##### Table of Contents



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 1934For the quarterly period ended
    September 30, 2006.ORo

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
    SECURITIES EXCHANGE ACT OF 1934For the transition period
    from          to   Commission file number:
 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(Address of principal
    executive offices)

08054-4632(Zip Code)    (856) 206-4000
 (Registrants telephone
    number, including area code)
   o þ
  Rule 12b-2
 o þ o
  Rule 12b-2 o þ




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##### 



MEDQUIST
    INC.
  INDEX
  PagePART I.

FINANCIAL
    INFORMATION


1Item 1.

Financial Statements


1Item 2.

Managements
    Discussion and Analysis of Financial Condition and Results of
    Operations


19Item 3.

Quantitative and
    Qualitative Disclosures About Market Risk


29Item 4.

Controls and
    Procedures


29PART II.

OTHER
    INFORMATION


30Item 1.

Legal
    Proceedings


30Item 1A.

Risk
    Factors


33Item 2.

Unregistered Sales
    of Equity Securities and Use of Proceeds


41Item 3.

Defaults Upon
    Senior Securities


41Item 4.

Submission of
    Matters to a Vote of Security Holders


41Item 5.

Other
    Information


41Item 6.

Exhibits


41Certification of Chief Executive OfficerCertification of Chief Financial OfficerCertification of Chief Executive Officer, pursuant to Section 906Certification of Chief Financial Officer, pursuant to Section 906   i




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##### Table of Contents



PART I.  FINANCIAL
    INFORMATION  Item 1.
    Financial
    Statements  MedQuist
    Inc. and Subsidiaries
  Condensed
    Consolidated Statements of Operations
 (In thousands, except per share amounts)
    Unaudited
  Three Months Ended


Nine Months EndedSeptember 30,


September 30,2006


2005


2006


2005Net revenues

$
82,096


$
97,084


$
271,469


$
308,897Operating costs and expenses:Cost of revenues


67,929



75,353



214,656



238,629Selling, general and administrative


12,765



13,116



39,408



38,900Research and development


3,447



2,641



9,705



7,587Depreciation


3,149



4,341



9,043



13,059Amortization of intangible assets


1,363



2,031



4,474



6,182Cost of investigation and legal
    proceedings


(3,854
)


9,293



9,019



23,974Restructuring charges


1,234



630



2,939



630Total operating costs and expenses


86,033



107,405



289,244



328,961Operating loss


(3,937
)


(10,321
)


(17,775
)


(20,064
)Equity in income of affiliated
    company


180



137



738



404Interest income, net


1,977



1,623



5,675



4,027Loss before income taxes


(1,780
)


(8,561
)


(11,362
)


(15,633
)Income tax provision (benefit)


324



(3,839
)


1,629



(6,503
)Net loss

$
(2,104
)

$
(4,722
)

$
(12,991
)

$
(9,130
)Net loss per share:Basic

$
(0.06
)

$
(0.13
)

$
(0.35
)

$
(0.24
)Diluted

$
(0.06
)

$
(0.13
)

$
(0.35
)

$
(0.24
)Weighted average shares
    outstanding:Basic


37,484



37,484



37,484



37,484Diluted


37,484



37,484



37,484



37,484   The accompanying notes are an integral part of these
    condensed consolidated financial statements.
 1




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##### Table of Contents



MedQuist
    Inc. and Subsidiaries
    Condensed Consolidated Balance Sheets
    (In thousands)
    Unaudited
  September 30,


December 31,2006


2005AssetsCurrent assets:Cash and cash equivalents

$
154,678


$
178,271Accounts receivable, net of
    allowance of $5,005 and $4,389, respectively


57,627



71,761Income tax receivable


20,140



21,708Deferred income taxes


616



2,385Other current assets


17,131



9,973Total current assets


250,192



284,098Property and equipment, net


21,899



23,961Goodwill


124,428



123,849Other intangible assets, net


46,835



51,278Deferred income taxes


3,092



2,756Other assets


6,859



7,249Total assets

$
453,305


$
493,191Liabilities and
    Shareholders EquityCurrent liabilities:Accounts payable

$
11,932


$
10,046Accrued expenses


27,662



37,401Accrued compensation


17,087



21,073Customer accommodation and
    quantification


32,125



46,878Deferred revenue


15,863



18,039Total current liabilities


104,669



133,437Deferred income tax liability


17,582



15,482Other non-current liabilities


614



3,052Commitments and contingenciesShareholders equity:Common stock  no par
    value; authorized 60,000 shares; 37,484 and
    37,484 shares issued and outstanding, respectively


234,549



232,963Retained earnings


91,644



104,635Deferred compensation


332



332Accumulated other comprehensive
    income


3,915



3,290Total shareholders equity


330,440



341,220Total liabilities and
    shareholders equity

$
453,305


$
493,191   The accompanying notes are an integral part of these
    condensed consolidated financial statements.
 2




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##### Table of Contents



MedQuist
    Inc. and Subsidiaries
    Condensed Consolidated Statements of Cash Flows
    (In thousands)
    Unaudited
  Nine Months EndedSeptember 30,2006


2005Operating activities:Net cash (used in) provided by
    operating activities

$
(16,328
)

$
9,909Investing activities:Purchase of property and equipment


(7,296
)


(7,189
)Capitalized software


(21
)


(37
)Net cash used in investing
    activities


(7,317
)


(7,226
)Financing activities:Repayment of debt






(25
)Net cash used in financing
    activities






(25
)Effect of exchange rate changes


52



(74
)Net (decrease) increase in cash
    and cash equivalents


(23,593
)


2,584Cash and cash
    equivalents  beginning of period


178,271



196,219Cash and cash
    equivalents  end of period

$
154,678


$
198,803Supplemental cash flow
    information:Cash (recovered) paid for income
    taxes

$
(3,465
)

$
596Accommodation payments made with
    credits

$
424


$
   The accompanying notes are an integral part of these
    condensed consolidated financial statements.
 3




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##### Table of Contents



MedQuist
    Inc. and Subsidiaries
    Notes to Condensed Consolidated Financial Statements
    (In thousands, except per share amounts)
    Unaudited
  1.
    Description
    of Business    2.
    Introductory
    Note  2003 Form 10-K.
       4




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MedQuist
    Inc. and Subsidiaries
    Notes to Condensed Consolidated Financial Statements
    (In thousands, except per share amounts)
    Unaudited
  and/or and/or and/or
      3.
    Basis of
    Presentation      4.
    Stock-Based
    Compensation  Share-Based Payment Accounting for Stock-Based Compensation
 5




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


Nine Months EndedSeptember 30,


September 30,2006


2006Selling, general and administrative

$
87


$
398Research and development


39



175Cost of revenues


313



1,018Total

$
439


$
1,591     Accounting for Stock Issued to Employees
    Three Months Ended


Nine Months EndedSeptember 30,


September 30,2005


2005Net loss

$
(4,722
)

$
(9,130
)Add: Stock-based employee
    compensation expense included in reported net loss






37Deduct: Total stock-based employee
    compensation expense determined under fair-value based method
    for all awards


(503
)


(1,622
)Pro forma net loss

$
(5,225
)

$
(10,715
)Basic net loss per share:As reported

$
(0.13
)

$
(0.24
)Pro forma

$
(0.14
)

$
(0.29
)Diluted net loss per share:As reported

$
(0.13
)

$
(0.24
)Pro forma

$
(0.14
)

$
(0.29
)    6




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##### Table of Contents



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

Number of


Intrinsic


ExerciseExercise Prices

Shares


Value


Price$ 2.71 - $10.00



34


$
212


$
5.39$10.01 - $20.00



123






$
15.59$20.01 - $70.00



423






$
46.59580


$
212       WeightedWeighted


AverageShares


Average


Remaining


AggregateSubject to


Exercise


Contractual


IntrinsicOptions


Price


Life in Years


ValueOutstanding, December 31, 2005


3,432


$
28.18Forefeited


(68
)

$
22.06Canceled


(1,127
)

$
21.39Outstanding, September 30,
    2006


2,237


$
31.78



4.2


$
275Exercisable, September 30,
    2006


2,011


$
32.82



4.1


$
275Options vested and expected to
    vest as of September 30, 2006


2,120


$
32.29



4.2


$
275    7




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##### Table of Contents



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


Options ExercisableWeighted Average


Weighted





WeightedRemaining


Average





AverageRange of

Number


Contractual Life


Exercise


Number


ExerciseExercise Prices

of Shares


(in years)


Price


of Shares


Price$ 2.71 - $10.00



46



2.6


$
6.00



46


$
6.00$10.01 - $20.00



590



4.8


$
16.62



463


$
16.40$20.01 - $30.00



876



4.5


$
26.78



777


$
26.47$30.01 - $40.00



199



3.2


$
32.39



199


$
32.39$40.01 - $70.00



526



3.3


$
59.21



526


$
59.212,237



4.2


$
31.78



2,011


$
32.82     5.
    Net Loss
    per Share      Three Months Ended September 30,

Nine Months Ended September 30,2006

2005

2006

2005Net loss

$
(2,104
)

$
(4,722
)

$
(12,991
)

$
(9,130
)Weighted average shares
    outstanding:Basic


37,484



37,484



37,484



37,484Diluted


37,484



37,484



37,484



37,484Net loss per share:Basic

$
(0.06
)

$
(0.13
)

$
(0.35
)

$
(0.24
)Diluted

$
(0.06
)

$
(0.13
)

$
(0.35
)

$
(0.24
)    8




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MedQuist
    Inc. and Subsidiaries
    Notes to Condensed Consolidated Financial Statements
    (In thousands, except per share amounts)
    Unaudited
    6.
    Customer
    Accommodation and Quantification          and/or
 9




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


Year EndedSeptember 30,


December 31,2006


2005Beginning balance

$
46,878


$
9,702Quantification






133Customer accommodation


9,744



57,678Payments and other adjustments


(24,073
)


(20,635
)Credits


(424
)


Ending balance

$
32,125


$
46,878   7.
    Cost of
    Investigation and Legal Proceedings    Three Months Ended


Nine Months EndedSeptember 30,


September 30,2006


2005


2006


2005Legal fees

$
3,327


$
5,800


$
11,552


$
15,132Other professional fees


805



2,668



3,642



6,111Nightingale and Associates, LLC
    (Nightingale) services


648



762



2,356



2,502Insurance claims


(8,702
)






(8,702
)


Other


68



63



171



229Total

$
(3,854
)

$
9,293


$
9,019


$
23,974    10




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##### Table of Contents



MedQuist
    Inc. and Subsidiaries
    Notes to Condensed Consolidated Financial Statements
    (In thousands, except per share amounts)
    Unaudited
  8.
    2005
    Restructuring Plan    Three Months Ended September 30, 2006Non-CancelableTotal


Leases


Severance


EquipmentBalance as of June 30, 2006

$
1,287


$
1,161


$
126


$
Additional charge


1,234



796



328



110Usage


(1,467
)


(1,105
)


(252
)


(110
)Balance as of September 30,
    2006

$
1,054


$
852


$
202


$
   Nine Months Ended September 30, 2006Non-CancelableTotal


Leases


Severance


EquipmentBalance as of December 31,
    2005

$
2,050


$
1,693


$
357


$
Additional charge


2,939



1,369



1,239



331Usage


(3,935
)


(2,210
)


(1,394
)


(331
)Balance as of September 30,
    2006

$
1,054


$
852


$
202


$
   Three and Nine Months Ended September 30, 2005Non-CancelableTotal


Leases


Severance


EquipmentInitial charge

$
630


$
544


$
86


$
Usage


(259
)


(173
)


(86
)


Balance as of September 30,
    2005

$
371


$
371


$



$
     9.
    Commitments
    and Contingencies  Governmental
    Investigations
     11




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##### Table of Contents



MedQuist
    Inc. and Subsidiaries
    Notes to Condensed Consolidated Financial Statements
    (In thousands, except per share amounts)
    Unaudited
    and/or
  Shareholder
    Securities Litigation
  William
    Steiner v. MedQuist, Inc., et al. No. 1:04-cv-05487-FLW Rule 10b-5,
  Rule 10b-5
  Customer
    Litigation
  No. CV-04-7520-TJH-VBKx,
 12




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##### Table of Contents



MedQuist
    Inc. and Subsidiaries
    Notes to Condensed Consolidated Financial Statements
    (In thousands, except per share amounts)
    Unaudited
         13




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##### Table of Contents



MedQuist
    Inc. and Subsidiaries
    Notes to Condensed Consolidated Financial Statements
    (In thousands, except per share amounts)
    Unaudited
    Medical
    Transcriptionist Litigation
  Hoffmann
    Putative Class Action
  No. 1:04-CV-3452,
  Force
    Putative Class Action
  No. 05-cv-2608-WSD,
  Myers
    Putative Class Action
  No. 05-cv-4608
   14




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##### Table of Contents



MedQuist
    Inc. and Subsidiaries
    Notes to Condensed Consolidated Financial Statements
    (In thousands, except per share amounts)
    Unaudited
    Shareholder
    Derivative Litigation
          Other
    Matters
       15




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##### Table of Contents



MedQuist
    Inc. and Subsidiaries
    Notes to Condensed Consolidated Financial Statements
    (In thousands, except per share amounts)
    Unaudited
  10.
    Related
    Party Transactions      Licensing
    Agreement
          OEM
    Supply Agreement
  and/or
       16




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##### Table of Contents



MedQuist
    Inc. and Subsidiaries
    Notes to Condensed Consolidated Financial Statements
    (In thousands, except per share amounts)
    Unaudited
      Equipment
    Sales
    Insurance
    Coverage through Philips
    Purchasing
    Agreements
          Three Months Ended


Nine Months EndedSeptember 30,


September 30,2006


2005


2006


2005PSRS licensing

$
718


$
315


$
1,843


$
797PSRS consulting










3



161OEM agreement


383



197



928



738Dictation equipment


129



209



659



977Insurance


843



239



1,289



717PENAC






10



20



44Other










42



248Total

$
2,073


$
970


$
4,784


$
3,682    17




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##### Table of Contents



MedQuist
    Inc. and Subsidiaries
    Notes to Condensed Consolidated Financial Statements
    (In thousands, except per share amounts)
    Unaudited
       18




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##### Table of Contents



Item 2.
    Managements
    Discussion and Analysis of Financial Condition and Results of
    Operations  This Quarterly Report on
    Form 10-Q,
    including the following Managements Discussion and
    Analysis of Financial Condition and Results of Operations,
    contains forward-looking statements within the meaning of
    Section 21E of the Securities Exchange Act of 1934, as
    amended, and the Private Securities Litigation Reform Act of
    1995, that involve a number of risks and uncertainties. Such
    statements are based on current expectations of future events
    that involve a number of risks and uncertainties that may cause
    the actual events to differ materially from those discussed
    herein. In addition, such forward-looking statements are
    necessarily dependent upon assumptions, estimates and dates that
    may be incorrect or imprecise and involve known and unknown
    risks and other factors. Accordingly, any forward-looking
    statements included herein do not purport to be predictions of
    future events or circumstances and may not be realized.
    Forward-looking statements can be identified by, among other
    things, the use of forward-looking terminology such as
    believes, expects, may,
    could, will, should,
    seeks, pro forma, potential,
    anticipates, predicts,
    plans, estimates, or
    intends, or the negative of any thereof, or other
    variations thereon or comparable terminology, or by discussions
    of strategy or intentions. Given these uncertainties, readers
    are cautioned not to place undue reliance on such
    forward-looking statements. Forward-looking statements should be
    considered in light of various important factors, including
    those set forth under the caption Risk Factors in
    this
    Form 10-Q.
    All forward-looking statements, and reasons why results may
    differ, that are included in this report are made as of the date
    of this report, and except as required by law, we disclaim any
    obligations to update any such factors or to publicly announce
    the results of any revisions to any of the forward-looking
    statements contained herein or reasons why results might differ
    to reflect future events or developments.
  Executive
    Overview
        tm
   19




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##### Table of Contents



Form 10-K
      
    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. 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.
    There have been 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.      
    reduction in overhead and other administrative costs;
    improvement in the quality and speed of delivery of transcribed
    medical reports;
    access to leading technologies, such as speech recognition
    technology, without any development and investment risk;
    expertise in implementing and managing a medical transcription
    system tailored to the providers specific requirements;
    access to skilled MTs; and
    support for compliance with governmental and industry mandated
    privacy and security requirements and electronic health record
    initiatives.   20




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##### Table of Contents




    revenues;
    operating income;
    net income per share;
    net cash provided by operating activities; and
    days sales outstanding.    Critical
    Accounting Policies, Judgments and Estimates
    Form 10-K Form 10-K
  Basis
    of Presentation
  Sources
    of Revenues
    Form 10-K
  Cost of
    Revenues
   21




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Selling,
    General and Administrative (SG&A)
    Research
    and Development (R&D)
    Depreciation
    and amortization
    Cost of
    investigation and legal proceedings
   22




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##### Table of Contents



Comparison
    of Three Months Ended September 30, 2006 and
    2005
  Three Months Ended September 30,2006


2005% of Net





% of NetAmount


Revenues


Amount


Revenues


$ Change


% Change($ in thousands)Net revenues

$
82,096



100.0
%

$
97,084



100.0
%


(14,988
)

$
(15.4
)%Operating costs and expenses:Cost of revenues


67,929



82.7
%


75,353



77.6
%


(7,424
)


(9.9
)%Selling, general and administrative


12,765



15.5
%


13,116



13.5
%


(351
)


(2.7
)%Research and development


3,447



4.2
%


2,641



2.7
%


806



30.5
%Depreciation


3,149



3.8
%


4,341



4.5
%


(1,192
)


(27.5
)%Amortization of intangible assets


1,363



1.7
%


2,031



2.1
%


(668
)


(32.9
)%Cost of investigation and legal
    proceedings


(3,854
)


(4.7
)%


9,293



9.6
%


(13,147
)


(141.5
)%Restructuring charges


1,234



1.5
%


630



0.6
%


604



95.9
%Total operating costs and expenses


(86,033
)


104.8
%


107,405



110.6
%


(21,372
)


(19.9
)%Operating loss


(3,937
)


(4.8
)%


(10,321
)


(10.6
)%


6,384



(61.9
)%Equity in income of affiliated
    company


180



0.2
%


137



0.1
%


43



31.4
%Interest income, net


1,977



2.4
%


1,623



1.7
%


354



21.8
%Loss before income taxes


(1,780
)


(2.2
)%


(8,561
)


(8.8
)%


6,781



(79.2
)%Income tax expense (benefit)


324



0.4
%


(3,839
)


(4.0
)%


4,163



(108.4
)%Net loss

$
(2,104
)


(2.6
)%

$
(4,722
)


(4.9
)%

$
2,618



(55.4
)%   Net
    revenues
    
    reduced service revenues of $12.1 million resulting
    primarily from lower pricing to both new and existing customers
    and lower medical transcription volume of $7.8 million and
    a higher charge for the customer accommodation program in the
    2006 period ($8.5 million) compared to the 2005 period
    ($4.2 million). We believe the reduction in volume was the
    result primarily of customer losses to other outsourced medical
    transcription providers due to, among other things, price
    competition and our requirement that our medical transcription
    customers migrate from disparate and older technology platforms
    to our DEP; and
    reduced sales and implementations of our technology products of
    $2.9 million resulting primarily from the impact of certain
    technology products reaching the end of their life cycle.  Cost of
    revenues
    
    decreased telecommunications costs of $2.5 million
    associated with both the decrease in our service revenues and
    the transition of customers from our non-DEP medical
    transcription platforms, which required 23




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
    reduced medical transcription payroll costs of $2.2 million
    related directly to the decrease in our service revenues as well
    as our increased use of speech recognition technology, which
    reduces the payroll costs associated with the production of
    revenues;
    reduced technology product costs of $1.3 million related
    directly to the reduction in technology product revenues;
    reduced costs of $0.8 million resulting from facility
    closures; and
    reduced other costs of $0.6 million.    Selling,
    general and administrative
    Research
    and development
    Depreciation
    Amortization
   24




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Cost of
    investigation and legal proceedings
    Restructuring
    charges
    Interest
    income, net
    Income
    tax provision
   25




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##### Table of Contents



Comparison
    of Nine Months Ended September 30, 2006 and
    2005
  Nine Months Ended September 30,2006


2005% of Net





% of NetAmount


Revenues


Amount


Revenues


$ Change


% Change($ in thousands)Net revenues

$
271,469



100.0
%

$
308,897



100.0
%

$
(37,428
)


(12.1
)%Operating costs and expenses:Cost of revenues


214,656



79.1
%


238,629



77.3
%


(23,973
)


(10.0
)%Selling, general and administrative


39,408



14.5
%


38,900



12.6
%


508



1.3
%Research and development


9,705



3.6
%


7,587



2.5
%


2,118



27.9
%Depreciation


9,043



3.3
%


13,059



4.2
%


(4,016
)


(30.8
)%Amortization of intangible assets


4,474



1.6
%


6,182



2.0
%


(1,708
)


(27.6
)%Cost of investigation and legal
    proceedings


9,019



3.3
%


23,974



7.8
%


(14,955
)


(62.4
)%Restructuring charges


2,939



1.1
%


630



0.2
%


2,309



366.5
%Total operating costs and expenses


289,244



106.5
%


328,961



106.5
%


(39,717
)


(12.1
)%Operating loss


(17,775
)


(6.5
)%


(20,064
)


(6.5
)%


2,289



(11.4
)%Equity in income of affiliated
    company


738



0.3
%


404



0.1
%


334



82.7
%Interest income, net


5,675



2.1
%


4,027



1.3
%


1,648



40.9
%Loss before income taxes


(11,362
)


(4.2
)%


(15,633
)


(5.1
)%


4,271



(27.3
)%Income tax expense (benefit)


1,629



0.6
%


(6,503
)


(2.1
)%


8,132



(125.0
)%Net loss

$
(12,991
)


(4.8
)%

$
(9,130
)


(3.0
)%

$
(3,861
)


42.3
%   Net
    revenues
    
    reduced service revenues of $28.6 million resulting
    primarily from lower pricing to both new and existing customers
    and lower medical transcription volume of $24.5 million and
    from a higher charge for the customer accommodation program in
    the 2006 period ($9.8 million) compared to the 2005 period
    ($5.7 million). We believe the reduction in volume was the
    result primarily of customer losses to other outsourced medical
    transcription providers due to, among other things, price
    competition and our requirement that our medical transcription
    customers migrate from disparate and older technology platforms
    to our DEP; and
    reduced sales and implementations of our technology products of
    $8.8 million resulting primarily from the impact of certain
    technology products reaching the end of their life cycle. 26




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##### Table of Contents



Cost of
    revenues
    
    reduced medical transcription payroll costs of $7.4 million
    related directly to the decrease in our service revenues as well
    as our increased use of speech recognition technology, which
    reduces the payroll costs associated with the production of
    revenues;
    decreased telecommunications costs of $6.9 million
    associated with both the decrease in our service revenues and
    the transition of customers from our non-DEP medical
    transcription platforms, which required MTs to access dictation
    using traditional phone lines, to our DEP, which allows MTs to
    access dictation through the internet;
    reduced all other costs of $4.1 million related primarily
    to non-MT payroll;
    reduced costs of $3.0 million resulting from facility
    closures; and
    reduced technology product costs of $2.6 million related
    directly to the reduction in our technology product revenues.    Selling,
    general and administrative
    Research
    and development
    Depreciation
   27




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##### Table of Contents



Amortization
    Cost of
    investigation and legal proceedings
    Restructuring
    charges
    Interest
    income, net
    Income
    tax provision
    Liquidity
    and Capital Resources
   28




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##### Table of Contents




    the SEC, DOJ and DOL investigations and proceedings; and
    the defense and resolution of the civil litigation matters.  Off-Balance
    Sheet Arrangements
    Item 3.
    Quantitative
    and Qualitative Disclosures About Market Risk    Item 4.
    Controls
    and Procedures  Evaluation
    of Disclosure Controls and Procedures
  Rule 13a-15(e) Form 10-K Form 10-K
 29




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##### Table of Contents



Changes
    in Internal Control Over Financial Reporting
    
    Engaged a third party to perform an inventory of fixed assets in
    the field.    PART II.
    OTHER INFORMATION
  Item 1.
    Legal
    Proceedings  Governmental
    Investigations
        and/or
  Shareholder
    Securities Litigation
  William
    Steiner v. MedQuist, Inc., et al. No. 1:04-cv-05487-FLW Rule 10b-5,
  Rule 10b-5
 30




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##### Table of Contents



Customer
    Litigation
  No. CV-04-7520-TJH-VBKx,
       31




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##### Table of Contents



Medical
    Transcriptionist Litigation
  Hoffmann
    Putative Class Action
  No. 1:04-CV-3452,
  Force
    Putative Class Action
  No. 05-cv-2608-WSD,
  Myers
    Putative Class Action
  No. 05-cv-4608
 32




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##### Table of Contents



Shareholder
    Derivative Litigation
      Item 1A.
    Risk
    Factors  CAUTIONARY
    STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
    
    each of the factors discussed in this Part II,
    Item 1A, Risk Factors as well as risks discussed elsewhere
    in this report;
    each of the matters discussed in Part II, Item 1,
    Legal Proceedings;
    difficulties relating to our significant management turnover; 33




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##### Table of Contents




    our ability to recruit and retain qualified medical MTs and
    other employees;
    the impact of our new services and products on the demand for
    our existing services and products;
    our current dependence on medical transcription for
    substantially all of our business;
    our ability to become current in our periodic reporting
    obligations under the Exchange Act;
    our ability to expand our customer base;
    changes in law, including, without limitation, the impact Health
    Insurance Portability and Accountability Act of 1996 (HIPAA)
    will have on our business;
    infringement on the proprietary rights of others;
    our ability to diversify into other businesses;
    the results of our review of strategic alternatives;
    our ability to effectively integrate newly-acquired operations;
    competitive pricing pressures in the medical transcription
    industry and our response to those pressures; and
    general conditions in the economy and capital markets.      We are
    subject to ongoing investigations, which could require us to pay
    substantial fines or other penalties or subject us to sanctions
    and we cannot predict the timing of developments in these
    matters.
       34




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##### Table of Contents



and/or and/or
  Several
    lawsuits have been filed against us involving our billing
    practices and other related matters and the outcome of these
    lawsuits may have a material adverse effect on our business,
    financial condition, results of operations and cash
    flows.
  and/or
  The
    continuing time, effort, and expense relating to the allegations
    raised regarding our past billing practices, our efforts to
    become current in our SEC filings and the development and
    implementation of improved internal controls and procedures may
    have an adverse effect on our business.
    Our
    ability to expand our business and properly service our
    customers depends on our ability to effectively manage our
    domestic production capacity, including our ability to recruit,
    train and retain qualified MTs and maintain high standards of
    quality service in our operations, which we may not be able to
    do.
   35




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##### Table of Contents



We have
    experienced significant management turnover.
    We are
    not current in our periodic reporting obligations under the
    Exchange Act.
  Forms 10-Q
  
    our ineligibility to use certain short-form registration
    statements under the Securities Act, such as
    Forms S-3
    and S-8,
    until we have filed all reports required under the Exchange Act
    for a continuous period of 12 months; and
    the unavailability of Rule 144 for holders of outstanding
    restricted or control securities until we have filed all reports
    required under the Exchange Act for a continuous period of
    12 months.    We have
    had material weaknesses in our internal control over financial
    reporting and cannot provide assurance that additional material
    weaknesses will not be identified in the future. Our failure to
    effectively maintain our internal control over financial
    reporting could result in material misstatements in our
    financial statements which could require us to restate financial
    statements, cause us to fail to meet our reporting obligations,
    cause investors to lose confidence in our reported financial
    information or have a negative affect on our stock
    price.
  Form 10-K
    We have
    not complied with Section 404 of the Sarbanes-Oxley Act of
    2002 (SOX) for our fiscal year ended December 31,
    2004.
   36




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##### Table of Contents



Form 10-K. Form 10-K
  Forms 10-K 10-Q.
  Form 10-K Form 10-K. Form 10-K
  Current
    and prospective investors, customers and employees may react
    adversely to the allegations concerning our billing practices
    and our inability to file in a timely manner all of our SEC
    filings.
    We
    compete with many others in the market for medical transcription
    services which may result in lower prices for our services,
    reduced operating margins and an inability to maintain or
    increase our market share and expand our service
    offerings.
   37




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##### Table of Contents



We are
    reviewing strategic alternatives which could impact our
    operating results, our stock price and our business.
    
    the review of strategic alternatives may disrupt our operations,
    affect morale, distract management and result in the loss of
    employees, vendors or customers, which could have a material
    adverse effect on our operating results and our business;
    the process of reviewing strategic alternatives may be more time
    consuming and expensive than we currently anticipate; and
    we may not be able to identify strategic alternatives that are
    worth pursuing.  We may
    pursue future transactions which could require us to incur debt
    and assume contingent liabilities and expenses, and we may not
    be able to effectively integrate new operations.
     38




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##### Table of Contents



Our
    success will depend on our ability to adopt and integrate new
    technology into our DEP, to improve our production capabilities
    and expand the breadth of our service offerings, as well as our
    ability to address any unanticipated problems with our
    information technology systems, which we may not be able to do
    quickly, or at all.
    Due to
    the critical nature of medical transcription to our
    customers operations, potential customers may be reluctant
    to outsource or change service providers as a result of the cost
    and potential for disruption in services, which may inhibit our
    ability to attract new customers.
    If our
    intellectual property is not adequately protected, we may lose
    our market share to our competitors and be unable to operate our
    business profitably.
    We are
    dependent on third party speech recognition software
    incorporated in certain of our technologies, and impaired
    relations with such third party or the inability to enhance such
    third party software over time could harm our
    business.
     39




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##### Table of Contents



If we
    fail to comply with extensive contractual obligations and
    applicable laws and government regulations governing the
    handling of patient identifiable medical information, including
    those imposed on our customers in connection with HIPAA, we
    could suffer material losses or be negatively impacted as a
    result of our customers being subject to material penalties and
    liabilities.
    Proposed
    legislation and possible negative publicity may impede our
    ability to utilize global service capabilities.
    Philips
    owns approximately 69.6% of our outstanding common stock, and
    its interests may conflict with the interests of our other
    shareholders.
   40




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##### Table of Contents



Our stock
    trades on the over-the-counter Pink Sheets market,
    which may decrease the liquidity of our common stock.
    Item 2.
    Unregistered
    Sales of Equity Securities and Use of Proceeds    Item 3.
    Defaults
    Upon Senior Securities    Item 4.
    Submission
    of Matters to a Vote of Security Holders    Item 5.
    Other
    Information   41




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##### Table of Contents



Item 6.
    Exhibits    No.

Description10
.1*(1)

Employment Agreement, dated as of
    August 10, 2006, between MedQuist Inc. and Linda Reino10
.2*(2)

Amendment to Engagement Letter,
    dated as of September 25, 2006 between MedQuist Inc. and
    Nightingale & Associates, LLC10
.3(3)

Confirmation of Lease Term
    regarding Mt. Laurel New Jersey Office Lease dated as of
    August 10, 200631
.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 200231
.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 200232
.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 200232
.2

Certification of Chief Financial
    Officer pursuant to 18 U.S.C. 1350, as adopted pursuant to
    Section 906 of the Sarbanes-Oxley Act of 2002     *
    
    Management contract or compensatory plan or arrangement.(1)
    
    Incorporated by reference to Exhibit 10.22 to our Annual
    Report on Form
    10-K for the
    year ended December 31, 2005 filed with the SEC on
    July 5, 2007.(2)
    
    Incorporated by reference to Exhibit 10.24.2 to our Annual
    Report on
    Form 10-K
    for the year ended December 31, 2005 filed with the SEC on
    July 5, 2007.(3)
    
    Incorporated by reference to Exhibit 10.34 to our Annual
    Report on Form
    10-K for the
    year ended December 31, 2005 filed with the SEC on
    July 5, 2007. 42




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##### Table of Contents



SIGNATURES      /s/  Howard
    S. Hoffmann        Kathleen
    E. Donovan
       43




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##### Table of Contents



Exhibit Index
  No.

Description31
.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 200231
.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 200232
.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 200232
.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  44