##### Table of Contents

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549



FORM 10-Q



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



For the quarterly period ended March 31, 2004



OR



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



For the transition period from
 to



Commission File Number 0-18217



TRANSCEND SERVICES, INC.

(Exact name
of registrant as specified in its charter)



|                                                              |  |                                   
|------------------------------------------------------------- |  | ----------------------------------
|Delaware                                                      |  | 33-0378756                        
|(State or other jurisdiction ofincorporation or organization) |  | (I.R.S EmployerIdentification 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 April 22, 2004
|Common Stock, $.05 par value |  | 7,327,565 Shares             



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##### Table of Contents

INDEX



|           |  |                                                                                          |  |            
|---------- |  | ---------------------------------------------------------------------------------------- |  | -----------
|           |  |                                                                                          |  | Page Number
|           |  |                                                                                         
|PART I.    |  | FINANCIAL INFORMATION                                                                    |  | 3          
|           |  |                                                                                         
|Item 1.    |  | Financial Statements                                                                     |  | 3          
|           |  |                                                                                         
|           |  | Consolidated Balance Sheets as of March 31, 2004 and December 31, 2003                   |  | 3          
|           |  |                                                                                         
|           |  | Consolidated Statements of Operations for the Three Months Ended March 31, 2004 and 2003 |  | 4          
|           |  |                                                                                         
|           |  | Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2004 and 2003 |  | 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                               |  | 9          
|           |  |                                                                                         
|Item 4.    |  | Controls and Procedures                                                                  |  | 9          
|           |  |                                                                                         
|PART II.   |  | OTHER INFORMATION                                                                        |  | 9          
|           |  |                                                                                         
|Item 1.    |  | Legal Proceedings                                                                        |  | 9          
|           |  |                                                                                         
|Item 6.    |  | Exhibits and Reports on Form 8-K                                                         |  | 10         
|           |  |                                                                                         
|SIGNATURES |  |                                                                                          |  | 12         



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##### Table of Contents

PART I. FINANCIAL INFORMATION



|Item 1. | Financial Statements
|------- | --------------------



TRANSCEND SERVICES, INC.

CONSOLIDATED BALANCE SHEETS

(Unaudited)



|                                                                                                                                                                        |  |                |             |   |                   |   |             |  
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | -------------- | ----------- | - | ----------------- | - | ----------- | -
|                                                                                                                                                                        |  | March 31, 2004 |             |   | December 31, 2003 |  
|ASSETS                                                                                                                                                                  |  |                |             |   |                   |   |             |  
|Current assets:                                                                                                                                                         |  |                |             |   |                   |   |             |  
|Cash and cash equivalents                                                                                                                                               |  | $              | 566,000     |   |                   | $ | 558,000     |  
|Accounts receivable, net of allowance for doubtful accounts of $12,000 at March 31, 2004 and $39,000 at December 31, 2003,
respectively                                 |  |                | 1,352,000   |   |                   |   | 1,306,000   |  
|Prepaid expenses and other current assets                                                                                                                               |  |                | 150,000     |   |                   |   | 216,000     |  
|                                                                                                                                                                        |  |                |             |   |                   |   |             |  
|Total current assets                                                                                                                                                    |  |                | 2,068,000   |   |                   |   | 2,080,000   |  
|                                                                                                                                                                        |  |                |             |   |                   |   |             |  
|Property and equipment:                                                                                                                                                 |  |                |             |   |                   |   |             |  
|Computer equipment                                                                                                                                                      |  |                | 2,056,000   |   |                   |   | 1,971,000   |  
|Software development                                                                                                                                                    |  |                | 1,957,000   |   |                   |   | 1,826,000   |  
|Furniture and fixtures                                                                                                                                                  |  |                | 170,000     |   |                   |   | 170,000     |  
|                                                                                                                                                                        |  |                |             |   |                   |   |             |  
|Property and equipment                                                                                                                                                  |  |                | 4,183,000   |   |                   |   | 3,967,000   |  
|Accumulated depreciation                                                                                                                                                |  |                | (2,914,000  | ) |                   |   | (2,749,000  | )
|                                                                                                                                                                        |  |                |             |   |                   |   |             |  
|Property and equipment, net                                                                                                                                             |  |                | 1,269,000   |   |                   |   | 1,218,000   |  
|                                                                                                                                                                        |  |                |             |   |                   |   |             |  
|Other assets                                                                                                                                                            |  |                | 48,000      |   |                   |   | 48,000      |  
|                                                                                                                                                                        |  |                |             |   |                   |   |             |  
|Total assets                                                                                                                                                            |  | $              | 3,385,000   |   |                   | $ | 3,346,000   |  
|                                                                                                                                                                        |  |                |             |   |                   |   |             |  
|LIABILITIES AND STOCKHOLDERS EQUITY                                                                                                                                    |  |                |             |   |                   |   |             |  
|Current liabilities:                                                                                                                                                    |  |                |             |   |                   |   |             |  
|Promissory notes payable                                                                                                                                                |  | $              | 100,000     |   |                   | $ | 200,000     |  
|Accounts payable                                                                                                                                                        |  |                | 147,000     |   |                   |   | 109,000     |  
|Accrued compensation and benefits                                                                                                                                       |  |                | 500,000     |   |                   |   | 486,000     |  
|Other accrued liabilities                                                                                                                                               |  |                | 121,000     |   |                   |   | 111,000     |  
|                                                                                                                                                                        |  |                |             |   |                   |   |             |  
|Total current liabilities                                                                                                                                               |  |                | 868,000     |   |                   |   | 906,000     |  
|                                                                                                                                                                        |  |                |             |   |                   |   |             |  
|Commitments and contingencies                                                                                                                                           |  |                |             |   |                   |   |             |  
|                                                                                                                                                                        |  |               
|Stockholders equity:                                                                                                                                                   |  |                |             |   |                   |   |             |  
|Preferred stock, $.01 par value; 2,000,000 shares authorized; none outstanding                                                                                          |  |                |            |   |                   |   |            |  
|Common stock, $.05 par value; 15,000,000 shares authorized; 7,328,000 and 7,317,000 shares issued and outstanding at March 31, 2004 and
December 31, 2003, respectively |  |                | 365,000     |   |                   |   | 364,000     |  
|Additional paid-in capital                                                                                                                                              |  |                | 27,071,000  |   |                   |   | 27,058,000  |  
|Accumulated deficit                                                                                                                                                     |  |                | (24,919,000 | ) |                   |   | (24,982,000 | )
|                                                                                                                                                                        |  |                |             |   |                   |   |             |  
|Total stockholders equity                                                                                                                                              |  |                | 2,517,000   |   |                   |   | 2,440,000   |  
|                                                                                                                                                                        |  |                |             |   |                   |   |             |  
|Total liabilities and stockholders equity                                                                                                                              |  | $              | 3,385,000   |   |                   | $ | 3,346,000   |  
|                                                                                                                                                                        |  |                |             |   |                   |   |             |  



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 |          
|                                                           |  | 3/31/04            |           |   | 3/31/03 |  
|Revenue                                                    |  | $                  | 3,867,000 |   |         | $ | 3,481,000 |  
|Direct costs                                               |  |                    | 2,839,000 |   |         |   | 2,371,000 |  
|                                                           |  |                    |           |   |         |   |           |  
|Gross profit                                               |  |                    | 1,028,000 |   |         |   | 1,110,000 |  
|                                                           |  |                    |           |   |         |   |           |  
|Operating expenses:                                        |  |                    |           |   |         |   |           |  
|Sales and marketing                                        |  |                    | 248,000   |   |         |   | 202,000   |  
|Research and development                                   |  |                    | 105,000   |   |         |   | 111,000   |  
|General and administrative                                 |  |                    | 604,000   |   |         |   | 599,000   |  
|                                                           |  |                    |           |   |         |   |           |  
|Total operating expenses                                   |  |                    | 957,000   |   |         |   | 912,000   |  
|                                                           |  |                    |           |   |         |   |           |  
|Operating income                                           |  |                    | 71,000    |   |         |   | 198,000   |  
|Interest income (expense), net                             |  |                    | (8,000    | ) |         |   | 1,000     |  
|                                                           |  |                    |           |   |         |   |           |  
|Net income                                                 |  |                    | 63,000    |   |         |   | 199,000   |  
|Dividends on preferred stock                               |  |                    | 0         |   |         |   | (119,000  | )
|                                                           |  |                    |           |   |         |   |           |  
|Net income attributable to common stockholders             |  | $                  | 63,000    |   |         | $ | 80,000    |  
|                                                           |  |                    |           |   |         |   |           |  
|Basic earnings per share:                                  |  |                    |           |   |         |   |           |  
|Net earnings per share attributable to common stockholders |  | $                  | 0.01      |   |         | $ | 0.02      |  
|                                                           |  |                    |           |   |         |   |           |  
|Weighted average shares outstanding                        |  |                    | 7,324,000 |   |         |   | 4,427,000 |  
|                                                           |  |                    |           |   |         |   |           |  
|Diluted earnings per share                                 |  |                    |           |   |         |   |           |  
|Net earnings per share attributable to common stockholders |  | $                  | 0.01      |   |         | $ | 0.02      |  
|                                                           |  |                    |           |   |         |   |           |  
|Weighted average shares outstanding                        |  |                    | 7,667,000 |   |         |   | 4,486,000 |  
|                                                           |  |                    |           |   |         |   |           |  



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)



|                                                                                  |  |                             |          |   |      |   |          |  
|--------------------------------------------------------------------------------- |  | --------------------------- | -------- | - | ---- | - | -------- | -
|                                                                                  |  | Three Months EndedMarch 31, |         
|                                                                                  |  | 2004                        |          |   | 2003 |  
|Cash flows from operating activities:                                             |  |                             |          |   |      |   |          |  
|Net income attributable to common stockholders                                    |  | $                           | 63,000   |   |      | $ | 80,000   |  
|                                                                                  |  |                             |          |   |      |   |          |  
|Adjustments to reconcile net income to net cash provided by operating activities: |  |                             |          |   |      |   |          |  
|Depreciation and amortization                                                     |  |                             | 183,000  |   |      |   | 165,000  |  
|Preferred stock dividends                                                         |  |                             | 0        |   |      |   | 119,000  |  
|Changes in assets and liabilities:                                                |  |                             |          |   |      |   |          |  
|Accounts receivable, net                                                          |  |                             | (46,000  | ) |      |   | (17,000  | )
|Prepaid expenses and other current assets                                         |  |                             | 66,000   |   |      |   | (111,000 | )
|Note receivable and other assets                                                  |  |                             | 0        |   |      |   | 5,000    |  
|Accounts payable                                                                  |  |                             | 38,000   |   |      |   | 37,000   |  
|Accrued liabilities                                                               |  |                             | 24,000   |   |      |   | 47,000   |  
|                                                                                  |  |                             |          |   |      |   |          |  
|Total adjustments                                                                 |  |                             | 265,000  |   |      |   | 245,000  |  
|                                                                                  |  |                             |          |   |      |   |          |  
|Net cash provided by operating activities                                         |  |                             | 328,000  |   |      |   | 325,000  |  
|                                                                                  |  |                             |          |   |      |   |          |  
|Cash flows from investing activities:                                             |  |                             |          |   |      |   |          |  
|Capital expenditures                                                              |  |                             | (234,000 | ) |      |   | (129,000 | )
|                                                                                  |  |                             |          |   |      |   |          |  
|Net cash used in investing activities                                             |  |                             | (234,000 | ) |      |   | (129,000 | )
|                                                                                  |  |                             |          |   |      |   |          |  
|Cash flows from financing activities:                                             |  |                             |          |   |      |   |          |  
|Payment of promissory note payable                                                |  |                             | (100,000 | ) |      |   | 0        |  
|Preferred stock dividends                                                         |  |                             | 0        |   |      |   | (73,000  | )
|Proceeds from issuances of common stock                                           |  |                             | 14,000   |   |      |   | 0        |  
|                                                                                  |  |                             |          |   |      |   |          |  
|Net cash used in financing activities                                             |  |                             | (86,000  | ) |      |   | (73,000  | )
|                                                                                  |  |                             |          |   |      |   |          |  
|Net increase in cash and cash equivalents                                         |  |                             | 8,000    |   |      |   | 123,000  |  
|Cash and cash equivalents, at beginning of period                                 |  |                             | 558,000  |   |      |   | 782,000  |  
|                                                                                  |  |                             |          |   |      |   |          |  
|Cash and cash equivalents, at end of period                                       |  | $                           | 566,000  |   |      | $ | 905,000  |  
|                                                                                  |  |                             |          |   |      |   |          |  
|Supplemental cash flow information:                                               |  |                             |          |   |      |   |          |  
|Cash paid for interest expense                                                    |  | $                           | 3,000    |   |      | $ | 0        |  
|                                                                                  |  |                             |          |   |      |   |          |  
|Noncash financing activities:                                                     |  |                             |          |   |      |   |          |  
|Issuance of common stock in lieu of preferred stock cash dividends                |  | $                           | 0        |   |      | $ | 46,000   |  
|                                                                                  |  |                             |          |   |      |   |          |  



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



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TRANSCEND SERVICES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2004 and 2003

(Unaudited)



(1) The accompanying consolidated financial statements are unaudited and
have been prepared by 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, 2003. Footnote disclosure that substantially duplicates the disclosure contained in that document has been omitted.



(2) Revenue attributable to one customer totaled $457,000, or 12% and $398,000, or 11% of
total revenue for the three months ended March 31, 2004 and 2003, respectively. Additionally, one other customer contributed revenue totaling $386,000, or 11% of total revenue for the three months ended March 31, 2003.



(3) 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 carryforwards. Since the Companys taxable income for the three months ended March 31, 2004 and 2003 were offset by available net operating loss carryforwards, no income tax provisions have been recorded for these
periods.



(4) 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 months ended March 31, 2004 and 2003.



(5) On March 8, 2004, the Company replaced its existing $1.5 million line of credit
(LOC) with a $1 million LOC that has a maturity date of April 30, 2005. Borrowings, if any, under the new LOC shall bear interest at the lenders prime rate and shall be secured by the Companys accounts receivable.



(6) On April 5, 2001, Our Lady of the Lakes Hospital, Inc. (OLOL) filed a
lawsuit against the Company. The lawsuit, styled Our Lady of the Lakes Hospital, Inc. v. Transcend Services, Inc., was filed in the 19th Judicial District Court, Parish of East, State of Louisiana, Civil Case Number 482775, Div. A. The
lawsuit alleges, among other things, that the Company breached certain contracts entered into between OLOL and the Company, including a staffing and management servicing contract, a transcription platform agreement and a marketing agreement. OLOL is
seeking an unspecified amount of monetary damages. On May 30, 2001, the Company filed a timely Answer 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.



In May 2003,
a company threatened Transcend with a demand for binding arbitration related to a dispute between that company and Transcend regarding the level of fees payable under a cross-marketing agreement that provides for binding arbitration of disputes. The
threatened binding arbitration process has not been initiated at this time and it is uncertain when, if ever, the threatened binding arbitration process will be initiated. While Transcend 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 threatened binding arbitration will not have a material adverse effect on Transcends results of operations and financial condition.



(7) On February 18, 2003, the Company issued 31,050 shares of its unregistered common stock
at $1.50 per share to certain holders of its Series A Convertible Preferred Stock who elected to receive their quarterly preferred stock dividends in shares of the Companys common stock in lieu of cash at the preferred stock dividend payment
date of February 15, 2003. All outstanding shares of the Companys preferred stock were either converted into 2,860,000 shares of common stock or redeemed on June 25, 2003 and July 1, 2003, respectively, in transactions that were approved by
the Companys stockholders.



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(8) On March 31, 2004, the Financial Accounting Standards Board (FASB) published an exposure draft regarding
Share-Based Payment, an Amendment of FASB Statements No. 123 and 95 (the Exposure Draft). If the provisions of the Exposure Draft become generally accepted accounting principles as presently proposed, such provisions would
affect the way that the Company presently accounts for stock-based compensation plans and would result in increased compensation expense of a presently indeterminable amount being included in the Companys results of operations after the
effective date of such provisions.



|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. Among the important factors that could cause actual results to differ materially from those indicated by such forward-looking statements are competitive pressures, loss of
significant customers, the mix of revenue, changes in pricing policies, delays in revenue recognition, lower-than-expected demand for the Companys products and services, business conditions in the integrated health care delivery network
market, general economic conditions, and the risk factors detailed from time to time in the Companys periodic reports and registration statements filed with the Securities and Exchange Commission. 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.



Three Months Ended March 31, 2004 Compared to Three Months Ended March 31, 2003



Revenue increased $386,000, or 11%, to $3.9 million for the three months ended March 31, 2004, compared to revenue of $3.5 million for the
three months ended March 31, 2003. The net increase in revenue is primarily attributable to: (1) transcription revenue of $1,149,000 from new transcription customers; (2) a decrease of $418,000 in transcription revenue from customers that terminated
contracts since March 31, 2003; (3) a decrease in transcription revenue of $336,000 from existing customers; and (4) a decrease of $9,000 in other revenue.



Direct costs increased $468,000, or 20%, to $2.8 million for the three months ended March 31, 2004, compared to direct costs of $2.4 million for the three months ended
March 31, 2003. Direct costs include costs attributable to compensation for transcriptionists, recruiting of transcriptionists, production management, customer service, technical support for production operations, implementation of transcription
services and depreciation and amortization related to production operations. Transcription compensation is a variable cost based on lines transcribed or edited multiplied by specified per-line pay rates that vary by individual as well as type of
work. The per-line pay rates are higher for transcription work on the Companys transcription platform than for transcription and editing work on a third-partys voice recognition platform, used for approximately 8% and 2% of the
Companys revenue for the three months ended March 31, 2004 and 2003, respectively. All direct costs referred to above other than compensation for transcriptionists are semi-variable production infrastructure costs that periodically change in
anticipation of or in response to the overall level of production activity. Compensation for transcriptionists increased $331,000 due to the overall increase in revenue of $386,000 referred to above. The remaining net increase in direct costs of
$137,000 was attributable to a net increase in production infrastructure costs to support the higher level of revenue. Production management accounted for $122,000 of the $137,000 change in production infrastructure costs due primarily to the
addition of quality control and documentation personnel to support the higher level of production activity and revenue. No single other production infrastructure cost varied significantly between the first quarters of 2004 and 2003.



Gross profit decreased $82,000, or 7%, to $1 million for the three months ended March 31,
2004, compared to gross profit of $1.1 million for the three months ended March 31, 2003. Gross profit as a percentage of revenue decreased to 26.6% in the first quarter of



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2004 compared to 31.9% in the first quarter of 2003. This decrease of 5.3% in gross profit as a percentage of revenue between the periods is primarily due
to: (i) an increase in production infrastructure costs, in particular in the production management area as discussed above, in anticipation of a projected revenue level that was not achieved in the first quarter of 2004, which accounted for 2.3% of
the 5.3% unfavorable variance; (ii) as discussed above, an increase in the revenue generated on a third-partys voice recognition platform, which yields lower gross profits as a percentage of revenue than revenue generated on the Companys
transcription platform, which accounted for 1.5% of the 5.3% unfavorable variance; and (iii) competitive pricing pressure on new and existing transcription work performed on the Companys transcription platform and the loss of transcription
work performed on the Companys transcription platform due to either (a) the termination of customer contracts or (b) the transfer of the transcription work to a third partys voice recognition platform, which accounted for 1.5% of the
5.3% unfavorable variance.



Sales and marketing expenses increased $46,000, or
23%, to $248,000 in the first quarter of 2004, compared to sales and marketing expenses of $202,000 in the first quarter of 2003. Sales and marketing expenses as a percentage of revenue were 6% for both periods. The increase in sales and marketing
expense is primarily due to an increase in the size of the sales force that resulted in higher levels of salaries, commissions on new sales and travel expenses. Partially offsetting these increases in direct sales expenses were lower marketing
expenses in the first quarter of 2004.



Research and development expenses
decreased $6,000, or 5%, to $105,000 in the first quarter of 2004, compared to research and development expenses of $111,000 in the first quarter of 2003, but remained at 3% of revenue for both periods. During the first quarter of 2004, the Company
capitalized internal software development costs of $33,000 related to the development of a speech recognition technology platform. Offsetting this reduction of costs was the reassignment of technology resources from other areas to work on technology
development projects.



General and administrative expenses increased $5,000, or
1%, to $604,000 in the first quarter of 2004, compared to general and administrative expenses of $599,000 in the first quarter of 2003. This net increase was primarily due to an increase of $17,000 in state franchise taxes and business licenses in
the first quarter of 2004, as the Companys operations have expanded to 48 states. Additionally, insurance expense increased $12,000 and rent expense increased $7,000 in the first quarter of 2004. These increases were substantially offset by a
reduction in bad debt expense of $33,000 in the first quarter of 2004 compared to the first quarter of 2003.



The Company reported net interest expense of $8,000 in the first quarter of 2004, which was comprised primarily of amortization expense of $5,000 for a line of credit facility fee paid to the Companys Chief
Executive Officer and one of its Directors as guarantors. In addition, during the first quarter of 2004 the Company incurred $1,000 of interest expense on a promissory note payable due on April 1, 2004 related to the preferred stock redemption. For
the first quarter of 2003, the Company reported net interest income of $1,000 that was earned primarily on the investment of cash in overnight money market funds.



Liquidity and Capital Resources



The Companys current financial condition has been significantly influenced by four factors: (1) profitable and positive cash flow operations for 2003 and the first
quarter of 2004; (2) the redemption of a portion of its preferred stock for $600,000 cash on July 1, 2003; (3) the conversion of the remaining shares of preferred stock into common stock on June 25, 2003, thereby eliminating quarterly cash dividend
payments of approximately $120,000 after May 15, 2003; and (4) the payment of a promissory note payable of $100,000 on January 1, 2004 related to the 2003 preferred stock redemption. As of March 31, 2004, the Company had cash and cash equivalents of
$566,000, working capital of $1,200,000, no debt and full availability of its $1 million line of credit, which expires on April 30, 2005.



Net cash provided by operating activities totaled $328,000 for the three months ended March 31, 2004, due primarily to profitable operations and noncash depreciation and
amortization expenses.



Net cash used in investing activities of the Company
was comprised of capital expenditures of $234,000, primarily for computer hardware and software upgrades and enhancements.



Net cash used in financing activities of the Company during the first three months of 2004 consisted of the $100,000 payment of a promissory note payable on January 1,
2004, partially offset by the issuance of common stock as a result of stock option exercises. The second $100,000 promissory note payable related to the 2003 preferred stock redemption was paid on April 1, 2004.



Aside from cash available under its $1 million line of credit referred to above, during the
fourth quarter of 2004 and 2005 inclusive,



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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 one lawsuit and has been threatened regarding a separate
dispute that is subject to binding arbitration. See Note 6 to the Consolidated Financial Statements included with this report and Legal Proceedings.



Absent a material adverse outcome from either or both the lawsuit and threatened 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 operations and make capital investments in the normal and ordinary course
of its business during 2004 and for the foreseeable future.



|Item 3. | Quantitative and Qualitative Disclosures About Market Risk
|------- | ----------------------------------------------------------



The Company had no material exposure to market risk from derivatives or other financial instruments as of March 31, 2004.



|Item 4. | Controls and Procedures
|------- | -----------------------



The SEC defines the term disclosure controls and procedures to mean a companys controls and other procedures that are designed to ensure that
information required to be disclosed in the reports that it files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported, within the time periods specified in the SECs rules and forms. The
Companys principal executive officer and principal financial officer, based on their evaluation of the Companys disclosure controls and procedures as of the end of the quarterly period covered by this report, concluded that the
Companys disclosure controls and procedures were effective for this purpose.



Internal control over financial reporting consists of control processes designed to provide assurance regarding the reliability of financial reporting and the preparation of the Companys financial statements in accordance with GAAP.
To the extent that components of the Companys internal control over financial reporting are included in the Companys disclosure controls, they are included in the scope of the evaluation by the Companys principal executive officer
and principal financial officer referenced above. There were no changes in the Companys internal control over financial reporting during the Companys last fiscal quarter that have materially affected, or are reasonably likely to
materially affect, the Companys internal control over financial reporting.



PART II. OTHER INFORMATION



|Item 1. | Legal Proceedings
|------- | -----------------



On April 5, 2001, Our Lady of the Lakes Hospital, Inc. (OLOL) filed a lawsuit against the Company. The lawsuit, styled Our Lady of the Lakes Hospital, Inc. v. Transcend Services, Inc., was
filed in the 19th Judicial District Court, Parish of East, State of Louisiana, Civil Case Number 482775, Div. A. The lawsuit alleges, among other things, that the Company breached certain contracts entered into between OLOL and the Company,
including a staffing and management servicing contract, a transcription platform agreement and a marketing agreement. OLOL is seeking an unspecified amount of monetary damages. On May 30, 2001, the Company filed a timely Answer 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 has been threatened by another company related to a dispute with that company regarding the level of fees payable under a
cross-marketing agreement that provides for binding arbitration of disputes. The threatened binding arbitration process has not been initiated at this time and it is uncertain when, if ever, the threatened binding arbitration process will be
initiated. 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 threatened binding arbitration will not have material adverse effect on
the Companys results of operations and financial condition.



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



(a) Exhibits



The following exhibits are filed with or incorporated by reference into this report. The exhibits which are denoted by an asterisk (*) were previously filed as a part of, and are hereby incorporated by reference from,
either (i) a Registration Statement on Form S-8 under the Securities Act of 1933 for the Company, Registration No. 33-57072, filed on January 15, 1993 (referred to as 1993 S-8); (ii) a Registration Statement on Form S-8 under the
Securities Act of 1933 for the Company, Registration No. 333-16213, filed on November 15, 1996 (referred to as 1996 S-8); (iii) the Companys Annual Report on form 10-K for the year ended May 31, 1993 (referred to as 1993
10-K); (iv) the Companys Current Report on Form 8-K filed October 30, 2000 (referred to as 10/30/00 8-K); (v) the Companys Annual Report on Form 10-K for the year ended December 31, 2001 (referred to as 2001
10-K); or (vi) a Registration Statement on Form S-3 under the Securities Act of 1933 for the Company, Registration No. 333-106446, filed on June 25, 2003 (referred to as 2003 S-3).



|            |  |   |  |                                                                                                                                                                            
|----------- |  | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|EXHIBIT NO. |  |   |  | DESCRIPTION                                                                                                                                                                
|            |  |  
|*2.1        |  |  |  | Asset Purchase Agreement dated October 13, 2000 with Provider HealthNet Services, Inc. (10/30/00 8-K, Exhibit 2.7)                                                         
|            |  |  
|*3.1        |  |  |  | Certificate of Incorporation (2003 S-3, Exhibit 4.1)                                                                                                                       
|            |  |  
|*3.2        |  |  |  | Restated Bylaws (1993 10-K, Exhibit 3(a))                                                                                                                                  
|            |  |  
|*4.1        |  |  |  | 1992 Stock Option Plan, as amended (1993 S-8, Exhibit 4(a))                                                                                                                
|            |  |  
|*4.2        |  |  |  | 1992 Stock Option Plan, as Amended and Restated (1996 S-8, Exhibit 4.1)                                                                                                    
|            |  |  
|*4.3        |  |  |  | 2001 Stock Option Plan (2001 10-K, Exhibit 4.15)                                                                                                                           
|            |  |  
|4.4         |  |  |  | Business Loan Agreement and Promissory Note dated March 8, 2004 for line of credit with Bank of America, N.A.                                                              
|            |  |  
|*10.1       |  |  |  | Form of Incentive Stock Option Agreement under 1992 Stock Option Plan, as Amended and Restated (1996 S-8, Exhibit 4.2)                                                     
|            |  |  
|*10.2       |  |  |  | Form of indemnification agreement (1993 10-K, Exhibit 10(a))                                                                                                               
|            |  |  
|**31.1      |  |  |  | Certification of Chief Executive Officer of the Registrant Pursuant to Rule 13a-14(a) and Rule 15d-14(a), promulgated under the Securities Exchange Act of 1934, as amended
|            |  |  
|**31.2      |  |  |  | Certification of Chief Financial Officer of the Registrant Pursuant to Rule 13a-14(a) and Rule 15d-14(a), promulgated under the Securities Exchange Act of 1934, as amended
|            |  |  
|**32.1      |  |  |  | Certification of Chief Executive Officer of the Registrant Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002                                                       
|            |  |  
|**32.2      |  |  |  | Certification of Chief Financial Officer of the Registrant Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002                                                       



|** | This certification is furnished to, but not filed with, the Commission. This certification shall not be deemed to be incorporated by reference into any filing under the Securities
Act of 1933 or the Securities Exchange Act of 1934, except to the extent that the Registrant specifically incorporates it by reference.
|-- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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(b) Reports on Form 8-K:



The following report on Form 8-K was filed during the three months ended March 31, 2004:



(1) Form 8-K, dated and filed January 21, 2004, a press release announcing the Companys unaudited operating results
for the three months and year ended December 31, 2003 and its unaudited financial condition as of December 31, 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.



|               |  |  |  |                          |  |                                                                         |  |                     
|-------------- |  |  |  | ------------------------ |  | ----------------------------------------------------------------------- |  | --------------------
|               |  |  |  | TRANSCEND SERVICES, INC.
|               |  |  | 
|April 30, 2004 |  |  |  | By:                      |  | /s/ Larry G. Gerdes                                                    
|               |  |  |  |                          |  |                                                                         | 
|               |  |  |  |                          |  | Larry G. Gerdes, Chief Executive Officer (Principal Executive Officer) 
|               |  |  |  |                         
|               |  |  |  |                          |  | By:                                                                     |  | /s/ Joseph G. Bleser
|               |  |  |  |                          |  |                                                                         |  |                     
|               |  |  |  |                          |  | Joseph G. Bleser, Chief Financial Officer (Principal Financial Officer)



12