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UNITED STATES


SECURITIES AND EXCHANGE COMMISSION


WASHINGTON, D.C. 20549





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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, 2002





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





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TRANSCEND SERVICES, INC.


(Exact name of registrant as specified in its charter)





Delaware

33-0378756(State or other jurisdiction of

(I.R.S Employerincorporation 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, 2002Common Stock, $.05 par value

4,513,143 Shares





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INDEX


Page NumberPART I.

FINANCIAL INFORMATIONItem 1.

Financial StatementsConsolidated Balance Sheets as of September 30, 2002 and December 31, 2001

3Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2002 and 2001

4Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2002 and 2001

5Notes to Consolidated Financial Statements

6Item 2.

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

8Item 3.

Quantitative and Qualitative Disclosures About Market Risk

10Item 4.

Controls and Procedures

10PART II.

OTHER INFORMATION

11Item 1.

Legal Proceedings

11Item 6.

Exhibits and Reports on Form 8-K

11SIGNATURES

12




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PART I.    FINANCIAL INFORMATION


Item 1.    Financial Statements





TRANSCEND SERVICES, INC.


CONSOLIDATED BALANCE
SHEETS


(Unaudited)


September 30, 2002


December 31, 2001ASSETSCurrent assets:Cash and cash equivalents

$
625,000


$
304,000Accounts receivable, net of allowance for doubtful accounts of $61,000 at September 30, 2002 and $89,000 at December 31,
2001


809,000



1,016,000Prepaid expenses and other current assets


42,000



116,000Total current assets


1,476,000



1,436,000Property and equipment:Computer equipment


1,504,000



3,071,000Software development


1,679,000



1,566,000Furniture and fixtures


156,000



275,000Property and equipment


3,339,000



4,912,000Accumulated depreciation


(1,916,000
)


(3,218,000
)Property and equipment, net


1,423,000



1,694,000Note receivable and other assets


117,000



46,000Total assets

$
3,016,000


$
3,176,000LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilities:Accounts payable

$
98,000


$
174,000Accrued compensation and benefits


379,000



327,000Other accrued liabilities


279,000



366,000Total current liabilities


756,000



867,000Net liabilities of discontinued operations


0



300,000Commitments and contingenciesStockholders 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, 2002 and December 31,
2001


2,000



2,000Series B convertible preferred stock; 60,000 shares issued and outstanding at September 30, 2002 and December 31,
2001


1,000



1,000Common Stock, $.05 par value; 6,000,000 shares authorized, 4,513,000 shares issued and outstanding at September 30, 2002
and December 31, 2001


225,000



225,000Additional paid-in capital


28,141,000



28,141,000Subscription receivable for the purchase of 100,000 shares of common stock


(126,000
)


(126,000
)Accumulated deficit


(25,983,000
)


(26,234,000
)Total stockholders equity


2,260,000



2,009,000Total liabilities and stockholders equity

$
3,016,000


$
3,176,000





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




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TRANSCEND SERVICES, INC.


CONSOLIDATED STATEMENTS OF OPERATIONS


(Unaudited)


Three Months Ended


Nine Months Ended9/30/02


9/30/01


9/30/02


9/30/01Revenue

$
2,988,000


$
2,993,000


$
8,890,000


$
8,810,000Direct costs


2,250,000



2,263,000



6,655,000



6,623,000Gross profit


738,000



730,000



2,235,000



2,187,000Operating expenses:Sales and marketing


126,000



60,000



326,000



260,000Research and development


93,000



83,000



263,000



240,000General and administrative


619,000



621,000



1,882,000



1,807,000Total operating expenses


838,000



764,000



2,471,000



2,307,000Operating loss


(100,000
)


(34,000
)


(236,000
)


(120,000
)Gain (loss) on sale of assets


(6,000
)


200,000



956,000



200,000Loss on legal settlement


0



0



0



(576,000
)Interest income (expense), net


2,000



31,000



0



(7,000
)Income (loss) before income tax and discontinued operations


(104,000
)


197,000



720,000



(503,000
)Income tax benefit


0



0



0



116,000Income (loss) from continuing operations


(104,000
)


197,000



720,000



(387,000
)Loss from discontinued operations


0



(199,000
)


(109,000
)


(323,000
)Net income (loss)


(104,000
)


(2,000
)


611,000



(710,000
)Dividends on preferred stock


(120,000
)


(120,000
)


(360,000
)


(359,000
)Net income (loss) attributable to common stockholders

$
(224,000
)

$
(122,000
)

$
251,000



(1,069,000
)Basic income (loss) per share:From continuing operations

$
(0.05
)

$
0.02


$
0.08


$
(0.17
)From discontinued operations


0.00



(0.05
)


(0.02
)


(0.07
)Net income (loss) attributable to common stockholders

$
(0.05
)

$
(0.03
)

$
0.06


$
(0.24
)Weighted average shares outstanding


4,513,000



4,413,000



4,513,000



4,393,000Diluted income (loss) per shareFrom continuing operations

$
(0.05
)

$
0.02


$
0.08


$
(0.17
)From discontinued operations


0.00



(0.05
)


(0.02
)


(0.07
)Net income (loss) attributable to common stockholders

$
(0.05
)

$
(0.03
)

$
0.06


$
(0.24
)Weighted average shares outstanding


4,513,000



4,413,000



4,526,000



4,393,000





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




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TRANSCEND SERVICES, INC.


CONSOLIDATED STATEMENTS OF CASH FLOWS


(Unaudited)





Nine Months Ended September 30,2002


2001Cash flows from operating activities:Net income (loss) attributable to common stockholders

$
251,000


$
(1,069,000
)Adjustments to reconcile net income (loss) to net cash provided by operating activities:Depreciation and amortization


453,000



610,000Gain on sale of assets


(956,000
)


(200,000
)Loss on legal settlement


0



576,000Loss from discontinued operations


109,000



323,000Preferred stock dividends


360,000



359,000Changes in assets and liabilities:Short-term investment


0



1,160,000Accounts receivable, net


207,000



644,000Prepaid expenses


74,000



115,000Notes receivable and other assets


(71,000
)


(44,000
)Accounts payable


(99,000
)


(625,000
)Accrued liabilities


(62,000
)


(1,075,000
)Total adjustments


15,000



1,843,000Net cash provided by continuing operations


266,000



774,000Net cash provided by (used in) discontinued operations


(197,000
)


121,000Net cash provided by operating activities


69,000



895,000Cash flows from investing activities:Capital expenditures


(299,000
)


(437,000
)Proceeds from disposition of assets


911,000



0Net cash provided by (used in) investing activities


612,000



(437,000
)Cash flows from financing activities:Borrowings under line of credit agreement, net


0



54,000Preferred stock dividends


(360,000
)


(359,000
)Proceeds from the exercise of stock options and other issuances


0



34,000Net cash used in financing activities


(360,000
)


(271,000
)Net increase in cash and cash equivalents


321,000



187,000Cash and cash equivalents, at beginning of period


304,000



6,000Cash and cash equivalents, at end of period

$
625,000


$
193,000Supplemental cash flow information:Cash paid for interest expense

$
2,000


$
38,000





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




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TRANSCEND SERVICES, INC.


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


September 30, 2002 and 2001


(Unaudited)





(1)    The accompanying consolidated financial
statements are unaudited and have been prepared by the management of Transcend Services, Inc. (the Company or Transcend) 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. 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, 2001. Footnote disclosure that substantially duplicates the disclosure contained in that document has been omitted.





(2)    On May 31, 2002, the Company sold certain assets and the operations of Cascade Health Information Software,
Inc. (Cascade), a wholly owned subsidiary of the Company, to QuadraMed Corporation for $911,000 in cash, which resulted in a gain on the sale of assets of $956,000. All information presented in the accompanying consolidated financial
statements has been restated to classify Cascade as discontinued operations. As a result of the sale of Cascade, the Company now operates in one, and only one, reportable business segment as a provider of medical transcription services. The
operating results for Cascade were as follows:





Nine Months Ended September 30,2002*


2001Revenue

$
641,000


$
1,437,000Net loss

$
(109,000
)

$
(323,000
)


* Represents
Cascades results for the five months ended May 31, 2002 (the date of sale).





(3)    Effective April 1,
2002, the Company changed the estimated useful life of its proprietary T2K transcription system from four to six years to reflect the success of the Companys on-going software maintenance and enhancement efforts, which are expensed as
incurred, in extending the useful life of the system. This change reduced amortization expense by approximately $17,000 per month, or $51,000 (approximately $0.01 per share) and $102,000 (approximately $0.02 per share) for the three and nine months
ended September 30, 2002, respectively. In addition, during the first quarter of 2002, the Company wrote off fully depreciated computer equipment of $1,710,000 and furniture and fixtures of $162,000 that were no longer in productive use.





(4)    The source of cash from short-term investment of $1,160,000, net of commission expense of $10,000, presented
in the accompanying consolidated statement of cash flows for the nine months ended September 30, 2001 and the loss on legal settlement of $576,000 presented in the accompanying consolidated statement of operations for the nine months ended September
30, 2001 relate to the sale of a short-term investment in the open market on April 2, 2001. This short-term investment, which consisted of 248,703 unregistered shares of common stock of Core, Inc. with resale restrictions that expired on April 1,
2001, was received in a legal settlement on March 31, 2000 at which time the fair market value of said common stock was $1,736,000.





(5)    The Company accounts for its income taxes in accordance with Statement of Financial Accounting Standards (SFAS) No. 109. Certain deferred income 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 during the first quarter of
2001 is included in the consolidated statement of operations for the nine months ended September 30, 2001. An unrelated income tax expense of $5,000 during the second quarter of 2001 for state income taxes is also included in the consolidated
statement of operations for the nine months ended September 30, 2001.





(6)    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. Potentially
dilutive securities were antidilutive and therefore are not included in diluted loss per share calculations in the accompanying statements of operations for the three months ended September 30, 2002 and the three months and nine months ended
September 30, 2001.





(7)    The Company accounts for comprehensive income (loss) under the provisions of SFAS No.
130, Reporting Comprehensive




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Income.The Companys comprehensive income (loss) is presented below for the periods indicated:





Three Months Ended September 30,


Nine Months Ended September 30,2002


2001


2002

2001Net income (loss) attributable to common stockholders

$
(224,000
)

$
(122,000
)

$
251,000

$
(1,069,000
)Reverse valuation reserve on short-term investment


0



0



0


866,000Comprehensive income (loss)

$
(224,000
)

$
(122,000
)

$
251,000

$
(203,000
)





(8)    On March 25, 2002, the Company extended the maturity date of
its $1.5 million line of credit to March 31, 2003. 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 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 19  th
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 that 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. OLOL has subsequently added Transcends insurance carriers as defendants to the lawsuit.





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





On July 9, 2001, Provider HealthNet
Services, Inc. (PHNS) made a written demand for payment from Transcend in the amount of approximately $750,000. The demand was based on allegations that Transcend had breached certain representations and warranties contained in an Asset
Purchase Agreement between PHNS and Transcend entered into on October 13, 2000. Thereafter, Transcend made a counter-demand against PHNS for payment of approximately $93,000 owed under that same Asset Purchase Agreement. The parties subsequently
submitted all disputes in this matter to binding arbitration, which was held on January 23 and 24, 2002. On March 11, 2002, the Final Order of the Arbitrator awarded a net settlement in the amount of approximately $13,000 to PHNS, pending an appeal
to the Arbitrator by Transcend for a credit of approximately $7,000 for interest income due to Transcend from PHNS. On June 13, 2002, Transcend paid approximately $6,000 to PHNS as final settlement of the dispute.





On September 14, 2001, the Company filed a lawsuit against Palmer & Cay Consulting Group, Inc. (P&C), the Companys former insurance
broker. The lawsuit, styled Transcend Services, Inc. v. Palmer & Cay Consulting Group, Inc. was filed in the Superior Court of Fulton County, State of Georgia, Civil Action File No.: 2001-CV-42725. The lawsuit alleged that P&C
negligently failed to advise Transcend of, or otherwise failed to make arrangements to cover, Transcends potential liability for certain healthcare claims submitted by Transcends employees. Transcend sought damages of $450,000,
attorneys fees and interest. On April 10, 2002, Transcend filed a voluntary dismissal of the lawsuit in the Superior Court of Fulton County.





The Company is involved in a dispute with the Internal Revenue Service regarding the timely payment of payroll taxes in prior years. The Company 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. Further, there can be no assurances that this dispute will not have a material adverse effect on the Companys results of operations and
financial condition.




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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





On May 31, 2002, the Company sold certain assets and the operations of Cascade Health Information Software, Inc. (Cascade), a wholly owned subsidiary of the Company, to QuadraMed
Corporation. All information presented in the accompanying consolidated financial statements has been restated to classify Cascade as discontinued operations. As a result of the sale of Cascade, the Company now operates in one, and only one,
reportable business segment that provides medical transcription services to the healthcare industry. The Companys 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. Unless otherwise indicated, the following discussion of the results of operations focuses on the continuing operations of the Company.





Three Months Ended September 30, 2002 Compared to Three Months Ended September 30, 2001





Revenue decreased $5,000 to $2,988,000 for the three months ended September 30, 2002 when compared to revenue in the prior year period due primarily to a slight decrease in production
volume.





Gross profit increased $8,000, or 1%, to $738,000 for the three months ended September 30, 2002 when compared to the gross
profit amount in the comparable prior year period. As a result, gross profit as a percentage of revenue increased to 25% in the third quarter of 2002 compared to 24% in the third quarter of 2001 due to slight production efficiencies.





Sales and marketing expenses increased $66,000, or 110%, to $126,000 in the third quarter of 2002 compared to the same period in 2001. As a result,
sales and marketing expenses as a percentage of revenue increased to 4% in the third quarter of 2002 compared to 2% in the third quarter of 2001. The Company expanded its sales force to enhance the opportunity for revenue growth.





Research and development expenses increased $10,000, or 12%, to $93,000 in the third quarter of 2002 when compared to the amount in the prior year
period and were 3% of revenue in both periods. 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 $2,000 to $619,000 in the third quarter of 2002 when compared to the amount in the prior year period.





The loss on sale of assets of $6,000 in the third quarter of 2002 represents additional charges related to the $962,000 gain on the sale of certain
assets and the operations of Cascade in the second quarter of 2002 for which the Company received $911,000 in cash. The Company reported a gain on the sale of assets of $200,000 in the third quarter of 2001, which represents the earned portion of
earn-out income paid during December 2001 related to operations sold in 1999.





The Company reported net interest income of $2,000 that
was earned primarily on the investment of cash in overnight money market funds for the 3 months ended September 30, 2002. The Company reported net interest income of $31,000 in the third quarter of 2001 due to the recognition of interest income of
approximately $43,000 upon the Companys determination of the ultimate




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collectibility of this interest income on a note receivable.





The Company reported a loss from discontinued operations of $199,000 in the third quarter of 2001 attributable to Cascades operations that were sold during the second quarter of 2002. The loss is
primarily due to relatively low software revenue from new customers in the third quarter of 2001.





Nine Months Ended September 30,
2002 Compared to Nine Months Ended September 30, 2001





Revenue increased $80,000, or 1%, to $8.9 million for the nine months
ended September 30, 2002 when compared to revenue of $8.8 million for the nine months ended September 30, 2001 due primarily to an increase in production volume.





While gross profit increased $48,000, or 2%, to $2.2 million for the nine months ended September 30, 2002 when compared to the amount in the comparable prior year period, gross profit as a percentage of revenue remained the
same at 25% for both periods.





Sales and marketing expenses increased $66,000, or 25%, to $326,000 for the nine months ended September
30, 2002. As a result, sales and marketing expense were 4% of revenue for the nine months ended September 30, 2002 compared to 3% for the same period in 2001. The Company expanded its sales force to enhance the opportunity for revenue growth.





Research and development expenses increased $23,000, or 10%, to $263,000 in the nine months ended September 30, 2002 when compared to
the amount in the prior year period and was 3% of revenue in both periods. 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 increased $75,000, or 4%, to $1.9 million for the nine months ended September 30, 2002 when compared
to the amount in the prior year period primarily as a result of the Companys increasing its reserve for certain legal matters. See Note 9 to the Consolidated Financial Statements included with this report.





The gain on sale of assets of $956,000 represents the gain on the sale of certain assets and the operations of Cascade for which the Company received $911,000 in
cash in the second quarter of 2002. The Company reported a gain on sales of assets of $200,000 in the third quarter of 2001, which represents the earned portion of earn-out income paid during December 2001 related to operations sold in 1999.





The loss on legal settlement of $576,000 in the nine months ended September 30, 2001 was attributable to the sale of publicly held
securities in April 2001 that were acquired in a legal settlement related to ceasing the operations of Transcend Case Management, Inc., a former wholly owned subsidiary of the Company, in 1999.





The Companys interest income and expense netted to zero in the nine months ended September 30, 2002. The interest income earned on the investment of cash in overnight money market
funds during the nine months ended September 30, 2002 was offset by interest expense incurred on periodic short-term borrowings under the Companys line of credit. The Company reported net interest expense of $7,000 in the same period of the
prior year primarily due to borrowings under the Companys line of credit.





The Company reported an income tax benefit of $121,000
in the first quarter of 2001 due to the elimination of deferred income tax liabilities established in prior years that are no longer required. This tax benefit was partially offset by an insignificant amount of state income taxes in the second
quarter of 2001 despite having net operating loss carry-forwards in excess of approximately $20 million. The Company has established a 100% valuation allowance for its net deferred income tax assets due to the uncertainty regarding the realizability
of these net deferred income tax assets, including its net operating loss carry-forwards.





The Company reported losses from discontinued
operations of $109,000 and $323,000 for the nine months ended September 30, 2002 and 2001, respectively, both solely attributable to Cascades operations. The decreased loss is primarily due to Cascades capitalized software development
costs of $169,000 in the five months prior to the sale of Cascade on May 31, 2002.





Liquidity and Capital Resources





The proceeds of $911,000 from the sale of certain assets and the operations of Cascade during the second quarter of 2002 contributed significantly to
the Companys current financial condition. As of September 30, 2002, the Company had cash and cash




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equivalents of $625,000, working capital of $720,000, no debt and full availability of its $1.5 million line of credit, which expires on March
31, 2003.





Stockholders equity totaled $2,260,000 as of September 30, 2002. At present, the Company exceeds the minimum net
tangible assets requirement of $2 million for continued listing on the Nasdaq SmallCap Market System (Nasdaq). Nasdaqs criterion for continued listing changes from minimum net tangible assets of $2 million to minimum
stockholders equity of $2.5 million on November 1, 2002. Management is currently working on a plan to comply with this new criterion.





Net cash provided by continuing operations totaled $266,000 for the nine months ended September 30, 2002 due primarily to non-cash depreciation and amortization expenses and the continued aggressive collection of accounts receivable.
There are only 24 days of revenue in accounts receivable as of September 30, 2002. Prior to its disposition on May 31, 2002, Cascade consumed cash totaling $197,000. As a result, cash provided by operating activities for the nine months ended
September 30, 2002 totaled $69,000.





Other than the proceeds from the sale of Cascade of $911,000 referred to above, the only other
investing activities of the Company during the first nine months of 2002 were capital expenditures of $299,000, primarily for computer hardware and software upgrades and enhancements.





The only financing activities of the Company during the first nine months of 2002 were the payments of the three quarterly preferred stock dividends of $120,000 each.





Aside from cash available under its $1.5 million line of credit referred to above, during the fourth quarter of each year between 2002 and 2005 inclusive, the
Company has potential cash resources of an undetermined amount of earn-out payments, if any, payable by 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 by Transcend in October 2000.





The Company is a defendant in the OLOL lawsuit. In
addition, the Company is involved in a dispute with the Internal Revenue Service (IRS) regarding the timely payment of payroll taxes in prior years. See Note 9 to the Consolidated Financial Statements included with this report and
Legal Proceedings. It is unlikely that the outcome of the OLOL matter will be known in 2002. While the results of an appeals hearing regarding the IRS dispute should be known before the end of 2002, it is not possible to predict the
outcome at this time. However, if either or both outcomes were unfavorable to Transcend, the Company would most likely appeal the verdict or decision. Nonetheless, either or both issues could have a material adverse effect on the Companys
results of operations and financial condition in the future.





Absent a material adverse outcome from the lawsuit and dispute discussed
above, the Company anticipates that cash on hand, together with internally generated funds, cash available under its line of credit and potential cash from the PHNS earn-out agreement, 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 2002 and for the foreseeable future.





Impact of Inflation





Inflation has not had
a material effect on the Company to date. However, the effects of inflation on future operating results will depend in part, on the Companys ability to increase prices or lower expenses, or both, in amounts that offset inflationary cost
increases.





Item 3.    Quantitative and Qualitative Disclosures About Market Risk





The Company has no
material exposure to market risk from derivatives or other financial instruments as of September 30, 2002.





Item 4.    Controls and Procedures





Management has developed and implemented a policy and
procedures for reviewing disclosure controls and procedures and internal controls on a quarterly basis. On October 14 and 15, 2002 (the evaluation dates related to this quarterly report on Form 10-Q for the




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quarterly period ended September 30, 2002) management, including the Companys principal executive and financial officer, evaluated the
effectiveness of the design and operation of disclosure controls and procedures, and, based on its evaluation, our principal executive and financial officer has concluded that these controls and procedures are operating effectively. There were no
significant changes in the Companys internal controls or in other factors that could significantly affect these controls subsequent to the date of managements evaluation. Management noted no significant deficiencies in the design or
operation of the Companys internal controls and the Companys auditors were so advised.





Disclosure controls and procedures
are the Companys controls and other procedures that are designed to ensure that information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported,
within the time periods specified in the Securities and Exchange Commissions rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed
by the Company in the reports that it files under the Exchange Act is accumulated and communicated to management, including the principal executive and financial officer, as appropriate to allow timely decisions regarding required disclosure.





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 19  th 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 that 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. OLOL has subsequently added Transcends insurance carriers as defendants to the lawsuit.





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





The Company is involved in a dispute with the Internal Revenue Service regarding the timely payment of payroll taxes in prior years. The Company believes that it
has meritorious defenses to the related claims and assertions and intends to vigorously defend all claims; however, there can be no assurance that the Company will be successful in defending such claims and assertions. Further, there can be no
assurances that this dispute will not have a material adverse effect on the Companys results of operations and financial condition.





Item 6.    Exhibits and Reports on Form 8-K





| | (a) |  | Exhibit 99.1  Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
| | --- |  | ---------------------------------------------------------------------------------------




| | (b) |  | Reports on Form 8-K:
| | --- |  | --------------------




During the quarter ended September 30, 2002 the Company did not file any reports on Form 8-K.




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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.








October 25, 2002

TRANSCEND SERVICES, INC.  
By:           /S/    LARRY G.
GERDES Larry G. Gerdes, President, Chief Executive Officer and Chief Financial Officer (Principal Executive and Financial Officer)





CERTIFICATION





I, Larry G. Gerdes, certify that:





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





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





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





4.    I am responsible for establishing and maintaining disclosure controls and procedures for the registrant and I have:





a)    designed such disclosure controls and procedures to ensure that material information relating to the
registrant (including its consolidated subsidiaries) is made known to me by others within these entities, particularly during the period in which this quarterly report is being prepared;





b)    evaluated the effectiveness of the registrants disclosure controls and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the Evaluation Date); and





c)    presented in this
quarterly report my conclusions about the effectiveness of the disclosure controls and procedures based on my evaluation as of the Evaluation Date;





5.    I have disclosed, based on my most recent evaluation, to the registrants auditors and audit committee of the registrants board of directors:





a)    All significant deficiencies in the design or operation of the registrants internal controls which could adversely affect the
companys ability to record, process, summarize and report financial data and have identified for the registrants auditors any material weaknesses in the internal controls; and





b)    Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrants internal
controls; and





6.    I have indicated in this quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect internal controls subsequent to the date of my most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.








Date:  October 25, 2002

/S/    LARRY G. GERDES Larry G. Gerdes Chief Executive Officer and Chief Financial Officer







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