Form 10-Q

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)


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

For the quarterly period ended September 30, 2008


o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from ___________________ to ___________________.

COMMISSION FILE NUMBER: 333-132641

SPHERIS INC.

(Exact name of registrant as specified in its charter)


Delaware (State or other jurisdiction of		62-1805254 (I.R.S. Employer Identification No.)
incorporation or organization)

9009 Carothers Pkwy, Suite C-3		37067
Franklin, Tennessee		(Zip Code)
(Address of principal executive offices)

(615) 261-1500
(Registrant’s telephone number, including area code)

Not applicable.
(Former name, former address and former fiscal year, if changed since last report)

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

(Note: As a voluntary filer, not subject to the filing requirements, the registrant filed all reports under Section 13 or 15(d) of the Exchange Act during the preceding 12 months (or such shorter period that the registrant was required to file such reports).)

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


Large accelerated filer o		Accelerated filer o

Non-accelerated filer þ		Smaller reporting company o
(Do not check if a smaller reporting company.)

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ

As of November 12, 2008, 100%, or 10 shares, of Spheris Inc.’s common stock outstanding was owned by Spheris Holding II, Inc., its sole stockholder.

SPHERIS INC.

TABLE OF CONTENTS
QUARTERLY REPORT ON FORM 10-Q


	Page
PART I FINANCIAL INFORMATION
Item 1. Financial Statements		1
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		19
Item 3. Quantitative and Qualitative Disclosures About Market Risk		26
Item 4T. Controls and Procedures		26

PART II OTHER INFORMATION

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

SIGNATURES		29
EX-31.1
EX-31.2

We are a Delaware corporation. On June 18, 2003, we acquired all of the outstanding stock of EDiX Corporation (“EDiX”). On November 5, 2004, a company owned by affiliates of Warburg Pincus, LLC, TowerBrook Capital Partners, LLC and indirectly by certain members of our senior management team, acquired us. On December 22, 2004, we acquired HealthScribe, Inc. and its subsidiaries (“HealthScribe”). On January 1, 2006, we merged EDiX and HealthScribe into Spheris Operations Inc., a wholly-owned subsidiary of ours. On March 31, 2006, we acquired Vianeta Communications (“Vianeta”). Effective July 1, 2006, Spheris Operations Inc. was converted from a Tennessee corporation to a single member Tennessee limited liability company, and renamed Spheris Operations LLC (“Operations”).

We conduct our operations through our direct and indirect wholly-owned subsidiaries: Operations, Spheris Leasing LLC, Spheris Canada Inc., Spheris, India Private Limited, and Vianeta.

Unless this Quarterly Report on Form 10-Q (this “Quarterly Report”) indicates otherwise or the context otherwise requires, the terms “we”, “us”, “our”, “Company” or “Spheris” as used in this Quarterly Report refer to Spheris Inc. and its subsidiaries as of September 30, 2008.

Spheris Inc.
Condensed Consolidated Balance Sheets
(Amounts in Thousands, Except Share Amounts)


	(Unaudited)
	September 30, 2008			December 31, 2007
Assets
Current assets
Unrestricted cash and cash equivalents	$	9,902		$	7,195
Restricted cash		309			309
Accounts receivable, net of allowance of $1,387 and $1,569, respectively		30,514			33,595
Deferred taxes		4,635			3,386
Prepaid expenses and other current assets		5,365			4,460

Total current assets		50,725			48,945

Property and equipment, net		12,830			12,747
Internal-use software, net		1,712			1,932
Customer contracts, net		1,987			13,968
Goodwill		218,841			218,841
Deferred taxes		4,557			—
Other noncurrent assets		5,808			3,689

Total assets	$	296,460		$	300,122


Liabilities and stockholders’ equity
Current liabilities
Accounts payable	$	2,911		$	4,237
Accrued wages and benefits		12,540			18,130
Current portion of long-term debt and lease obligations		387			35
Other current liabilities		8,510			4,324

Total current liabilities		24,348			26,726

Long-term debt and lease obligations, net of current portion		199,907			191,761
Deferred tax liabilities		—			92
Other long-term liabilities		4,742			4,857

Total liabilities		228,997			223,436


Commitments and contingencies

Common stock, $0.01 par value, 100 shares authorized, 10 shares issued and outstanding		—			—
Other comprehensive income		181			564
Contributed capital		111,600			111,158
Accumulated deficit		(44,318	)		(35,036	)

Total stockholders’ equity		67,463			76,686

Total liabilities and stockholders’ equity	$	296,460		$	300,122

See accompanying notes.

Spheris Inc.
Condensed Consolidated Statements of Cash Flows
(Unaudited and Amounts in Thousands)


	Nine Months Ended September 30,
	2008			2007
Cash flows from operating activities:
Net loss	$	(9,282	)	$	(7,528	)
Adjustments to reconcile net loss to net cash provided by operating activities:
Depreciation and amortization		17,720			18,172
Amortization of acquired technology		162			486
Deferred taxes		(5,898	)		(5,198	)
Change in fair value of derivative financial instruments		1,311			(10	)
Amortization of debt discounts and issuance costs		630			602
Loss on debt refinancing		—			1,828
Other non-cash items		471			305
Changes in operating assets and liabilities, net of acquisitions:
Accounts receivable		3,081			(345	)
Prepaid expenses and other current assets		(991	)		(1,031	)
Accounts payable		(1,326	)		(872	)
Accrued wages and benefits		(5,590	)		(993	)
Other current liabilities		3,090			4,369
Other noncurrent assets and liabilities		(2,385	)		(4	)

Net cash provided by operating activities		993			9,781


Cash flows from investing activities:
Purchases of property and equipment		(4,241	)		(3,086	)
Purchase and development of internal-use software		(748	)		(558	)
Purchase of Vianeta, net of cash acquired		—			(1,547	)

Net cash used in investing activities		(4,989	)		(5,191	)


Cash flows from financing activities:
Proceeds from debt		7,288			71,320
Payments on debt and lease obligations		(202	)		(76,051	)
Debt issuance costs		—			(583	)

Net cash provided by (used in) financing activities		7,086			(5,314	)


Effect of exchange rate change on cash and cash equivalents		(383	)		836

Net increase in unrestricted cash and cash equivalents		2,707			112
Unrestricted cash and cash equivalents, at beginning of period		7,195			6,323

Unrestricted cash and cash equivalents, at end of period	$	9,902		$	6,435


Supplemental Schedule of Non-cash Investing and Financing Activities:
Purchases of property and equipment and internal-use software through lease obligations	$	1,019		$	—

See accompanying notes.

Spheris Inc.
Notes to Condensed Consolidated Financial Statements
September 30, 2008
(Unaudited)

1. Description of Business and Summary of Significant Accounting Policies

Organization and Operations

Spheris Inc. (“Spheris”) is a Delaware corporation. On June 18, 2003, Spheris Holdings LLC (“Holdings”) acquired all of the outstanding stock of EDiX Corporation (“EDiX”). On December 22, 2004, Spheris acquired ownership of HealthScribe, Inc. and its subsidiaries (“HealthScribe”). On January 1, 2006, EDiX and HealthScribe were merged into Spheris Operations Inc., a wholly-owned subsidiary of Spheris. On March 31, 2006, Spheris acquired Vianeta Communications (“Vianeta”). Effective July 1, 2006, Spheris Operations Inc. was converted from a Tennessee corporation to a single member Tennessee limited liability company, and renamed Spheris Operations LLC (“Operations”).

Spheris and its direct or indirect wholly-owned subsidiaries: Operations, Spheris Leasing LLC, Spheris Canada Inc., Spheris, India Private Limited (“SIPL”) and Vianeta (sometimes referred to collectively as the “Company”), provide clinical documentation technology and services to more than 500 health systems, hospitals and group practices located throughout the United States. The Company receives medical dictation in digital format from subscribing physicians, converts the dictation into text format, stores specific data elements from the records, then transmits the completed medical record to the originating physician in the prescribed format. As of September 30, 2008, the Company employed approximately 5,000 skilled medical language specialists (“MLS”) in the U.S. and India. More than 2,300 of these MLS work out of the Company’s facilities in India, making the Company one of the largest global providers of clinical documentation technology and services.

Reporting Unit and Principles of Condensed Consolidation

Prior to its acquisition by certain institutional investors in November 2004 (the “November 2004 Recapitalization”), Spheris was a wholly-owned subsidiary of Holdings. Subsequent to the November 2004 Recapitalization, Spheris became a wholly-owned subsidiary of Spheris Holding II, Inc. (“Spheris Holding II”), and an indirect wholly-owned subsidiary of Spheris Holding III, Inc. (“Spheris Holding III”), an entity owned by affiliates of Warburg Pincus LLC and TowerBrook Capital Partners LLC (together, the “Parent Investors”), and indirectly by certain members of Spheris’ management team. For all periods presented in the accompanying condensed consolidated financial statements and footnotes, Spheris is the reporting unit. All dollar amounts shown in these condensed consolidated financial statements and tables in the notes are in thousands unless otherwise noted. The condensed consolidated financial statements include the financial statements of Spheris, including its direct or indirect wholly-owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation.

Additionally, the accompanying interim condensed consolidated financial statements have been prepared by the Company without audit and, in the opinion of management, reflect all normal recurring adjustments necessary for a fair presentation of results for the unaudited interim periods presented. Certain information and footnote disclosures normally included in year-end financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted. The results of operations for the interim period are not necessarily indicative of the results to be obtained for the full fiscal year. These condensed consolidated financial statements should be read in conjunction with the audited financial statements and the notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2007, filed with the Securities and Exchange Commission (“SEC”).

Recent Accounting Pronouncements

SFAS No. 157. In September 2006, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 157, “Fair Value Measurements” (“SFAS No. 157”). SFAS No. 157 clarifies the principle that fair value should be based on the assumptions market participants would use when pricing an asset or liability and establishes a fair value hierarchy that prioritizes the information used to develop those assumptions. Under SFAS No. 157, fair value measurements would be separately disclosed by level within the fair value hierarchy. SFAS No. 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years, with early adoption permitted. On February 12, 2008, the FASB issued FASB Staff Position No. FAS 157-2, “Effective Date of FASB Statement No. 157” (“FSP FAS 157-2”). With the issuance of FSP FAS 157-2, the FASB delayed the effective date of SFAS No. 157 until fiscal years beginning after November 15, 2008 as it applies to certain nonfinancial assets and liabilities. The deferral is intended to provide the FASB additional time to consider the

Spheris Inc.
Notes to Condensed Consolidated Financial Statements
September 30, 2008
(Unaudited)

effect of certain implementation issues that have arisen from the application of SFAS No. 157 to these assets and liabilities. Effective January 1, 2008, the Company adopted SFAS No. 157, except as it applies to nonfinancial assets and liabilities as addressed in FSP FAS 157-2. The Company has not yet fully evaluated the impact, if any, that the implementation of SFAS No. 157 will have on nonfinancial assets and liabilities included in its financial statements.

SFAS No. 159. In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities — Including an Amendment of FASB Statement No. 115” (“SFAS No. 159”). SFAS No. 159 permits a company to choose to measure many financial instruments and certain other items at fair value at specified election dates. A company will report unrealized gains and losses on items for which the fair value option has been elected in earnings (or another performance indicator if the company does not report earnings) at each subsequent reporting date. The fair value option: (i) may be applied instrument by instrument, with a few exceptions, such as investments otherwise accounted for by the equity method; (ii) is irrevocable (unless a new election date occurs); and (iii) is applied only to entire instruments and not to portions of instruments. SFAS No. 159 became effective for the Company as of January 1, 2008. The Company did not make a fair value election pursuant to this standard at the effective date and as such, the adoption of SFAS No. 159 had no effect on its results of operations or financial position.

SFAS No. 141(R). In December 2007, the FASB issued SFAS No. 141(R), “Business Combinations” (“SFAS No. 141(R)”). SFAS No. 141(R) retains the current purchase method of accounting for acquisitions, but requires a number of changes, including changes in the way assets and liabilities are recognized in the purchase accounting, as well as requiring the expensing of acquisition-related costs as incurred. Furthermore, SFAS No. 141(R) provides guidance for recognizing and measuring the goodwill acquired in the business combination and specifies what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combination. SFAS No. 141(R) will be effective for fiscal years beginning on or after December 15, 2008. Earlier adoption is prohibited. While the Company has not yet fully evaluated the impact, if any, that the implementation of SFAS No. 141(R) will have on its results of operations or financial position, the Company has determined that it will be required to expense costs related to any future acquisitions as they are incurred beginning January 1, 2009.

SFAS No. 160. In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements — An Amendment of ARB No. 51” (“SFAS No. 160”). SFAS No. 160 establishes accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. SFAS No. 160 requires that earnings or losses attributed to noncontrolling interests be reported as part of consolidated earnings rather than as a separate component of income or expense. SFAS No. 160 will be effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 31, 2008. Earlier adoption is prohibited. As all of the Company’s subsidiaries are wholly-owned, the Company does not anticipate that the adoption of SFAS No. 160 will have a material impact on its results of operations or financial position.

SFAS No. 161. In March 2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities — An Amendment of FASB Statement No. 133” (“SFAS No. 161”). SFAS No. 161 requires entities that utilize derivative instruments to provide qualitative disclosures about their objectives and strategies for using such instruments, as well as any details of credit-risk-related contingent features contained within the derivative instruments. SFAS No. 161 requires disclosure of the amounts and location of derivative instruments included in an entity’s financial statements, as well as the accounting treatment of such instruments under FASB Statement No. 133, “Accounting for Derivative Instruments and Hedging Activities” and the impact that hedges have on an entity’s financial position, financial performance and cash flows. SFAS No. 161 is effective for fiscal years and interim periods beginning after November 15, 2008, with early adoption encouraged. SFAS No. 161 encourages, but does not require, comparative disclosures for earlier periods at initial adoption. The Company does not anticipate that the adoption of SFAS No. 161 will have a material impact on the disclosures contained within its financial statements.

Spheris Inc.
Notes to Condensed Consolidated Financial Statements
September 30, 2008
(Unaudited)

Fair Value of Financial Instruments

The Company has adopted the provisions of SFAS No. 157 as of January 1, 2008, for financial instruments. Although the adoption of SFAS No. 157 did not materially impact its financial condition, results of operations or cash flow for the periods presented, the Company is now required to provide additional disclosures as part of its financial statements.

SFAS No. 157 establishes a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value. These tiers include: Level 1, defined as observable inputs such as quoted prices in active markets; Level 2, defined as inputs other than quoted prices in active markets that are either directly or indirectly observable; and Level 3, defined as unobservable inputs in which little or no market data exists, therefore requiring an entity to develop its own assumptions.

As of September 30, 2008, the Company held certain financial assets that are required to be measured at fair value on a recurring basis. These included the Company’s derivative financial instruments — both related to interest rates and foreign currency. The Company utilizes derivative financial instruments to reduce interest rate risks and to manage risk exposure to foreign currency changes. The Company records these derivatives in accordance with the provisions of SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities”, which was subsequently amended by SFAS No. 138 and SFAS No. 149 (“SFAS No. 133, as amended”). SFAS No. 133, as amended, established accounting and reporting standards for derivative instruments and hedging activities. SFAS No. 133, as amended, requires all derivatives to be recognized in the statement of financial position and to be measured at fair value. Changes in the fair value of those instruments are reported in earnings or other comprehensive income depending on the use of the derivative and whether it qualifies for hedge accounting.

The Company determines the fair value of its derivative financial instruments — both related to interest rates and foreign currency — utilizing inputs for similar or identical assets or liabilities that are either readily available in public markets, can be derived from information available in publicly quoted markets or are quoted by counterparties to these contracts. As a result, the Company has categorized these derivative instruments as Level 2. The Company has consistently applied these valuation techniques in all periods presented and believes it has obtained the most accurate information available for the types of derivative contracts it holds.

Payments to SIPL are denominated in U.S. dollars. In order to hedge against fluctuations in exchange rates, SIPL maintains a portfolio of forward currency exchange contracts. The Company’s accounting for these derivative financial instruments did not meet the hedge accounting criteria under SFAS No. 133, as amended, and related interpretations. As of September 30, 2008, these contracts were recorded at a fair value of $1.1 million as a component of other current liabilities in the accompanying condensed consolidated balance sheets. As of December 31, 2007, the contracts were recorded at a fair value of $0.2 million as a component of prepaid expenses and other current assets in the accompanying condensed consolidated balance sheets. Changes in fair value were included as a component of other (income) expense in the accompanying condensed consolidated statements of operations.

The Company has entered into certain interest rate management agreements to reduce its exposure to fluctuations in market interest rates under its senior secured credit facilities. The Company’s accounting for these derivative financial instruments did not meet the hedge accounting criteria under SFAS No. 133, as amended, and related interpretations. As a result, these contracts were recorded at a fair value of $1.3 million and $1.1 million as of September 30, 2008 and December 31, 2007, respectively, as a component of other long-term liabilities in the accompanying condensed consolidated balance sheets. Changes in fair value were included as a component of other (income) expense in the accompanying condensed consolidated statements of operations.

2. Customer Contracts

In connection with the November 2004 Recapitalization, the Company assigned a value of $50.7 million as the fair value of Spheris customer contracts existing as of the date of the transaction. These contracts are being amortized over an expected life of four years. In connection with the HealthScribe acquisition in December 2004, the Company assigned a value of $13.1 million to the acquired contracts and is amortizing these contracts over an estimated life of four years. Additionally, the Company assigned a value of $0.1 million for customer contracts acquired in connection with the Vianeta acquisition consummated on March 31, 2006. These contracts are being amortized over an expected life of three years.

Spheris Inc.
Notes to Condensed Consolidated Financial Statements
September 30, 2008
(Unaudited)

The components of the Company’s customer contracts were as follows:

September 30, 2008

December 31, 2007

Gross Carrying

Accumulated

Gross Carrying

Accumulated

Amount

Amortization

Amount

Amortization

Customer contracts

63,864

(61,877

)

63,864

(49,896

)

Amortization expense for customer contracts for each of the three and nine months ended September 30, 2008 and 2007 was $4.0 million and $12.0 million, respectively. The $2.0 million of estimated remaining amortization expense for these contracts is expected to be recognized during the fourth quarter of 2008.

3. Other Comprehensive Loss

Other comprehensive loss was as follows:


	Three Months Ended						Nine Months Ended
	September 30,						September 30,
	2008			2007			2008			2007
Net loss	$	(2,591	)	$	(3,541	)	$	(9,282	)	$	(7,528	)
Foreign currency translation (loss) gain		(490	)		101			(383	)		836

Comprehensive loss	$	(3,081	)	$	(3,440	)	$	(9,665	)	$	(6,692	)

4. Debt

Outstanding debt obligations of the Company at September 30, 2008 and December 31, 2007 consisted of the following:


	September 30,			December 31,
	2008			2007
2007 Senior Credit Facility, net of discount, with principal due at maturity on July 17, 2012; interest payable periodically at variable rates. The weighted average interest rate was 6.4% at September 30, 2008	$	76,320		$	68,883
11.0% Senior Subordinated Notes, net of discount, with principal due at maturity in December 2012; interest payable semi-annually in June and December		123,122			122,878
Lease obligations		852			35

		200,294			191,796
Less: Current portion of long-term debt and lease obligations		(387	)		(35	)

Long-term debt and lease obligations, net of current portion	$	199,907		$	191,761

2007 Senior Credit Facility

In July 2007, the Company entered into a financing agreement (the “2007 Senior Credit Facility”), to replace the Company’s previous $100.0 million facility. The 2007 Senior Credit Facility consists of a term loan in the original principal amount of $70.0 million and a revolving credit facility in an aggregate principal amount not to exceed $25.0 million outstanding at any time. The revolving loans and the term loan bear interest at LIBOR plus an applicable margin or the reference bank’s base rate plus an applicable margin, at the Company’s option. Under the revolving credit facility, the Company may borrow up to the lesser of $25.0 million or a loan limiter amount, as defined in the 2007 Senior Credit Facility, less amounts outstanding under letters of credit.

Spheris Inc.
Notes to Condensed Consolidated Financial Statements
September 30, 2008
(Unaudited)

During August 2008, the Company utilized $2.3 million of its revolving credit facility to fund certain security deposits, previously secured through letters of credit. At September 30, 2008, the $2.3 million of deposits are included in other noncurrent assets in the accompanying condensed consolidated balance sheet. As of September 30, 2008, the Company had $7.3 million outstanding under the revolver portion of the 2007 Senior Credit Facility. As a result, the Company’s total remaining capacity for borrowings under the 2007 Senior Credit Facility was $17.7 million as of September 30, 2008.

All unpaid principal amounts under the 2007 Senior Credit Facility are due at maturity on July 17, 2012. Additionally, the Company is required to perform annual excess cash flow calculations, as defined in the 2007 Senior Credit Facility, and to remit any applicable amounts to reduce the outstanding term loan balance. Interest payments under the 2007 Senior Credit Facility are due monthly or at other intervals not to exceed every three months, depending on the interest elections made by the Company. At September 30, 2008, approximately $0.1 million of accrued interest was outstanding under the 2007 Senior Credit Facility and is included in other current liabilities in the accompanying condensed consolidated balance sheet.

Under the 2007 Senior Credit Facility, Operations is the borrower. The 2007 Senior Credit Facility is secured by substantially all of the Company’s assets and is guaranteed by Spheris, Spheris Holding II and all of Operations’ subsidiaries, except SIPL. The 2007 Senior Credit Facility contains certain covenants which, among other things, limit the incurrence of additional indebtedness, investments, dividends, transactions with affiliates, asset sales, acquisitions, mergers and consolidations, liens and encumbrances and other matters customarily restricted in such agreements. The 2007 Senior Credit Facility also contains customary events of default, the occurrence of which could allow the collateral agent to declare any outstanding amounts to be immediately due and payable. The financial covenants contained in the 2007 Senior Credit Facility will become more restrictive over time. Future drawings under the 2007 Senior Credit Facility will be available only if, among other things, the Company is in compliance with the financial covenants and other conditions required under the 2007 Senior Credit Facility. The Company believes it was in compliance with the financial covenants in the 2007 Senior Credit Facility as of September 30, 2008. Although the Company currently believes that it will be able to maintain continued compliance with its financial covenants, there can be no assurance that the Company will remain in compliance with the financial covenants for future periods or that, if the Company defaults under any of its covenants, the Company will be able to obtain waivers or amendments that will allow the Company to operate its business in accordance with its plans.

In connection with the borrowings under the 2007 Senior Credit Facility, the Company incurred $0.6 million and $1.2 million in debt issuance costs and debt discounts, respectively. These costs are being amortized as additional interest expense over the term of the debt. The balance of the issuance costs at September 30, 2008 of $0.5 million, net of accumulated amortization, was reflected in other noncurrent assets in the Company’s condensed consolidated balance sheet. The debt discount at September 30, 2008 of $1.0 million was reflected as a reduction in the carrying amount of the debt under the 2007 Senior Credit Facility.

Senior Subordinated Notes

In December 2004, the Company issued $125.0 million of 11% senior subordinated notes due 2012 (the “Senior Subordinated Notes”). The Senior Subordinated Notes bear interest at a fixed rate of 11.0% per annum. Interest is payable in semi-annual installments through maturity on December 15, 2012.

The Company incurred $1.9 million and $2.9 million in debt issuance costs and debt discounts, respectively, in connection with the Senior Subordinated Notes. These costs are being amortized as additional interest expense over the term of the Senior Subordinated Notes. The remaining balance of the issuance costs at September 30, 2008 of $1.2 million, net of accumulated amortization, was reflected in other noncurrent assets in the Company’s condensed consolidated balance sheet. The remaining debt discount at September 30, 2008 of $1.9 million was reflected as a reduction in the carrying amount of the Senior Subordinated Notes.

The Senior Subordinated Notes are junior to the obligations of the 2007 Senior Credit Facility, but are senior to general purpose credit obligations of the Company. The Senior Subordinated Notes are guaranteed by the Company’s domestic operating subsidiaries. The Senior Subordinated Notes contain certain restrictive covenants that place limitations on the Company regarding incurrence of additional debt, payment of dividends and other items as specified in the indenture governing the Senior Subordinated Notes. Defaults under, and acceleration of amounts due on, the Company’s

Spheris Inc.
Notes to Condensed Consolidated Financial Statements
September 30, 2008
(Unaudited)

obligations under the 2007 Senior Credit Facility would create an event of default under the Senior Subordinated Notes, which would cause the notes to become due and payable immediately upon notice by the holders. The Senior Subordinated Notes are redeemable at the option of the Company subject to certain prepayment penalties and restrictions as set forth in the indenture governing the Senior Subordinated Notes.

The Company completed the sale and issuance of the Senior Subordinated Notes in a private placement to qualified institutional buyers pursuant to Rule 144A under the Securities Act of 1933, as amended (the “Securities Act”). During 2006, the Company filed a registration statement on Form S-4 (Registration No. 333-132641) with the SEC to exchange the Senior Subordinated Notes for a new issuance of identical debt securities that are registered under the Securities Act. The exchange offer was completed during June 2006.

5. Stockholders’ Equity

Subsequent to the November 2004 Recapitalization, Spheris Holding III approved the establishment of the Spheris Holding III, Inc. Stock Incentive Plan (the “Plan”) for issuance of common stock to employees, non-employee directors and other designated persons providing substantial services to the Company. As of September 30, 2008, 15.6 million shares have been authorized for issuance under the Plan. Shares are subject to restricted stock and stock option agreements and typically vest over a three or four-year period. As of September 30, 2008, an aggregate of 12.3 million shares of restricted stock and 2.5 million stock options were issued and outstanding under the Plan. Additionally, 0.1 million shares of Series A convertible preferred restricted stock have been issued by Spheris Holding III to the Company’s board members for services rendered. As these shares were issued for services provided to the Company, compensation expense of $0.1 million and $0.4 million was reflected in the Company’s condensed consolidated statements of operations for the three and nine months ended September 30, 2008 as compared to compensation expense of $0.1 million and $0.3 million for the three and nine months ended September 30, 2007, respectively.

6. Income Taxes

Income taxes are accounted for under the provisions of SFAS No. 109, “Accounting for Income Taxes” (“SFAS No. 109”). SFAS No. 109 generally requires the Company to record deferred income taxes for the tax effect of differences between book and tax bases of its assets and liabilities. In accordance with the provisions of SFAS No. 109, the Company records a valuation allowance to reduce its net deferred tax assets to the amount that is more likely than not to be realized. The valuation allowance decreased by $0.1 million during the nine months ended September 30, 2008 as compared to $1.2 million for the nine months ended September 30, 2007. To the extent valuation allowance is released that was previously recorded as a result of business combinations, the offsetting credit will be recognized first as a reduction to goodwill, then to other intangible assets, and lastly as a reduction in the current period’s income tax provision. During the nine months ended September 30, 2007, $0.2 million of net valuation allowance was released and charged against goodwill as a result of the utilization of state net operating losses. The valuation allowance released and charged against goodwill was related to the November 2004 Recapitalization. As of September 30, 2008, the Company’s valuation allowance that is reflected as a reduction to the carrying value of its net deferred tax balances was $34.2 million.

In the United States, the Company currently benefits from federal and state net operating loss carryforwards. The Company’s consolidated federal net operating loss carryforwards available to reduce future taxable income were $103.6 million and $99.6 million at September 30, 2008 and December 31, 2007, respectively, and began to expire in 2007. The Company’s state net operating loss carryforwards at September 30, 2008 and December 31, 2007 were $68.7 million and $65.9 million, respectively, and began to expire in 2005. The majority of these federal and state net operating loss carryforwards are restricted due to limitations associated with ownership change, and as such, are fully reserved to reduce the amount that is more likely than not to be realized. In addition, the Company has alternative minimum tax credits which do not have an expiration date and certain other federal tax credits that will begin to expire in 2014.

The Company recognized an income tax benefit of $1.7 million and $5.6 million during the three and nine months ended September 30, 2008 as compared to $1.9 million and $4.6 million during the three and nine months ended September 30, 2007, respectively. The change in the total effective tax rate for the three months ended September 30, 2008 as compared to the prior year period resulted primarily from the timing of the deduction for transaction related expenses and changes in valuation amounts on the Company’s net operating loss assets. The change in the total effective tax rate for the nine months ended September 30, 2008 as compared to the prior year period was primarily due to changes in valuation amounts on the Company’s net operating loss assets.

Spheris Inc.
Notes to Condensed Consolidated Financial Statements
September 30, 2008
(Unaudited)

Spheris Holding III and related subsidiaries (the “filing group members”) file their U.S. federal and certain state income tax returns on a consolidated, unitary, combined or similar basis. To accurately reflect each filing group member’s share of consolidated tax liabilities on separate company books and records, on November 5, 2004, Spheris Holding III and each of its subsidiaries entered into a tax sharing agreement. Under the terms of the tax sharing agreement, each subsidiary of Spheris Holding III is obligated to make payments on behalf of Spheris Holding III equal to the amount of the federal and state income taxes that its subsidiaries would have owed if such subsidiaries did not file federal and state income tax returns on a consolidated, unitary, combined or similar basis. Likewise, Spheris Holding III may make payments to subsidiaries if it benefits from the use of a subsidiary loss or other tax benefit. The tax sharing agreement allows each subsidiary to bear its respective tax burden (or enjoy use of a tax benefit, such as a net operating loss) as if its return was prepared on a stand-alone basis. To date, no amounts have been paid under this agreement.

Operations pays certain franchise tax obligations on behalf of Spheris Holding III. Approximately $0.5 million of payments by Operations related to these taxes are reflected as a receivable due from affiliate and included as a component of prepaid expenses and other current assets in the accompanying condensed consolidated balance sheet as of September 30, 2008.

The Company adopted the provisions of FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes — An Interpretation of FASB Statement No. 109” (“FIN No. 48”), effective January 1, 2007. The Company has analyzed filing positions for all federal, state and international jurisdictions for all open tax years where it is required to file income tax returns. Although the Company files tax returns in every jurisdiction in which it has a legal obligation to do so, it has identified the following as “major” tax jurisdictions, as defined in FIN No. 48: Tennessee, Michigan and Texas, as well as India. Within these major jurisdictions, the Company has tax examinations in progress related to transfer pricing rates for its Indian facilities, as discussed in Note 7, as well as significant federal and state net operating loss carryovers, for which the earliest open tax year is 1996. Based on the facts of these examinations, the Company believes that it is more likely than not that it will be successful in supporting its current positions related to the applicable filings. The Company believes that all income tax filing positions and deductions will be sustained upon audit and does not anticipate any adjustments resulting in a material adverse impact on the Company’s financial condition, results of operations or cash flow. Therefore, no reserves for uncertain income tax positions have been recorded pursuant to FIN No. 48. In addition, the Company did not record a cumulative effect adjustment related to the adoption of FIN No. 48.

7. Commitments and Contingencies

Litigation

On November 6, 2007, the Company was sued for patent infringement by Anthurium Solutions, Inc. in the U.S. District Court for the Eastern District of Texas, alleging that the Company had infringed and continues to infringe United States Patent No. 7,031,998 through the Company’s use of its Clarity technology platform. The complaint also alleges claims against MedQuist Inc. and Arrendale Associates, Inc., and seeks injunctive relief and unspecified damages, including enhanced damages and attorneys’ fees. The Company timely filed its answer and a counterclaim seeking a declaratory judgment of non-infringement and invalidity. Although the Company currently believes these claims are without merit, the Company’s investigation of the claims is ongoing. The discovery phase of the litigation has commenced. The claim construction hearing was held on November 6, 2008, and we expect a ruling to be made in sixty (60) to ninety (90) days. The trial date is currently set for October 6, 2009. The Company plans to vigorously defend against the claim of infringement and pursue all available defenses.

The Company is also subject to various other claims and legal actions that arise in the ordinary course of business. In the opinion of management, any amounts for probable exposures are adequately reserved for in the Company’s condensed consolidated financial statements, and the ultimate resolution of such matters is not expected to have a material adverse effect on the Company’s financial position or results of operations.

Spheris Inc.
Notes to Condensed Consolidated Financial Statements
September 30, 2008
(Unaudited)

Employment Agreements

The Company has employment agreements with certain members of senior management that provide for the payment to these persons of amounts equal to the applicable base salary, unpaid annual bonus and health insurance premiums over the applicable periods specified in their individual employment agreements in the event the employee’s employment is terminated without cause or for certain other specified reasons. The maximum contingent liabilities, excluding any earned but unpaid bonuses accrued in the Company’s condensed consolidated financial statements, under these agreements were $1.4 million and $1.8 million at September 30, 2008 and December 31, 2007, respectively.

Tax Assessment

During the fourth quarter of 2006, SIPL received notification of a tax assessment resulting from a transfer pricing tax audit by Indian income tax authorities amounting to $1.7 million including penalties and interest, which was subsequently adjusted to $1.4 million, for the fiscal tax period ended March 31, 2004 (the “2004 Assessment”). In January 2007, the Company filed a formal appeal with the India Commissioner of Income Tax. Prior to resolution of the Company’s appeals process, the Indian income tax authorities have required the Company to make advance payments toward the 2004 Assessment of $1.1 million. Any amounts paid by the Company related to the 2004 Assessment are subject to a claim by the Company for reimbursement against the HealthScribe acquisition escrow funds. The Company has recorded its assessment payments made to the Indian income tax authorities with corresponding receivables from the escrow funds in the Company’s condensed consolidated financial statements. Accordingly, $0.9 million is reflected as a component of prepaid expenses and other current assets in the accompanying consolidated balance sheet as of September 30, 2008.

During 2007, the Company received notice from the Indian income tax authorities of a potential audit of transfer pricing amounts for the tax year ended March 31, 2005. In the event that additional amounts are assessed to the Company related to transfer pricing disputes for the tax year ended March 31, 2005, the Company currently intends to file appeals for any such assessments as well. Assessment amounts for the tax year ended March 31, 2005 also would be subject to a claim under the HealthScribe acquisition escrow agreement for periods prior to the Company’s acquisition of HealthScribe in December 2004.

The Company intends to vigorously pursue all avenues with the Indian taxing authorities, legal and administrative agencies, and if necessary, the Indian courts to rescind the assessments. If the assessments were brought forward from March 31, 2004 through September 30, 2008, a reasonable estimate of additional liability could range from zero to $8.0 million, contingent upon the final outcome of the claim. Payment of such amounts would also result in potential credit adjustments to the Company’s U.S. federal tax returns. The Company currently believes that it is more likely than not that it will be successful in supporting its position relating to these assessments. Accordingly, in accordance with FIN No. 48, the Company has not recorded any accrual for contingent liabilities associated with the tax assessments as of September 30, 2008 or December 31, 2007.

8. Related Party Transactions

During each of the three and nine months ended September 30, 2008, the Company provided clinical documentation technology and services to Community Health Systems, Inc. (“CHS”), whose Chairman, President and Chief Executive Officer, Mr. Wayne Smith, served on the Company’s board of directors during the same period.

The clinical documentation technology and services were provided to CHS in the ordinary course of business at prices and on terms and conditions that the Company believes are the same as those that would result from arm’s-length negotiations between unrelated parties. For the three and nine months ended September 30, 2008, the Company recognized $0.5 million and $1.4 million, respectively, of net revenues from this customer in the accompanying condensed consolidated statements of operations.

As further described in Note 10, on October 3, 2008, Operations entered into an exclusive services agreement with a subsidiary of CHS to provide clinical documentation technology and services to all of its affiliated hospitals. In connection with this transaction, CHS became a minority owner in Spheris Holding III, the Company’s indirect parent, and acquired the right to appoint two members to the Company’s board of directors. Simultaneous with the closing of the transaction, CHS appointed two of its senior executives to the Company’s board of directors, and Mr. Smith stepped down from the Company’s board of directors.

Spheris Inc.
Notes to Condensed Consolidated Financial Statements
September 30, 2008
(Unaudited)

9. Information Concerning Guarantor and Non-Guarantor Subsidiaries

All but one of the Company’s subsidiaries guarantee the Senior Subordinated Notes (the “Guarantors”). Each of the Guarantors is 100% owned, directly or indirectly, by Spheris. Additionally, each of the guarantees is full and unconditional, and guaranteed by the Guarantors on a joint and several basis. SIPL does not guarantee the Senior Subordinated Notes (the “Non-Guarantor”). The condensed consolidating financial information includes certain allocations of revenues and expenses based on management’s best estimates, which are not necessarily indicative of financial position, results of operations and cash flows that these entities would have achieved on a stand alone basis.

The following unaudited condensed consolidating schedules present condensed financial information of Spheris, the Guarantors and the Non-Guarantor as of September 30, 2008 and December 31, 2007 and for the three and nine months ended September 30, 2008 and 2007:

Condensed Consolidating Balance Sheet
(Unaudited and Amounts in Thousands)

September 30, 2008

Issuer

Non-

(Spheris)

Guarantors

Guarantor

Eliminations

Consolidated

Assets

Current assets

Unrestricted cash and cash equivalents

7,495

2,405

—

9,902

Restricted cash

—

309

—

309

Accounts receivable, net of allowance

—

30,514

—

30,514

Intercompany receivables

—

116,066

6,402

(122,468

)

Deferred taxes

—

4,635

—

4,635

Prepaid expenses and other current assets

—

3,411

1,954

—

5,365

Total current assets

162,430

10,761

(122,468

)

50,725

Property and equipment, net

—

10,576

2,254

—

12,830

Internal-use software, net

—

1,712

—

1,712

Customer contracts, net

—

1,987

—

1,987

Goodwill

—

218,841

—

218,841

Investment in subsidiaries

305,285

—

(305,285

)

Deferred taxes

—

3,530

1,027

—

4,557

Other noncurrent assets

1,249

3,550

1,009

—

5,808

Total assets

306,536

402,626

15,051

(427,753

)

296,460

Liabilities and stockholders’ equity

Current liabilities

Accounts payable

—

2,552

359

—

2,911

Accrued wages and benefits

—

9,101

3,439

—

12,540

Intercompany payables

116,066

6,402

—

(122,468

)

Current portion of long-term debt and lease obligations

—

387

—

387

Other current liabilities

4,011

3,046

1,453

—

8,510

Total current liabilities

120,077

21,488

5,251

(122,468

)

24,348

Long-term debt and lease obligations, net of current portion

123,122

76,785

—

199,907

Other long-term liabilities

—

4,643

—

4,742

Total liabilities

243,199

102,916

5,350

(122,468

)

228,997

Stockholders’ equity

63,337

299,710

9,701

(305,285

)

67,463

Total stockholders’ equity

63,337

299,710

9,701

(305,285

)

67,463

Total liabilities and stockholders’ equity

306,536

402,626

15,051

(427,753

)

296,460

Spheris Inc.
Notes to Condensed Consolidated Financial Statements
September 30, 2008
(Unaudited)

Condensed Consolidating Balance Sheet
(Amounts in Thousands)


	December 31, 2007
	Issuer				Non-
	(Spheris)		Guarantors		Guarantor			Eliminations			Consolidated
Assets
Current assets
Unrestricted cash and cash equivalents	$	5	$	4,967	$	2,223		$	—		$	7,195
Restricted cash		—		309		—			—			309
Accounts receivable, net of allowance		—		33,595		—			—			33,595
Intercompany receivables		66,500		119,394		7,303			(193,197	)		—
Deferred taxes		—		3,386		—			—			3,386
Prepaid expenses and other current assets		—		2,467		1,993			—			4,460

Total current assets		66,505		164,118		11,519			(193,197	)		48,945

Property and equipment, net		—		10,536		2,211			—			12,747
Internal-use software, net		—		1,932		—			—			1,932
Customer contracts, net		—		13,968		—			—			13,968
Goodwill		—		218,841		—			—			218,841
Investment in subsidiaries		305,285		—		—			(305,285	)		—
Other noncurrent assets		1,412		1,528		749			—			3,689

Total assets	$	373,202	$	410,923	$	14,479		$	(498,482	)	$	300,122


Liabilities and stockholders’ equity
Current liabilities
Accounts payable	$	—	$	3,858	$	379		$	—		$	4,237
Accrued wages and benefits		—		14,082		4,048			—			18,130
Intercompany payables		119,394		73,803		—			(193,197	)		—
Current portion of long-term debt and lease obligations		—		35		—			—			35
Other current liabilities		573		3,614		137			—			4,324

Total current liabilities		119,967		95,392		4,564			(193,197	)		26,726

Long-term debt and lease obligations, net of current portion		122,878		68,883		—			—			191,761
Deferred tax liabilities		—		678		(586	)		—			92
Other long-term liabilities		—		4,801		56			—			4,857

Total liabilities		242,845		169,754		4,034			(193,197	)		223,436


Stockholders’ equity		130,357		241,169		10,445			(305,285	)		76,686

Total stockholders’ equity		130,357		241,169		10,445			(305,285	)		76,686

Total liabilities and stockholders’ equity	$	373,202	$	410,923	$	14,479		$	(498,482	)	$	300,122

Spheris Inc.
Notes to Condensed Consolidated Financial Statements
September 30, 2008
(Unaudited)

Condensed Consolidating Statement of Operations
(Unaudited and Amounts in Thousands)


	For the Three Months Ended September 30, 2008
	Issuer						Non-
	(Spheris)			Guarantors			Guarantor			Eliminations			Consolidated
Net revenues	$	—		$	44,749		$	5,446		$	(5,446	)	$	44,749

Operating expenses:
Direct costs of revenues (exclusive of depreciation and amortization below)		—			32,168			4,951			(5,446	)		31,673
Marketing and selling expenses		—			400			—			—			400
General and administrative expenses		1			5,448			191			—			5,640
Depreciation and amortization		—			5,649			213			—			5,862

Total operating costs		1			43,665			5,355			(5,446	)		43,575


Operating income (loss)		(1	)		1,084			91			—			1,174

Interest expense, net of income		3,577			1,107			(3	)		—			4,681
Other expense		—			230			590			—			820

Net loss before income taxes		(3,578	)		(253	)		(496	)		—			(4,327	)


Provision for (benefit from) income taxes		(1,597	)		75			(214	)		—			(1,736	)

Net loss	$	(1,981	)	$	(328	)	$	(282	)	$	—		$	(2,591	)

Condensed Consolidating Statement of Operations
(Unaudited and Amounts in Thousands)


	For the Three Months Ended September 30, 2007
	Issuer						Non-
	(Spheris)			Guarantors			Guarantor			Eliminations			Consolidated
Net revenues	$	—		$	48,943		$	5,790		$	(5,790	)	$	48,943

Operating expenses:
Direct costs of revenues (exclusive of depreciation and amortization below)		—			35,945			4,989			(5,790	)		35,144
Marketing and selling expenses		—			1,186			—			—			1,186
General and administrative expenses		—			4,925			103			—			5,028
Depreciation and amortization		—			5,780			259			—			6,039

Total operating costs		—			47,836			5,351			(5,790	)		47,397


Operating income		—			1,107			439			—			1,546

Interest expense, net of income		5,364			(82	)		(2	)		—			5,280
Loss on debt refinancing		1,828			—			—			—			1,828
Other (income) expense		(4,125	)		4,088			(112	)		—			(149	)

Net income (loss) before income taxes		(3,067	)		(2,899	)		553			—			(5,413	)


Provision for (benefit from) income taxes		(78	)		(2,066	)		272			—			(1,872	)

Net income (loss)	$	(2,989	)	$	(833	)	$	281		$	—		$	(3,541	)

Spheris Inc.
Notes to Condensed Consolidated Financial Statements
September 30, 2008
(Unaudited)

Condensed Consolidating Statement of Operations
(Unaudited and Amounts in Thousands)

For the Nine Months Ended September 30, 2008

Issuer

Non-

(Spheris)

Guarantors

Guarantor

Eliminations

Consolidated

Net revenues

—

141,074

17,304

(17,304

)

141,074

Operating expenses:

Direct costs of revenues (exclusive of depreciation and amortization below)

—

104,333

15,746

(17,304

)

102,775

Marketing and selling expenses

—

2,276

—

2,276

General and administrative expenses

16,714

613

—

17,337

Depreciation and amortization

—

16,962

758

—

17,720

Total operating costs

140,285

17,117

(17,304

)

140,108

Operating income (loss)

(10

)

789

187

—

966

Interest expense, net of income

21,721

(7,317

)

(25

)

—

14,379

Other (income) expense

5,500

(5,029

)

967

—

1,438

Net income (loss) before income taxes

(27,231

)

13,135

(755

)

—

(14,851

)

Provision for (benefit from) income taxes

(10,211

)

5,035

(393

)

—

(5,569

)

Net income (loss)

(17,020

)

8,100

(362

)

—

(9,282

)

Condensed Consolidating Statement of Operations
(Unaudited and Amounts in Thousands)


	For the Nine Months Ended September 30, 2007
	Issuer						Non-
	(Spheris)			Guarantors			Guarantor			Eliminations			Consolidated
Net revenues	$	—		$	151,795		$	15,960		$	(15,960	)	$	151,795

Operating expenses:
Direct costs of revenues (exclusive of depreciation and amortization below)		—			111,055			13,709			(15,960	)		108,804
Marketing and selling expenses		—			3,755			—			—			3,755
General and administrative expenses		57			14,608			274			—			14,939
Depreciation and amortization		—			17,370			802			—			18,172

Total operating costs		57			146,788			14,785			(15,960	)		145,670


Operating income (loss)		(57	)		5,007			1,175			—			6,125

Interest expense, net of income		15,050			1,091			(8	)		—			16,133
Loss on debt refinancing		1,828			—			—			—			1,828
Other (income) expense		(4,125	)		4,035			420			—			330

Net income (loss) before income taxes		(12,810	)		(119	)		763			—			(12,166	)


Provision for (benefit from) income taxes		750			(5,716	)		328			—			(4,638	)

Net income (loss)	$	(13,560	)	$	5,597		$	435		$	—		$	(7,528	)

Spheris Inc.
Notes to Condensed Consolidated Financial Statements
September 30, 2008
(Unaudited)

Condensed Consolidating Statement of Cash Flows
(Unaudited and Amounts in Thousands)


	For the Nine Months Ended September 30, 2008
	Issuer						Non-
	(Spheris)			Guarantors			Guarantor			Eliminations		Consolidated
Cash flows from operating activities:
Net cash (used in) provided by operating activities	$	(3	)	$	206		$	790		$	—	$	993

Net cash (used in) provided by operating activities		(3	)		206			790			—		993


Cash flows from investing activities:
Purchases of property and equipment		—			(4,016	)		(225	)		—		(4,241	)
Purchase and development of internal-use software		—			(748	)		—			—		(748	)

Net cash used in investing activities		—			(4,764	)		(225	)		—		(4,989	)


Cash flows from financing activities:
Proceeds from debt		—			7,288			—			—		7,288
Payments on debt and lease obligations		—			(202	)		—			—		(202	)

Net cash provided by financing activities		—			7,086			—			—		7,086

Effect of exchange rate change on cash and cash equivalents		—			—			(383	)		—		(383	)

Net (decrease) increase in unrestricted cash and cash equivalents		(3	)		2,528			182			—		2,707
Unrestricted cash and cash equivalents, at beginning of period		5			4,967			2,223			—		7,195

Unrestricted cash and cash equivalents, at end of period	$	2		$	7,495		$	2,405		$	—	$	9,902

Condensed Consolidating Statement of Cash Flows
(Unaudited and Amounts in Thousands)


	For the Nine Months Ended September 30, 2007
	Issuer						Non-
	(Spheris)			Guarantors			Guarantor			Eliminations		Consolidated
Cash flows from operating activities:
Net cash provided by (used in) operating activities	$	73,502		$	(63,914	)	$	193		$	—	$	9,781

Net cash provided by (used in) operating activities		73,502			(63,914	)		193			—		9,781


Cash flows from investing activities:
Purchases of property and equipment		—			(2,633	)		(453	)		—		(3,086	)
Purchase and development of internal-use software		—			(558	)		—			—		(558	)
Purchase of Vianeta, net of cash acquired		—			(1,547	)		—			—		(1,547	)

Net cash used in investing activities		—			(4,738	)		(453	)		—		(5,191	)


Cash flows from financing activities:
Proceeds from debt		—			71,320			—			—		71,320
Payments on debt and lease obligations		(73,500	)		(2,551	)		—			—		(76,051	)
Debt issuance costs		—			(583	)		—			—		(583	)

Net cash (used in) provided by financing activities		(73,500	)		68,186			—			—		(5,314	)

Effect of exchange rate change on cash and cash equivalents		—			—			836			—		836

Net increase (decrease) in unrestricted cash and cash equivalents		2			(466	)		576			—		112
Unrestricted cash and cash equivalents, at beginning of period		4			4,918			1,401			—		6,323

Unrestricted cash and cash equivalents, at end of period	$	6		$	4,452		$	1,977		$	—	$	6,435

Spheris Inc.
Notes to Condensed Consolidated Financial Statements
September 30, 2008
(Unaudited)

10. Subsequent Event

On October 3, 2008, Operations entered into an exclusive services agreement with Community Health Systems Professional Services Corporation, a subsidiary of CHS, to provide clinical documentation technology and services to all of its affiliated hospitals. The initial term of the services agreement is five years, and unless terminated in accordance with the terms of the services agreement, will be automatically extended for additional successive one-year periods.

In connection with entering into the services agreement, CHS became a minority owner in Spheris Holding III, the Company’s indirect parent. Additionally, Spheris Holding III issued warrants to CHS to purchase shares of common stock of Spheris Holding III upon the attainment of certain revenue milestones set forth in the warrants. Also in connection with entering into the services agreement, CHS acquired the right to appoint two members to the Company’s board of directors. Simultaneous with the closing of the transaction, CHS appointed two of its senior executives to the Company’s board of directors, and Mr. Wayne Smith, Chairman, President and Chief Executive Officer of CHS, stepped down from the Company’s board of directors.


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

The following discussion of our financial condition and results of operations should be read in conjunction with our condensed consolidated financial statements and related notes thereto included elsewhere in this document. Data for the three and nine months ended September 30, 2008 and 2007 has been derived from our unaudited condensed consolidated financial statements.

FORWARD LOOKING STATEMENTS

This Quarterly Report contains forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Those forward-looking statements include all statements that are not historical statements of fact and those regarding our intent, belief or expectations, including, but not limited to, those statements including the words “expects”, “intends”, “believes”, “may”, “will”, “should”, “continue” and similar language or the negative of such terms or other comparable terminology. Although we believe that the expectations reflected in the forward-looking statements are reasonable, our actual results may differ significantly from those projected in the forward-looking statements. Factors that might cause or contribute to such differences include, but are not limited to, the following in addition to those discussed elsewhere in this Quarterly Report:

	•		the effect of substantial indebtedness on our ability to raise additional capital to fund our business, to react to changes in the economy or our business and to fulfill our obligations under our indebtedness, including our ability to meet financial covenants and other conditions of our senior secured credit facility and indenture governing our senior subordinated notes;

	•		the effect of interest rate fluctuations on our variable rate debt;

	•		restrictions on our operations under our senior secured credit facility and indenture governing our senior subordinated notes;

	•		our ability to fulfill our repayment and repurchase obligations under our senior secured credit facility and the indenture governing our senior subordinated notes upon a change of control;

	•		our history of losses and accumulated deficit;

	•		our ability to effectively manage our global production capacity, including our ability to recruit, train and retain qualified medical language specialists (“MLS”) and maintain high standards of quality service in our operations;

	•		our ability to adapt and integrate new technology into our clinical documentation platforms to improve our production capabilities and expand the breadth of our technology and service offerings, as well as our ability to address any potential unanticipated problems with our information technology systems that could cause an interruption in our services or a decrease in responsiveness to our customers;

	•		our ability to maintain our competitive position against current and future competitors, including our ability to gain new business with acceptable operating margins and on-going price pressures related to our technology and services and the healthcare markets in general;

	•		the reluctance of potential customers to outsource or change providers of their clinical documentation technology and services and its impact on our ability to attract new customers and increase revenues;

	•		financial and operational risks inherent in our global operations, including foreign currency exchange rate fluctuations and transfer pricing laws between the United States and India;

	•		our ability to attract, hire or retain technical and managerial personnel necessary to develop and implement technology and services to our customers;

	•		the effect on our business if we incur additional debt and assume contingent liabilities and expenses in connection with future acquisitions or if we cannot effectively integrate newly acquired operations;

	•		our ability to adequately protect our intellectual property rights, including our proprietary technology and the intellectual property we license from third parties;

	•		our ability to comply with extensive laws and government regulations applicable to us and our customers and our contractual obligations, including those relating to the Health Insurance Portability and Accountability Act (“HIPAA”), and industry scrutiny of billing practices relating to the counting of transcription lines that has been the subject of controversy in the clinical documentation industry;

	•		proposed legislation and possible negative publicity limiting the use of our global service capabilities; and

	•		the effect on our business, including potential operational limitations and conflicts of interest, caused by Warburg Pincus LLC’s control of us and the right of Warburg Pincus LLC, TowerBrook Capital Partners LLC and Community Health Systems, Inc. (“CHS”) to designate certain members of our board of directors and make decisions concerning our business and operations.

Any or all of our forward-looking statements in this Quarterly Report may turn out to be inaccurate. We have based these forward-looking statements largely on our current expectations and projections about future events and financial trends that we believe may affect our financial condition, results of operations, business strategy and financial needs. They can be affected by inaccurate assumptions we might make or by known or unknown risks, uncertainties and assumptions, including the risks, uncertainties and assumptions described in “Risk Factors” disclosed in detail in our Annual Report on Form 10-K for the fiscal year ended December 31, 2007 (our “Annual Report”), filed with the Securities and Exchange Commission (the “SEC”) on March 31, 2008 and in other reports we file with the SEC from time to time. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof. We undertake no obligation to publicly revise these forward-looking statements to reflect events or circumstances occurring after the date hereof or to reflect the occurrence of unanticipated events. All subsequent written and oral forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by the cautionary statements contained in this Quarterly Report and in our Annual Report.

OVERVIEW

We are a leading global provider of clinical documentation technology and services to more than 500 health systems, hospitals and group practices throughout the United States, with significant scale in the highly fragmented clinical documentation marketplace. As of September 30, 2008, we employed approximately 5,000 skilled MLS in the U.S. and India. More than 2,300 of these MLS work out of our three facilities in India, making us one of the largest global providers of clinical documentation technology and services in the industry. We provide quality, value-added clinical documentation technology and service solutions with flexible dictation options for our physician clients, flexible data review options for hospital administrators and well managed work flow and protocols through our proprietary MLS workstation software and integrated clinical documentation platforms.

Clinical documentation is the process of converting dictated patient information into a textual format for inclusion in the patient’s medical record and is an integral part of the health information management, or HIM, department for healthcare providers. Clinical documentation is used by many healthcare industry participants to further patient care, support medical reimbursements, facilitate legal and compliance standards, and can be leveraged for research purposes. We believe an increase in demand for clinical documentation technology and services will be driven by:

	•		the growing and aging population’s need for more medical tests, treatments and procedures that require documentation;

	•		the migration of record-keeping from paper to electronic format;

	•		the need for accurate documentation necessary to comply with increasingly stringent regulations and reimbursement requirements;

	•		the desire of healthcare providers to maximize the amount of time spent on patient care, while minimizing the physicians’ administrative duties; and

•

the need for healthcare providers to have timely and accurate documentation in order to improve receivables collection, manage costs and provide high quality care.

We utilize leading technologies to support our clinical documentation technology and services. Our systems have the capability to capture, store and manage voice dictation, digitize voice dictation and deliver electronically formatted records via print, facsimile, secure internet portal and direct interface with a customer’s HIM system. We also utilize encryption and security systems that assist our customers with their compliance with privacy and security standards, such as HIPAA, and the protection of the confidentiality of medical records.

Our operations are conducted through Operations and its subsidiaries — Spheris Leasing LLC, which has historically been used to facilitate equipment procurement; Spheris Canada Inc., which was formed to facilitate our Canadian operations; Spheris, India Private Limited (“SIPL”), which was formed to conduct our Indian operations; and Vianeta Communications (“Vianeta”), which was acquired in March 2006.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

Critical accounting policies are those accounting policies that can have a significant impact on the presentation of our financial condition and results of operations, and that require the use of complex and subjective estimates and assumptions that are believed to be reasonable under the circumstances based on past experience and management’s judgment. Actual results could differ from these estimates. As more information becomes known, these estimates and assumptions could change, having an impact on the amounts reported in the future. A summary of our critical accounting policies is described under the caption “Critical Accounting Policies and Estimates” in “Management’s Discussion and Analysis of

Financial Condition and Results of Operations” in our Annual Report. There have not been any material changes in our critical accounting policies since December 31, 2007.

RESULTS OF OPERATIONS

Net Revenues and Expense Components

The following descriptions of the components of net revenues and expenses apply to the comparison of results of operations for the periods presented.

Net Revenues. Net revenues are generated primarily from the provision of clinical documentation and related services to healthcare providers, including the sale and licensing of clinical documentation software products. Historical net revenue growth has been driven by revenue from acquisitions, market share gains from competitors, new business from increased outsourcing of in-house clinical documentation departments and revenue growth from existing customers. Other factors affecting net revenues include customer retention, competing technologies and price stability. Net revenues from existing customers are primarily driven by three factors: (i) adding new departments within existing customers, (ii) growth in the number of authors at customer sites and (iii) growth in transcribed lines per author (generally resulting from increased documentation of patient encounters and increased familiarity with our clinical documentation system). Additionally, net revenues are impacted by contractual revenue adjustments, which represent credits against billings and ultimately reductions to revenues. We monitor actual performance against contract standards and record credits against billings when the contract standards are not met. We have historically experienced no material seasonal fluctuation that affects operating results.

Direct Costs of Revenues. Direct costs of revenues consist primarily of salaries of, and employee benefits for, MLS and the functions that support our clinical documentation technology and services, including: (i) MLS managers and personnel involved with helpdesk services, (ii) new customer implementation, (iii) MLS recruiting, (iv) training, (v) account services, (vi) telecommunications support and (vii) other applications support. Other direct costs include telecommunication costs and other production-related operating expenses, including: (i) MLS recruitment advertising, (ii) maintenance and support for hardware and software, (iii) travel for support personnel, (iv) bad debt expense, (v) professional fees, (vi) shipping and (vii) supplies. Direct costs of revenues do not include depreciation and amortization, which are discussed below.

Selling, General and Administrative Expenses. Selling expenses include sales and marketing expenses associated with our sales personnel and marketing department. General and administrative expenses represent costs associated with our senior management team, back office support and other non-operating departments. Additionally, general and administrative expenses include the costs of the development of our software products.

Depreciation and Amortization. Depreciation and amortization consist of fixed asset depreciation and amortization of intangibles considered to have finite lives.

Interest Expense. Interest expense primarily relates to interest paid on outstanding debt balances and financed lease obligations.

Executive Summary

Our long-term strategy is to be the clinical documentation industry leader by providing technology and services to healthcare providers supported by a global workforce network. The clinical documentation industry, as a whole, continues to be challenged by the development and integration of new technology into clinical documentation service offerings to improve production capabilities and expand the breadth of products and services offered. The increased demand for electronic health records, shorter turnaround times and on-going pricing pressures related to our products, technology and services and the healthcare markets in general are placing additional pressure on the clinical documentation industry. We believe the global and technology investments we have made to increase our production capabilities and the efficiencies of our MLS workforce have placed us in an improved position to address these challenges.

During the first nine months of 2008, we continued to focus our efforts on improving our production capabilities through better utilization of our global workforce, which helped improve both service levels and production efficiencies. In furtherance of these initiatives, we expanded our global operations through the opening of our third India site in Hyderabad, India during the first quarter of 2008. We also continued to make investments in our technologies to further accelerate the development and enhancement of our product and service offerings, including the integration of speech recognition technology into our clinical documentation platforms. While these technology investments increased the

direct costs of revenues and general and administrative expenses during the first nine months of 2008, these technology initiatives are already beginning to drive operating margin improvements as our new and improved products and services are implemented throughout our customer base.

On October 3, 2008, we entered into an exclusive, five-year services agreement with Community Health Systems Professional Services Corporation, a subsidiary of CHS, the leading operator of community-based hospitals in the U.S., to provide clinical documentation technology and services to all of its affiliated hospitals. The initial term of the services agreement is five years, and unless terminated in accordance with the terms of the services agreement, will be automatically extended for additional successive one-year periods. The system-wide transition of CHS facilities to our clinical documentation technology and services is expected to take place over the next thirty-six months.

In connection with entering into the services agreement, CHS became a minority owner in Spheris Holding III, our indirect parent. Additionally, Spheris Holding III issued warrants to CHS to purchase shares of common stock of Spheris Holding III upon the attainment of certain revenue milestones set forth in the warrants. Also in connection with entering into the services agreement, CHS acquired the right to appoint two members to our board of directors. Simultaneous with the closing of the transaction, CHS appointed two of its senior executives to our board of directors, and Mr. Wayne Smith, Chairman, President and Chief Executive Officer of CHS, stepped down from our board of directors after more than seven years of service.

Three Months Ended September 30, 2008 Compared to Three Months Ended September 30, 2007

Net Revenues. Net revenues were $44.7 million for the three months ended September 30, 2008 as compared to $48.9 million for the three months ended September 30, 2007. The decrease in net revenues during the third quarter of 2008 as compared to the prior year period was due primarily to the impact of net lost business and lower average pricing.

Direct Costs of Revenues. Direct costs of revenues were $31.7 million, or 70.9% of net revenues, for the three months ended September 30, 2008 as compared to $35.1 million, or 71.8% of net revenues, for the three months ended September 30, 2007. The decrease in direct costs of revenues as a percentage of net revenues during the third quarter of 2008 as compared to the prior year period was primarily due to operational efficiencies gained through increased utilization of our global production workforce and speech recognition technologies. These savings were partially offset by costs associated with the expansion of our global capacity and the impact of revenue pricing.

Marketing, Selling, General and Administrative Expenses. Marketing, selling, general and administrative expenses were $6.0 million, or 13.4% of net revenues, for the three months ended September 30, 2008 as compared to $6.2 million, or 12.7% of net revenues, for the three months ended September 30, 2007. The decrease in marketing, selling, general and administrative expenses during the third quarter of 2008 as compared to the prior year period was primarily due to savings from the restructuring of certain overhead departments and other operational cost savings initiatives. These savings were partially offset by accelerated technology investments to further develop and enhance our product and service offerings.

Depreciation and Amortization. Depreciation and amortization was $5.9 million, or 13.2% of net revenues, for the three months ended September 30, 2008 as compared to $6.0 million, or 12.3% of net revenues, for the three months ended September 30, 2007.

Interest Expense. Interest expense was $4.7 million, or 10.5% of net revenues, for the three months ended September 30, 2008 as compared to $5.3 million, or 10.8% of net revenues, for the three months ended September 30, 2007. The decrease in interest expense during the third quarter of 2008 as compared to the prior year period was due to lower interest rates on our outstanding debt during the current-year period.

Other Expense. Other expense of $0.8 million, or 1.8% of net revenues, for the three months ended September 30, 2008, was primarily composed of the change in the fair value of our forward currency exchange contracts used to hedge against fluctuations in exchange rates.

Income Taxes. We recognized a $1.7 million income tax benefit for the three months ended September 30, 2008 as compared to a $1.9 million income tax benefit for the three months ended September 30, 2007. The change in the total effective tax rate for the three months ended September 30, 2008 as compared to the prior year period resulted primarily from changes in valuation amounts on our net operating loss assets.

Net Loss. Net loss was $2.6 million for the three months ended September 30, 2008 as compared to $3.5 million for the three months ended September 30, 2007.

Nine Months Ended September 30, 2008 Compared to Nine Months Ended September 30, 2007

Net Revenues. Net revenues were $141.1 million for the nine months ended September 30, 2008 as compared to $151.8 million for the nine months ended September 30, 2007. The decrease in net revenues during the first half of 2008 as compared to the prior year period was due primarily to the impact of net lost business and lower average pricing.

Direct Costs of Revenues. Direct costs of revenues were $102.8 million, or 72.9% of net revenues, for the nine months ended September 30, 2008 as compared to $108.8 million, or 71.7% of net revenues, for the nine months ended September 30, 2007. The increase in direct costs of revenues as a percentage of net revenues during the first nine months of 2008 as compared to the prior year period was primarily due to the impact of costs associated with the expansion of our global capacity, certain costs associated with training and transitioning our workforce to speech recognition technologies, service level investments and the impact of revenue pricing. These increases were partially off-set by operational efficiencies gained through increased utilization of our global production workforce and speech recognition technologies, in addition to the realization of certain overhead cost savings.

Marketing, Selling, General and Administrative Expenses. Marketing, selling, general and administrative expenses were $19.6 million, or 13.9% of net revenues, for the nine months ended September 30, 2008 as compared to $18.7 million, or 12.3% of net revenues, for the nine months ended September 30, 2007. The increase in marketing, selling, general and administrative expenses during the first nine months of 2008 as compared to the prior year period was primarily due to accelerated technology investments to further develop and enhance our product and service offerings, $1.3 million of expenses relating to a transaction that was not consummated and defense costs associated with our patent infringement lawsuit. These increases were partially offset by savings from the restructuring of certain overhead departments and other operational cost savings initiatives.

Depreciation and Amortization. Depreciation and amortization was $17.7 million, or 12.5% of net revenues, for the nine months ended September 30, 2008 as compared to $18.2 million, or 12.0% of net revenues, for the nine months ended September 30, 2007.

Interest Expense. Interest expense was $14.4 million, or 10.2% of net revenues, for the nine months ended September 30, 2008 as compared to $16.1 million, or 10.6% of net revenues, for the nine months ended September 30, 2007. The decrease in interest expense during the first nine months of 2008 as compared to the prior year period was due to more favorable interest margins under our 2007 Senior Credit Facility, which replaced our prior senior secured credit facility in July 2007, as well as lower interest rates on our outstanding debt during the current-year period.

Other Expense. Other expense of $1.4 million, or 1.0% of net revenues, for the nine months ended September 30, 2008, was primarily composed of the change in the fair value of our forward currency exchange contracts used to hedge against fluctuations in exchange rates.

Income Taxes. We recognized a $5.6 million income tax benefit during the nine months ended September 30, 2008 as compared to a $4.6 million income tax benefit for the nine months ended September 30, 2007. The change in the total effective tax rate for the nine months ended September 30, 2008 as compared to the prior year period was primarily due to changes in valuation amounts on our net operating loss assets.

Net Loss. Net loss was $9.3 million for the nine months ended September 30, 2008 as compared to $7.5 million for the nine months ended September 30, 2007.

Liquidity and Capital Resources

Our primary sources of liquidity are cash flow provided by our operations, available cash on hand and borrowings under our revolving credit facility. We had total unrestricted cash and cash equivalents and net working capital of $9.9 million and $26.4 million, respectively, as of September 30, 2008 as compared to total unrestricted cash and cash equivalents and net working capital of $7.2 million and $22.2 million, respectively, as of December 31, 2007. The increase in net working capital was primarily attributable to a $5.0 million draw from the revolver portion of our 2007 Senior Credit Facility in June 2008, which has been used in part to help fund our accelerated technology spending and certain operating obligations.

We generated $1.0 million of cash from operating activities during the nine months ended September 30, 2008 as compared to $9.8 million of cash generated from operating activities during the same period in 2007. The decrease in cash generated from operating activities during the first nine months of 2008 as compared to the prior year period was attributable to the year over year change in operating performance, timing of wages and benefit payments, and the current

period payment of certain security deposits, as offset by the favorable impact of improved collections on accounts receivable.

We had $5.0 million, or 3.5% of net revenues, of capital expenditures during the nine months ended September 30, 2008 as compared to $3.6 million, or 2.4% of net revenues, of capital expenditures for the same period in 2007. The increase in capital expenditures during the first nine months of 2008 as compared to the prior year period was due to the expansion of our global operations through the opening of our third site in India, which opened in the first quarter of 2008, the relocation of certain corporate functions to our Franklin, Tennessee corporate headquarters, and technology and infrastructure improvements to support our systems and services. Our growth strategy will require continued capital expenditures in 2008. We currently expect that our capital expenditures will be $6.0 million to $7.0 million in 2008. For the remainder of 2008, we anticipate incurring additional capital expenditures for technology improvements and upgrades to support our systems and services. We plan to finance our proposed capital expenditures with cash generated from operations, cash on hand and, if necessary, borrowings under our revolving credit facility.

The 2007 Senior Credit Facility consists of a term loan in the original principal amount of $70.0 million and a revolving credit facility in an aggregate principal amount not to exceed $25.0 million outstanding at any time. The revolving loans and the term loan bear interest at LIBOR plus an applicable margin or the reference bank’s rate plus an applicable margin, at our option. Under the revolving credit facility, we may borrow up to the lesser of $25.0 million or a loan limiter amount, as defined in the 2007 Senior Credit Facility, less amounts outstanding under letters of credit. During August 2008, we utilized $2.3 million of our revolving credit facility to fund certain security deposits, previously secured through letters of credit. As of September 30, 2008, we had $7.3 million outstanding under the revolver portion of the 2007 Senior Credit Facility. As a result, our total remaining capacity for borrowings under the 2007 Senior Credit Facility was $17.7 million as of September 30, 2008.

All unpaid principal amounts under the 2007 Senior Credit Facility are due at maturity on July 17, 2012. Additionally, we are required to perform annual excess cash flow calculations, as defined in the 2007 Senior Credit Facility, and to remit any applicable amounts to reduce the outstanding term loan balance. Interest payments under the 2007 Senior Credit Facility are due monthly or at other intervals not to exceed every three months, depending on the interest elections made by us. At September 30, 2008, approximately $0.1 million of accrued interest was outstanding under the 2007 Senior Credit Facility.

Under the 2007 Senior Credit Facility, Operations is the borrower. The 2007 Senior Credit Facility is secured by substantially all of our assets and is guaranteed by Spheris, Spheris Holding II and all of Operations’ subsidiaries, except SIPL. The 2007 Senior Credit Facility contains certain covenants which, among other things, limit the incurrence of additional indebtedness, investments, dividends, transactions with affiliates, asset sales, acquisitions, mergers and consolidations, liens and encumbrances and other matters customarily restricted in such agreements. The 2007 Senior Credit Facility also contains customary events of default, the occurrence of which could allow the collateral agent to declare any outstanding amounts to be immediately due and payable. The financial covenants contained in the 2007 Senior Credit Facility will become more restrictive over time. Future drawings under the 2007 Senior Credit Facility will be available only if, among other things, we are in compliance with the financial covenants and other conditions required under the 2007 Senior Credit Facility. Our ability to meet those covenants and conditions will depend on our results of operations. We believe we were in compliance with the financial covenants in the 2007 Senior Credit Facility as of September 30, 2008. Although we currently believe that we will be able to maintain continued compliance with our financial covenants, there can be no assurance that we will remain in compliance with the financial covenants for future periods or that, if we default under any of our covenants, we will be able to obtain waivers or amendments that will allow us to operate our business in accordance with our plans.

Our $125.0 million of 11% senior subordinated notes are due 2012. The notes are general unsecured senior subordinated obligations of ours, are subordinated in right of payment to existing and future senior debt, are pari passu in right of payment with any future senior subordinated debt and are senior in right of payment to any future subordinated debt. Our domestic operating subsidiaries are guarantors of the notes. Interest is payable semi-annually on these notes, and all principal is due on maturity in 2012. The senior subordinated notes are effectively subordinated to all of our and our guarantors’ secured debt to the extent of the value of the assets securing the debt and are structurally subordinated to all liabilities and commitments (including trade payables and lease obligations) of our subsidiary that is not a guarantor of the notes. The senior subordinated notes contain certain restrictive covenants that place limitations on our incurrence of additional debt, payment of dividends and other items as specified in the indenture governing the notes. Defaults under, and acceleration of amounts due on, our obligations under the 2007 Senior Credit Facility would create an event of default under the senior subordinated notes, which would cause the notes to become due and payable immediately upon notice by the holders.

We completed the sale and issuance of our senior subordinated notes in a private placement to qualified institutional buyers pursuant to Rule 144A under the Securities Act of 1933, as amended (the “Securities Act”). During 2006, we filed a registration statement on Form S-4 (Registration No. 333-132641) with the SEC to exchange the senior subordinated notes for a new issuance of identical debt securities that are registered under the Securities Act. The exchange offer was completed during June 2006.

To fund a portion of the purchase price of Vianeta in March 2006, our current equity investors contributed $8.0 million in cash through an equity investment to Spheris Holding III, which was contributed to Operations. We held $0.2 million in restricted cash as of September 30, 2008 as part of the Vianeta acquisition, including amounts being held until resolution of certain tax matters related to the acquisition.

We believe that the results of our anticipated future operations, together with our cash and cash equivalents, restricted cash and available capacity on our revolving credit facility will be sufficient to meet anticipated cash needs for principal and interest payments on our outstanding indebtedness, working capital, new product development, capital expenditures, contractual obligations and other operating needs for at least the next 12 months. In evaluating the sufficiency of our liquidity, we considered the expected cash flow to be generated by our operations, cash on hand and the available borrowings under the 2007 Senior Credit Facility compared to our anticipated cash requirements for debt service, working capital, new product development, capital expenditures and the payment of taxes, as well as funding requirements for long-term liabilities. We cannot assure you, however, that our operating performance will generate sufficient cash flow or that future borrowings will be available under the 2007 Senior Credit Facility, or otherwise, to enable us to grow our business, service our indebtedness, including the 2007 Senior Credit Facility and the senior subordinated notes, or make anticipated capital expenditures.

Off-Balance Sheet Arrangements

None.

Recent Accounting Pronouncements

SFAS No. 159. In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities — Including an Amendment of FASB Statement No. 115” (“SFAS No. 159”). SFAS No. 159 permits a company to choose to measure many financial instruments and certain other items at fair value at specified election dates. A company will report unrealized gains and losses on items for which the fair value option has been elected in earnings (or another performance indicator if the company does not report earnings) at each subsequent reporting date. The fair value option: (i) may be applied instrument by instrument, with a few exceptions, such as investments otherwise accounted for by the equity method; (ii) is irrevocable (unless a new election date occurs); and (iii) is applied only to entire instruments and not to portions of instruments. SFAS No. 159 became effective for us as of January 1, 2008. We did not make a fair value election pursuant to this standard at the effective date and as such, the adoption of SFAS No. 159 had no effect on our results of operations or financial position.

SFAS No. 141(R). In December 2007, the FASB issued SFAS No. 141(R), “Business Combinations” (“SFAS No. 141(R)”). SFAS No. 141(R) retains the current purchase method of accounting for acquisitions, but requires a number of changes, including changes in the way assets and liabilities are recognized in the purchase accounting, as well as requiring the expensing of acquisition-related costs as incurred. Furthermore, SFAS No. 141(R) provides guidance for recognizing and measuring the goodwill acquired in the business combination and specifies what information to disclose to enable

users of the financial statements to evaluate the nature and financial effects of the business combination. SFAS No. 141(R) will be effective for fiscal years beginning on or after December 15, 2008. Earlier adoption is prohibited. While we have not yet fully evaluated the impact, if any, that the implementation of SFAS No. 141(R) will have on our results of operations or financial position, we have determined that we will be required to expense costs related to any future acquisitions as they are incurred beginning January 1, 2009.

SFAS No. 160. In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements — An Amendment of ARB No. 51” (“SFAS No. 160”). SFAS No. 160 establishes accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. SFAS No. 160 requires that earnings or losses attributed to noncontrolling interests be reported as part of consolidated earnings rather than as a separate component of income or expense. SFAS No. 160 will be effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 31, 2008. Earlier adoption is prohibited. As all of our subsidiaries are wholly-owned, we do not anticipate that the adoption of SFAS No. 160 will have a material impact on our results of operations or financial position.

SFAS No. 161. In March 2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities — An Amendment of FASB Statement No. 133” (“SFAS No. 161”). SFAS No. 161 requires entities that utilize derivative instruments to provide qualitative disclosures about their objectives and strategies for using such instruments, as well as any details of credit-risk-related contingent features contained within the derivative instruments. SFAS No. 161 requires disclosure of the amounts and location of derivative instruments included in an entity’s financial statements, as well as the accounting treatment of such instruments under FASB Statement No. 133, “Accounting for Derivative Instruments and Hedging Activities” and the impact that hedges have on an entity’s financial position, financial performance and cash flows. SFAS No. 161 is effective for fiscal years and interim periods beginning after November 15, 2008, with early adoption encouraged. SFAS No. 161 encourages, but does not require, comparative disclosures for earlier periods at initial adoption. We do not anticipate that the adoption of SFAS No. 161 will have a material impact on the disclosures contained within our financial statements.


Item 3.		Quantitative and Qualitative Disclosures About Market Risk

The variable interest rates under our senior secured credit facility expose us to market risk from changes in interest rates. We manage this risk by managing the time span of the interest periods elected under this facility. Assuming a 10% increase in interest rates available to us on our variable portion of debt, we would have incurred $0.1 million and $0.3 million in additional interest expense during the three and nine months ended September 30, 2008, respectively. We have entered into certain interest rate management agreements under our 2007 Senior Credit Facility to protect us from unfavorable changes in market interest rates.

We are exposed to market risk with respect to our cash and cash equivalent balances. As of September 30, 2008, we had unrestricted cash and cash equivalents of $9.9 million. The remaining cash of $0.3 million as of September 30, 2008 is restricted cash that is currently available for distribution to former HealthScribe and Vianeta shareholders, and certain amounts being held until resolution of certain tax matters related to the Vianeta acquisition. Assuming a 10% decrease in interest rates available on invested cash balances, interest income would have decreased by $1,000 and $7,000 during the three and nine months ended September 30, 2008.

We had $2.4 million in cash accounts in India in U.S. dollar equivalents as of September 30, 2008. We manage the risk of changes in exchange rates through forward foreign currency contracts.

The above market risk discussion and the estimated amounts presented are forward-looking statements of market risk assuming the occurrence of certain adverse market conditions. Actual results in the future may differ materially from those projected as a result of actual developments in the market.

Item 4T. Controls and Procedures

Disclosure Controls. An evaluation was performed under the supervision and with the participation of our senior management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the period covered by this Quarterly Report. Based on that evaluation, our senior management, including our Chief Executive Officer and Chief Financial Officer, concluded that as of the end of the period covered by this Quarterly Report our disclosure controls and procedures were effective in causing material information relating to us (including our consolidated subsidiaries) to be recorded, processed, summarized and reported by management on a timely basis and to ensure that the quality and timeliness of our public disclosures complies with SEC disclosure obligations.

Changes in Internal Control Over Financial Reporting. There were no changes in our internal control over financial reporting that occurred during the third quarter of 2008 that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Limitations on the Effectiveness of Controls. Our management, including our Chief Executive Officer and Chief Financial Officer, does not expect that our disclosure controls and internal procedures will prevent all errors and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, with us have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of simple error and mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people or by management override of controls.

The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions; over time, a control may become inadequate because of changes in conditions or the degree of compliance with the policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and may not be detected.

PART II
OTHER INFORMATION

Item 1. Legal Proceedings

On November 6, 2007, we were sued for patent infringement by Anthurium Solutions, Inc. in the U.S. District Court for the Eastern District of Texas, alleging that we had infringed and continue to infringe United States Patent No. 7,031,998 through our use of our Clarity technology platform. The complaint also alleges claims against MedQuist Inc. and Arrendale Associates, Inc., and seeks injunctive relief and unspecified damages, including enhanced damages and attorneys’ fees. We timely filed our answer and a counterclaim seeking a declaratory judgment of non-infringement and invalidity. Although we currently believe these claims are without merit, our investigation of the claims is ongoing. The discovery phase of the litigation has commenced. The claim construction hearing was held on November 6, 2008, and we expect a ruling to be made in sixty (60) to ninety (90) days. The trial date is currently set for October 6, 2009. We plan to vigorously defend against the claim of infringement and pursue all available defenses

Item 1A. Risk Factors

There have not been any material changes in our risk factors as previously disclosed in our Annual Report.


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

None.


Item 3.		Defaults Upon Senior Securities

None.


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

None.


Item 5.		Other Information

None.


Item 6.		Exhibits

The following exhibits are filed herewith:


Exhibit
Number		Description of Exhibits

	31.1	Certification of the Company’s Chief Executive Officer pursuant to Securities Exchange Act Rules 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

	31.2	Certification of the Company’s Chief Financial Officer pursuant to Securities Exchange Act Rules 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.


Condensed Consolidated Balance Sheets as of September 30, 2008 (Unaudited) and December 31, 2007			2
Condensed Consolidated Statements of Operations (Unaudited) for the three and nine months ended September 30, 2008 and 2007			3
Condensed Consolidated Statements of Cash Flows (Unaudited) for the nine months ended September 30, 2008 and 2007			4
Notes to Condensed Consolidated Financial Statements (Unaudited)			5


	SPHERIS INC.
Date: November 12, 2008	By:	/s/ Steven E. Simpson
		Steven E. Simpson
		President and Chief Executive Officer


	By:	/s/ Brian P. Callahan
		Brian P. Callahan
		Chief Financial Officer

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Item 1.		Financial Statements