##### Table of Contents

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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 June 30, 2003



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 incorporation or organization) |  | (I.R.S Employer 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 by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Securities Exchange Act of 1934). Yes ̈No  x



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



|Class                        |  | Outstanding at July 31, 2003
|---------------------------- |  | ----------------------------
|Common Stock, $.05 par value |  | 7,316,565 Shares            



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##### Table of Contents

INDEX



|           |  |                                                                                                 |  | PageNumber
|---------- |  | ----------------------------------------------------------------------------------------------- |  | ----------
|PART I.    |  | FINANCIAL INFORMATION                                                                           |  |           
|          
|Item 1.    |  | Financial Statements                                                                            |  |           
|          
|           |  | Consolidated Balance Sheets as of June 30, 2003 and December 31, 2002                           |  | 3         
|          
|           |  | Consolidated Statements of Operations for the Three and Six Months Ended June 30, 2003 and 2002 |  | 4         
|          
|           |  | Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2003 and 2002           |  | 5         
|          
|           |  | Notes to Consolidated Financial Statements                                                      |  | 6         
|          
|Item 2.    |  | Managements Discussion and Analysis of Financial Condition and Results of Operations           |  | 7         
|          
|Item 3.    |  | Quantitative and Qualitative Disclosures About Market Risk                                      |  | 10        
|          
|Item 4.    |  | Controls and Procedures                                                                         |  | 10        
|          
|PART II.   |  | OTHER INFORMATION                                                                               |  | 11        
|          
|Item 1.    |  | Legal Proceedings                                                                               |  | 11        
|          
|Item 2.    |  | Changes in Securities and Use of Proceeds                                                       |  | 11        
|          
|Item 4.    |  | Submission of Matters to a Vote of Security Holders                                             |  | 11        
|          
|Item 6.    |  | Exhibits and Reports on Form 8-K                                                                |  | 12        
|          
|SIGNATURES |  | 13                                                                                             



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##### Table of Contents

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements



|TRANSCEND SERVICES, INC.                                                                                                                                                                                                                  | 
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | 
|CONSOLIDATED BALANCE SHEETS                                                                                                                                                                                                              
|(Unaudited)                                                                                                                                                                                                                              
|                                                                                                                                                                                                                                          | 
|ASSETS                                                                                                                                                                                                                                    | 
|Current assets:                                                                                                                                                                                                                           | 
|Cash and cash equivalents                                                                                                                                                                                                                 | 
|Accounts receivable, net of allowance for doubtful accounts of $48,000 at June 30, 2003 and $50,000 at December 31,
2002                                                                                                                  | 
|Prepaid expenses and other current assets                                                                                                                                                                                                 | 
|                                                                                                                                                                                                                                          | 
|Total current assets                                                                                                                                                                                                                      | 
|                                                                                                                                                                                                                                          | 
|Property and equipment:                                                                                                                                                                                                                   | 
|Computer equipment                                                                                                                                                                                                                        | 
|Software development                                                                                                                                                                                                                      | 
|Furniture and fixtures                                                                                                                                                                                                                    | 
|                                                                                                                                                                                                                                          | 
|Property and equipment                                                                                                                                                                                                                    | 
|Accumulated depreciation                                                                                                                                                                                                                  | 
|                                                                                                                                                                                                                                          | 
|Property and equipment, net                                                                                                                                                                                                               | 
|                                                                                                                                                                                                                                          | 
|Note receivable and other assets                                                                                                                                                                                                          | 
|                                                                                                                                                                                                                                          | 
|Total assets                                                                                                                                                                                                                              | 
|                                                                                                                                                                                                                                          | 
|LIABILITIES AND STOCKHOLDERS EQUITY                                                                                                                                                                                                      | 
|                                                                                                                                                                                                                                          | 
|Current liabilities:                                                                                                                                                                                                                      | 
|Accounts payable                                                                                                                                                                                                                          | 
|Accrued compensation and benefits                                                                                                                                                                                                         | 
|Other accrued liabilities                                                                                                                                                                                                                 | 
|                                                                                                                                                                                                                                          | 
|Total current liabilities                                                                                                                                                                                                                 | 
|                                                                                                                                                                                                                                          | 
|Commitments and contingencies                                                                                                                                                                                                             | 
|                                                                                                                                                                                                                                          | 
|Stockholders equity:                                                                                                                                                                                                                     | 
|Preferred stock, $.01 par value; 2,000,000 and 21,000,000 shares authorized at June 30, 2003 and December 31, 2002,
respectively:                                                                                                         | 
|Series A convertible preferred stock; 32,000 and 213,000 shares issued and outstanding atJune 30, 2003 and December 31,
2002, respectively.                                                                                               | 
|Series B convertible preferred stock; 0 and 60,000 shares issued and outstanding at June 30, 2003 and December 31, 2002,
respectively                                                                                                     | 
|Common Stock, $.05 par value; 15,000,000 and 6,000,000 shares authorized at June 30, 2003 and December 31, 2002,
respectively: 7,317,000 and 4,413,000 shares issued and outstanding at June 30, 2003 and December 31, 2002, respectively | 
|                                                                                                                                                                                                                                          | 
|Additional paid-in capital                                                                                                                                                                                                                | 
|Accumulated deficit                                                                                                                                                                                                                       | 
|                                                                                                                                                                                                                                          | 
|Total stockholders equity                                                                                                                                                                                                                | 
|                                                                                                                                                                                                                                          | 
|Total liabilities and stockholders equity                                                                                                                                                                                                | 
|                                                                                                                                                                                                                                          | 





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



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##### Table of Contents

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



|                                                     |  | Three Months Ended |           |   | Six Months Ended |  
|---------------------------------------------------- |  | ------------------ | --------- | - | ---------------- | -
|                                                     |  | 6/30/03            |           |   | 6/30/02          |  
|Revenue                                              |  | $                  | 3,393,000 |   |                  | $
|Direct costs                                         |  |                    | 2,321,000 |   |                  |  
|                                                     |  |                    |           |   |                  |  
|Gross profit                                         |  |                    | 1,072,000 |   |                  |  
|                                                     |  |                    |           |   |                  |  
|Operating expenses:                                  |  |                    |           |   |                  |  
|Sales and marketing                                  |  |                    | 206,000   |   |                  |  
|Research and development                             |  |                    | 112,000   |   |                  |  
|General and administrative                           |  |                    | 562,000   |   |                  |  
|                                                     |  |                    |           |   |                  |  
|Total operating expenses                             |  |                    | 880,000   |   |                  |  
|                                                     |  |                    |           |   |                  |  
|Operating income (loss)                              |  |                    | 192,000   |   |                  |  
|Gain on sale of assets                               |  |                    | 0         |   |                  |  
|Interest expense, net                                |  |                    | (1,000    | ) |                  |  
|                                                     |  |                    |           |   |                  |  
|Income before income tax and discontinued operations |  |                    | 191,000   |   |                  |  
|Income tax (expense) benefit                         |  |                    | 0         |   |                  |  
|                                                     |  |                    |           |   |                  |  
|Income from continuing operations                    |  |                    | 191,000   |   |                  |  
|Income (loss) from discontinued operations           |  |                    | 0         |   |                  |  
|                                                     |  |                    |           |   |                  |  
|Net income                                           |  |                    | 191,000   |   |                  |  
|Dividends on preferred stock                         |  |                    | (61,000   | ) |                  |  
|                                                     |  |                    |           |   |                  |  
|Net income attributable to common stockholders       |  | $                  | 130,000   |   |                  | $
|                                                     |  |                    |           |   |                  |  
|Basic income (loss) per share:                       |  |                    |           |   |                  |  
|From continuing operations                           |  | $                  | 0.03      |   |                  | $
|From discontinued operations                         |  |                    | 0.00      |   |                  |  
|                                                     |  |                    |           |   |                  |  
|Net income attributable to common stockholders       |  | $                  | 0.03      |   |                  | $
|                                                     |  |                    |           |   |                  |  
|Weighted average shares outstanding                  |  |                    | 4,634,000 |   |                  |  
|                                                     |  |                    |           |   |                  |  
|Diluted income (loss) per share                      |  |                    |           |   |                  |  
|From continuing operations                           |  | $                  | 0.03      |   |                  | $
|From discontinued operations                         |  |                    | 0.00      |   |                  |  
|                                                     |  |                    |           |   |                  |  
|Net income attributable to common stockholders       |  | $                  | 0.03      |   |                  | $
|                                                     |  |                    |           |   |                  |  
|Weighted average shares outstanding                  |  |                    | 4,815,000 |   |                  |  
|                                                     |  |                    |           |   |                  |  



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)



|                                                                                            |  | Six Months Ended June 30, |         
|------------------------------------------------------------------------------------------- |  | ------------------------- | --------
|                                                                                            |  | 2003                      |         
|Cash flows from operating activities:                                                       |  |                           |         
|Net income attributable to common stockholders                                              |  | $                         | 210,000 
|                                                                                            |  |                           |         
|Adjustments to reconcile net income to net cash provided by (used in) operating activities: |  |                           |         
|Depreciation and amortization                                                               |  |                           | 328,000 
|Gain on sale of assets                                                                      |  |                           | 0       
|Loss related to discontinued operations                                                     |  |                           | 0       
|Preferred stock dividends                                                                   |  |                           | 180,000 
|Changes in assets and liabilities:                                                          |  |                           |         
|Accounts receivable, net                                                                    |  |                           | 28,000  
|Prepaid expenses and other current assets                                                   |  |                           | (202,000
|Notes receivable and other assets                                                           |  |                           | 17,000  
|Accounts payable                                                                            |  |                           | (27,000 
|Accrued liabilities                                                                         |  |                           | (6,000  
|                                                                                            |  |                           |         
|Total adjustments                                                                           |  |                           | 318,000 
|                                                                                            |  |                           |         
|Net cash provided by continuing operations                                                  |  |                           | 528,000 
|Net cash used in discontinued operations                                                    |  |                           | 0       
|                                                                                            |  |                           |         
|Net cash provided by (used in) operating activities                                         |  |                           | 528,000 
|                                                                                            |  |                           |         
|Cash flows from investing activities:                                                       |  |                           |         
|Capital expenditures                                                                        |  |                           | (212,000
|Proceeds from disposition of assets                                                         |  |                           | 0       
|                                                                                            |  |                           |         
|Net cash provided by (used in) investing activities                                         |  |                           | (212,000
|                                                                                            |  |                           |         
|Cash flows from financing activities:                                                       |  |                           |         
|Preferred stock dividends                                                                   |  |                           | (180,000
|Preferred stock redemption/conversion expenses                                              |  |                           | (28,000 
|Proceeds from issuances of common stock                                                     |  |                           | 70,000  
|                                                                                            |  |                           |         
|Net cash used in financing activities                                                       |  |                           | (138,000
|                                                                                            |  |                           |         
|Net increase in cash and cash equivalents                                                   |  |                           | 178,000 
|Cash and cash equivalents, at beginning of period                                           |  |                           | 782,000 
|                                                                                            |  |                           |         
|Cash and cash equivalents, at end of period                                                 |  | $                         | 960,000 
|                                                                                            |  |                           |         
|Supplemental cash flow information:                                                         |  |                           |         
|Cash paid for interest expense                                                              |  | $                         | 0       
|                                                                                            |  |                           |         



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



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TRANSCEND SERVICES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2003 and 2002

(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, 2002. 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 and the assumption of certain liabilities, which resulted in a gain on the sale of assets of $962,000. The Cascade gain was subsequently reduced to $954,000 due to delayed additional
transaction expenses. 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:



|                                                                                                  |  | Three Months Ended June 30, |  | Six Months Ended June 30,
|------------------------------------------------------------------------------------------------- |  | --------------------------- |  | -------------------------
|                                                                                                  |  | 2003                        |  | 2002*                    
|Revenue                                                                                           |  | $0                          |  | $296,000                 
|Net income (loss)                                                                                 |  | $0                          |  | $24,000                  
|* Represents Cascades results for the two and 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) for the three months ended June 30, 2003 and 2002 and the six months ended June 30,
2002; and $102,000 (approximately $0.02 per share) for the six months ended June 30, 2003.



(4) The Company accounts for its income taxes in accordance with Statement of Financial Accounting Standards (SFAS) No. 109. Deferred tax assets and liabilities are recognized for the expected tax
consequences of temporary differences between the tax basis of assets and liabilities and their reported amounts and for operating loss and tax credit carry-forwards. Since the Companys taxable income for the three and six months ended June
30, 2003 and 2002 were offset by available net operating loss carry-forwards, no income tax provisions have been recorded for these periods.



(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.



(6) The Company accounts for comprehensive income (loss) under the provisions of SFAS No. 130, Reporting Comprehensive Income.The Companys comprehensive income was equivalent to its net income
attributable to common stockholders for the three and six months ended June 30, 2003 and 2002.



(7) On March 21, 2003, the Company extended the maturity date of its $1.5 million line of credit to March 31, 2004. 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.



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(8) 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 19thJudicial 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 party to a dispute with another Company regarding the level of fees payable under a cross-marketing agreement that provides for binding arbitration of
disputes. The binding arbitration process has not been scheduled at this time. While the Company believes that it has meritorious defenses against the claims of the other party in the dispute, there can be no assurance that the results of this
binding arbitration will not have material adverse effect on the Companys results of operations and financial condition.



(9) The Company issued 31,050 and 12,372 shares of its unregistered common stock at $1.50 and $2.00 per share, respectively, to certain holders of its Series A
Convertible Preferred Stock who elected to receive their quarterly preferred stock dividends in common stock in lieu of cash at the preferred stock dividend payment dates of February 15 and May 15, 2003.



The Company issued 2,860,000 shares of its unregistered common stock to the holders of its
Series A and B Convertible Preferred Stock in a stockholder-approved transaction to convert most of its outstanding preferred stock to common stock at $2.00 per share on June 25, 2003.



Subsequent to the end of the second quarter of 2003, the Company redeemed the remaining outstanding shares of its preferred stock on July 1,
2003 in a stockholder-approved transaction for $600,000 cash and two short-term promissory notes payable of $100,000 each.



The Company filed a registration statement of Form S-3 with the Securities and Exchange Commission to register these 2,903,422 shares of common stock.





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) provides medical transcription services to the healthcare industry. Powered by its web-based voice and data
distribution technology, the Companys home-based medical language specialists document patient care by converting physicians voice recordings into electronic medical record documents. On May 31, 2002, the Company sold certain assets and
the operations of its wholly owned subsidiary, Cascade Health Information Software, Inc. (Cascade). Cascade previously provided software for the coding and abstracting of patient medical records and is presented as discontinued
operations in 2002.



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Three Months Ended June 30, 2003 Compared to Three Months Ended June 30, 2002



Revenue increased $404,000, or 14% to $3.4 million for the three months ended June 30, 2003
when compared to revenue of $3.0 million for the three months ended June 30, 2002. The net addition of 28 hospital and clinic groups and 13 small physician practice groups since the second quarter of 2002 contributed revenue of $404,000 during the
second quarter of 2003.



Direct costs increased $46,000, or 2%, to $2,321,000
for the three months ended June 30, 2003 when compared to direct costs in the prior year period due primarily to an increase in depreciation and amortization expense related to the amount and timing of capital expenditures for production operations
in the current and prior year.



Gross profit increased $358,000, or 50%, to
$1.1 million for the three months ended June 30, 2003 when compared to the gross profit amount in the comparable prior year period. Gross profit as a percentage of revenue increased to 32% in the second quarter of 2003 compared to 24% in the second
quarter of 2002. The increase in gross profit as a percentage of revenue is primarily due to the mix of gross profit contributed by new and existing customers and the insignificant change in production management, customer service and technical
support infrastructure direct costs during the three months ended June 30, 2003 compared to the same prior year period.



Sales and marketing expenses increased $90,000, or 78%, to $206,000 in the second quarter of 2003 compared to the same period in 2002. As a result, sales and marketing
expenses as a percentage of revenue increased to 6% in the second quarter of 2003 compared to 4% in the second quarter of 2002. The increase in sales and marketing expense is primarily due to increased commissions of $30,000 on new sales, outsourced
marketing services of $20,000 and an increase in the size of the sales force and related recruiting, salary and travel expenses of $40,000.



Research and development expenses increased $26,000, or 30% to $112,000 in the second quarter of 2003 when compared to the amount in the prior year period and were 3% of
revenue in both periods. The increase is primarily due to a reassignment of technology resources from other areas to work on transcription technology development projects. 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 $111,000, or 16% to $562,000, primarily due to the Company increasing its reserve for certain legal matters by $80,000 in the three months ended June 30, 2002. The
remaining expense reduction is attributable to a $30,000 reduction in the allowance for doubtful accounts in the second quarter of 2003 which management deemed appropriate based on customer payment trends with respect to past due accounts.



The gain on sale of assets of $962,000 for the three months ended June 30,
2002 represents the gain from the sale of certain assets and the operations of Cascade on May 31, 2002 (The Cascade gain). The Cascade gain was subsequently reduced to $954,000 due to delayed additional transaction expenses.



The Company reported net interest expense of $1,000 for both periods primarily due to
accounts receivable early payment discounts offered during the three months ended June 30, 2003 and periodic borrowings under the Companys line of credit during the three months ended June 30, 2002.



The Company reported income from discontinued operations of $24,000 in the second quarter of
2002 attributable to Cascades operations that were sold during the second quarter of 2002. Cascade capitalized software development costs of $71,000 in the second quarter of 2002.





Six Months Ended June 30, 2003 Compared to Six Months
Ended June 30, 2002



Revenue increased $972,000, or 16%, to $6.9
million for the six months ended June 30, 2003 when compared to revenue of $5.9 million for the six months ended June 30, 2002 due primarily to the net addition of 28 hospital and clinic groups and 13 small physician practice groups since the first
half of 2002 that contributed revenue of $969,000 during the first half of 2003.



Direct costs increased $287,000, or 7% to $4.7 million for the six months ended June 30, 2003 when compared to direct costs of $4.4 million for the six months ended June 30, 2002. Direct costs as a percentage of revenue decreased from 75%
for the six months ended June 30, 2002 to 68% for the six months ended June 30, 2003. Direct costs consist of the following: 1) transcription



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##### Table of Contents

compensation, 2) production infrastructure expense including production management, customer service, support, and
implementation, and 3) depreciation and amortization expense. The increase in direct costs is primarily due to increased transcription compensation expenses in the amount of $202,000 to handle actual transcription service revenue growth and
increased depreciation and amortization expense of $81,000 related to the amount and timing of capital expenditures for the production operations for the six months ended June 30, 2003. There was a slight increase in total production infrastructure
costs between periods.



While gross profit increased $685,000, or 46%, to $2.2
million for the six months ended June 30, 2003 when compared to the amount in the comparable prior year period, gross profit as a percentage of revenue was 32% for the six months ended June 30, 2003 when compared to 25% for same prior year period.
The increase in gross profit as a percentage of revenue is primarily due to the mix of gross profit contributed by new and existing customers during the six months ended June 30, 2003.



Sales and marketing expenses increased $208,000, or 104%, to $408,000 for the first half of 2003 compared to the first half of 2002. As a
result, sales and marketing expenses as a percentage of revenue increased to 6% in the second quarter of 2003 compared to 3% in the second quarter of 2002. The increase in sales and marketing expense is primarily due to increased commissions of
$103,000 on new sales, outsourced marketing services of $38,000 and an increase in the size of the sales force and related recruiting, salary and travel expenses of $67,000.



Research and development expenses increased $53,000, or 31%, to $223,000 in six months ended June 30, 2003 when compared to the amount in
the prior year period and were 3% of revenue in both periods. The increase is primarily due to a reassignment of technology resources from other areas to work on transcription technology development projects. 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 $102,000, or 8%, to $1.2 million for the six months ended June 30, 2003 when compared to the amount in the prior year period
as a result of the Company increasing its reserve for certain legal matters by $80,000 in the six months ended June 30, 2002.



The gain on sale of assets of $962,000 for the six months ended June 30, 2002 represents the gain from the sale of certain assets and the operations of Cascade on May 31,
2002 (The Cascade gain). The Cascade gain was subsequently reduced to $954,000 due to delayed additional transaction expenses.



Net interest expense decreased $2,000 to zero in the six months ended June 30, 2003 from $2,000 in the six months ended June 30, 2002 due to periodic borrowings under the
Companys line of credit during the six months ended June 30, 2002.



The
Company reported a loss from discontinued operations of $109,000 for the six months ended June 30, 2002 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 first half of 2002 partially offset by capitalized software development costs of $71,000 in the second quarter of 2002.





Liquidity and Capital Resources



The proceeds of $911,000 from the Companys sale of certain assets and the operations
of Cascade during the second quarter of 2002 and the Companys profitable and positive cash flow operations during the fourth quarter of 2002 and the first six months of 2003 contributed significantly to the Companys current financial
condition. As of June 30, 2003, the Company had cash and cash equivalents of $960,000, working capital of $1,421,000, no debt and full availability of its $1.5 million line of credit, which expires on March 31, 2004. However, as discussed below, the
Company used $600,000 cash and short-term promissory notes totaling $200,000 to redeem its remaining outstanding preferred stock on July 1, 2003.



Net cash provided by operating activities totaled $528,000 for the first six months ended June 30, 2003 due primarily to profitable operations and non-cash depreciation
and amortization expenses.



Net cash used in investing activities of the
Company were capital expenditures of $212,000, primarily for computer hardware and software upgrades and enhancements.



Net cash used in financing activities of the Company during the first six months of 2003 were the payments of the quarterly preferred stock dividends of $180,000 and
expenses totaling approximately $28,000 related to the stockholder-approved, redemption and



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conversion of the Companys preferred stock, both partially offset by the proceeds from issuances of common stock to
certain preferred shareholders who elected to receive common stock in lieu of cash dividends at the February 15, 2003 and May 15,2003 preferred stock dividend payment dates.



To simplify its capital structure and to eliminate the adverse cash and net income effects of the preferred stock dividends, the
Companys stockholders approved the amendment to redeem a portion of its preferred stock and convert the remaining preferred stock to common stock at its annual meeting of stockholders on May 6, 2003 (the Preferred Stock Strategy).
As a result, the Company is required to expend $800,000 cash to redeem a portion of the preferred stock. The Company paid $600,000 of this total cash expenditure on July 1, 2003, $100,000 is due on January 1, 2004 and the remaining $100,000 is due
on April 1, 2004.



Aside from cash available under its $1.5 million line of
credit referred to above, during the fourth quarter of each year between 2003 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 and a party to a dispute to be resolved in
binding arbitration. See Note 8 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 2003, but the dispute subject to binding
arbitration should be resolved during the second half of 2003. However, if the outcome of the OLOL lawsuit is unfavorable to Transcend, the Company would most likely appeal the verdict or decision. Nonetheless, the OLOL lawsuit and the results of
the binding arbitration 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 binding arbitration 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 fund
the Preferred Stock Strategy during the remainder of 2003 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 June 30, 2003.





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 July 14, 2003 (the evaluation date related to this quarterly report on Form 10-Q for the quarterly
period ended June 30, 2003) 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.



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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 19thJudicial 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 party to a dispute with another Company
regarding the level of fees payable under a cross-marketing agreement that provides for binding arbitration of disputes. The binding arbitration process has not been scheduled at this time. While the Company believes that it has meritorious defenses
against the claims of the other party in the dispute, there can be no assurance that the results of this binding arbitration will not have material adverse effect on the Companys results of operations and financial condition.





Item 2. Changes in Securities and Use of Proceeds



On February 15, 2003, certain holders of the Companys Series A Convertible Preferred Stock elected to receive their quarterly cash dividends in the aggregate amount of $46,575 in the form of 31,050 shares of unregistered common stock
of the Company based on the closing price per share of the Companys common stock as reported on the Nasdaq SmallCap Market of $1.50 was February 14, 2003, the last trading day before the transaction. On May 15, 2003, certain holders of the
Companys Series A Convertible Preferred Stock elected to receive their quarterly cash dividends in the aggregate amount of $24,744 in the form of 12,372 shares of unregistered common stock of the Company priced at $2.00 per share in a
transaction that was approved by the Companys stockholders on May 6, 2003. The closing stock price per share as reported on the Nasdaq SmallCap Market was $2.92 on May 14, 2003, the last trading day before the transaction. The issuance of
securities described above was made in reliance on the exemption from registration provided by Section 4(2) of the Securities Act of 1933 as a transaction by an issuer not involving a public offering. The securities were acquired by the recipients
thereof for investment and with no view toward the resale or distribution thereof. The offers and sales of the above securities were made without any public solicitation and the stock certificates bear restrictive legends. No underwriter was
involved in the transaction and no commissions were paid.



The Company issued
2,860,000 shares of its unregistered common stock to the holders of its Series A and B Convertible Preferred Stock in a stockholder-approved transaction to convert most of its outstanding preferred stock to common stock at $2.00 per share on June
25, 2003.



Subsequent to the end of the second quarter of 2003, the Company
redeemed the remaining outstanding shares of its preferred stock on July 1, 2003 in a stockholder-approved transaction for $600,000 cash and two short-term promissory notes payable of $100,000 each.



The Company filed a registration statement of Form S-3 with the Securities and Exchange
Commission to register these 2,903,422 shares of common stock.





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



The Company held its Annual Meeting of Stockholders on May 6, 2003. The Stockholders voted on the following four proposals and the results of the voting are presented below.



1. To elect a Board of Directors consisting of four members to hold office until the next
annual meeting of stockholders or until their successors are elected and qualified:



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|Nominee             |  | Votes For |  | VotesWithheld
|------------------- |  | --------- |  | -------------
|Joseph P. Clayton   |  | 4,952,795 |  | 62,851       
|Larry G. Gerdes     |  | 4,930,815 |  | 84,831       
|Walter S. Huff, Jr. |  | 4,931,131 |  | 84,515       
|Charles E. Thoele   |  | 4,952,724 |  | 62,922       



2. To approve an amendment to the
Certificate of Designations, Preferences and Rights of the Companys Series A Convertible Preferred Stock contained in the Companys Certificates of Incorporation, authorizing the Company to partially redeem for cash shares of the
Companys Series A Convertible Preferred Stock and to adjust, for a limited time period, the conversion price of the remainder of the Series A Convertible Preferred Stock. The Stockholders approved said amendment with 2,876,725 votes FOR,
64,113 votes AGAINST and 19,001 ABSTAINING.



3. To approve an amendment to the
Certificate of Designations, Preferences and Rights of the Companys Series B Convertible Preferred Stock contained in the Companys Certificate of Incorporation, authorizing the Company to adjust, for a limited time period, the conversion
price of the Series B Convertible Preferred Stock. The Stockholders approved said amendment with 2,878,528 votes FOR, 65,613 votes AGAINST and 15,698 ABSTAINING.



4. To ratify the appointment of Miller Ray & Houser LLP as independent public accountants to audit the accounts of the Company and its
subsidiaries for the year ending December 31, 2002. The Stockholders ratified said appointment with 5,003,792 votes FOR, 1,749 votes AGAINST and 10,105 ABSTAINING.



The Company held a Special Meeting of Stockholders on June 25, 2003. The Stockholders voted on the following proposal and the results of the
voting are presented below.



1. To approve an amendment to the Companys
Certificate of Incorporation authorizing the Company to increase the number of authorized shares of Common Stock of the Company and to decrease the number of authorized shares of the Preferred Stock of the Company. The Stockholders approved said
amendment with 3,536,091 votes FOR, 10,382 votes AGAINST and 3,293 ABSTAINING.





Item 6. Exhibits and Reports on Form 8-K



(a) Exhibit 31Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.



(b) Exhibit 32Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.



(c) Reports on Form 8-K:



The following report on Form 8-K was filed during the three
months ended June 30, 2003:



(1) Form 8-K, dated and filed
April 21, 2003, a press release announcing the Companys unaudited operating results for the three months ended March 31, 2003 and its unaudited financial condition as of March 31, 2003 and December 31, 2002.

(2) Form 8-K, dated and filed June 25, 2003, filed in connection with the stockholder-approved actions: (a) redeem a portion of its Series A Convertible
Preferred Stock for cash; (b) convert the remaining portion of its Series A Convertible Preferred Stock and all of its Series B Convertible preferred stock into common stock of the Company; and (c) change the Companys capital structure whereby
the Company increased the number of authorized shares of common stock of the Company from 6 million to 15 million shares and decreased the number of authorized shares of preferred stock of the Company from 21 million to 2 million, Transcend
Services, Inc. (the Company) filed three amendments to its Certificate of Incorporation (collectively, the Amendments). Each of the Amendments was approved by the Stockholders of the Company at meetings held on May 6, 2003
and June 25, 2003.



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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.





|August 4, 2003 |  | TRANSCEND SERVICES, INC.   By: /s/ Larry G.
GerdesLarry G. Gerdes, President, Chief Executive Officer andChief Financial Officer (Principal Executive and Financial Officer)
|-------------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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