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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 September 30, 2008

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 000-18217





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.)

One Glenlake Parkway, Suite 1325, Atlanta, GA 30328

(Address of principal executive offices and zip code)

Registrants telephone number, including area code: (678) 808-0600



(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 a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company.
See definitions of large accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act. (Check one):



|                             |  |                                               |  |                            |  |                               
|---------------------------- |  | --------------------------------------------- |  | -------------------------- |  | ------------------------------
|Large accelerated filer     ̈ |  | Accelerated filer    x                        |  | Non-accelerated filer     ̈ |  | Smaller reporting company     ̈
|                             |  | (Do not check if a smaller reporting company)

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

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



|                             |  |                                
|---------------------------- |  | -------------------------------
|Class                        |  | Outstanding at October 31, 2008
|Common Stock, $.05 par value |  | 8,448,492                      









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INDEX



|           |  |                                                                                                       |  |           
|---------- |  | ----------------------------------------------------------------------------------------------------- |  | ----------
|           |  |                                                                                                       |  | PageNumber
|PART I.    |  | FINANCIAL INFORMATION                                                                                 |  | 3         
|           |  |                                                                                                      
|Item 1.    |  | Financial Statements (Unaudited)                                                                      |  | 3         
|           |  |                                                                                                      
|           |  | Consolidated Balance Sheets as of September 30, 2008 and December 31, 2007                            |  | 3         
|           |  |                                                                                                      
|           |  | Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2008 and 2007 |  | 4         
|           |  |                                                                                                      
|           |  | Consolidated Statement of Stockholders Equity for the Nine Months Ended September 30, 2008           |  | 5         
|           |  |                                                                                                      
|           |  | Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2008 and 2007           |  | 6         
|           |  |                                                                                                      
|           |  | Notes to Consolidated Financial Statements                                                            |  | 7         
|           |  |                                                                                                      
|Item 2     |  | Managements Discussion and Analysis of Financial Condition and Results of Operations                 |  | 12        
|           |  |                                                                                                      
|Item 3.    |  | Quantitative and Qualitative Disclosures About Market Risk                                            |  | 15        
|           |  |                                                                                                      
|Item 4.    |  | Controls and Procedures                                                                               |  | 15        
|           |  |                                                                                                      
|PART II.   |  | OTHER INFORMATION                                                                                     |  | 16        
|           |  |                                                                                                      
|Item 1.    |  | Legal Proceedings                                                                                     |  | 16        
|           |  |                                                                                                      
|Item 1A.   |  | Risk Factors                                                                                          |  | 16        
|           |  |                                                                                                      
|Item 2.    |  | Unregistered Sales of Equity Securities and Use of Proceeds                                           |  | 16        
|           |  |                                                                                                      
|Item 4.    |  | Submission of Matters to a Vote of Security Holders                                                   |  | 16        
|           |  |                                                                                                      
|Item 6.    |  | Exhibits                                                                                              |  | 16        
|           | 
|SIGNATURES |  | 18                                                                                                   



2



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##### Table of Contents

PART I. FINANCIAL INFORMATION



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

TRANSCEND SERVICES, INC.

CONSOLIDATED BALANCE SHEETS

(Rounded to the nearest thousand)



|                                                                                                                                                                                                                         |  |                              |             |   |                               |   |             |  
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ |  | ---------------------------- | ----------- | - | ----------------------------- | - | ----------- | -
|                                                                                                                                                                                                                         |  | September 30,2008(unaudited) |             |   | December 31,2007(as restated) |  
|ASSETS                                                                                                                                                                                                                   |  |                              |             |   |                               |   |             |  
|Current assets:                                                                                                                                                                                                          |  |                              |             |   |                               |   |             |  
|Cash and cash equivalents                                                                                                                                                                                                |  | $                            | 10,101,000  |   |                               | $ | 4,996,000   |  
|Accounts receivable, net of allowance for doubtful accounts of $124,000 and $85,000 at September 30, 2008 and December 31, 2007,
respectively                                                                            |  |                              | 5,329,000   |   |                               |   | 5,092,000   |  
|Deferred income tax, net                                                                                                                                                                                                 |  |                              | 1,169,000   |   |                               |   | 2,704,000   |  
|Prepaid expenses and other current assets                                                                                                                                                                                |  |                              | 294,000     |   |                               |   | 289,000     |  
|                                                                                                                                                                                                                         |  |                              |             |   |                               |   |             |  
|Total current assets                                                                                                                                                                                                     |  |                              | 16,893,000  |   |                               |   | 13,081,000  |  
|Property and equipment:                                                                                                                                                                                                  |  |                              |             |   |                               |   |             |  
|Computer equipment                                                                                                                                                                                                       |  |                              | 3,804,000   |   |                               |   | 3,507,000   |  
|Software                                                                                                                                                                                                                 |  |                              | 2,667,000   |   |                               |   | 3,222,000   |  
|Furniture and fixtures                                                                                                                                                                                                   |  |                              | 487,000     |   |                               |   | 399,000     |  
|                                                                                                                                                                                                                         |  |                              |             |   |                               |   |             |  
|Total property and equipment                                                                                                                                                                                             |  |                              | 6,958,000   |   |                               |   | 7,128,000   |  
|Accumulated depreciation and amortization                                                                                                                                                                                |  |                              | (5,344,000  | ) |                               |   | (5,738,000  | )
|                                                                                                                                                                                                                         |  |                              |             |   |                               |   |             |  
|Property and equipment, net                                                                                                                                                                                              |  |                              | 1,614,000   |   |                               |   | 1,390,000   |  
|Intangible assets:                                                                                                                                                                                                       |  |                              |             |   |                               |   |             |  
|Goodwill                                                                                                                                                                                                                 |  |                              | 4,727,000   |   |                               |   | 4,701,000   |  
|Other intangible assets                                                                                                                                                                                                  |  |                              | 795,000     |   |                               |   | 795,000     |  
|                                                                                                                                                                                                                         |  |                              |             |   |                               |   |             |  
|Total intangible assets                                                                                                                                                                                                  |  |                              | 5,522,000   |   |                               |   | 5,496,000   |  
|Accumulated amortization                                                                                                                                                                                                 |  |                              | (490,000    | ) |                               |   | (371,000    | )
|                                                                                                                                                                                                                         |  |                              |             |   |                               |   |             |  
|Intangible assets, net                                                                                                                                                                                                   |  |                              | 5,032,000   |   |                               |   | 5,125,000   |  
|Deferred income tax, net                                                                                                                                                                                                 |  |                              | 326,000     |   |                               |   | 866,000     |  
|Other assets                                                                                                                                                                                                             |  |                              | 222,000     |   |                               |   | 287,000     |  
|                                                                                                                                                                                                                         |  |                              |             |   |                               |   |             |  
|Total assets                                                                                                                                                                                                             |  | $                            | 24,087,000  |   |                               | $ | 20,749,000  |  
|                                                                                                                                                                                                                         |  |                              |             |   |                               |   |             |  
|                                                                                                                                                                                                                         |  |                             
|LIABILITIES AND STOCKHOLDERS EQUITY                                                                                                                                                                                     |  |                              |             |   |                               |   |             |  
|Current liabilities:                                                                                                                                                                                                     |  |                              |             |   |                               |   |             |  
|Accounts payable                                                                                                                                                                                                         |  | $                            | 873,000     |   |                               | $ | 625,000     |  
|Accrued compensation and benefits                                                                                                                                                                                        |  |                              | 1,447,000   |   |                               |   | 1,449,000   |  
|Promissory notes payable to related parties                                                                                                                                                                              |  |                              |            |   |                               |   | 1,167,000   |  
|Promissory notes payable                                                                                                                                                                                                 |  |                              | 110,000     |   |                               |   | 165,000     |  
|Other accrued liabilities                                                                                                                                                                                                |  |                              | 714,000     |   |                               |   | 856,000     |  
|                                                                                                                                                                                                                         |  |                              |             |   |                               |   |             |  
|Total current liabilities                                                                                                                                                                                                |  |                              | 3,144,000   |   |                               |   | 4,262,000   |  
|Long term liabilities:                                                                                                                                                                                                   |  |                              |             |   |                               |   |             |  
|Revolving promissory note                                                                                                                                                                                                |  |                              | 4,000       |   |                               |   | 4,000       |  
|Promissory notes payable                                                                                                                                                                                                 |  |                              | 706,000     |   |                               |   | 839,000     |  
|Other liabilities                                                                                                                                                                                                        |  |                              |            |   |                               |   | 10,000      |  
|                                                                                                                                                                                                                         |  |                              |             |   |                               |   |             |  
|Total long term liabilities                                                                                                                                                                                              |  |                              | 710,000     |   |                               |   | 853,000     |  
|Commitments and contingencies                                                                                                                                                                                            |  |                              |             |   |                               |   |             |  
|Stockholders equity:                                                                                                                                                                                                    |  |                              |             |   |                               |   |             |  
|Preferred stock, $0.01 par value; 2,000,000 shares authorized and no shares outstanding at September 30, 2008 and December 31, 2007                                                                                      |  |                              |            |   |                               |   |            |  
|Common stock, $0.05 par value; 15,000,000 shares authorized at September 30, 2008 and December 31, 2007; 8,448,000 and 8,435,000
shares issued and outstanding at September 30, 2008 and December 31, 2007, respectively |  |                              | 423,000     |   |                               |   | 422,000     |  
|Additional paid-in capital                                                                                                                                                                                               |  |                              | 30,311,000  |   |                               |   | 29,992,000  |  
|Retained deficit                                                                                                                                                                                                         |  |                              | (10,501,000 | ) |                               |   | (14,780,000 | )
|                                                                                                                                                                                                                         |  |                              |             |   |                               |   |             |  
|Total stockholders equity                                                                                                                                                                                               |  |                              | 20,233,000  |   |                               |   | 15,634,000  |  
|                                                                                                                                                                                                                         |  |                              |             |   |                               |   |             |  
|Total liabilities and stockholders equity                                                                                                                                                                               |  | $                            | 24,087,000  |   |                               | $ | 20,749,000  |  
|                                                                                                                                                                                                                         |  |                              |             |   |                               |   |             |  

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



3



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TRANSCEND SERVICES, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited and rounded to the nearest thousand)



|                                    |      |                                  |            |                                 |  |      |            |      |   |            |  |   |           
|----------------------------------- | ---- | -------------------------------- | ---------- | ------------------------------- |  | ---- | ---------- | ---- | - | ---------- |  | - | ----------
|                                    |      | Three months ended September 30, |            | Nine months ended September 30,
|                                    | 2008 |                                  |            | 2007                            |  | 2008 |            | 2007
|Revenue                             |      | $                                | 12,161,000 |                                 |  | $    | 10,629,000 |      | $ | 35,863,000 |  | $ | 31,570,000
|Direct costs                        |      |                                  | 7,643,000  |                                 |  |      | 7,048,000  |      |   | 22,788,000 |  |   | 21,588,000
|                                    |      |                                  |            |                                 |  |      |            |      |   |            |  |   |           
|Gross profit                        |      |                                  | 4,518,000  |                                 |  |      | 3,581,000  |      |   | 13,075,000 |  |   | 9,982,000 
|Operating expenses:                 |      |                                  |            |                                 |  |      |            |      |   |            |  |   |           
|Sales and marketing                 |      |                                  | 309,000    |                                 |  |      | 87,000     |      |   | 798,000    |  |   | 383,000   
|Research and development            |      |                                  | 230,000    |                                 |  |      | 151,000    |      |   | 763,000    |  |   | 474,000   
|General and administrative          |      |                                  | 1,474,000  |                                 |  |      | 1,364,000  |      |   | 4,245,000  |  |   | 3,857,000 
|Depreciation and amortization       |      |                                  | 208,000    |                                 |  |      | 202,000    |      |   | 605,000    |  |   | 608,000   
|                                    |      |                                  |            |                                 |  |      |            |      |   |            |  |   |           
|Total operating expenses            |      |                                  | 2,221,000  |                                 |  |      | 1,804,000  |      |   | 6,411,000  |  |   | 5,322,000 
|                                    |      |                                  |            |                                 |  |      |            |      |   |            |  |   |           
|Operating income                    |      |                                  | 2,297,000  |                                 |  |      | 1,777,000  |      |   | 6,664,000  |  |   | 4,660,000 
|Interest (income) expense, net      |      |                                  | (13,000    | )                               |  |      | 38,000     |      |   | 3,000      |  |   | 228,000   
|                                    |      |                                  |            |                                 |  |      |            |      |   |            |  |   |           
|Income before income taxes          |      |                                  | 2,310,000  |                                 |  |      | 1,739,000  |      |   | 6,661,000  |  |   | 4,432,000 
|Income taxes                        |      |                                  | 826,000    |                                 |  |      | 83,000     |      |   | 2,382,000  |  |   | 106,000   
|                                    |      |                                  |            |                                 |  |      |            |      |   |            |  |   |           
|Net income                          |      | $                                | 1,484,000  |                                 |  | $    | 1,656,000  |      | $ | 4,279,000  |  | $ | 4,326,000 
|                                    |      |                                  |            |                                 |  |      |            |      |   |            |  |   |           
|Basic earnings per share:           |      |                                  |            |                                 |  |      |            |      |   |            |  |   |           
|Net earnings per share              |      | $                                | 0.18       |                                 |  | $    | 0.20       |      | $ | 0.51       |  | $ | 0.53      
|                                    |      |                                  |            |                                 |  |      |            |      |   |            |  |   |           
|Weighted average shares outstanding |      |                                  | 8,448,000  |                                 |  |      | 8,370,000  |      |   | 8,448,000  |  |   | 8,210,000 
|                                    |      |                                  |            |                                 |  |      |            |      |   |            |  |   |           
|Diluted earnings per share:         |      |                                  |            |                                 |  |      |            |      |   |            |  |   |           
|Net earnings per share              |      | $                                | 0.17       |                                 |  | $    | 0.19       |      | $ | 0.49       |  | $ | 0.50      
|                                    |      |                                  |            |                                 |  |      |            |      |   |            |  |   |           
|Weighted average shares outstanding |      |                                  | 8,835,000  |                                 |  |      | 8,887,000  |      |   | 8,822,000  |  |   | 8,723,000 
|                                    |      |                                  |            |                                 |  |      |            |      |   |            |  |   |           

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



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TRANSCEND SERVICES, INC.

CONSOLIDATED STATEMENT OF STOCKHOLDERS EQUITY

FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2008

(Unaudited and rounded to the nearest thousand)



|                                                    |  |                                       |  |                        |   |                              |           |   |             |   |                           |  |                  |            |  |                          |             |   |  |   |           
|--------------------------------------------------- |  | ------------------------------------- |  | ---------------------- | - | ---------------------------- | --------- | - | ----------- | - | ------------------------- |  | ---------------- | ---------- |  | ------------------------ | ----------- | - |  | - | ----------
|                                                    |  | Numberof SharesSeries APreferredStock |  | Series APreferredStock |   | Numberof SharesofCommonStock |           |   | CommonStock |   | AdditionalPaid-in Capital |  | Retained Deficit |            |  | TotalStockholdersEquity
|Balance, December 31, 2007 (as restated)            |  |                                      |  | $                      |  |                              | 8,435,000 |   |             | $ | 422,000                   |  | $                | 29,992,000 |  | $                        | (14,780,000 | ) |  | $ | 15,634,000
|                                                    |  |                                       |  |                        |   |                              |           |   |             |   |                           |  |                  |            |  |                          |             |   |  |   |           
|Net income                                          |  |                                      |  |                        |  |                              |          |   |             |   |                          |  |                  |           |  |                          | 4,279,000   |   |  |   | 4,279,000 
|Issuance of common stock from stock incentive plans |  |                                      |  |                        |  |                              | 21,000    |   |             |   | 1,000                     |  |                  | 60,000     |  |                          |            |   |  |   | 61,000    
|Share-based expense                                 |  |                                      |  |                        |  |                              |          |   |             |   |                          |  |                  | 259,000    |  |                          |            |   |  |   | 259,000   
|Share retirement                                    |  |                                      |  |                        |  |                              | (8,000    | ) |             |   |                          |  |                  |           |  |                          |            |   |  |   |          
|                                                    |  |                                       |  |                        |   |                              |           |   |             |   |                           |  |                  |            |  |                          |             |   |  |   |           
|Balance, September 30, 2008                         |  |                                      |  | $                      |  |                              | 8,448,000 |   |             | $ | 423,000                   |  | $                | 30,311,000 |  | $                        | (10,501,000 | ) |  | $ | 20,233,000
|                                                    |  |                                       |  |                        |   |                              |           |   |             |   |                           |  |                  |            |  |                          |             |   |  |   |           

The accompanying notes are an integral part of this consolidated financial statement.



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TRANSCEND SERVICES, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited and rounded to the nearest thousand)



|                                                                                  |      |                                 |            |      |  |   |            |  
|--------------------------------------------------------------------------------- | ---- | ------------------------------- | ---------- | ---- |  | - | ---------- | -
|                                                                                  |      | Nine months ended September 30, |           
|                                                                                  | 2008 |                                 |            | 2007 | 
|Cash flows from operating activities:                                             |      |                                 |            |      |  |   |            |  
|Net income                                                                        |      | $                               | 4,279,000  |      |  | $ | 4,326,000  |  
|Adjustments to reconcile net income to net cash provided by operating activities: |      |                                 |            |      |  |   |            |  
|Deferred income taxes                                                             |      |                                 | 2,075,000  |      |  |   |           |  
|Depreciation and amortization                                                     |      |                                 | 605,000    |      |  |   | 608,000    |  
|Equity-based compensation                                                         |      |                                 | 259,000    |      |  |   | 207,000    |  
|Employment credits  debt forgiveness                                             |      |                                 | (23,000    | )    |  |   | (48,000    | )
|Changes in assets and liabilities                                                 |      |                                 |            |      |  |   |            |  
|Accounts receivable, net                                                          |      |                                 | (237,000   | )    |  |   | (513,000   | )
|Prepaid expenses and other current assets                                         |      |                                 | (5,000     | )    |  |   | (227,000   | )
|Other assets                                                                      |      |                                 | 65,000     |      |  |   | 10,000     |  
|Accounts payable                                                                  |      |                                 | 248,000    |      |  |   | 707,000    |  
|Accrued and other liabilities                                                     |      |                                 | (149,000   | )    |  |   | 11,000     |  
|                                                                                  |      |                                 |            |      |  |   |            |  
|Total adjustments                                                                 |      |                                 | 2,838,000  |      |  |   | 1,131,000  |  
|                                                                                  |      |                                 |            |      |  |   |            |  
|Net cash provided by operating activities                                         |      |                                 | 7,117,000  |      |  |   | 5,457,000  |  
|                                                                                  |      |                                 |            |      |  |   |            |  
|                                                                                  |      |                                
|Cash flows from investing activities:                                             |      |                                 |            |      |  |   |            |  
|Capital expenditures                                                              |      |                                 | (701,000   | )    |  |   | (503,000   | )
|Purchase of business, net of cash acquired                                        |      |                                 | (40,000    | )    |  |   | (562,000   | )
|                                                                                  |      |                                 |            |      |  |   |            |  
|Net cash used in investing activities                                             |      |                                 | (741,000   | )    |  |   | (1,065,000 | )
|                                                                                  |      |                                 |            |      |  |   |            |  
|                                                                                  |      |                                
|Cash flows from financing activities:                                             |      |                                 |            |      |  |   |            |  
|Proceeds from stock options and other issuances                                   |      |                                 | 61,000     |      |  |   | 1,015,000  |  
|Repayment of promissory notes payable to related parties                          |      |                                 | (1,167,000 | )    |  |   | (1,105,000 | )
|Repayment of promissory notes payable                                             |      |                                 | (165,000   | )    |  |   |           |  
|Proceeds from revolving promissory notes                                          |      |                                 |           |      |  |   | 520,000    |  
|Repayment of revolving promissory notes                                           |      |                                 |           |      |  |   | (1,670,000 | )
|                                                                                  |      |                                 |            |      |  |   |            |  
|Net cash used in financing activities                                             |      |                                 | (1,271,000 | )    |  |   | (1,240,000 | )
|                                                                                  |      |                                 |            |      |  |   |            |  
|Net change in cash and cash equivalents                                           |      |                                 | 5,105,000  |      |  |   | 3,152,000  |  
|Cash and cash equivalents at beginning of period                                  |      |                                 | 4,996,000  |      |  |   | 215,000    |  
|                                                                                  |      |                                 |            |      |  |   |            |  
|Cash and cash equivalents at end of period                                        |      | $                               | 10,101,000 |      |  | $ | 3,367,000  |  
|                                                                                  |      |                                 |            |      |  |   |            |  
|                                                                                  |      |                                
|Supplemental cash flow information:                                               |      |                                 |            |      |  |   |            |  
|Cash paid for interest to related parties                                         |      | $                               | 59,000     |      |  | $ | 114,000    |  
|Cash paid for interest                                                            |      | $                               | 54,000     |      |  | $ | 149,000    |  
|Cash paid for income taxes                                                        |      | $                               | 250,000    |      |  | $ | 73,000     |  
|                                                                                  |      |                                
|Non-cash investing and financing activities:                                      |      |                                 |            |      |  |   |            |  
|Additional contingent consideration accrued for previous acquisition              |      | $                               | 26,000     |      |  | $ |           |  
|Promissory note issued in connection with the acquisition of OTP                  |      | $                               |           |      |  | $ | 330,000    |  
|Common stock issued in connection with the acquisition of OTP                     |      | $                               |           |      |  | $ | 220,000    |  
|Cashless exercise of warrants                                                     |      | $                               |           |      |  | $ | 225,000    |  

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



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TRANSCEND SERVICES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1. BASIS OF PRESENTATION

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 (as amended) for the year ended December 31, 2007. Footnote disclosure that substantially
duplicates the disclosure contained in that document has been omitted. Certain items previously reported in specific financial statement captions have been reclassified to conform to this presentation.

RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS

In September 2006,
the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standard (SFAS) No. 157, Fair Value Measurements. This Statement defines fair value, establishes a framework for measuring
fair value and expands disclosure requirements about fair value measurements. SFAS 157 was effective for the Company on January 1, 2008. However, in February 2008, the FASB released a FASB Staff Position (FSP FAS 157-2Effective Date of
FASB Statement No. 157) which delayed the effective date of SFAS 157 for all non-financial assets and non-financial liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis
(at least annually). The adoption of SFAS 157 for our financial assets and liabilities did not have a material impact on our consolidated financial statements upon adoption. We are evaluating the impact the adoption of SFAS 157, effective
January 1, 2009, will have on our non-financial assets and liabilities. SFAS 157 establishes a fair value hierarchy that distinguishes between assumptions based on market data (observable inputs) and the Companys assumptions (unobservable
inputs). The hierarchy consists of three broad levels as follows:

Level 1  Quoted market prices in active markets for identical assets or
liabilities

Level 2  Inputs other than level 1 that are either directly or indirectly observable

Level 3  Unobservable inputs developed using the Companys estimates and assumptions, which reflect those that market participants would use.

In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities, including an amendment of SFAS
No. 115. This Statement, which is effective for financial statements issued for fiscal years beginning after November 15, 2007, including interim periods within that fiscal year, permits companies to measure financial instruments and
certain other items at fair value and provides the opportunity to mitigate volatility in earnings caused by measuring related assets and liabilities without having to apply complex hedge accounting provisions. The Company did not elect the fair
value option for any of its existing financial instruments as of September 30, 2008 and has not determined whether or not it will elect this option for financial instruments it may acquire in the future.

In December 2007, the FASB issued SFAS No. 141(R), Business Combinations. This Statement retains the fundamental requirements in SFAS 141, Business
Combinations. However, SFAS 141(R) requires that acquisition costs be recognized separately from the acquisition and also requires the recognition of assets and liabilities assumed arising from contractual contingencies as of the acquisition
date. SFAS 141(R) is effective for our fiscal year beginning January 1, 2009. This Statement amends FASB Statement No. 109, Accounting for Income Taxes, to require the acquirer to recognize changes in the amount of its deferred tax
benefits that are recognizable because of a business combination either in income from continuing operations in the period of the combination or directly in contributed capital, depending on the circumstances. The Statement also requires that a
Company account for the potential tax effects of temporary differences, carryforwards, and any income tax uncertainties of an acquiree that exist at the acquisition date or that arise as a result of the acquisition in accordance with
Statement 109, as amended, and related interpretative guidance, including FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes. The adoption of SFAS 141(R) will likely have a significant impact on our accounting
for any acquisitions completed after the effective date of the pronouncement.

In March 2008, the FASB issued SFAS No. 161, Disclosures about
Derivative Instruments and Hedging Activitiesan Amendment of FASB Statement 133. SFAS 161 requires enhanced disclosures regarding how: (a) an entity uses derivative instruments; (b) derivative instruments and
related hedged items are accounted for under FASB Statement No. 133,Accounting for Derivative Instruments and Hedging Activities; and (c) derivative instruments and related hedged items affect an entitys



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financial position, financial performance, and cash flows. SFAS 161 is effective for fiscal years and interim periods beginning after November 15, 2008
with early application being encouraged. The Company does not have any derivative instruments nor is it currently involved in hedging activities and therefore adoption of SFAS 161 is not expected to have a material impact on the Companys
consolidated financial statements.

In April 2008, the FASB issued FSP FAS No. 142-3, which amends the factors that must be considered in
developing renewal or extension assumptions used to determine the useful life over which to amortize the cost of a recognized intangible asset under SFAS No. 142,  Goodwill and Other Intangible Assets . The FSP requires an entity
that is estimating the useful life of a recognized intangible asset to consider its historical experience in renewing or extending similar arrangements or, in the absence of historical experience, must consider assumptions that market participants
would use about renewal or extension that are both consistent with the assets highest and best use and adjusted for entity-specific factors under SFAS No. 142. The FSP is effective for fiscal years beginning after December 15,
2008, and the guidance for determining the useful life of a recognized intangible asset must be applied prospectively to intangible assets acquired after the effective date. The Company does not expect the adoption of FSP FAS No. 142-3 to have
a material effect on its consolidated financial statements.

In May 2008, the FASB issued SFAS No. 162, The Hierarchy of Generally Accepted
Accounting Principles. SFAS 162 is intended to improve financial reporting by identifying a consistent framework, or hierarchy, for selecting accounting principles to be used in financial statements that are presented in conformity with
U.S. generally accepted accounting principles for nongovernmental entities. SFAS 162 is effective 60 days following the SECs approval of the Public Company Accounting Oversight Board amendments to AU Section 411,The Meaning of
Present Fairly in Conformity With Generally Accepted Accounting Principles. The adoption of SFAS 162 is not expected to have a significant impact on the Companys consolidated financial statements.

2. ACQUISITIONS

Transcend purchased certain assets of OTP
Technologies, Inc. (OTP), a Chicago area medical transcription company, on January 16, 2007. Transcend purchased the assets to expand its medical transcription business in the Midwest, capitalize on the potential for the acquired
business to grow and leverage Transcends fixed overhead costs across a larger revenue base. Transcend paid $1,070,000, consisting of $520,000 in cash, a $330,000 promissory note and $220,000 (60,274 shares) of Transcend common stock. In
addition, based on the final earnout calculation stemming from 2007 revenue, Transcend paid $40,000 in additional consideration in January 2008. The promissory note bears interest at 5% per annum and is payable in five installments, with the
first installment paid on January 16, 2008 and final installment due on January 16, 2010. The consideration exchanged exceeded the value of the net tangible assets acquired by approximately $1.2 million, which was allocated as follows:
$220,000 to customer relationships to be amortized over a period of five years and $1.0 million to goodwill, including $46,000 in acquisition costs. All goodwill and intangible asset amortization related to the acquisition of the OTP assets is
expected to be deductible for income tax purposes.

On December 31, 2005, the Company purchased the assets of PracticeXpert, Inc. for $40,000, with
earnout potential of an additional $460,000. To date, $45,000 in additional earnout has been accrued under the agreement. The earnout period ends on February 14, 2009.

3. MAJOR CUSTOMERS

No single customer accounted for greater than 10% of total revenue for the three and nine months
ended September 30, 2008 and 2007. The Company provides medical transcription services under individual contracts to customers that are members of a group of hospitals. Revenue attributable to members of this group comprised 20% and 22% of the
Companys total revenue for the three months ended September 30, 2008 and 2007, respectively, and 22% and 23% of the Companys total revenue for the nine months ended September 30, 2008 and 2007, respectively.

4. GOODWILL AND OTHER INTANGIBLE ASSETS

The Company accounts for
goodwill and other intangible assets in accordance with the provisions of SFAS No. 142, Goodwill and Other Intangible Assets.Under the provisions of this Statement, goodwill and intangible assets that have indefinite useful lives are
tested at least annually for impairment rather than being amortized like intangible assets with finite useful lives, which are amortized over their useful lives.



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Other Intangible Assets

(rounded to the nearest thousand)



|                             |                      |   |             |                               |                         |                   |           |         |             |   |                         |  |           |         |  |   |         |  |   |        
|---------------------------- | -------------------- | - | ----------- | ----------------------------- | ----------------------- | ----------------- | --------- | ------- | ----------- | - | ----------------------- |  | --------- | ------- |  | - | ------- |  | - | -------
|                             |                      |   |             | September 30, 2008(unaudited) |                         | December 31, 2007
|                             | Useful Life in Years |   | GrossAssets |                               | AccumulatedAmortization |                   | NetAssets |         | GrossAssets |   | AccumulatedAmortization |  | NetAssets
|Amortized intangible assets: |                      |   |             |                               |                         |                   |           |         |             |   |                         |  |           |         |  |   |         |  |   |        
|Covenants-not-to-compete     |                      | 5 |             | $                             | 50,000                  |                   | $         | 36,000  |             | $ | 14,000                  |  | $         | 50,000  |  | $ | 29,000  |  | $ | 21,000 
|Customer relationships       |                      | 5 |             |                               | 745,000                 |                   |           | 454,000 |             |   | 291,000                 |  |           | 745,000 |  |   | 342,000 |  |   | 403,000
|Total intangible assets      |                      |   |             | $                             | 795,000                 |                   | $         | 490,000 |             | $ | 305,000                 |  | $         | 795,000 |  | $ | 371,000 |  | $ | 424,000
|                             |                      |   |             |                               |                         |                   |           |         |             |   |                         |  |           |         |  |   |         |  |   |        

5. BORROWING ARRANGEMENTS

Revolving promissory note and term loan

The Company maintains a $5.6 million credit facility with Healthcare Finance
Group (HFG), which matures on December 30, 2009 and is comprised of up to $3.6 million on an accounts receivable-based revolving promissory note and up to $2.0 million of term loans to fund acquisitions. As a part of the agreement
with HFG, the Company issued a warrant to HFG to purchase 100,000 shares of Transcend common stock at an exercise price of $2.25 per share. The fair value of the warrant at grant date was estimated to be $74,000 and is being amortized into interest
expense over the life of the credit facility. On June 20, 2007, HFG exercised the warrant, receiving 89,008 unregistered shares of Transcend common stock in a cashless exercise. Borrowings bear interest at LIBOR plus 4% (6.49% as of
September 30, 2008), are secured by accounts receivable and other Company assets and require that the Company maintain certain financial and other covenants. The balance outstanding under the revolving promissory note was $4,000 at
September 30, 2008 and December 31, 2007. There was no balance outstanding on the term loan as of September 30, 2008 and December 31, 2007.

On January 16, 2007, the Company borrowed $520,000 from HFG against its term loan availability to fund the cash portion of the OTP acquisition. The term loan requires the principal to be repaid in 36 equal monthly installments
beginning May 1, 2007. On May 22, 2007, the Company prepaid the balance of the term loan in full.

As of September 30, 2008, $2.0 million
was available for borrowing under the HFG term loan and $3.6 million was available under the HFG revolving promissory note.

MDI Promissory Note

On January 31, 2005, the Company entered into a three year, $3.5 million promissory note in conjunction with the purchase of MDI. The note was secured
by the common stock of MDI and bears interest at 5.0%. The note repayment terms are as follows:



| |  | On January 31, 2006, one-third of the principal payable together with all accrued but unpaid interest.
|- |  | ------------------------------------------------------------------------------------------------------



| |  | On January 31, 2007, one-half of the remaining principal together with all accrued but unpaid interest.
|- |  | -------------------------------------------------------------------------------------------------------



| |  | On January 31, 2008, the remaining principal together with all accrued but unpaid interest.
|- |  | -------------------------------------------------------------------------------------------

On August 15, 2005, the holder of the $3.5 million promissory note reduced the principal amount of the note by $100,000 in consideration for 35,971 unregistered
shares of Transcends common stock issued at $2.78 per share, or 110% of fair market value. On December 26, 2005, the holder of the promissory note reduced the principal amount of the note by an additional $300,000 in consideration for
140,815 unregistered shares of Transcends common stock issued at $2.13 per share, or 105% of fair market value. As of December 31, 2007, the balance of the note was $1.2 million, which was subsequently paid with available cash in the
first quarter of 2008.

DCOA Promissory Note

On
April 6, 2005, the Company fulfilled the prerequisites for receiving the proceeds under a promissory note dated March 1, 2005 payable to the Development Corporation of Abilene, Inc. (DCOA) in the principal amount of $1.0
million (the Promissory Note). The Promissory Note relates to the Agreement for Financial Assistance by and between DCOA and



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Transcend effective as of March 1, 2005 that was approved by DCOA on March 4, 2005 and amended on June 6, 2006 (collectively, the
Agreement). Under the terms of the Agreement, DCOA shall provide up to $2.0 million of interest-free, secured loans to Transcend (the Loans). In return, Transcend established and operated a medical transcription training
center and regional office in Abilene, Texas. In addition, Transcend shall recruit, hire and train up to 208 medical transcription professionals, the majority of whom shall be recruited from Abilene or the area surrounding Abilene, as defined in the
Agreement. Through March 31, 2008, the latest date for which data has been certified by DCOA, Transcend has trained and hired 90 medical transcription professionals. DCOA shall offer the Loans to Transcend in two increments of $1 million each
in return for Transcend recruiting, hiring and training up to 104 medical transcription professionals for each Loan. The Promissory Note is the first such Loan.

Transcend received $850,000 under the Promissory Note on April 7, 2005 and was pre-funded $150,000 under the Promissory Note on March 31, 2005. The Promissory Note was initially secured by a $150,000 letter of credit from a bank
and certain furniture and equipment. The letter of credit was released December 7, 2005 and the remaining collateral shall be released as the principal balance of the Promissory Note is reduced. Transcend currently has no plans to attempt to
obtain the second $1 million Loan.

Transcend and DCOA intend for the Promissory Note to be paid by Transcend using quarterly training credits and annual
job creation/retention incentive credits provided to Transcend by DCOA as defined in the Agreement. Principal reductions of the Promissory Note shall be effected through quarterly training credits and annual earned job creation incentive credits,
not cash, as follows: (1) $25,000 per month for the first nine months of the Agreement provided that 15 employees are hired by Transcend during that period; (2) a quarterly training credit equal to 50% of the total wages paid to newly
hired Medical Language Specialists (MLS) during their probationary period (not to exceed $4,000 per MLS); and (3) an annual job creation incentive credit of between 10% and 12% of compensation for the year for each full time
equivalent employee (FTE), with cumulative per FTE credits capped at 30% to 35% of the FTEs annual compensation (depending on the FTEs compensation band) for FTEs hired on or before March 31, 2010.

As of September 30, 2008, Transcend has earned credits of $349,000, reducing the principal balance on the Promissory Note to $651,000. These credits are reported as
reductions of direct operating costs. In July 2007, the Company closed the regional office and modified the training program to allow trainees to work from home, thereby eliminating the need for a physical office presence in Abilene. The principal
balance of the Promissory Note, if any, remaining on March 1, 2013 is payable in cash by Transcend.

OTP Promissory Note

On January 16, 2007, the Company entered into a three year, $330,000 unsecured promissory note in conjunction with the purchase of OTP. The note bears interest at
5.0% and the principal is to be repaid as follows: $110,000 on January 16, 2008; $55,000 on July 16, 2008; $55,000 on January 16, 2009; $55,000 on July 16, 2009 and $55,000 on January 16, 2010. As of September 30, 2008,
the balance of the promissory note was $165,000.

6. TRANSACTIONS WITH RELATED PARTIES

The Company purchased the assets of OTP on January 16, 2007. The purchase was financed with $520,000 in cash, a $330,000 promissory note and $220,000 (60,274 shares) of Transcend common stock. The promissory note
and additional consideration is payable to OTP. The owners of OTP, James and Sharon Vonderhaar, were employed by the Company until April 1, 2007 and February 5, 2008, respectively. In addition, Transcend, based on the final earn-out
calculation stemming from 2007 revenue, paid $40,000 in additional consideration in January 2008.

Susan McGrogan is the Companys Chief Operating
Officer. Ms. McGrogan is also the co-founder of MDI, which was purchased by Transcend on January 31, 2005. In conjunction with the purchase of MDI, the Company entered into a $3.5 million promissory note payable to Ms. McGrogan, the
terms of which are described in Note 5, Borrowing Arrangements. On January 31, 2007 the Company paid $1.1 million as the second installment on the note plus $114,000 of accrued interest. During the first quarter of 2008, the Company
repaid $1.2 million as the final installment on the note plus $59,000 of accrued interest.

7. STOCK-BASED COMPENSATION

The Company has five stockholder-approved stock incentive plans (the Plans) for its key employees, directors and key consultants. The Plans provide for the
grant of incentive stock options, nonqualified stock options, restricted stock awards, and in the case of the plan approved by the shareholders on May 10, 2007, restricted stock units and stock appreciation rights. The Company intends to grant
new awards under the 2007 stock incentive plan only. The options are granted at fair market value, as defined in the option agreement, on the date of grant. There were 68,926 options available for issuance at September 30, 2008.



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On January 1, 2006, the Company adopted, using a modified version of prospective application, SFAS No. 123(R),
Share Based Payment (SFAS 123(R)). This Statement requires all share-based payments to employees, including grants of employee stock options, to be recognized in the financial statements based on their fair values at the date of
grant.

The fair value of each option grant is estimated on the date of grant using the Black-Scholes-Merton option-pricing model with the following
assumptions used for all options granted during the quarter ending September 30, 2008: dividend yield of 0%; volatility of 107.62%; risk-free interest rate of 2.89%; expected forfeiture rate of 50%; a weighted average exercise price of $11.75;
and a weighted average expected life of 4.00 years.

Transactions involving Company stock options for the nine months ended September 30, 2008 were as
follows:



|                                  |  |                                        |   |  |                               |       |                                         |           |                          |   |          
|--------------------------------- |  | -------------------------------------- | - |  | ----------------------------- | ----- | --------------------------------------- | --------- | ------------------------ | - | ---------
|                                  |  | Number ofSharesSubject toStock Options |   |  | WeightedAverageExercise Price |       | WeightedAverageRemainingContractualLife |           | AggregateIntrinsicValue*
|Outstanding at December 31, 2007  |  | 626,667                                |   |  | $                             | 4.68  |                                         | 7.8 years |                          |   |          
|Granted                           |  | 253,000                                |   |  | $                             | 10.96 |                                         |           |                          |   |          
|Forfeited                         |  | (5,250                                 | ) |  | $                             | 4.72  |                                         |           |                          |   |          
|Exercised                         |  | (21,650                                | ) |  | $                             | 2.82  |                                         |           |                          |   |          
|Outstanding at September 30, 2008 |  | 852,767                                |   |  | $                             | 6.59  |                                         | 7.8 years |                          | $ | 3,326,000



|* | The aggregate intrinsic value is based on a closing stock price of $10.49 as of September 30, 2008.
|- | ---------------------------------------------------------------------------------------------------

The Company recognized equity-based compensation and other expense of approximately $112,000 and $259,000 for the three and nine months ended September 30, 2008, respectively, and $70,000 and $172,000 for the
three and nine months ended September 30, 2007, respectively. As of September 30, 2008, the Company had approximately $1,128,000 of future compensation expense which it expects to record in its statements of operations through 2012.

8. INCOME TAXES

Total net deferred tax assets as of
September 30, 2008 of $1.5 million result primarily from the federal net operating loss carryforwards. At the end of 2007, the Company reversed all but $219,000 of its valuation allowance against its net deferred tax assets at December 31,
2007 based upon its determination that the realization of the federal net operating loss carryforwards in the future was sufficiently predictable. The valuation allowance was reduced to $162,000 at June 30, 2008 and further reduced to $62,000
as of September 30, 2008. based on increased profitability in certain states where the state net operating loss carryforwards were reserved. The Companys effective income tax rate was approximately 36% for the three and nine months ended
September 30, 2008. However, the cash actually expended for income taxes will be nominal until the net operating loss carryforwards are fully utilized. The Company is subject to federal alternative minimum tax and income tax in certain states
where net operating loss carryforwards are not available.

During the quarter ended June 30, 2008, we determined that the $1.8 million gain realized
by HFG on the exercise of their warrants in 2007 is not deductible by the Company. This $1.8 million gain was previously included in our federal net operating loss carryforwards and recorded as a deferred tax asset. In addition, the $1.8 million
benefit was also recorded as a deferred tax liability since the tax deduction related to these equity-based awards exceeded the cumulative cost recognized for the awards. Typically, this deferred tax liability would be recorded as a credit to
additional paid-in capital; however, since the Company had net operating loss carryforwards, the benefit was recorded as a deferred tax liability. This conclusion reduces the amount of federal net operating loss carryforwards available as of
December 31, 2007 from $15.7 million, as previously reported, to $13.9 million. Similarly, this change reduces the amount of federal net operating loss carryforwards available as of March 31, 2008 from $13.5 million, as previously
reported, to $11.7 million. However, the net deferred tax assets presented on our balance sheet at December 31, 2007 and March 31, 2008 are unaffected by this change due to the reversal of both the related deferred tax asset and the
deferred tax liability. During the second and third quarters of 2008, the federal net operating loss carryforwards were further reduced by $5.0 million due to taxable income generated during these quarters, bringing federal net operating loss
carryforwards at September 30, 2008 to approximately $6.7 million available to offset future taxable income.



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|Item 2. | Managements Discussion and Analysis of Financial Condition and Results of Operations
|------- | -------------------------------------------------------------------------------------

This Quarterly report on Form 10-Q contains certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of
1934, that represent our expectations, anticipations or beliefs about future events, including our operating results, financial condition, liquidity, expenditures, and compliance with legal and regulatory requirements. For this purpose, any
statements that are not statements of historical fact may be deemed to be forward-looking statements. These statements involve risks and uncertainties that could cause actual results to differ materially depending on a variety of important factors.
Factors that might cause or contribute to such differences include, but are not limited to, 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 in our periodic, quarterly and annual reports on Forms 8-K,
10-Q and 10-K that we file with the Securities Exchange Commission (SEC) from time to time. With respect to such forward-looking statements, we claim protection under the Private Securities Litigation Reform Act of 1995. Our SEC filings
are available from us, and also may be examined at public reference facilities maintained by the SEC or, to the extent filed via EDGAR, accessed through the website of the SEC (http://www.sec.gov). In addition, factors that we are not currently
aware of could harm our future operating results. You are cautioned not to place undue reliance on forward-looking statements, which speak only as of the date of this filing. We undertake no obligation to make any revisions to the forward-looking
statements or to reflect events or circumstances after the date of this filing.

Overview

Transcend provides medical transcription services to the healthcare industry. The Company utilizes a combination of its proprietary internet-based voice and data
distribution technology, third-party speech recognition technology, customer-based technology and domestic home-based and offshore medical language specialists to convert physicians voice recordings into electronic documents.

Critical Accounting Estimates which are Material to Registrant

A critical accounting estimate meets two criteria: (1) it requires assumptions about highly uncertain matters; and (2) there would be a material effect on the financial statements from either using a different, also reasonable,
amount within the range of the estimate in the current period or from reasonably likely period-to-period changes in the estimate. Our critical accounting estimates are as follows:

Goodwill and Intangible Assets.As of September 30, 2008, we had goodwill and net intangible assets at carrying amounts of $4.7 million and $305,000, respectively. The total of $5.0 million represents
approximately 21% of total assets as of September 30, 2008. Our intangible assets are amortized over their estimated useful lives. We review goodwill and intangibles for impairment annually and whenever events or changes in circumstances
indicate that the carrying value may not be recoverable. In testing for impairment, we calculate the fair value of the reporting units to which the goodwill and intangibles relate based on the present value of estimated future cash flows. The
approach utilized is dependent on a number of factors including estimates of future revenues and costs, appropriate discount rates and other variables. We base our estimates on assumptions that we believe to be reasonable, but which are
unpredictable and inherently uncertain. Therefore, future impairments could result if actual results differ from those estimates.

Deferred Taxes.
As of September 30, 2008, we have net deferred tax assets of $1.5 million, resulting primarily from federal net operating loss carryforwards of $6.7 million. Deferred tax assets represent future tax benefits we expect to realize. Our ability to
utilize the deferred tax benefits is dependent upon our ability to generate future taxable income. SFAS 109, Accounting for Income Taxes, requires us to record a valuation allowance against any deferred income tax benefits that we
believe may not be realized. We use current estimates of future taxable income to determine whether a valuation allowance is needed. Projecting our future taxable income requires us to use significant judgment regarding expected future revenues and
expenses. In addition, we must assume that tax laws will not change sufficiently to materially impact the expected tax liability associated with our expected taxable income. As of December 31, 2007, we determined that, except for deferred tax
assets related to certain state net operating loss carryforwards, we will more likely than not be able to utilize our deferred tax benefits in the future and accordingly, we reduced the valuation allowance to $219,000. The valuation allowance was
reduced to $162,000 as of June 30, 2008 and further reduced to $62,000 as of September 30, 2008 based on increased profitability in certain states where the net operating loss carryforwards were reserved.



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

Revenue increased $1.5 million, or 14%, to $12.2 million in the quarter ended September 30, 2008 compared to revenue of $10.6 million in the same period in 2007. The
$1.5 million increase in revenue is attributable to revenue from new customers of $1.5 million and increased revenue from existing customers of $416,000, offset by a decrease in revenue of $413,000 from customers who terminated their contracts.

Direct costs increased $595,000, or 8%, to $7.6 million in the quarter ended September 30, 2008 compared to $7.0 million in the same period in 2007.
Direct costs include costs attributable to compensation for transcriptionists, recruiting, management, customer service, technical support for operations, fees paid for speech recognition processing, telephone expenses and implementation of
transcription services. Transcriptionist 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. Speech recognition processing is a variable
cost based on the minutes of dictation processed. All other direct costs referred to above are semi-variable production infrastructure costs that periodically change in anticipation of or in response to the overall level of production activity.

Direct costs decreased to 63% of revenue in the quarter ended September 30, 2008 from 66% in the same period of 2007. The decrease in costs as a
percentage of revenue is due primarily to the growth of semi-variable direct costs of operations at a slower rate than the rate of revenue growth, cost savings that resulted from the rollout of the Companys speech recognition-enabled BeyondTXT
platform and the use of offshore transcription resources.

Gross profit increased $937,000, or 26%, to $4.5 million in the quarter ended September 30,
2008 compared to $3.6 million in the same period in 2007. Gross profit as a percentage of revenue increased to 37% in the quarter ended September 30, 2008 compared to 34% in the same period in 2007 (see direct costs discussion).

Sales and marketing expenses increased $222,000, or 255%, to $309,000 in the quarter ended September 30, 2008, compared to $87,000 in the same period of 2007. Sales
and marketing expenses as a percentage of revenue were 3% and 1% in the quarters ended September 30, 2008 and 2007, respectively. The increase in sales and marketing expense is primarily due to hiring three additional sales resources in 2008
and increased marketing activities.

Research and development expenses increased $79,000, or 52%, to $230,000 in the quarter ended September 30, 2008
compared to $151,000 in the same period in 2007. Research and development expenses as a percentage of revenue were 2% and 1% in the quarters ended September 30, 2008 and 2007, respectively. The increase is primarily due to an increase in
telecommunication and compensation-related expenses.

General and administrative expenses increased $110,000, or 8%, to $1.5 million in the quarter ended
September 30, 2008 compared to $1.4 million in the same period in 2007. The increase is due primarily to increased legal and audit expense as well as increased healthcare insurance costs. General and administrative expenses as a percentage of
revenue were 12% and 13% in the three month periods ended September 30, 2008 and 2007, respectively.

Depreciation and amortization expense was
relatively unchanged at $208,000 in the quarter ended September 30, 2008 compared to $202,000 in the same period in 2007.

Interest and other expenses
improved from $38,000 of expense in the third quarter of 2007 to $13,000 of income in the quarter ended September 30, 2008. The improvement is due primarily to a reduction in the amount of debt outstanding during the three months ended
September 30, 2008 compared to the same period of 2007, along with a significant increase in cash and cash equivalents versus prior year which drove interest income higher.

The income tax provision of $826,000 for the three months ended September 30, 2008 results from a current provision of $222,000 related to the 2007 return to provision true-up and 2008 federal alternative minimum
tax and state income tax in states where net operating loss carryforwards are not available and deferred expense of $705,000 related primarily to the utilization of net operating loss carryforwards, offset by a reduction in the valuation allowance
for deferred income tax assets of $101,000. The net income tax provision of $83,000 for the three months ended September 30, 2007 resulted primarily from state income tax provisions for states in which net operating loss carryforwards were not
available and alternative minimum taxes.

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

Revenue increased $4.3 million, or 14%, to $35.9 million in the nine months ended September 30, 2008 compared to revenue of $31.6 million in the
same period in 2007. The $4.3 million increase in revenue is attributable to revenue from new customers of $3.2 million and increased revenue from existing customers of $2.3 million, offset by a decrease in revenue of $1.2 million from customers who
terminated their contracts.



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Direct costs increased $1.2 million, or 6%, to $22.8 million in the nine months ended September 30, 2008 compared to
$21.6 million in the same period in 2007. Direct costs include costs attributable to compensation for transcriptionists, recruiting, management, customer service, technical support for operations, fees paid for speech recognition processing,
telephone expenses and implementation of transcription services. Transcriptionist 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. Speech
recognition processing is a variable cost based on the minutes of dictation processed. All other direct costs referred to above are semi-variable production infrastructure costs that periodically change in anticipation of or in response to the
overall level of production activity.

Direct costs decreased to 64% of revenue in the nine months ended September 30, 2008 from 68% in the same
period of 2007. The decrease in costs as a percentage of revenue is due primarily to cost savings that resulted from the rollout of the Companys speech recognition-enabled BeyondTXT platform and the use of offshore transcription resources.

Gross profit increased $3.1 million, or 31%, to $13.1 million in the nine months ended September 30, 2008 compared to $10.0 million in the same
period in 2007. Gross profit as a percentage of revenue increased to 36% in the nine months ended September 30, 2008 compared to 32% in the same period in 2007 (see direct costs discussion).

Sales and marketing expenses increased $415,000, or 108%, to $798,000 in the nine months ended September 30, 2008, compared to $383,000 in the same period of 2007.
Sales and marketing expenses as a percentage of revenue were 2% and 1% in the nine months ended September 30, 2008 and 2007, respectively. The increase in sales and marketing expense is primarily due to hiring three additional sales resources
in 2008 and increased marketing activities.

Research and development expenses increased $289,000, or 61%, to $763,000 in the nine months ended
September 30, 2008 compared to $474,000 in the same period in 2007. Research and development expenses as a percentage of revenue were 2% in both the nine months ended September 30, 2008 and 2007. The increase is primarily due to an
increase in telecommunication and compensation-related expenses.

General and administrative expenses increased $388,000, or 10%, to $4.2 million in the
nine months ended September 30, 2008 compared to $3.9 million in the same period in 2007. The increase is due primarily to increases in healthcare insurance costs and expenses related to amending our 2007 10-K. General and administrative
expenses as a percentage of revenue were 12% both the nine month periods ended September 30, 2008 and September 30, 2007.

Depreciation and
amortization expense was relatively unchanged at $605,000 in the nine months ended September 30, 2008 compared to $608,000 in the same period in 2007.

Interest and other expenses decreased $225,000, or 99%, to $3,000 in the nine months ended September 30, 2008 compared to $228,000 in the same period of 2007. The decrease is due primarily to a reduction in the amount of debt
outstanding during the nine months ended September 30, 2008 compared to the same period of 2007, along with a significant increase in cash and cash equivalents versus prior year which drove interest income higher.

The income tax provision of $2.4 million for the nine months ended September 30, 2008 results from a current provision of $456,000 related to the 2007 return to
provision true-up and 2008 federal alternative minimum tax and state income tax in states where net operating loss carryforwards are not available and deferred expense of $2.1 million related primarily to the utilization of net operating loss
carryforwards, offset by a reduction in the valuation allowance for deferred income tax assets of $158,000. The net income tax provision of $106,000 for the nine months ended September 30, 2007 resulted primarily from state income tax
provisions for states in which net operating loss carryforwards were not available and alternative minimum taxes.

Liquidity and Capital
Resources

As of September 30, 2008, the Company had cash and cash equivalents of $10.1 million, working capital of $13.7 million,
availability of approximately $3.6 million on its revolving promissory note and $2.0 million available on its acquisition term loan facility.

Cash
provided by operating activities was $7.1 million for the nine months ended September 30, 2008 compared to $5.5 million for the nine months ended September 30, 2007. The improvement was due primarily to improved profitability before income
taxes.



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Cash used in investing activities was $741,000 for the nine months ended September 30, 2008, compared to cash used
of $1.1 million for the nine months ended September 30, 2007. In 2007, the company purchased OTP for $550,000 plus acquisition costs; there was no similar acquisition during the same period of 2008.

Cash used in financing activities was $1.3 million for the nine months ended September 30, 2008, consisting of a $1.2 million principal repayment on the MDI
promissory note and a $165,000 repayment on the OTP promissory note, offset by proceeds of $61,000 from the exercise of stock options. For the nine months ended September 30, 2007, cash used in financing activities was $1.2 million, consisting
of net repayments on the HFG credit facility of $1.2 million and a $1.1 million repayment on the MDI promissory note, offset by proceeds of $1.0 million from the exercise of stock options.

The Company anticipates that cash on hand, together with cash flow from operations and cash available under its credit facility should be sufficient for the next twelve
months to finance operations, make capital investments in the ordinary course of business, and pay indebtedness when due.

Part of the growth strategy for
Transcend is the completion of acquisitions. Management believes sources of acquisition financing, including cash on hand, the $5.6 million available on the HFG credit facilities and the ability to issue Company stock, are sufficient to complete
smaller acquisitions. Additional financing would be required for larger acquisitions.



|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 September 30, 2008.



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

Disclosure controls and procedures are
controls and other procedures that are designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Securities Exchange Act of 1934, as amended (the Exchange Act) is recorded,
processed, summarized and reported, within the time periods specified in the rules and forms of the Securities and Exchange Commission (SEC). Disclosure controls and procedures include, without limitation, controls and procedures
designed to ensure that information we are required to disclose in the reports that we file or submit under the Exchange Act is accumulated and communicated to our management as appropriate to allow timely decisions regarding required disclosure.

During the second quarter of 2008, our management reevaluated the effectiveness of our disclosure controls and procedures (as such term is defined in
Rules 13a-15(e) or 15d-15(e) under the Exchange Act). Based on that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were not effective because of the material weakness in our
internal controls described below.

A material weakness in internal control over financial reporting (as defined in paragraph A7 of Auditing Standard
No. 5 of the Public Company Accounting Oversight Board) is a deficiency, or combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the
Companys annual or interim financial statements will not be prevented or detected on a timely basis. A deficiency in internal control over financial reporting exists when the design or operation of a control does not allow management or
employees, in the normal course of performing their assigned functions, to prevent or detect misstatements on a timely basis.

In April and May of 2008,
the Company identified an internal control deficiency as of December 31, 2007 related to certain aspects of accounting for income taxes. The internal control deficiency was expanded in May of 2008 to encompass accounting for income taxes in
general as follows:



|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Controls over the accounting for income taxes: The Company did not maintain effective controls over accounting for income taxes. The Company did not have effective policies and procedures
and adequately trained and qualified accounting personnel to ensure that the financial impact to the Company of transactions and assets and liabilities affecting income taxes were accounted for in accordance with GAAP. As a result of this material
weakness, the Company was required to restate its consolidated financial statements and related disclosures as of and for the year ended December 31, 2007.

We are in the process of implementing certain changes in internal control over financial reporting and will
continue to implement remediation efforts, as described below. Accordingly, we believe that the consolidated financial statements included in this Form 10-Q fairly present in all material respects our financial position, results of operations and
cash flows for the periods presented.



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Management believes, however, that a controls system, no matter how well designed and operated, cannot provide absolute
assurance that the objectives of the controls system are met, and no evaluation of controls can provide absolute assurance that all controls are working as designed and that instances of fraud, if any, within a company have been detected.

Changes in Internal Control over Financial Reporting

Internal control over financial reporting consists of control processes designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of the Companys financial statements for external
purposes 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. In April of 2008, in connection with the identification of the material weakness described above, we began the process of making improvements in our
internal control. The following improvements to our internal control over financial reporting are in process:



| |  |  | the preparation and adoption of a remediation plan related specifically to the material weakness;
| | - |  | -------------------------------------------------------------------------------------------------



| |  |  | the engagement of BDO Seidman, LLP to provide accounting services related to income taxes;
| | - |  | ------------------------------------------------------------------------------------------



| |  |  | additional training of accounting personnel;
| | - |  | --------------------------------------------



| |  |  | thorough documentation of the tax accounting processes and procedures; and
| | - |  | --------------------------------------------------------------------------



| |  |  | periodic internal reviews to ensure that accounting for income taxes is in compliance with GAAP.
| | - |  | ------------------------------------------------------------------------------------------------

PART II. OTHER INFORMATION



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

From time to time, we are a party to litigation.
We were not party to any material litigation during the quarter ended September 30, 2008.



|Item 1A. | Risk Factors
|-------- | ------------

There have been no material changes in the risk
factors previously disclosed in our Annual Report on Form 10-K (as amended) for the year ended December 31, 2007.



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

There
were no unregistered sales of equity securities during the quarter ended September 30, 2008.



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

None.



|Item 6. | Exhibits
|------- | --------

The following exhibits are filed with or incorporated by
reference into this report.



|              |  |                              |  |                            |  |            |  |             |  |                  
|------------- |  | ---------------------------- |  | -------------------------- |  | ---------- |  | ----------- |  | -----------------
|ExhibitNumber |  | Exhibit Description          |  | Incorporation by Reference
|              |  | Form                         |  | File No.                   |  | Exhibit    |  | Filing Date
|3.1           |  | Certificate of Incorporation |  | S-3                        |  | 333-106446 |  | 4.1         |  | June 25, 2003    
|              |  |                              |  |                            | 
|3.2           |  | Restated Bylaws              |  | 8-K                        |  | 000-18217  |  | 3 (a)       |  | December 19, 2007



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|        |  |                                                                                                                                                                            |  |                            |  |  |  |  |  | 
|------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | -------------------------- |  |  |  |  |  | 
|Exhibit |  |                                                                                                                                                                            |  | Incorporation by Reference
|31.1    |  | Certification of Chief Executive Officer of the Registrant Pursuant to Rule 13a-14(a) or 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) or 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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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 thereunto duly authorized.



|                  |  |                          |  |                                                                    
|----------------- |  | ------------------------ |  | -------------------------------------------------------------------
|                  |  | TRANSCEND SERVICES, INC.
|                  |  |                         
|November 10, 2008 |  | By:                      |  | /s/ Larry G. Gerdes                                                
|                  |  |                          |  | Larry G. Gerdes,                                                   
|                  |  |                          |  | President and Chief Executive Officer (Principal
Executive Officer)
|                  |  |                         
|                  |  | By:                      |  | /s/ Lance Cornell                                                  
|                  |  |                          |  | Lance Cornell,                                                     
|                  |  |                          |  | Chief Financial Officer (Principal Financial Officer)              



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