<PAGE>

================================================================================

                                  UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549

                                    FORM 10-Q


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

                For the quarterly period ended September 30, 2001

                                       OR

( )  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 0-18217


                            TRANSCEND SERVICES, INC.
             (Exact name of registrant as specified in its charter)


                Delaware                                      33-0378756
     (State or other jurisdiction of                       (I.R.S Employer
      incorporation or organization)                     Identification No.)

           945 East Paces Ferry Rd, Suite 1475, Atlanta, Georgia 30326
             (Address of principal executive offices and zip code)
       Registrant's telephone number, including area code: (404) 364-8000

                                       N/A
     (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  X   No ___
                                                ---

     Indicate the number of shares outstanding of the Registrant's common stock
as of the latest practicable date.

                Class                       Outstanding at October 15, 2001
                -----                       -------------------------------
     Common Stock, $.05 par value                   4,413,143 Shares

================================================================================

<PAGE>

                                      INDEX

<TABLE>
<CAPTION>
                                                                                         Page
                                                                                        Number
                                                                                        ------
<S>                                                                                     <C>
PART I.   FINANCIAL INFORMATION

Item 1.   Financial Statements

              Consolidated Balance Sheets as of
              September 30, 2001 and December 31, 2000 ................................     3

              Consolidated Statements of Operations for the
              Three and Nine Months Ended September 30, 2001 and 2000 .................     4

              Consolidated Statements of Cash Flows for the
              Nine Months Ended September 30, 2001 and 2000 ...........................     5

              Notes to Consolidated Financial Statements ..............................     6

Item 2.   Management's Discussion and Analysis of
              Financial Condition and Results of Operations ...........................     8

Item 3.   Quantitative and Qualitative Disclosures About Market Risk ..................    11

PART II.  OTHER INFORMATION ...........................................................    12

Item 1.   Legal Proceedings ...........................................................    12

Item 6.   Exhibits and Reports on Form 8-K ............................................    12

SIGNATURES ............................................................................    13
</TABLE>


                                       2

<PAGE>

PART I.   FINANCIAL INFORMATION
Item 1. Financial Statements

                            TRANSCEND SERVICES, INC.
                           CONSOLIDATED BALANCE SHEETS
                                   (Unaudited)

<TABLE>
<CAPTION>
                                                                                            September 30, 2001    December 31, 2000
                                                                                            ------------------    -----------------
<S>                                                                                         <C>                   <C>
                                       ASSETS
                                       ------
Current assets:
Cash and cash equivalents                                                                         $    193,000         $      6,000
Short-term investment                                                                                        0              870,000
Accounts receivable, net of allowance for doubtful accounts of $62,000 at
  September 30, 2001 and $542,000 at December 31, 2000                                               1,529,000            1,974,000
Prepaid expenses and other current assets                                                              248,000              165,000
                                                                                            ------------------   ------------------
Total current assets                                                                                 1,970,000            3,015,000
                                                                                            ------------------   ------------------

Property and equipment:
  Computer equipment                                                                                 3,264,000            2,975,000
  Software development                                                                               1,653,000            1,550,000
  Furniture and fixtures                                                                               274,000              220,000
                                                                                            ------------------   ------------------
     Property and equipment                                                                          5,191,000            4,745,000
  Accumulated depreciation                                                                          (3,366,000)          (2,487,000)
                                                                                            ------------------   ------------------
     Property and equipment, net                                                                     1,825,000            2,258,000
                                                                                            ------------------   ------------------
Notes receivable and other assets                                                                      450,000              406,000
                                                                                            ------------------   ------------------
Total assets                                                                                      $  4,245,000         $  5,679,000
                                                                                            ==================   ==================
                        LIABILITIES AND STOCKHOLDERS' EQUITY
                        ------------------------------------
Current liabilities:
Borrowings under line of credit                                                                   $    668,000         $          0
Accounts payable                                                                                       439,000            1,059,000
Accrued compensation and benefits                                                                      257,000              399,000
Other accrued liabilities                                                                              874,000            1,310,000
Deferred income taxes                                                                                        0              121,000
                                                                                            ------------------   ------------------
Total current liabilities                                                                            2,238,000            2,889,000
                                                                                            ------------------   ------------------

Borrowings under line of credit                                                                              0              614,000
                                                                                            ------------------   ------------------

Commitments and contingencies

Stockholders' equity:
Preferred stock, $.01 par value; 21,000,000 shares authorized:
  Series A convertible preferred stock; 212,800 shares issued and outstanding at
     September 30, 2001 and December 31, 2000                                                            2,000                2,000
  Series B convertible preferred stock; 60,000 shares issued and outstanding at
     September 30, 2001 and December 31, 2000                                                            1,000                1,000
Common Stock, $.05 par value; 6,000,000 shares authorized, 4,413,000 and 4,383,000
  shares issued and outstanding at September 30, 2001 and  December 31, 2000, respectively             225,000              224,000
Additional paid-in capital                                                                          28,015,000           27,982,000
Unrealized loss on short-term investment                                                                     0             (866,000)
Accumulated deficit                                                                                (26,236,000)         (25,167,000)
                                                                                            ------------------   ------------------
  Total stockholders' equity                                                                         2,007,000            2,176,000
                                                                                            ------------------   ------------------
Total liabilities and stockholders' equity                                                        $  4,245,000         $  5,679,000
                                                                                            ==================   ==================
</TABLE>


        The accompanying notes are an integral part of these consolidated
                                balance sheets.


                                       3

<PAGE>

                            TRANSCEND SERVICES, INC.
                      CONSOLIDATED STATEMENTS OF OPERATIONS
                                   (Unaudited)


<TABLE>
<CAPTION>
                                                                   Three Months Ended           Nine Months Ended
                                                               ---------------------------  ---------------------------
                                                                  9/30/01       9/30/00       9/30/01        9/30/00
                                                                  -------       -------       -------        -------
<S>                                                            <C>             <C>          <C>            <C>
Revenue:
  Transcription Services                                          $2,993,000   $3,305,000    $8,810,000    $10,796,000
  Cascade Software                                                   432,000      533,000     1,437,000      1,837,000
  Co-Sourcing and CodeRemote                                               0    2,397,000             0      9,857,000
                                                               -------------------------------------------------------
    Total revenue                                                  3,425,000    6,235,000    10,247,000     22,490,000
                                                               -------------------------------------------------------

Direct costs:
  Transcription Services                                           2,263,000    2,711,000     6,623,000      8,977,000
  Cascade Software                                                   263,000      187,000       729,000        621,000
  Co-Sourcing and CodeRemote                                               0    2,126,000             0      8,497,000
                                                               -------------------------------------------------------
    Total direct costs                                             2,526,000    5,024,000     7,352,000     18,095,000
                                                               -------------------------------------------------------

Gross profit:
  Transcription Services                                             730,000      594,000     2,187,000      1,819,000
  Cascade Software                                                   169,000      346,000       708,000      1,216,000
  Co-Sourcing and CodeRemote                                               0      271,000             0      1,360,000
                                                               -------------------------------------------------------
    Total gross profit                                               899,000    1,211,000     2,895,000      4,395,000
                                                               -------------------------------------------------------

Operating expenses:
  Sales and marketing                                                174,000      227,000       629,000        689,000
  Research and development                                           221,000      277,000       625,000        816,000
  General and administrative                                         737,000      751,000     2,084,000      2,632,000
                                                               -------------------------------------------------------
     Total operating expenses                                      1,132,000    1,255,000     3,338,000      4,137,000
                                                               -------------------------------------------------------

Operating income (loss)                                             (233,000)     (44,000)     (443,000)       258,000

Interest income (expense), net                                        31,000     (107,000)       (6,000)      (358,000)
                                                               -------------------------------------------------------

Loss before income tax and discontinued operations                  (202,000)    (151,000)     (449,000)      (100,000)
Income tax benefit                                                         0            0       116,000              0
                                                               -------------------------------------------------------
Loss from continuing operations                                     (202,000)    (151,000)     (333,000)      (100,000)

Income (loss) from discontinued operations                           200,000      231,000      (376,000)       503,000
                                                               -------------------------------------------------------

Net income (loss)                                                     (2,000)      80,000      (709,000)       403,000
Dividends on preferred stock                                        (120,000)    (120,000)     (360,000)      (360,000)
                                                               -------------------------------------------------------
Net income (loss) attributable to common stockholders              ($122,000)  $  (40,000)  ($1,069,000)   $    43,000
                                                               =======================================================

Basic income (loss) per share:
  From continuing operations                                          ($0.07)  $    (0.06)       ($0.16)        ($0.11)
  From discontinued operations                                          0.05         0.05         (0.09)          0.12
                                                               -------------------------------------------------------
     Net income (loss) attributable to common stockholders            ($0.03)      ($0.01)       ($0.24)   $      0.01
                                                               =======================================================
Weighted average shares outstanding                                4,413,000    4,353,000     4,400,000      4,334,000
                                                               =======================================================

Diluted income (loss) per share
  From continuing operations                                          ($0.07)  $    (0.06)       ($0.16)        ($0.09)
  From discontinued operations                                          0.05         0.05         (0.09)          0.10
                                                               -------------------------------------------------------
     Net income (loss) attributable to common stockholders            ($0.03)  $    (0.01)       ($0.24)   $      0.01
                                                               =======================================================
Weighted average shares outstanding                                4,413,000    4,353,000     4,400,000      4,974,000
                                                               =======================================================
</TABLE>

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


                                       4

<PAGE>

                            TRANSCEND SERVICES, INC.
                      CONSOLIDATED STATEMENTS OF CASH FLOWS
                                   (Unaudited)

<TABLE>
<CAPTION>
                                                                                        Nine Months Ended September 30,
                                                                                     ------------------------------------
                                                                                          2001                  2000
                                                                                     ----------------     ---------------
<S>                                                                                  <C>                  <C>
Cash flows from operating activities:
Net income (loss) attributable to common stockholders                                   ($1,069,000)          $    43,000
                                                                                     --------------       ---------------
Adjustments to reconcile net income (loss) to net cash provided by (used in)
operating activities:
  Depreciation and amortization                                                             879,000             1,134,000
  Income (loss) from discontinued operations                                                376,000              (503,000)
  Non-cash operating expenses                                                                     0               553,000
  Preferred stock dividends                                                                 360,000               360,000
  Changes in assets and liabilities:
     Accounts receivable, net                                                               445,000             1,321,000
     Prepaid expenses                                                                       117,000              (143,000)
     Notes receivable and other assets                                                      (44,000)              250,000
     Accounts payable                                                                      (620,000)           (1,540,000)
     Accrued liabilities                                                                   (699,000)           (3,792,000)
                                                                                     --------------       ---------------
        Total adjustments                                                                   814,000            (2,360,000)
                                                                                     --------------       ---------------
Net cash used in continuing operations                                                     (255,000)           (2,317,000)
Net cash provided by (used in) discontinued operations                                    1,160,000              (240,000)
                                                                                     --------------       ---------------
Net cash provided by (used in) operating activities                                         905,000            (2,557,000)
                                                                                     --------------       ---------------

Cash flows from investing activities:
  Capital expenditures                                                                     (446,000)             (725,000)
                                                                                     --------------       ---------------
Net cash used in investing activities                                                      (446,000)             (725,000)
                                                                                     --------------       ---------------

Cash flows from financing activities:
  Borrowings (repayments) under line of credit agreement, net                                54,000              (600,000)
  Principle payments on long-term debt                                                            0              (171,000)
  Preferred stock dividends                                                                (360,000)             (360,000)
  Proceeds from the exercise of stock options and other issuances                            34,000               115,000
                                                                                     --------------       ---------------
Net cash used in financing activities                                                      (272,000)           (1,016,000)
                                                                                     --------------       ---------------

Net increase (decrease) in cash and cash equivalents                                        187,000            (4,298,000)
Cash and cash equivalents, at beginning of period                                             6,000             4,388,000
                                                                                     --------------       ---------------

Cash and cash equivalents, at end of period                                              $  193,000           $    90,000
                                                                                     ==============       ===============

Supplemental cash flow information:
Cash paid for interest expense                                                           $   38,000           $   453,000
Non-cash investing and financing activities:
  Receipt of short-term investment in legal settlement                                   $        0           $ 1,740,000
  Unrealized loss on short-term investment                                               $        0           $  (248,000)
  Conversion of convertible notes payable to a related party to Series B Convertible
     Preferred Stock                                                                     $        0           $ 1,500,000
</TABLE>

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


                                       5

<PAGE>

                            TRANSCEND SERVICES, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                           September 30, 2001 and 2000
                                   (Unaudited)

(1)  The accompanying consolidated financial statements are unaudited and have
been prepared by the management of Transcend Services, Inc. (the "Company") in
accordance with the rules and regulations of the Securities and Exchange
Commission. In the opinion of management, all adjustments, consisting of normal
recurring accruals necessary for the fair presentation of the consolidated
financial position, results of operations and cash flows, have been included.
Common shares and per share data have been restated to include the 1-for-5
reverse stock split effected by the Company on January 14, 2000. For further
information, refer to the consolidated financial statements and footnotes
thereto included in the Company's Form 10-K for the year ended December 31,
2000. Footnote disclosure that substantially duplicates the disclosure contained
in that document has been omitted.

(2)  On March 13, 2001, the Company announced the termination of its efforts to
sell Cascade Health Information Software, Inc. ("Cascade"), which had previously
been reported as discontinued operations in the Company's consolidated financial
statements, due to market conditions. All information presented has been
restated to show the reclassification of Cascade from discontinued to continuing
operations.

(3)  The short-term investment reflected in the accompanying consolidated
balance sheet as of December 31, 2000 was sold in the open market for
approximately $1,164,000, net of commission expense of approximately $10,000, on
April 2, 2001. This investment consisted of the unregistered common stock of a
publicly traded company (Core, Inc.) with a cost basis of approximately
$1,740,000 that was received in a legal settlement effective March 31, 2000 and
was included in the short-term investment account at that time, but it was not
available-for-sale until April 1, 2001 due to resale restrictions under the
securities laws. Subsequent to acquiring this short-term investment, its
carrying value in the Company's books and records was adjusted to the lower of
cost or fair market value by entries to a separate valuation account included in
the stockholders' equity section of the Company's balance sheet. The fair market
value of this short-term investment was approximately $1,181,000 as of March 31,
2001, thereby resulting in an unrealized loss of approximately $559,000, which
was reflected as a reduction in stockholders' equity in the Company's balance
sheet as of that date. The sale transaction resulted in a realized loss of
approximately $576,000 during the second quarter of 2000. See note 9. The loss
from discontinued operations of $376,000 presented in the accompanying
statements of operations for the nine months ended September 30, 2001 includes
this unrealized loss of $576,000 referred to above and the earned portion of an
earn-out payment of $200,000 due December 31, 2001 related to the sale of
certain operations in 1999.

(4)  The Company accounts for its income taxes in accordance with Statement of
Financial Accounting Standards ("SFAS") No. 109. Certain deferred tax
liabilities established in prior years related to the expected tax consequences
of temporary differences between the tax basis of assets and liabilities and
their related reported amounts are no longer required. Accordingly, an income
tax benefit of $121,000 was included in the consolidated statements of
operations during the three months ended March 31, 2001.

(5)  The Company follows SFAS No. 128, "Earnings per Share." That statement
requires the disclosure of basic net income (loss) per share and diluted net
income (loss) per share. Basic net income (loss) per share is computed by
dividing net income (loss) available to common shareholders by the
weighted-average number of common shares outstanding during the period and does
not include any other potentially dilutive securities. Diluted net income per
share gives effect to all potentially dilutive securities. All potentially
dilutive securities were antidilutive and therefore are not included in diluted
net income (loss) per share calculations for the three and nine months ended
September 30, 2001 and for the three months ended September 30, 2000.


                                       6

<PAGE>

(6)  The Company accounts for comprehensive income (loss) under the provisions
of SFAS No. 130, Reporting Comprehensive Income. The Company's comprehensive
income is presented below for the periods indicated:

<TABLE>
<CAPTION>
                           (in 000's)                           Three Months Ended       Nine Months Ended
                                                                ------------------       -----------------
                                                                9/30/01    9/30/00       9/30/01     9/30/00
                                                                -------    -------       -------     -------
     <S>                                                        <C>        <C>           <C>         <C>
     Net income (loss) attributable to common stockholders        ($122)     ($ 40)      ($1,069)        $43
     Unrealized gain (loss) on short-term investment                  0       (196)            0        (248)
                                                                  -----      -----       -------       -----
     Comprehensive loss                                           ($122)     ($236)      ($1,069)      ($205)
                                                                  =====      =====       ========      =====
</TABLE>


(7)  Effective on January 14, 2000 the Company converted $1,500,000 in
convertible notes held by certain directors and executive officers of the
Company into 60,000 shares of Transcend Series B Convertible Preferred Stock
(the "Preferred B Shares"). The Preferred B Shares have a stated value of $25.00
per share. The Preferred B Shares do not pay dividends and have voting rights
equal to the number of shares of Transcend common stock into which the Preferred
B Shares may be converted from time to time. Each share is convertible, at the
option of the holder, at any time into 6.9 unregistered shares of Transcend
Common Stock. The Series B Preferred Shares were issued pursuant to the
exemption from registration contained in Section 4(2) of the Securities Act of
1933 and the regulations promulgated thereunder.

(8)  On March 30, 2001, the Company extended the due date of its $1.5 million
line of credit to March 31, 2002. Repayment of borrowings, if any, under this
line of credit are personally guaranteed by the Company's Chief Executive
Officer and one of its Directors.

(9)  On March 16, 1998, Transcend sold the net assets of Transcend Case
Management, Inc. ("TCM"), its wholly owned subsidiary, to TCM Services, Inc., a
wholly owned subsidiary of Core, Inc. ("Core"). On December 23, 1998 the Company
reacquired TCM from Core and filed an arbitration claim against Core after
learning of Core's intent to discontinue the business. The reacquisition of TCM
was accounted for under the purchase method of accounting. On February 8, 2000,
an arbitrator ruled that Core breached its purchase contract with Transcend and
awarded approximately $1.7 million, plus attorney's fees and arbitration costs,
to Transcend. On March 31, 2000, Core issued 248,703 shares of its unregistered
common stock to Transcend in full and complete settlement of the arbitrator's
award in favor of Transcend. The Company reported gains of $269,000 and $191,000
on this legal settlement, which were included in income from discontinued
operations in the consolidated statements of operations for the three months
ended March 31, and September 30, 2000, respectively. The Company ceased TCM's
operations effective December 31, 1999. See note 3.

(10) On October 13, 2000, the Company completed the sale of its Co-Sourcing and
CodeRemote businesses (the "Businesses") to Provider HealthNet Services, Inc.
The unaudited revenue, direct costs and gross profit for the Businesses are
presented separately in the accompanying consolidated statements of operations.
Since many of the assets and operating expenses of the Businesses are not
separately identifiable, these divestitures are not reported as discontinued
operations. See note 11.

(11) The Company's reportable segments are strategic business units that offer
different services and products. Beginning January 1, 2001, the Company operates
in two segments: (1) Transcription Services; and (2) Cascade Software. The
Company operated in four segments (Transcription Services, Cascade Software,
Co-Sourcing and CodeRemote) throughout most of 2000. With the exception of
Cascade Software, the Company evaluated the other three business segments on the
basis of revenue and gross profit during 2000, since many of the assets and
operating expenses of these segments were not separately identifiable. Cascade
is evaluated based on revenue, gross profit and operating income. The revenue
and gross profit for each segment are presented in the accompanying consolidated
statements of operations for the three and nine months ended September 30, 2001
and 2000. Co-Sourcing and CodeRemote are combined in these statements due to the
insignificance of CodeRemote and the fact that both Co-Sourcing and CodeRemote
were sold during October 2000. The operating losses for Transcription Services
and Cascade Software were $34,000 and $199,000, respectively, for the three
months ended September 30, 2001 and $120,000 and $323,000, respectively, for the
nine months ended September 30, 2001. The operating losses for Cascade Software
were $142,000 and $133,000 for the three and nine months ended September 30,
2000, respectively.


                                       7

<PAGE>

(12) On April 5, 2001, Our Lady of the Lakes Hospital, Inc. ("OLOL") filed a
lawsuit against the Company. The lawsuit, styled "Our Lady of the Lakes
Hospital, Inc. v. Transcend Services, Inc." was filed in the 19th Judicial
District Court, Parish of East, State of Louisiana, Civil Case Number 482775,
Div. A. The lawsuit alleges, among other things, that the Company breached
certain contracts entered into between OLOL and the Company, including a
staffing and management servicing contract, a transcription platform agreement
and a marketing agreement. OLOL is seeking an unspecified amount of monetary
damages. On May 30, 2001, the Company filed a timely Answer which generally
denied all liability, and the Company filed a counterclaim against OLOL
primarily seeking fees owed by OLOL for services performed by the Company and
interest on unpaid invoices.

The Company intends to vigorously defend all claims made by OLOL. The lawsuit is
in a very early procedural stage, however, and therefore it is not possible at
this time to determine the outcome of the actions or the effect that their
outcome may have on the Company's financial condition or operating results.
There can be no assurances that this litigation will not have a material adverse
effect on the Company's results of operations or the Company's financial
condition.

In addition, the Company is a party to various lawsuits encountered in the
normal course of business and believes that it has meritorious defenses to the
related claims and assertions, however, there can be no assurance that the
Company will be successful in defending such claims and assertions.

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

Certain information included in this Quarterly Report on Form 10-Q contains, and
other reports or materials filed or to be filed by the Company with the
Securities and Exchange Commission (as well as information included in oral
statements or other written statements made or to be made by the Company or its
management) contain or will contain, "forward-looking statements" within the
meaning of Section 21E of the Securities Exchange Act of 1934, as amended,
Section 27A of the Securities Act of 1933, as amended and pursuant to the
Private Securities Litigation Reform Act of 1995. Such forward-looking
statements may relate to financial results and plans for future business
activities, and are thus prospective. Such forward-looking statements are
subject to risks, uncertainties and other factors that could cause actual
results to differ materially from future results expressed or implied by such
forward-looking statements. Potential risks and uncertainties include, but are
not limited to, general economic conditions, competition and other uncertainties
detailed in this report and detailed from time to time in other filings by the
Company with the Securities and Exchange Commission (as well as information
included in oral statements or other written statements made or to be made by
the Company or its management). Any forward-looking statements are made pursuant
to the Private Securities Litigation Reform Act of 1995 and, as such speak only
as of the date made.

Results of Operations

Transcend Services, Inc. (the "Company" or "Transcend") provides medical
transcription services and coding and abstracting software to the healthcare
industry. In the Company's Transcription Services business unit, home-based
medical transcription professionals utilizing web-based voice and data
distribution technology document patient care by converting physicians' voice
recordings into electronic medical record documents. The Company's wholly owned
subsidiary, Cascade Health Information Software, Inc. ("Cascade"), provides
state-of-the-art software for the coding and abstracting of patient medical
records.

On October 13, 2000, the Company sold both its facility management business
("Co-Sourcing"), which provided on-site management of hospital medical records
operations, and its remote coding business ("CodeRemote"), which helped
healthcare providers code their medical records, to Provider HealthNet Services,
Inc.

Results of operations presented in the accompanying consolidated statements of
operations include the continuing operations of Transcend Services and Cascade,
two sold operations (Co-Sourcing and CodeRemote) and one discontinued operation
(Transcend Case Management, Inc. ("TCM"), a wholly owned subsidiary that ceased
operations effective December 31, 1999.


                                       8

<PAGE>

Three Months Ended September 30, 2001 Compared to Three Months Ended September
30, 2000

Revenue decreased $2.8 million, or 45%, to $3.4 million for the three months
ended September 30, 2001 compared to revenue of $6.2 million for the three
months ended September 30, 2000. $2.4 million of the $2.8 million decrease is
attributable to the loss of revenue from the businesses that were sold during
October 2000 (Co-Sourcing and CodeRemote). Transcription Services revenue also
declined $312,000, or 9%, to $3.0 million as a result of the Company's
restructuring activities in late 1999 and 2000. At that time, the Company
determined that it was not prudent to convert certain transcription customer
accounts to its T2K technology. The Transcription Services revenue of $3.3
million reported in the third quarter of 2000 includes $387,000 from 7
transcription service agreements that were terminated by the Company during
2000. Accordingly, Transcription Services revenue attributable to current
customers increased slightly in the third quarter of 2001 compared to the third
quarter of 2000. Cascade's revenue decreased $101,000, or 19%, to $432,000 for
the third quarter of 2001 compared to the third quarter of 2000 due primarily to
relatively low software revenue generated from new customer accounts during the
third quarter of 2001.

While gross profit decreased $312,000, or 26%, to $899,000 for the three months
ended September 30, 2001 compared to the amount in the comparable prior year
period, gross profit as a percentage of revenue increased from 19% to 26% during
the same periods. The decrease in gross profit is attributable to the sale of
the Co-Sourcing and CodeRemote businesses, which collectively contributed gross
profit of $271,000 in the third quarter of 2000. The improvement in gross profit
as a percentage of revenue is due to the disposal of Co-Sourcing and CodeRemote,
which only had 11% gross profit margins, and the significant improvement in the
gross profit as a percentage of revenue achieved by Transcription Services,
which reported 24% gross profit margins in the third quarter of 2001, compared
to 18% gross profit margins in the third quarter of 2000. This improvement is
due in large part to the restructuring activity referred to above. Cascade's
gross profit decreased $177,000, or 51%, to $169,000 for the third quarter of
2001 compared to the third quarter of 2000 due to the lower level of high-gross
margin software in the third quarter of 2001 discussed above. As a result,
Cascade's gross profit as a percentage of revenue decreased to 39% in the third
quarter of 2001 compared to 65% in the third quarter of 2000.

Sales and marketing expenses decreased $53,000, or 23%, to $174,000 in the third
quarter of 2001 when compared to the same prior year period, but increased as a
percentage of revenue to 5% in the third quarter of 2001 compared to 4% in the
third quarter of 2000. The Company revamped and expanded its sales force to
enhance the opportunity for revenue growth.

Research and development expenses decreased $56,000, or 20%, to $221,000 in the
third quarter of 2001 when compared to the same prior year period, but increased
as a percentage of revenue to 6% in the third quarter of 2001 compared to 4% in
the third quarter of 2000. The Company believes that the size of its current
research and development staff is sufficient to accomplish its planned
development activities for the remainder of the year.

General and administrative expenses decreased slightly to $737,000 when compared
to the same prior year period due to the fact that the Company substantially
reduced its infrastructure expense required to handle its anticipated lower
level of operating activity and revenue in the second half of 2000.

The Company reported net interest income of $31,000 in the third quarter of 2001
and net interest expense of $107,000 in the third quarter of 2000. This
favorable change of $138,000 is due to: (1) the reduction of debt using a
portion of the proceeds from the sale of the Co-Sourcing and CodeRemote
businesses on October 13, 2000; (2) the reduction of debt using a portion of the
proceeds from the sale of the short-term investment on April 2, 2001; (3) the
nation-wide reduction in the prime interest rate; (4) the below-prime borrowing
rate on the Company's line of credit made possible by the personal repayment
guarantees of the Company's Chief Executive Officer and one of its Directors;
and (5) the recognition of interest income of approximately $43,000 upon the
Company's determination of the ultimate collectibility of this interest income.

The Company reported income from discontinued operations of $200,000 in the
third quarter of 2001, which represents the earned portion of an earn-out
payment due on December 31, 2001 related to operations sold in 1999. The Company
also reported income from discontinued operations of $231,000 in the third
quarter of 2000, most of which was attributable to a gain on the favorable
settlement of the arbitration case related to TCM.


                                       9

<PAGE>

Nine Months Ended September 30, 2001 Compared to Nine Months Ended September 30,
2000

Revenue decreased $12.2 million, or 54%, to $10.2 million for the nine months
ended September 30, 2001 compared to revenue of $22.5 million for the nine
months ended September 30, 2000. $9.9 million of the $10.2 million decrease is
attributable to the loss of revenue from the businesses that were sold during
October 2000 (Co-Sourcing and CodeRemote). Transcription Services revenue also
declined $2.0 million, or 18%, to $8.8 million as a result of the Company's
restructuring activities in late 1999 and 2000. At that time, the Company
determined that it was not prudent to convert certain transcription customer
accounts to its T2K technology. The Transcription Services revenue of $10.8
million reported for the first nine months of 2000 includes $2.1 million from 11
transcription service agreements that were terminated by the Company during
2000. Accordingly, Transcription Services revenue attributable to current
customers increased slightly in the first nine months of 2001 compared to the
first nine months of 2000. Cascade's revenue decreased $400,000, or 22%, to $1.4
million for the nine-month period ended September 30, 2001 when compare to the
prior year period due primarily to relatively low software revenue generated
from new customer accounts during the second and third quarters of 2001.

While gross profit decreased $1.5 million, or 34%, to $2.9 million for the nine
months ended September 30, 2001 compared to the amount in the comparable prior
year period, gross profit as a percentage of revenue increased from 20% to 28%
during the same periods. The decrease in gross profit is attributable to the
sale of the Co-Sourcing and CodeRemote businesses, which contributed gross
profit of $1.4 million in the first nine months of 2000. The improvement in
gross profit as a percentage of revenue is due to the disposal of Co-Sourcing
and CodeRemote, which only had 14% gross profit margins, and the significant
improvement in the gross profit as a percentage of revenue achieved by
Transcription Services, which reported 25% gross profit margins in the first
nine months of 2001, compared to 17% gross profit margins in the first nine
months of 2000. This improvement is due in large part to the restructuring
activity referred to above. Cascade's gross profit decreased $508,000, or 42%,
to $708,000 for the first nine months of 2001 compared to the first nine months
of 2000 due to the lower level of high-gross margin software in the second
quarter and third quarters of 2001 discussed above. As a result, Cascade's gross
profit as a percentage of revenue decreased to 49% in the first nine months of
2001 compared to 66% in the first nine months of 2000.

Sales and marketing expenses decreased $60,000, or 9%, to $629,000 for the nine
months ended September 30, 2001 as compared to the nine months ended September
30, 2000, but increased significantly as a percentage of revenue to 6% in the
first nine months of 2001 compared to 3% in the first nine months of 2000. The
Company revamped and expanded its sales force to enhance the opportunity for
revenue growth.

Research and development expenses decreased $191,000, or 23%, to $625,000 for
the nine months ended September 30, 2001 as compared to the same prior year
period, but increased as a percentage of revenue to 6% in the first nine months
of 2001 compared to 4% in the first nine months of 2000. The Company believes
that the size of its current research and development staff is sufficient to
accomplish its planned development activities for the remainder of the year.

General and administrative expenses decreased $548,000, or 21%, to $2.1 million
for the nine months ended September 30, 2001 compared to the nine months ended
September 30, 2000 as the Company substantially reduced its infrastructure
expense required to handle its lower level of operating activity and revenue.

Net interest expense decreased $352,000 to $6,000 in the first nine months of
2001 from $358,000 in the first nine months of 2000 due to: (1) the reduction of
debt using a portion of the proceeds from the sale of the Co-Sourcing and
CodeRemote businesses on October 13, 2000; (2) the reduction of debt using a
portion of the proceeds from the sale of the short-term investment on April 2,
2001; (3) the nation-wide reduction in the prime interest rate; (4) the
below-prime borrowing rate on the Company's line of credit made possible by the
personal repayment guarantees of the Company's Chief Executive Officer and one
of its Directors; and (5) the recognition of interest income of approximately
$43,000 upon the Company's determination of the ultimate collectibility of this
interest income.

The Company previously reported an income tax benefit of $121,000 in the first
quarter of 2001 due to the elimination of deferred tax liabilities established
in prior years that are no longer required. In the second quarter of 2001, the
Company reported an insignificant amount of state income taxes despite having
net operating loss carry-forwards in excess of approximately $20 million.


                                       10

<PAGE>

The Company reported a loss from discontinued operations of $576,000 in the
second quarter of 2001 attributable to the sale of the short-term investment in
April 2001 that was acquired in conjunction with ceasing the operations of TCM
in 1999. During the third quarter of 2001, the Company reported income from
discontinued operations of $200,000, which represents the earned portion of an
earn-out payment due on December 31, 2001 related to operations sold in 1999. In
the first nine months of 2000, the Company reported income from discontinued
operations of $503,000 due substantially to a gain of approximately $460,000 on
the favorable settlement of the arbitration case related to TCM.

Liquidity and Capital Resources

On April 2, 2001, the Company sold its short-term investment in the common stock
of Core, Inc. ("Core") for approximately $1.2 million. The Company used the
proceeds from the Core stock to reduce its then-current borrowings under its
$1.5 million line of credit, to finance its operating and investing activities,
to pay the quarterly dividends on its preferred stock and to increase its cash
balance. There is approximately $832,000 available for borrowing under the
Company's line of credit as of September 30, 2001. This line of credit expires
on March 31, 2002. The Company's cash balance is $193,000 as of September 30,
2001, which represents an increase of $187,000 relative to the start of 2001.

Continuing operations used cash of $255,000 in operating activities during the
nine months ended September 30, 2001 primarily due to scheduled reductions in
accounts payable and accrued liabilities, which were partially offset by the
aggressive collection of accounts receivable. The Company has a working capital
deficit of $268,000 as of September 30, 2001 compared to a working capital
balance of $126,000 as of December 31, 2000. This $394,000 variance in working
capital is due primarily to a change in the classification of borrowings under
the line of credit from a long-term obligation to a current liability during
2001.

The Company reported a relatively low level of capital expenditures of $446,000
for the nine months ended September 30, 2001. Such capital expenditures were
primarily made for planned additions of computer equipment.

Potential sources of non-operational cash flow during the remainder of 2001
include: (1) an undetermined amount of potential earn-out payments, if any, from
Provider HealthNet Services, Inc. ("PHNS") based on a fixed percentage of
certain defined future revenue recognized by PHNS from the Co-Sourcing and
CodeRemote businesses sold to PHNS in October 2000; (2) an undetermined amount
of potential earn-out payments, if any, from MedQuist, Inc. ("MedQuist") based
on the renewal of certain medical transcription contracts sold to MedQuist in
December 1999; and (3) payment of the note receivable and related accrued
interest approximating $400,000 from MedQuist, which becomes due in December
2001.

The Company anticipates that cash on hand, together with internally generated
funds, cash available under its line of credit, cash collected from the MedQuist
note receivable and related accrued interest and potential cash from the PHNS
and MedQuist earn-out agreements, if any, should be sufficient to finance
continuing operations, make capital investments in the normal and ordinary
course of its business and meet its Series A Convertible Preferred Stock
dividend payment requirements during the remainder of 2001.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Since the Company sold its short-term investment in the unregistered common
stock of a publicly traded company on April 2, 2001, the Company has no material
exposure to market risk from derivatives or other financial instruments. See
note 3 to the accompanying consolidated financial statements.


                                       11

<PAGE>

PART II.  OTHER INFORMATION

Item 1.  Legal Proceedings

On April 5, 2001, Our Lady of the Lakes Hospital, Inc. ("OLOL") filed a lawsuit
against the Company. The lawsuit, styled "Our Lady of the Lakes Hospital, Inc.
v. Transcend Services, Inc." was filed in the 19th Judicial District Court,
Parish of East, State of Louisiana, Civil Case Number 482775, Div. A. The
lawsuit alleges, among other things, that the Company breached certain contracts
entered into between OLOL and the Company, including a staffing and management
servicing contract, a transcription platform agreement and a marketing
agreement. OLOL is seeking an unspecified amount of monetary damages. On May 30,
2001, the Company filed a timely Answer which generally denied all liability,
and the Company filed a counterclaim against OLOL primarily seeking fees owed by
OLOL for services performed by the Company and interest on unpaid invoices.

The Company intends to vigorously defend all claims made by OLOL. The lawsuit is
in a very early procedural stage, however, and therefore it is not possible at
this time to determine the outcome of the actions or the effect that their
outcome may have on the Company's financial condition or operating results.
There can be no assurances that this litigation will not have a material adverse
effect on the Company's results of operations or the Company's financial
condition.

In addition, the Company is a party to various lawsuits encountered in the
normal course of business and believes that it has meritorious defenses to the
related claims and assertions, however, there can be no assurance that the
Company will be successful in defending such claims and assertions.

Item 6.  Exhibits and Reports on Form 8-K

         (a)   No exhibits are required to be filed with this report.

         (b)   Reports on Form 8-K:

               During the quarter ended September 30, 2001, the Company filed a
               Current Report on Form 8-K dated September 6, 2001 reporting the
               requisite information under Item 4 of said Form 8-K regarding
               Changes in Registrant's Certifying Accountant. On September 6,
               2001, the Audit Committee of the Company's Board of Directors
               dismissed Arthur Andersen LLP ("AA") and appointed Miller Ray &
               Houser as its independent auditors for the year ended December
               31, 2001. AA's report on the Company's consolidated financial
               statements for the years ended December 31, 2000 and 1999
               contained no adverse opinion or a disclaimer of opinion, and was
               not qualified or modified as to uncertainty, audit scope or
               accounting principles. There were no disagreements between the
               Company and AA on any matters of accounting principles or
               practices, financial statement disclosure or auditing scope or
               procedure at any time. AA confirmed the Company's representations
               in said Form 8-K in a letter addressed to the Securities and
               Exchange Commission filed with said Form 8-K.


                                       12

<PAGE>

                                   SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned hereunto duly authorized.

                                 TRANSCEND SERVICES, INC.



October 24, 2001                 By: /s/ Larry G. Gerdes
                                     ------------------------------------
                                     Larry G. Gerdes,
                                     President, Chief Executive Officer and
                                     Chief Financial Officer
                                     (Principal Executive and Financial Officer)

                                       13