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Article by DailyStocks_admin    (07-08-08 07:07 AM)

Filed with the SEC from June 26 to July 2:

MedQuist (MEDQ)
Newcastle Partners sued Philips Electronics (PHG), CBay Systems Holdings (CBAY), and MedQuist's former and current directors in connection with a proposed sale of Philips' stock in MedQuist to CBay. Newcastle alleges that MedQuist's directors breached their fiduciary duty to MedQuist's minority shareholders by facilitating a private sale of the stock. Newcastle wants a court to enjoin the transaction. Newcastle Partners has a 7.1% stake in MedQuist.

BUSINESS OVERVIEW

General
MedQuist is the largest Medical Transcription Service Organization (MTSO) in the world, and a leader in technology enabled clinical documentation workflow. We service health systems, hospitals and large group medical practices throughout the U.S., and we employ approximately 6,000 skilled medical transcriptionists (MTs), making us the largest employer of MTs in the U.S. We believe our services and enterprise technology solutions — including mobile voice capture devices, speech recognition technologies, Web-based workflow platforms, and global network of MTs and editors — enable healthcare facilities to improve patient care, increase physician satisfaction, and lower operational costs.
We perform a substantial majority of our medical transcription services utilizing the DocQment tm Enterprise Platform (DEP), our proprietary, web-based dictation and medical transcription management system. Our proprietary technologies enable our customers to efficiently manage the clinical documentation workflow.

The clinical documentation workflow begins when physicians or other medical professionals dictate findings and plans of care into one of several input devices, including standard telephones, handheld devices or PC-based dictation stations. Once dictated, the voice files securely route through our DEP to either an MT or our speech recognition engine for conversion to text. The resulting draft report may then proceed to the editing and quality assurance process prior to being routed back to the physician or other medical professional for review, finalization, execution and incorporation into a patient’s medical record. Throughout this process, our DEP utilizes security measures that assist our customers with their compliance with privacy and security standards and regulations, including those adopted under the Health Insurance Portability and Accountability Act of 1996 (HIPAA), and the protection of the confidentiality of medical records. We also provide document retention services.
Industry Overview
As a provider of medical transcription technology and services, our revenues and growth are affected in part by certain trends in healthcare.

Increased Spending and Demographic Factors in Healthcare Industry
Spending for healthcare in the U.S. has grown rapidly over the past few decades. According to estimates published by the Centers for Medicare & Medicaid Services (CMS) Office of the Actuary, the healthcare sector is growing faster than the overall economy. Healthcare spending increased as a share of U.S. gross domestic product from 13.3% in 2000 to 16% in 2005, as growth in healthcare spending outpaced economy-wide growth.
In 2005, healthcare spending in the U.S. was approximately $2 trillion. CMS estimates that by 2016 healthcare spending will have increased to $4.1 trillion, which will represent 19.6% of the projected U.S. gross domestic product. Demographic factors contribute to long-term growth projections in healthcare spending. According to the U.S. Census Bureau’s 2005 interim projections, there were approximately 35 million Americans aged 65 or older. The number of Americans aged 65 or older is expected to increase to approximately 40 million by 2010 and approximately 70 million by 2030, or 20% of the U.S. population. We believe that the aging of the U.S. population and the continuing growth in healthcare spending will increase demand for our products and services. Older age groups receive proportionately greater numbers of procedures, medical tests and treatments that require clinical documentation. We believe that the high demand for medical transcription services will also be sustained by the need of providers, third-party payors, consumers, regulators and health information networks to share electronic health information.
Competitive Environment
The healthcare industry is increasingly choosing to outsource services such as medical transcription. The medical transcription industry itself is highly fragmented and difficult to size based on a general lack of public market data and analysis. As such, we estimate that the U.S. medical transcription market is approximately $7 billion on an annual basis, including both outsourced services and medical transcription performed internally by healthcare providers. We believe that the top 10 medical transcription outsource providers based on revenues, of which we are the largest, account for less than 15% of the industry including in-house operations.
Although we are the leading provider of medical transcription services in the U.S., we experience competition from local, regional, national and international businesses. We believe that there are hundreds of companies in the U.S. and India currently performing medical transcription services for the U.S. market. 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 that a substantial portion of the medical transcription market is serviced internally by MTs directly employed by the healthcare providers.
We believe the outsourced portion of the medical transcription services market will increase due in part to healthcare providers seeking the following:
• reduction in overhead and other administrative costs;

• improvement in the quality and speed of delivery of transcribed medical reports;

• access to leading technologies, such as speech recognition technology, without development and investment risk;

• expertise in implementing and managing a system tailored to the providers’ specific requirements;

• access to skilled MTs; and

• support for compliance with increasing governmental and industry mandated privacy and security requirements and electronic health record (EHR) initiatives.
Our competitive position in the market is characterized primarily by the following factors:
• We are the leading medical transcription provider in the U.S., with a strong customer base, the largest pool of MTs and leading technologies capable of handling large volumes and complex workflows . As the largest medical transcription provider in the U.S., we are recognized as the leading brand in the industry. We have a well-established customer base, comprised of hundreds of health systems, hospitals and large group medical practices located throughout the U.S. We have an integrated, flexible and scalable technology platform that can be tailored to meet our customers’ needs. We are the largest employer of MTs and have the most widely deployed technology platform. As health systems, hospitals and large group medical practices increasingly seek to outsource their medical transcription and other clinical document workflow needs, we have the resources to quickly and efficiently provide our customers with comprehensive, scalable solutions.

• We offer a comprehensive array of products and services. We offer a comprehensive array of products and services for dictation, medical transcription, speech recognition and electronic signature through a combination of remote and on-premise solutions. These solutions are designed to maximize the efficiency, accuracy and security of our customers’ documentation and coding processes while enhancing their patient care, accelerating their revenue cycle and lowering their costs.

• We have a strong financial profile. We continue to maintain a substantial cash balance and have no debt.

• We continue to face competition from MTSOs providing low cost services. 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 causing some of our customers to switch to these providers, as well as resulting in a reduction in the prices we can charge our customers for our services.
Business Strategy
We intend to maintain our position as the leading provider of medical transcription technology and services while transforming into a leading provider of complete clinical documentation workflow solutions. We plan to achieve this objective through the following strategies:
Retain and Expand Customer Relationships. We constantly seek to improve turnaround time, medical transcription quality and customer communications. We believe that advances in these areas improve retention of existing customers and increase our ability to secure new customers. We also have a strong, experienced sales team that focuses on customer executive level decision-makers to enhance sales opportunities for new and existing customers.
Enhance Profitability. We continue to identify ways to maximize the efficiencies of the organization through the following initiatives:
• expand our use of speech recognition which should increase our productivity;

• realign our non-production workforce to match our current operational needs; and

• reorganize our production workforce to optimize workflow.
Leveraging our DEP. For medical transcription services that we perform on our platform, we completed in 2007 the migration of our outsourced medical transcription customers from disparate and older technology platforms to our DEP. We believe that the combination of standardization, advanced functionality and transparency with respect to service metrics provided by this platform will significantly increase our customers’ satisfaction and retention. Our commitment to our DEP allows us to accelerate the rate at which we can offer new functionalities to our customers. In addition, we currently offer and plan to expand the offering of our DEP to healthcare providers and other companies in the medical transcription industry for use as their medical dictation and transcription platform.
Expansion Into New Markets. We believe our breadth of products and services positions us to bridge the gap between traditional medical transcription and the EHR. The U.S. government has developed plans that call for all Americans to have an EHR by 2014.
We intend to leverage our market leading position and proprietary technologies to provide comprehensive solutions to our customers related to the management of health records. Historically, we have provided a combination of traditional medical transcription services, stand-alone products and other professional services to healthcare providers. We anticipate aggregating these existing services and products and new services and products into a more comprehensive clinical documentation workflow solution.
Exploration of Strategic Alternatives. In July 2007, we announced that, at the direction of our board of directors, we had engaged Bear, Stearns & Co. Inc. as our financial advisor to advise us and our board of directors on our strategic alternatives. On November 2, 2007, Koninklijke Philips Electronics N.V. (Philips), our majority shareholder, announced its intention to proceed with the sale of its approximate 69.6% ownership interest in us if a satisfactory price and other acceptable terms can be realized. On this same date and in light of Philips’ announcement, we announced that our board of directors, in connection with its previously disclosed review of strategic alternatives, is evaluating whether a sale of MedQuist is in the best interest of MedQuist and our shareholders. While such evaluation is continuing, there is no assurance that any sale transaction will occur as a result of such review.
Customer Base
We have a large and prestigious customer base. We believe that over 30% of non-federal acute care U.S. hospitals use at least one of our products or services. Additionally, we have the largest customer base of any medical transcription company in the U.S., currently serving over 1,500 hospital systems, clinics and large physician practices, including approximately 40% of hospitals with more than 500 licensed beds. We believe we are the medical transcription company of choice for large, complex hospitals and health systems in the U.S. due to our size, scale and scope. We provide services to entire healthcare systems as well as discrete departments within hospitals, such as health information management, emergency, radiology, pathology and cardiology departments and all types of clinic settings. None of our customers accounted for more than 10% of our annual net revenues in 2007.

Products and Services
For the years ended December 31, 2007, 2006 and 2005, approximately 83.3%, 83.8% and 79.5%, respectively, of our net revenues were derived from our medical transcription technology and services. In addition, we also derive net revenues from, among other things, maintenance services, our front-end speech recognition solution, SpeechQ for Radiology tm , and our enterprise digital dictation management system, DocQment Ovation.
Medical Transcription Services
We provide health systems, hospitals and large group medical practices with comprehensive solutions to meet their medical transcription needs. As the largest medical transcription services provider, we employ approximately 6,000 skilled MTs. This scale allows us to continually offer our customers effective, standardized medical transcription services that meet organization-wide or departmental needs. We perform the vast majority of our medical transcription services utilizing our DEP. For our medical transcription customers that do not use our DEP, we provide medical transcription services directly into their platform. In addition, we also service a specialized area of the medical transcription market — specifically, radiology — whereby we retrieve voice files from, and transcribe directly into, customer-hosted transcription platforms.
In the clinical documentation workflow, we provide, in addition to medical transcription technology and services, digital dictation, speech recognition and electronic signature technologies.

Features and benefits of our DEP include the following:
Security and Scalability
• supports all standards required by HIPAA and other applicable laws and regulations

• utilizes secure data centers with 24/7 system monitoring and maximum uptime

• satisfies increased clinical document workflow demands through seamless scalability
Cost Effectiveness
• provides one interface for health information systems

• eliminates the costs and challenges of supporting multiple dictation and medical transcription systems for individual hospitals and departments

• allows for the centralized maintenance of all system hardware and software at our data centers

• allows MTs and editors to work remotely

• eliminates traditional phone charges and other overhead costs associated with home-based medical transcription
Workflow
• allows viewing of medical reports on a real-time basis from multiple locations through a single and secure login, password and company identification

• increases the level of our customers’ management control over medical transcription workflow across healthcare enterprises

• reduces the amount of time reports spend in queue as well as MT downtime

• takes transcribed text and matches it to user pre-defined templates using automatic post-transcription formatting
Auditing and Reporting
• facilitates transparency in the billing process with detailed character count logs for every processed document

• provides audit trails with detailed information regarding access to patient health information

• offers quality and turnaround time reporting for tracking of service metrics
Maintenance Services
We provide onsite maintenance, remote “break-fix” services, and application, hardware and software technical support for our products.
SpeechQ for Radiology
SpeechQ for Radiology is a flexible front-end speech recognition software application. It allows radiologists to dictate, edit and sign their reports in a single session or send them to an editor following dictation. SpeechQ for Radiology continuously learns from changes to a specific radiologist’s dictation made by either the radiologist or an editor, increasing the speech recognition accuracy for such radiologist with every edit. Powered by the same Philips SpeechMagic tm speech engine used in our DEP, SpeechQ for Radiology is designed specifically for radiology and integrates with most radiology specific information systems providing a workflow that maximizes radiologists’ efficiency and significantly improves report turnaround time.
DocQment Ovation
DocQment Ovation is our latest web-based, enterprise digital voice capture and transport solution. DocQment Ovation creates opportunities to improve productivity by providing an enterprise view that allows medical transcription supervisors to easily manage MTs and voice files from a single dashboard instead of using multiple systems. DocQment Ovation was specifically engineered to be compatible with our previous generation dictation stations. An integral component of our growing technology portfolio, DocQment Ovation supports our end-to-end solution from dictation to billing. DocQment Ovation’s enterprise configuration options allow administrators to easily track work and share resources to get the right voice file to the right MTs at the right time.
Technological Capabilities
Research and Development
We continue to invest in our research and development capabilities to ensure we meet current and future customer requirements. Our proprietary software and hardware technologies support our medical transcription outsourced services. Our software capabilities enable us to operate a national service delivery model that includes nationwide multi-modal voice capture. Our expertise in the use of speech recognition enables us and our customers to achieve productivity gains and cost savings. We continue to work to enhance our speech recognition and editing technologies to achieve maximum productivity gains in the medical documentation process. Our DEP and technological expertise in the areas of work routing and work management support a nationwide, scalable model of medical transcription delivery. Our ability to focus on a single dictation and transcription management system, our DEP enables us to efficiently and effectively utilize our research and development resources.
We employ over 100 developers to conduct our research and development in five locations: Joplin, Missouri, Morgantown, West Virginia, Norcross, Georgia, Malvern, UK, and Hyderabad, India. Although we license a portion of our technology from third party vendors, a majority of our technological expertise resides in our development organization. Our development personnel have expertise across the breadth of our solutions including voice capture management, speech recognition and editing applications, medical transcription and electronic signature and distribution. All of our development teams follow the same rigorous development methodology which ensures repeatable, high quality and timely delivery of solutions.
Speech Recognition
A portion of our speech recognition technology is licensed from Philips Speech Recognition Systems GmbH (PSRS). We have integrated this technology into both SpeechQ for Radiology and our DEP which has provided us with productivity gains and streamlined workflows. In 2007 we significantly increased our use of automated speech recognition.
Sales and Marketing
We spend a significant portion of our sales and marketing resources on targeting healthcare facilities which are currently performing medical transcription in-house as well as those facilities that have already outsourced their medical transcription function, but are using a competitor.
In addition, we focus on retaining and expanding the business within our existing customer base. We use a direct sales force model of over 60 sales and account management associates throughout the U.S. This includes specialists for national accounts, technology and account management. In addition, we have an inside sales department that specializes in telesales and lead generation primarily for ancillary products to our existing customers including other medical transcription outsource companies.
To support our sales initiatives, we utilize various marketing programs to maintain and expand our brand. We promote our offerings regularly through:
• attending and sponsoring industry trade shows of national organizations such as the American Health Information Management Association, Healthcare Information and Management Systems Society, Association for Healthcare Documentation Integrity (formerly AAMT, American Association of Medical Transcription), Radiological Society of North America, and Society for Imaging Informatics in Medicine;

• advertising in industry focused print and electronic trade journals;

• demonstrating our thought leadership on industry topics and trends via webinars and participation in numerous state and regional trade show events; and

• hosting a national user group events for existing customers to exchange product and market information.
Service Delivery and Customer Support
We offer a wide range of customer support services through an expansive staff of customer-facing service personnel. The customer-facing relationship teams work with, and are supported by, our centrally managed customer service organization.
Centralized service delivery enhances workflow management, which we believe should result in improved levels of service and quality for our customers. This centralization coordinates the services of thousands of MTs on a nationwide level, facilitating superior capacity planning even when volume fluctuates. By applying streamlined processes and the highest standards nationwide, we are able to provide quick turnaround time and consistent quality documentation.
Our service and support organization is comprised of several smaller organizations, or teams, focused on delivering specific aspects of services. In addition to technical and product support, we offer implementation professional services, which provide our customers with complete implementation planning and services beginning with the initial scoping of system requirements through the customer acceptance phase of an implementation.

MANAGEMENT DISCUSSION FROM LATEST 10K

Executive Overview
We are the largest MTSO in the world, and a leader in technology enabled clinical documentation workflow. We service health systems, hospitals and large group medical practices throughout the U.S., and we employ approximately 6,000 skilled MTs, making us the largest employer of MTs in the U.S. In the clinical documentation workflow, we provide, in addition to medical transcription technology and services, digital dictation, speech recognition and electronic signature services.
We were incorporated in New Jersey in 1984 and reorganized in 1987 as a group of outpatient healthcare businesses affiliated with a non-profit healthcare provider. In May 1994, we acquired our first medical transcription business. Through the date of this report, we have acquired over 50 companies. By the end of 1995, we had divested all of our non-medical transcription businesses.
In July 2000, Philips completed a tender offer in which it acquired approximately 60% of our outstanding common stock. Subsequent to the completion of the tender offer, Philips increased its ownership position and currently owns approximately 69.6% of our common stock.
In 2001, we acquired Speech Machines, a company based in the United Kingdom, whose technology has since developed into our 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.
In July 2002, we acquired Lanier Healthcare, LLC (Lanier), which derived revenue largely from the sale and implementation of voice-capture and document management solutions and maintenance service of these products. In conjunction with the Lanier acquisition, we began operating in two segments: a Services segment, through which we provided our customers with medical transcription and coding reimbursement services, and a Solutions segment, which was comprised of the operations of Lanier. Effective January 1, 2005, we changed the way we review our financial performance and thus began operating in one segment for financial reporting purposes.

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 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. 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 can significantly reduce the length of time required to transcribe medical reports, in turn reducing the overall cost of medical transcription services.
Although we remain the leading provider of medical transcription services in the U.S., we experience competition from many local, regional and national businesses. The medical transcription industry is highly fragmented, and we believe there are hundreds of companies in the U.S. performing medical transcription services. There are currently two large service providers, one of which is us and the other of which is Spheris Inc., several mid-sized service providers with annual revenues of between $15 million and $100 million and hundreds of smaller, independent businesses with annual revenues of less than $15 million.
We believe the outsourced portion of the medical transcription services market will increase due in part to healthcare providers seeking the following:
• reduction in overhead and other administrative costs;

• improvement in the quality and speed of delivery of transcribed medical reports;

• access to leading technologies, such as speech recognition technology, without any development and investment risk;

• expertise in implementing and managing a medical transcription system tailored to the providers’ specific requirements;

• access to skilled MTs; and

• support for compliance with governmental and industry mandated privacy and security requirements and 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
Management’s Discussion and Analysis (MD&A) is based in part upon our consolidated financial statements which have been prepared in accordance with generally accepted accounting principles in the U.S. (GAAP). We believe there are several accounting policies that are critical to understanding our historical and future performance as these policies affect the reported amounts of revenues and other significant areas that involve management’s judgments and estimates. These critical accounting policies and estimates have been discussed with our audit committee.
The preparation of our consolidated financial statements requires us to make estimates and judgments that affect our reported amounts of assets, liabilities, expenses and related disclosure of contingent liabilities. On an ongoing basis, we evaluate these estimates and judgments. We base these estimates on historical experience and on various other assumptions that are believed to be reasonable at such time, 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. Actual results may ultimately differ from these estimates. A critical accounting estimate meets two criteria: (1) it requires assumptions about highly uncertain matters, and (2) there would be a material effect on the financial statements from either using a different, although reasonable, amount within the range of the estimate in the current period or from reasonably likely period-to-period changes in the estimate. While there are a number of accounting policies, methods and estimates affecting our consolidated financial statements as addressed in Note 2 to our consolidated financial statements, areas that are particularly significant and critical include:
Valuation of Long-Lived and Other Intangible Assets and Goodwill. In connection with acquisitions, we allocate portions of the purchase price to tangible and intangible assets, consisting of acquired technologies, customer relationships, tradenames and non-compete agreements based on independent appraisals received after each acquisition, with the remainder allocated to goodwill. We assess the realizability of goodwill and intangible assets with indefinite useful lives at least annually, or sooner if events or changes in circumstances indicate that the carrying amount may not be recoverable. After our annual impairment test was completed in the second quarter of 2005, we changed our annual goodwill impairment test date to the fourth quarter of each fiscal year. This change in the testing date for impairment was designed to align the testing with our normal business process for updating our strategic plan and forecasts which are finalized in the fourth quarter of each fiscal year. We have determined that the reporting unit level is our sole operating segment. The test for goodwill is a two-step process:
• First, we compare the carrying amount of our reporting unit, which is the book value of our entire company, to the fair value of our reporting unit. If the carrying amount of our reporting unit exceeds its fair value, we have to perform the second step of the process. If not, no further testing is needed.

• If the second part of the analysis is required, we allocate the fair value of our reporting unit to all assets and liabilities as if the reporting unit had been acquired in a business combination at the date of the impairment test. We then compare the implied fair value of our reporting unit’s goodwill to its carrying amount. If the carrying amount of our goodwill exceeds its fair value, we recognize an impairment loss in an amount equal to that excess.
We review our long-lived assets, including amortizable intangibles, for impairment when events indicate that their carrying amount may not be recoverable. When we determine that one or more impairment indicators are present for an asset, we compare the carrying amount of the asset to net future undiscounted cash flows that the asset is expected to generate. If the carrying amount of the asset is greater than the net future undiscounted cash flows that the asset is expected to generate, we compare the fair value to the book value of the asset. If the fair value is less than the book value, we recognize an impairment loss. The impairment loss is the excess of the carrying amount of the asset over its fair value.
Some of the events that we consider as impairment indicators for our long-lived assets, including goodwill, are:
• our net book value compared to our market capitalization;

• significant adverse economic and industry trends;

• significant decrease in the market value of the asset;

• the extent that we use an asset or changes in the manner that we use it;

• significant changes to the asset since we acquired it; and

• other changes in circumstances that potentially indicate all or a portion of our company will be sold.
Deferred income taxes. As of December 31, 2007, we had net deferred tax assets of $57.6 million prior to consideration of a valuation allowance. These deferred tax assets result primarily from expenses that have been recorded for book purposes but not yet recorded on tax returns and from net operating loss carry forwards. Deferred tax assets represent future tax benefits that we expect to be able to apply against future taxable income or that will result in future net operating losses that can be carried forward. Our ability to utilize the deferred tax assets is dependent upon our ability to generate future taxable income. To the extent that we believe it is more likely than not that all or a portion of the deferred tax asset will not be utilized, we record a valuation allowance against that asset. In making that determination we consider all positive and negative evidence and give stronger consideration to evidence that is objective in nature. Based on this analysis we determined that a valuation allowance would be provided against a portion of our deferred income tax assets in 2006 and 2007. No valuation allowance was established against deferred tax assets to the extent the asset could be benefited through the use of a net operating loss carry back or to the extent we have deferred tax liabilities as of the balance sheet date that will generate taxable income within the same period in which a deferred tax asset will reverse.
We will continue to evaluate the realizability of our deferred income tax assets in future periods and adjust the valuation allowance accordingly.
Commitments and contingencies. Other than an accrual of $7.5 million for the matter referenced under the caption “Customer Litigation” contained in Item 3, Legal Proceedings, as of December 31, 2007, we have not accrued for potential future settlements or adverse outcomes for the other items contained in Item 3, Legal Proceedings, since no matters were probable.
Revenue recognition. For the year ended December 31, 2007, approximately 83.3% of our net revenues were derived from our medical transcription technology and services. Medical transcription services revenues are recognized when there is persuasive evidence that an arrangement exists, the price is fixed or determinable, services are rendered and collectability is reasonably assured. These services are based on contracted rates. Medical transcription services revenues are net of estimates for customer credits. Historically, our estimates have been adequate. If actual results are higher or lower than our estimates, we would have to adjust our estimates and financial statements in future periods.
The remainder of our revenues is derived from the sale and implementation of voice-capture and document management products including software and implementation, training and maintenance services of these products. The application of the accounting guidelines requires judgment regarding the timing of the recognition of these revenues including: (i) whether a software arrangement includes multiple elements, and if so, whether vendor-specific objective evidence of fair value exists for those elements; (ii) whether customizations or modifications of the software are significant; and (iii) whether collection of the software fee is probable. Additionally, for certain contracts we recognize revenues using the percentage-of-completion method. Percentage-of-completion accounting involves estimates of the total costs to be incurred over the duration of the project.
Accounts receivable and allowance for doubtful accounts. Accounts receivable are recorded at the invoiced amount and do not bear interest. The carrying value of accounts receivable approximates fair value. The allowance for doubtful accounts is our best estimate of estimated losses resulting from the inability of our customers to make required payments and for service level credits offered to our customers. This allowance is used to state trade receivables at estimated net realizable value.
We estimate uncollectible amounts based upon our historical write-off experience, current customer receivable balances, aging of customer receivable balances, the customer’s financial condition and current economic conditions. Historically, these estimates have been adequate to cover our accounts receivable exposure.
We enter into medical transcription service arrangements which contain provisions for performance penalties in the event certain service levels, primarily related to turnaround time on transcribed reports, are not achieved. We reduce revenues for any performance penalties incurred and have included an estimate of such credits in our allowance for uncollectible accounts.
Product revenues for sales to end-user customers and resellers are recognized upon passage of title if all other revenue recognition criteria have been met. End-user customers generally do not have a right of return. We provide certain of our resellers and distributors with limited rights of return of our products. We reduce revenues for rights to return our product based upon our historical experience and have included an estimate of such credits in our allowance for uncollectible accounts.

Accounting for consideration given to a customer. In response to customers’ concerns regarding historical billing matters, we offered financial accommodations to certain of our customers. Consideration given by a vendor to a customer is presumed to be a reduction of the selling price of the vendor’s services. Therefore, $10.4 million and $57.7 million of the authorized accommodation amount for our customers was characterized as a reduction of revenues in 2006 and 2005, respectively.
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.
As a result of our individual accommodation offers made to certain of our customers, net revenues for the years ended December 31, 2006 and 2005 were reduced by $10.4 million and $57.7 million, respectively.
Net revenues from customers in the U.S. were $335.1 million, $353.5 million and $348.4 million for the years ended December 31, 2007, 2006 and 2005, respectively. Net revenues from customers outside the U.S. were $5.2 million, $4.6 million and $4.6 million for the years ended December 31, 2007, 2006 and 2005, respectively.
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 include legal fees incurred in connection with the SEC and DOJ investigations and proceedings and the defense of civil litigation matters described in Item 3, Legal Proceedings, litigation support consulting, and consulting services provided by Nightingale and Associates, LLC (Nightingale), net of insurance claims reimbursement. Howard Hoffmann serves as our non-employee President and Chief Executive Officer pursuant to the terms of an agreement between us and Nightingale. Our agreement with Nightingale also permits us to engage additional personnel employed by Nightingale to provide consulting services to us from time to time.
Shareholder Securities Litigation Settlement
Shareholder Securities Litigation Settlement represents the $7.75 million payment made pursuant to the memorandum of understanding and stipulation of settlement described under the caption “Shareholder Securities Litigation” in Item 3, Legal Proceedings.

Comparison of Years Ended December 31, 2007 and 2006

Net revenues
Net revenues decreased $17.7 million, or 5.0%, to $340.3 million for the year ended December 31, 2007 compared with $358.1 million for the year ended December 31, 2006. Excluding a charge of $10.4 million in 2006 related to our customer accommodation program, revenues declined $28.1 million. This decrease was attributable primarily to:
• a decline in service revenues of $25.3 million resulting primarily from lower medical transcription volume and lower pricing to both new and existing customers. 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 $2.4 million as technology products sold in 2007 had longer implementation and customer acceptance periods.
We continue to experience pricing pressures as our existing and prospective customers seek out opportunities to reduce costs, particularly through the utilization of offshore labor.
Cost of revenues
Cost of revenues decreased $19.4 million, or 6.9%, to $260.9 million for the year ended December 31, 2007 compared with $280.3 million for the year ended December 31, 2006. This decrease was attributable primarily to:
• reduced medical transcription payroll costs of $8.3 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 $3.8 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; and

• reduced other costs of $7.3 million resulting from headcount and facility reductions associated with restructuring actions taken to better align our overhead costs with our lower revenue levels.
As a percentage of net revenues, cost of revenues decreased to 76.7% for the year ended December 31, 2007 from 78.3% for the same period in 2006, as a result largely of actions taken to reduce fixed costs at a faster pace than the reduction of our net revenues.
Selling, general and administrative
SG&A expenses increased $8.6 million, or 16.0%, to $62.3 million for the year ended December 31, 2007 compared with $53.7 million for the year ended December 31, 2006. This increase was due primarily to $4.3 million in higher legal fees for matters unrelated to the cost of investigation and legal proceedings; the reassignment of Nightingale services in 2007 to focus on operational matters of $2.9 million; professional fees incurred related to the evaluation of strategic alternatives of $1.9 million; and an increase in audit fees of $0.6 million related to the audit of our consolidated financial statements and the audit of our internal control over financial reporting. These increases were offset by decreases in all other SG&A expenses of $1.1 million. SG&A expenses as a percentage of net revenues were 18.3% for the year ended December 31, 2007 compared with 15.0% for the same period in 2006.
Research and development
R&D expenses increased $0.5 million, or 3.6%, to $13.7 million for the year ended December 31, 2007 compared with $13.2 million for the year ended December 31, 2006. This increase was due primarily to an increase in fees paid to Philips for enhancements related to our Speech Recognition software. R&D expenses as a percentage of net revenues were 4.0% for the year ended December 31, 2007 compared with 3.7% for the same period in 2006.
Depreciation
Depreciation expense decreased $0.8 million, or 6.9%, to $11.0 million for the year ended December 31, 2007 compared with $11.8 million for the year ended December 31, 2006. This decrease was attributable primarily to fixed assets reaching the end of their depreciable period. Depreciation expense as a percentage of net revenues was 3.2% for the year ended December 31, 2007 compared with 3.3% for the same period in 2006.
Amortization
Amortization of intangible assets decreased $0.3 million, or 5.5%, to $5.5 million for the year ended December 31, 2007 compared with $5.8 million for the year ended December 31, 2006. Amortization of intangible assets as a percentage of net revenues was 1.6% for both periods.
Cost of investigation and legal proceedings, net
Cost of investigation and legal proceedings, net decreased $6.9 million to $6.1 million for the year ended December 31, 2007 compared with $13.0 million for the year ended December 31, 2006. This decrease was due primarily to the realization of $15.4 million of insurance claim reimbursements in 2007 compared with $9.4 million for the year ended December 31, 2006. In addition, for the year ended December 31, 2007, $2.9 million of costs were charged to SG&A related to Nightingale’s services due to Nightingale’s focus on operational matters.
Restructuring charges
During 2007, we recorded a restructuring charge of $2.8 million comprised of $2.4 million for severance obligations and $0.3 million for non-cancelable leases related to the closure of offices. During 2006, we recorded a restructuring charge of $3.4 million comprised of $1.7 million for non-cancelable leases related to the closure of offices, $0.3 million for the write-off of property and equipment and $1.4 million for severance obligations.

Interest income, net
Interest income, net reflects interest earned on cash and cash equivalent balances. Interest income, net increased $0.7 million, or 9.7%, to $8.4 million for the year ended December 31, 2007 compared with $7.6 million for the year ended December 31, 2006. This increase was attributable to higher interest rates earned in the 2007 period (5.0%) compared with the 2006 period (4.6%).
Income tax provision
The effective income tax rate for the year ended December 31, 2007 was 18.2% compared with an effective income tax rate of 15.7% for the year ended December 31, 2006. The difference in tax rates is related primarily to the decrease in the pre-tax loss from 2006 to 2007. After consideration of all evidence, both positive and negative, management concluded that it was more likely than not that a significant portion of the domestic deferred income tax assets would not be realized. In addition, various adjustments were recorded for the year ended December 31, 2007 including the reduction of the foreign valuation allowance and various adjustments related to state tax exposures.

MANAGEMENT DISCUSSION FOR LATEST QUARTER

Comparison of Three Months Ended March 31, 2008 and 2007

Net revenues
Net revenues decreased $5.3 million, or 6.0%, to $83.7 million for the three months ended March 31, 2008 compared with $89.1 million for the three months ended March 31, 2007. This decrease was attributable primarily to:
• reduced service revenues of $3.4 million resulting primarily from lower medical transcription volume. We believe the reduction in volume was the result primarily of customer losses to other outsourced medical transcription providers in the latter part of 2007; and

• reduced revenues from our technology products of $2.0 million due primarily to longer revenue recognition periods resulting from our contractual agreements.
We continue to experience pricing pressures as our existing and potential customers seek out opportunities to reduce costs, particularly through the utilization of technology and offshore labor.
Cost of revenues
Cost of revenues decreased $7.1 million, or 10.4%, to $61.3 million for the three months ended March 31, 2008 compared with $68.3 million for the three months ended March 31, 2007. This decrease was attributable primarily to:
• reduced medical transcription payroll costs of $2.6 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 $0.7 million related directly to the reduction in our technology product revenues; and

• reduced other costs of $3.8 million resulting from headcount reductions taken to better align our overhead costs with our lower revenues levels.
As a percentage of net revenues, cost of revenues decreased to 73.2% for the three months ended March 31, 2008 from 76.7% for the same period in 2007, as a result largely of actions taken to reduce fixed costs at a faster pace than net revenues.
Selling, general and administrative
SG&A expenses decreased $1.6 million, or 10.9%, to $13.1 million for the three months ended March 31, 2008 compared with $14.7 million for the three months ended March 31, 2007. This decrease was attributable primarily to a decrease in compensation expense of $1.0 million related to reductions in workforce; a decrease in audit fees of $0.8 million related to the audit of our consolidated financial statements and the audit of our internal control over financial reporting; and a decrease in all other SG&A costs of $1.1 million. These decreases were offset by an increase in professional fees incurred related to the evaluation of strategic alternatives of $0.8 million; and an increase in legal costs of $0.5 million due to higher legal fees for matters unrelated to the Review and Management’s Billing Assessment. SG&A expenses as a percentage of net revenues were 15.6% for the three months ended March 31, 2008 compared with 16.5% for the same period in 2007.
Research & development
R&D expenses increased $0.7 million, or 19.7%, to $4.1 million for the three months ended March 31, 2008 compared with $3.4 million for the three months ended March 31, 2007. This increase was due primarily to higher recruiting and staffing costs associated with additional investments in our industry leading DocQment tm Enterprise Platform technology of $0.4 million and higher miscellaneous expenses of $0.3 million. R&D expenses as a percentage of net revenues were 4.9% for the three months ended March 31, 2008 compared with 3.9% for the three months ended March 31, 2007.
Depreciation
Depreciation expense increased $0.4 million, or 15.3%, to $2.9 million for the three months ended March 31, 2008 compared with $2.5 million for the three months ended March 31, 2007. This increase was primarily the result of several assets being purchased in the latter part of 2007. Depreciation expense as a percentage of net revenues was 3.5% for the three months ended March 31, 2008 compared with 2.9% for the same period in 2007.
Cost of investigation and legal proceedings, net
Costs and expenses associated with the Review and Management’s Billing Assessment are being reported as cost of investigation and legal proceedings, net. These costs and expenses increased $4.7 million, or 267.5%, to $6.4 million for the three months ended March 31, 2008 compared with $1.7 million for the three months ended March 31, 2007. This increase in costs was primarily due to the recognition of $3.5 million of insurance claims in 2007 that did not occur in 2008; as well as a charge of $1.5 million recorded during the first quarter of 2008 for the proposed settlement of all claims related to the consolidated medical transcriptionist putative class action; offset by the reassignment of Nightingale services in 2007 to focus on operational matters of $0.2 million.
Restructuring charges
During the three months ended March 31, 2008, we did not record a restructuring charge compared with $0.3 million for the three months ended March 31, 2007. Restructuring charges were not recorded in 2008 because the majority of our actions were completed during 2007.
Interest income, net
Interest income, net reflects interest earned on cash and cash equivalent balances. Interest income, net decreased $0.8 million, or 38.7%, to $1.3 million for the three months ended March 31, 2008 compared with $2.1 million for the three months ended March 31, 2007. This decrease was attributable to lower weighted average interest rates earned in the 2008 period (3.3%) compared with the 2007 period (4.8%) combined with $17.3 million lower average cash balance for the three months ended March 31, 2008 compared with the same period in 2007 Income tax provision
The effective income tax rate for the three months ended March 31, 2008 was 19.6% compared with an effective income tax rate of 101.9% for the three months ended March 31, 2007. The rates consist primarily of provisions for the deferred tax liability related to the current year tax goodwill amortization which is indefinite in nature as well as the valuation allowance provided against a majority of U.S. deferred tax assets created in the quarter. The provisions also include state and foreign income taxes. The lower 2008 rate is due to a larger pretax loss in 2008 and the release of certain tax reserves associated with the expiration of a Statute of Limitations.
Liquidity and Capital Resources
As of March 31, 2008, we had net working capital of $131.3 million compared with $133.2 million as of December 31, 2007. Our principal source of liquidity was available cash on hand. Cash and cash equivalents decreased $8.9 million for the three months ended March 31, 2008 to $152.7 million as of March 31, 2007 from $161.6 million as of December 31, 2007. This decrease was driven primarily by cash used in operating activities of $6.4 million which included a net loss of $4.4 million, and other activity of $2.2 million. Cash used by investing activities included the purchase of property and equipment of $1.8 million and capitalized software of $0.6 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 SEC, DOJ and DOL investigations and proceedings; and

• the defense and resolution of the civil litigation matters.
Off-Balance Sheet Arrangements
We are not involved in any off-balance sheet arrangements that have or are reasonably likely to have a material current or future impact on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures, or capital resources.

CONF CALL

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