings for services performed.

Also, as of March 31, 2009 and December 31, 2008, Accounts Payable includes $14 and $40, respectively, related to travel expenses incurred by CBaySystems Holdings’ executives on our behalf.

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 subsequently amended by the parties as of January 1, 2002, February 23, 2003, August 10, 2003, September 1, 2004, December 30, 2005 and February 13, 2007. 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.

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 three months ended March 31, 2008.

Listed below is a summary of the expenses incurred by us in connection with the various Philips agreements noted above for the three months ended March 31, 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
	March 31,
	2008
Licensing agreement	$	805
OEM supply agreement		875
Equipment purchases		301
Insurance coverage		167
Other		(39	)

Total	$	2,109

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 three months ended March 31, 2008, we incurred charges of $641 respectively, for Nightingale services, which were recorded in selling, general and administrative expenses in the accompanying consolidated statements of operations.

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

As of March 31, 2009 and December 31, 2008, we had an investment of $6,322 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 since we owned 33.6% of A-Life’s outstanding voting shares as of March 31, 2009 and December 31, 2008. Our investment in A-Life is recorded in other assets in the accompanying consolidated balance sheets.

Our investment in A-Life included a note receivable plus accrued interest due from A-Life which matured on December 31, 2003. Prior to 2007, this note receivable and accrued interest had been recorded in other assets. In January 2008, A-Life paid us $1,250 to satisfy this note receivable and accrued interest in full, as well as all other disputes and claims between A-Life and us. In January 2008, we recorded $438 of other income related to this transaction.

12. Financial Instruments

Effective January 1, 2008, we adopted SFAS 157 for financial assets and financial liabilities recognized at fair value on a recurring basis. The partial adoption of SFAS 157 for these items did not have a material impact on our financial position, results of operations and cash flows. The statement establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into three broad categories. Level 1: Quoted market prices in active markets for identical assets or liabilities that the company has the ability to access. Level 2: Observable market based inputs or unobservable inputs that are corroborated by market data such as quoted prices, interest rates and yield curves. Level 3: Inputs are unobservable data points that are not corroborated by market data. At March 31, 2009, we held one financial asset, our Executive Deferred Compensation Plan assets (EDCP) included in other current assets with a fair value of $739. We measure the fair value of our EDCP on a recurring basis using Level 2 (significant other observable) inputs as defined by SFAS 157. The adoption of SFAS 157 did not have an impact on the basis for measuring the fair value of these items. Our EDCP previously allowed certain members of management and other highly compensated employees to defer a certain percentage of their income. Our board of directors indefinitely suspended the EDCP in June 2004.

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 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;

	•		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 medical transcription services and a leader in technology enabled clinical documentation workflow. We service health systems, hospitals and large group medical practices throughout the U.S., and we are the largest employer of MTs in the U.S. In the clinical documentation workflow, we provide, in addition to medical transcription technology and services, digital dictation, speech recognition and electronic signature services.

We were incorporated in New Jersey in 1984 and reorganized in 1987 as a group of outpatient healthcare businesses affiliated with a non-profit healthcare provider. In May 1994, we acquired our first medical transcription business. Through the date of this report, we have acquired over 50 companies. By the end of 1995, we had divested all of our non-medical transcription businesses.

On August 6, 2008, CBaySystems Holdings Limited (CBaySystems Holdings) purchased 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). In 2002, we began the process of migrating our customers to our DEP from our many disparate transcription platforms and completed this process in the first quarter of 2007. As a result of this process, we encountered customer attrition.

We have devoted significant resources over the past few years to improving our fundamental business systems, including our corporate governance functions, financial controls, and operational infrastructure. In addition, during this period we also devoted a significant portion of our time and attention to matters outside the ordinary course of business such as cooperating with federal investigations, responding to ongoing legal proceedings and reviewing past allegations of improper billing practices. As our organization was focusing on all of these issues, we also pursued major operational initiatives to consolidate technology platforms, communicate actively with our customers, and restructure our business.

During this same period there have been several significant developments in the medical transcription industry, including:

	•		A shortage of qualified domestic MTs has increased the demand for outsourced medical transcription services by U.S.-based healthcare providers. This demand for qualified MTs, as well as budgetary pressures experienced by healthcare providers, has also caused many more U.S.-based healthcare providers to evaluate and consider the use of offshore medical transcription labor;

	•		Several low cost providers have emerged and aggressively moved into our market offering medical transcription services (performed both domestically and offshore) at prices significantly below our traditional price point. One of these low cost providers is owned by CBaySystems Holdings. While we believe the market for outsourced medical transcription continues to expand, the growing acceptance by customers of the use of offshore labor has further increased the competitive environment in the medical transcription industry;

	•		Technological advances by us and our competitors which have reduced the length of time required to transcribe medical reports, in turn reducing the overall cost of medical transcription services; and

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

Although we remain the leading provider of medical transcription services in the U.S., we experience competition from many local, regional and national businesses. The medical transcription industry is highly fragmented, and we believe there are hundreds of companies in the U.S. performing medical transcription services. There are currently two large service providers, one of which is us and the other of which is Spheris Inc., several mid-sized service providers with annual revenues of between $15 million and $100 million and hundreds of smaller, independent businesses with annual revenues of less than $15 million.

We believe the outsourced portion of the medical transcription services market will increase due in part to healthcare providers seeking the following:

•

reduction in overhead and other administrative costs, 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: reverse recent market share decline, increase profit margins and continue to benefit from technological advances.

We evaluate our performance based upon the following factors:

	•		revenues;

	•		operating income;

	•		net income per share;

	•		net cash provided by operating activities; and

	•		days sales outstanding.

Our goal is to execute our strategy to yield growth in net revenues, operating income and net income per share.

Critical Accounting Policies, Judgments and Estimates

Our discussion and analysis of our financial condition and consolidated results of operations are based upon our consolidated financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles (GAAP). The preparation of our consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, net revenues and expenses and related disclosure of contingent assets and liabilities. On an on-going basis, we evaluate our estimates based upon historical experience and various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Our actual results may differ from these estimates. These critical accounting policies and estimates have been discussed with the Audit Committee of our board of directors.

We believe that our critical accounting policies affect our more significant estimates and judgments used in the preparation of our consolidated financial statements. Our Annual Report on Form 10-K for the year ended December 31, 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.

Basis of Presentation

Sources of Revenues

We derive revenues primarily from the provision of medical transcription services to health systems, hospitals and large group medical practices. Our customers are generally charged a rate times the volume of work that we transcribe or edit. In the clinical documentation workflow, we provide, in addition to medical transcription technology and services, maintenance services, digital dictation, speech recognition and electronic signature services. Our medical transcription revenues (excluding the impact of our customer accommodation program) have been declining over the past several years, as prices have declined and some customers have switched to alternative vendors. Our technology products and services revenues also declined over the past several years, as many products reached the end of their life and revenues from new products have not replaced the lost revenues.

Cost of Revenues

Cost of revenues includes compensation of MTs, other payroll costs (primarily related to operational and production management, quality assurance, quality control and customer and field service personnel), telecommunication and facility costs. Cost of revenues also includes the direct cost of technology products sold to customers. MT payroll cost is directly related to medical transcription revenues and is based on lines transcribed or edited multiplied by a specific rate. Therefore, MT costs trend directly in line with revenues. Fixed costs have been reduced though not at the same pace as net revenues.

Selling, General and Administrative (SG&A)

Our SG&A expenses include marketing and sales costs, accounting costs, information technology costs, professional fees, corporate facility costs, corporate payroll and benefits expenses.

Research and Development (R&D)

Our R&D expenses consist primarily of personnel and related costs, including salaries and employee benefits for software engineers and consulting fees paid to independent consultants who provide software engineering services to us. To date, our R&D efforts have been devoted to new products and services offerings and increases in features and functionality of our existing products and services.

Depreciation and amortization

Depreciation is calculated on a straight-line basis over the estimated useful lives of the assets which range from two to seven years for furniture, equipment and software, and the lesser of the lease term or estimated useful life for leasehold improvements. Intangible assets are being amortized using the straight-line method over their estimated useful lives which range from three to 20 years.

Cost of investigation and legal proceedings, net

Cost of investigation and legal proceedings, net include legal fees incurred in connection with investigations by the U.S. Securities and Exchange Commission (SEC) and the U.S. Department of Justice (DOJ), both of which were settled in 2008 and proceedings and the defense of civil litigation matters described in Part II, Item 1, Legal Proceedings in this report and litigation support consulting.

Consolidated Results of Operations

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

Comparison of Three Months Ended March 31, 2009 and 2008


	Three Months Ended March 31,
	2009					2008
			% of Net						% of Net
($ in thousands)	Amount		Revenues			Amount			Revenues			$ Change			% Change
Net revenues	$	78,944		100.0	%	$	83,725			100.0	%	$	(4,781	)		(5.7	%)


Operating costs and expenses:
Cost of revenues		53,868		68.2	%		61,258			73.2	%		(7,390	)		(12.1	%)
Selling, general and administrative		10,577		13.4	%		13,095			15.6	%		(2,518	)		(19.2	%)
Research and development		2,416		3.1	%		4,119			4.9	%		(1,703	)		(41.3	%)
Depreciation		2,552		3.2	%		2,928			3.5	%		(376	)		(12.8	%)
Amortization of intangible assets		1,511		1.9	%		1,361			1.6	%		150			11.0	%
Cost of investigation and legal proceedings, net		785		1.0	%		6,398			7.6	%		(5,613	)		(87.7	%)


Total operating costs and expenses		71,709		90.8	%		89,159			106.5	%		(17,450	)		(19.6	%)


Operating income (loss)		7,235		9.2	%		(5,434	)		(6.5	%)		12,669			(233.1	%)

Equity in income of affiliated company		72		0.1	%		16			0.0	%		56			350.0	%
Other income		—		—			438			0.5	%		(438	)		(100.0	%)
Interest income, net		46		0.1	%		1,288			1.5	%		(1,242	)		(96.4	%)


Income (loss) before income taxes		7,353		9.3	%		(3,692	)		(4.4	%)		11,045			(299.2	%)

Income tax provision (benefit)		499		0.6	%		725			0.9	%		(226	)		(31.2	%)


Net income (loss)	$	6,854		8.7	%	$	(4,417	)		(5.3	%)	$	11,271			(255.2	%)

Net revenues

Net revenues decreased $4.8 million, or 5.7%, to $78.9 million for the three months ended March 31, 2009 compared with $83.7 million for the three months ended March 31, 2008. This decrease was attributable primarily to reduced service revenues of $4.5 million resulting primarily from lower medical transcription volume. Other revenues decreased $0.3 million.

Cost of revenues

Cost of revenues decreased $7.4 million, or 12.1%, to $53.9 million for the three months ended March 31, 2009 compared with $61.3 million for the three months ended March 31, 2008. This decrease was attributable primarily to:

	•		reduced medical transcription payroll costs of $3.0 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 $0.9 million;

	•		reduced medical transcription payroll cost of $1.9 million related to the decrease in our lower medical transcription volumes; and

	•		reduced costs of $1.6 million resulting from headcount reductions taken in 2008 to better align our overhead costs with our lower revenues levels.

As a percentage of net revenues, cost of revenues decreased to 68.2% for the three months ended March 31, 2009 from 73.2% 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 $2.5 million, or 19.2%, to $10.6 million for the three months ended March 31, 2009 compared with $13.1 million for the three months ended March 31, 2008. This decrease was attributable to a decrease of $0.9 million due to reduced professional fees related to our evaluation of strategic alternatives; a decrease of $1.2 million related to compensation expense as a result of reductions in workforce and reduced audit fees of $0.4 million. SG&A expense in the three month period ended March 31, 2009 as a percentage of net revenues was 13.4% compared with 15.6% for the same period in 2008.

Research & development

R&D expenses decreased $1.7 million, or 41.3%, to $2.4 million for the three months ended March 31, 2009 compared with $4.1 million for the three months ended March 31, 2008. This decrease was related to a decrease of $0.9 million related to compensation expense as a result of reductions in workforce; an increase in the amounts we capitalized for software development of $0.7 million and a decrease of other costs of $0.1 million. R&D expenses as a percentage of net revenues were 3.1% for the three months ended March 31, 2009 compared with 4.9% for the three months ended March 31, 2008.

Depreciation

Depreciation expense decreased $0.3 million, or 12.8%, to $2.6 million for the three months ended March 31, 2009 compared with $2.9 million for the three months ended March 31, 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 three months ended March 31, 2009 compared with 3.5% for the same period in 2008.

Amortization

Amortization expense increased $0.1 million, or 11.0%, to $1.5 million for the three months ended March 31, 2009 compared with $1.4 million for the three months ended March 31, 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 three months ended March 31, 2009 compared with 1.6% for the same period in 2008.

Cost of investigation and legal proceedings, net

Costs and expenses associated with the Review are being reported as cost of investigation and legal proceedings, net. These costs and expenses decreased $5.6 million, or 87.7%, to $0.8 million for the three months ended March 31, 2009 compared with $6.4 million for the three months ended March 31, 2008. This decrease in costs was due primarily to a reduction in legal fees of $4.1 million as compared to the same period in 2008 and the proposed settlement of $1.5 million related to the medical transcriptionists putative class action which was accrued in 2008. We expect to incur additional legal fees in accordance with the indemnification of two former officers.

Interest income, net

Interest income, net reflects interest earned on cash and cash equivalent balances. Interest income, net decreased $1.2 million, or 96.4%, to $0.0 million for the three months ended March 31, 2009 compared with $1.3 million for the three months ended March 31, 2008. This decrease was attributable to the dividend payout of $103.3 million in August 2008, combined with lower weighted average interest rates earned in the 2009 period (0.4%) compared with the 2008 period (3.3%).

Income tax provision

The effective income tax rate for the three months ended March 31, 2009 was 6.8% compared with an effective income tax rate of (19.6)% for the three months ended March 31, 2008. The 2009 rate consists primarily of provisions for the deferred tax liability related to the current year tax goodwill amortization which is indefinite in nature as well as a decrease in the valuation allowance related to deferred tax assets utilized to offset earnings in the current quarter. The provisions also include state and foreign income taxes. The lower 2009 rate is due primarily to reduced tax expense attributable to the deferred tax liabilities associated with indefinite life intangible assets related to goodwill which was impaired in 2008 and a reduction in the overall valuation allowance in the period ended March 31, 2009 compared to an increase in the valuation allowance in the period ended March 31, 2008 due to pretax income for the period ended March 31, 2009 compared to a pretax loss for the period ended March 31, 2008.

Liquidity and Capital Resources

As of March 31, 2009, we had working capital of $49.3 million compared with $39.5 million as of December 31, 2008. Our principal source of liquidity was available cash on hand. Cash and cash equivalents increased $12.0 million for the three months ended March 31, 2009 to $51.9 million from $39.9 million as of December 31, 2008. This increase was driven primarily by cash provided by operating activities of $14.2 million offset by cash used to purchase property and equipment of $1.4 million, and cash used for software development activities of $0.8 million.

We believe our existing cash and cash equivalents and cash to be generated from operations, if any, will be sufficient to finance our operations for the foreseeable future. However, if we fail to generate adequate cash flows from operations in the future, due to an unexpected decline in our net revenues, or due to increased cash expenditures in excess of the net revenues generated, then our cash balances may not be sufficient to fund our continuing operations without obtaining additional debt or equity. There are no assurances that sufficient funding from external sources will be available to us on acceptable terms, if at all. For instance, we may have increased cash expenditures relating to the defense and resolution of the civil litigation matters.

Off-Balance Sheet Arrangements

We are not involved in any off-balance sheet arrangements that have or are reasonably likely to have a material current or future impact on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures, or capital resources.

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

Our management team, under the supervision and with the participation of our principal executive officer and our principal financial officer, evaluated the effectiveness of the design and operation of our disclosure controls and procedures as such term is defined under Rule 13a-15(e) promulgated under the Exchange Act, as of the last day of the fiscal period covered by this report, March 31, 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 March 31, 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 March 31, 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

SEC Investigations

Of the Company

Of Former Officers

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.

Medical Transcriptionist Litigation

Hoffmann Putative Class Action

Force Putative Class Action

Myers Putative Class Action

The allegations contained in the Myers case are substantially similar to those contained in the Hoffmann and Force putative class actions and, as detailed above, the three actions were consolidated.

On or about April 21, 2008, the parties reached an agreement in principle to settle all claims on behalf of a class of medical transcriptionists paid by the line for the period from November 29, 1998 through August 11, 2008 in exchange for payment of $1.5 million plus certain injunctive relief. The parties executed a final settlement agreement, and the court preliminarily approved the settlement on November 7, 2008. On December 23, 2008, the Court entered a further order preliminarily approving the settlement and modifying the notice schedule as agreed to by the parties. Notice was mailed to the settlement class, and summary notice was published. The deadlines to object to or request exclusion from the settlement class have passed, and the Court issued a final judgment and order of dismissal with prejudice on March 31, 2009. Neither we, nor any other party, has admitted or will admit liability or any wrongdoing in connection with the settlement.

Shareholder Litigation

Kahn Putative Class Action

On January 22, 2008, MedQuist shareholder Alan R. Kahn filed a shareholder putative class action lawsuit against us, Philips and four of our former non-independent directors, Clement Revetti, Jr., Stephen H. Rusckowski, Gregory M. Sebasky and Scott Weisenhoff. The action, entitled Alan R. Kahn v. Stephen H. Rusckowski, et al., Docket No. BUR-C-000007-08,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 the 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.

Reseller Arbitration Demand

Anthurium Patent Litigation

Other Matters

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

There have been no material changes to the risks to our business described in our Annual Report on Form 10-K for the year ended December 31, 2008 filed with the SEC on March 11, 2009.

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

None.

Item 3. Defaults Upon Senior Securities

None.

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

None.

Item 5. Other Information

None.

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: May 7, 2009	/s/ Peter Masanotti
	Peter Masanotti
	President and Chief Executive Officer (Principal Executive Officer)

Date: May 7, 2009	/s/ James Brennan
	James Brennan Controller and Vice-President
	(Principal Accounting Officer)

Exhibit Index


No.		Description

31.1		Certification of Chief Executive Officer required by Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

31.2		Certification of Chief Financial Officer required by Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

32.1		Certification of Chief Executive Officer pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

32.2		Certification of Chief Financial Officer pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002


(*)		Portions of this Exhibit were omitted and filed separately with the Secretary of the SEC pursuant to a request for confidential treatment that has been filed with the SEC.



By:	/s/ Dominick Golio
	Name:	Dominick Golio
	Title:	Chief Financial Officer

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents


	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		22

PART II. OTHER INFORMATION		23
Item 1. Legal Proceedings		23
Item 1A. Risk Factors		26
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds		26
Item 3. Defaults Upon Senior Securities		26
Item 4. Submission of Matters to a Vote of Security Holders		26
Item 5. Other Information		26
Item 6. Exhibits		27

Transcription Services Agreement

Certification of Chief Executive Officer

Certification of Chief Financial Officer

Certification of Chief Executive Officer

Certification of Chief Financial Officer


No.		Description

10.1⁽¹⁾		Amended and Restated Stock Option Agreement by and between Peter Masanotti and MedQuist Inc., dated March 2, 2009

10.1⁽²⁾		Transcription Services Subcontracting Agreement by and between MedQuist Inc. and CBay Systems & Services, Inc. dated March 31, 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 March 6, 2009

(2)		Incorporated by reference to our Current Report on Form 8-K filed with the SEC on April 6, 2009

	(a)		Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

	(b)		Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

	(c)		Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

	(d)		Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

	(a)		All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

	(b)		Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

	1.		I have reviewed this quarterly report on Form 10-Q of MedQuist Inc.;

	2.		Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

	3.		Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

	4.		The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:



	/s/ Peter Masanotti
	Peter Masanotti
	President and Chief Executive Officer