##### Table of Contents





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 June 30, 2010

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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File
required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such
files).    Yes   ̈    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.



|                        |  |   |  |  |  |                           |  |   |  | 
|----------------------- |  | - |  |  |  | ------------------------- |  | - |  | 
|Large accelerated filer |  |  ̈ |  |  |  | Accelerated filer         |  | x |  | 
|                        |  |   |  |  | 
|Non-accelerated filer   |  |  ̈ |  |  |  | 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 July 31,
2010
|Common Stock, $0.05 par value |  | 10,486,182                  









---

##### Table of Contents

INDEX



|              |  |                                                                                                 |  |           
|------------- |  | ----------------------------------------------------------------------------------------------- |  | ----------
|              |  |                                                                                                 |  | PageNumber
|              |  |                                                                                                
|PART I.       |  | FINANCIAL INFORMATION                                                                           |  | 3         
|              |  |                                                                                                
|Item 1.       |  | Financial Statements (unaudited)                                                                |  | 3         
|              |  | Consolidated Balance Sheets as of June 30, 2010 and December 31, 2009                           |  | 3         
|              |  | Consolidated Statements of Operations for the Three and Six Months Ended June 30, 2010 and 2009 |  | 4         
|              |  | Consolidated Statement of Stockholders Equity for the Six Months Ended June 30, 2010           |  | 5         
|              |  | Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2010 and 2009           |  | 6         
|              |  | Notes to Consolidated Financial Statements                                                      |  | 7         
|              |  |                                                                                                
|Item 2.       |  | Managements Discussion and Analysis of Financial Condition and Results of Operations           |  | 14        
|              |  |                                                                                                
|Item 3.       |  | Quantitative and Qualitative Disclosures About Market Risk                                      |  | 22        
|              |  |                                                                                                
|Item 4.       |  | Controls and Procedures                                                                         |  | 22        
|              |  |                                                                                                
|PART II.      |  | OTHER INFORMATION                                                                               |  | 22        
|              |  |                                                                                                
|Item 1.       |  | Legal Proceedings                                                                               |  | 22        
|              |  |                                                                                                
|Item 1A.      |  | Risk Factors                                                                                    |  | 23        
|              |  |                                                                                                
|Item 6.       |  | Exhibits                                                                                        |  | 23        
|              | 
|SIGNATURES    |  | 24                                                                                             
|              | 
|EXHIBIT INDEX |  | 25                                                                                             



2



---

##### Table of Contents

PART I. FINANCIAL INFORMATION



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

TRANSCEND SERVICES, INC.

CONSOLIDATED BALANCE SHEETS

(Rounded to the nearest thousand)



|                                                                                                                                                                                                                                                 |  |                         |            |   |                  |   |            |  
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ |  | ----------------------- | ---------- | - | ---------------- | - | ---------- | -
|                                                                                                                                                                                                                                                 |  | June 30,2010(unaudited) |            |   | December 31,2009 |  
|ASSETS                                                                                                                                                                                                                                           |  |                         |            |   |                  |   |            |  
|Current assets:                                                                                                                                                                                                                                  |  |                         |            |   |                  |   |            |  
|Cash and cash equivalents                                                                                                                                                                                                                        |  | $                       | 10,803,000 |   |                  | $ | 25,732,000 |  
|Short-term investments                                                                                                                                                                                                                           |  |                         | 16,932,000 |   |                  |   | 2,000,000  |  
|Accounts receivable, net of allowance for doubtful accounts of $97,000 at June 30, 2010 and $96,000 at December 31,
2009                                                                                                                         |  |                         | 9,617,000  |   |                  |   | 9,500,000  |  
|Deferred income tax, net                                                                                                                                                                                                                         |  |                         | 42,000     |   |                  |   | 317,000    |  
|Prepaid income tax                                                                                                                                                                                                                               |  |                         | 349,000    |   |                  |   | 64,000     |  
|Prepaid expenses and other current assets                                                                                                                                                                                                        |  |                         | 496,000    |   |                  |   | 252,000    |  
|                                                                                                                                                                                                                                                 |  |                         |            |   |                  |   |            |  
|Total current assets                                                                                                                                                                                                                             |  |                         | 38,239,000 |   |                  |   | 37,865,000 |  
|Property and equipment:                                                                                                                                                                                                                          |  |                         |            |   |                  |   |            |  
|Computer equipment                                                                                                                                                                                                                               |  |                         | 3,450,000  |   |                  |   | 3,095,000  |  
|Software                                                                                                                                                                                                                                         |  |                         | 3,663,000  |   |                  |   | 2,990,000  |  
|Furniture and fixtures                                                                                                                                                                                                                           |  |                         | 695,000    |   |                  |   | 611,000    |  
|                                                                                                                                                                                                                                                 |  |                         |            |   |                  |   |            |  
|Total property and equipment                                                                                                                                                                                                                     |  |                         | 7,808,000  |   |                  |   | 6,696,000  |  
|Accumulated depreciation and amortization                                                                                                                                                                                                        |  |                         | (5,428,000 | ) |                  |   | (4,857,000 | )
|                                                                                                                                                                                                                                                 |  |                         |            |   |                  |   |            |  
|Property and equipment, net                                                                                                                                                                                                                      |  |                         | 2,380,000  |   |                  |   | 1,839,000  |  
|Capitalized software                                                                                                                                                                                                                             |  |                         | 1,811,000  |   |                  |   | 176,000    |  
|Intangible assets:                                                                                                                                                                                                                               |  |                         |            |   |                  |   |            |  
|Goodwill                                                                                                                                                                                                                                         |  |                         | 23,650,000 |   |                  |   | 23,650,000 |  
|Other intangible assets                                                                                                                                                                                                                          |  |                         | 6,699,000  |   |                  |   | 6,699,000  |  
|                                                                                                                                                                                                                                                 |  |                         |            |   |                  |   |            |  
|Total intangible assets                                                                                                                                                                                                                          |  |                         | 30,349,000 |   |                  |   | 30,349,000 |  
|Accumulated amortization                                                                                                                                                                                                                         |  |                         | (1,351,000 | ) |                  |   | (1,014,000 | )
|                                                                                                                                                                                                                                                 |  |                         |            |   |                  |   |            |  
|Intangible assets, net                                                                                                                                                                                                                           |  |                         | 28,998,000 |   |                  |   | 29,335,000 |  
|Other assets                                                                                                                                                                                                                                     |  |                         | 100,000    |   |                  |   | 173,000    |  
|                                                                                                                                                                                                                                                 |  |                         |            |   |                  |   |            |  
|Total assets                                                                                                                                                                                                                                     |  | $                       | 71,528,000 |   |                  | $ | 69,388,000 |  
|                                                                                                                                                                                                                                                 |  |                         |            |   |                  |   |            |  
|LIABILITIES AND STOCKHOLDERS EQUITY                                                                                                                                                                                                             |  |                         |            |   |                  |   |            |  
|Current liabilities:                                                                                                                                                                                                                             |  |                         |            |   |                  |   |            |  
|Accounts payable                                                                                                                                                                                                                                 |  | $                       | 558,000    |   |                  | $ | 1,384,000  |  
|Accrued compensation and benefits                                                                                                                                                                                                                |  |                         | 2,928,000  |   |                  |   | 2,296,000  |  
|Promissory note payable to related party                                                                                                                                                                                                         |  |                         | 2,000,000  |   |                  |   | 2,000,000  |  
|Promissory notes payable                                                                                                                                                                                                                         |  |                         | 67,000     |   |                  |   | 899,000    |  
|Other accrued liabilities                                                                                                                                                                                                                        |  |                         | 1,342,000  |   |                  |   | 2,210,000  |  
|                                                                                                                                                                                                                                                 |  |                         |            |   |                  |   |            |  
|Total current liabilities                                                                                                                                                                                                                        |  |                         | 6,895,000  |   |                  |   | 8,789,000  |  
|Long term liabilities:                                                                                                                                                                                                                           |  |                         |            |   |                  |   |            |  
|Deferred income tax, net                                                                                                                                                                                                                         |  |                         | 934,000    |   |                  |   | 1,083,000  |  
|Other liabilities                                                                                                                                                                                                                                |  |                         | 143,000    |   |                  |   | 159,000    |  
|                                                                                                                                                                                                                                                 |  |                         |            |   |                  |   |            |  
|Total long term liabilities                                                                                                                                                                                                                      |  |                         | 1,077,000  |   |                  |   | 1,242,000  |  
|Commitments and contingencies                                                                                                                                                                                                                    |  |                         |            |   |                  |   |            |  
|Stockholders equity:                                                                                                                                                                                                                            |  |                         |            |   |                  |   |            |  
|Preferred stock, $0.01 par value; 2,000,000 shares authorized and no shares outstanding at June 30, 2010 and
December 31, 2009                                                                                                                   |  |                         |           |   |                  |   |           |  
|Common stock, $0.05 par value; 30,000,000 shares authorized at June 30, 2010 and 15,000,000 shares authorized at
December 31, 2009; 10,486,000 and 10,477,000 shares issued and outstanding at June 30, 2010 and December 31, 2009, respectively |  |                         | 525,000    |   |                  |   | 524,000    |  
|Additional paid-in capital                                                                                                                                                                                                                       |  |                         | 62,237,000 |   |                  |   | 61,086,000 |  
|Retained earnings (deficit)                                                                                                                                                                                                                      |  |                         | 794,000    |   |                  |   | (2,253,000 | )
|                                                                                                                                                                                                                                                 |  |                         |            |   |                  |   |            |  
|Total stockholders equity                                                                                                                                                                                                                       |  |                         | 63,556,000 |   |                  |   | 59,357,000 |  
|                                                                                                                                                                                                                                                 |  |                         |            |   |                  |   |            |  
|Total liabilities and stockholders equity                                                                                                                                                                                                       |  | $                       | 71,528,000 |   |                  | $ | 69,388,000 |  
|                                                                                                                                                                                                                                                 |  |                         |            |   |                  |   |            |  

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



3



---

##### Table of Contents

TRANSCEND SERVICES, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited and rounded to the nearest thousand,

except earnings per share)



|                                                                      |  |                             |            |   |                           |   |            |      |  |   |            |   |  |   |            |  
|--------------------------------------------------------------------- |  | --------------------------- | ---------- | - | ------------------------- | - | ---------- | ---- |  | - | ---------- | - |  | - | ---------- | -
|                                                                      |  | Three months endedJune 
30, |            |   | Six months endedJune 
30, |  
|                                                                      |  | 2010                        |            |   | 2009                      |   |            | 2010 |  |   | 2009       |  
|Revenue                                                               |  | $                           | 22,209,000 |   |                           | $ | 16,966,000 |      |  | $ | 44,415,000 |   |  | $ | 31,896,000 |  
|Direct costs (exclusive of depreciation & amortization)               |  |                             | 14,178,000 |   |                           |   | 10,851,000 |      |  |   | 28,904,000 |   |  |   | 20,438,000 |  
|                                                                      |  |                             |            |   |                           |   |            |      |  |   |            |   |  |   |            |  
|Gross profit                                                          |  |                             | 8,031,000  |   |                           |   | 6,115,000  |      |  |   | 15,511,000 |   |  |   | 11,458,000 |  
|Operating expenses:                                                   |  |                             |            |   |                           |   |            |      |  |   |            |   |  |   |            |  
|Sales and marketing (exclusive of depreciation & amortization)        |  |                             | 535,000    |   |                           |   | 446,000    |      |  |   | 938,000    |   |  |   | 853,000    |  
|Research and development (exclusive of depreciation & amortization)   |  |                             | 408,000    |   |                           |   | 364,000    |      |  |   | 834,000    |   |  |   | 733,000    |  
|General and administrative (exclusive of depreciation & amortization) |  |                             | 3,936,000  |   |                           |   | 2,174,000  |      |  |   | 7,695,000  |   |  |   | 3,940,000  |  
|Depreciation and amortization                                         |  |                             | 460,000    |   |                           |   | 309,000    |      |  |   | 908,000    |   |  |   | 564,000    |  
|                                                                      |  |                             |            |   |                           |   |            |      |  |   |            |   |  |   |            |  
|Total operating expenses                                              |  |                             | 5,339,000  |   |                           |   | 3,293,000  |      |  |   | 10,375,000 |   |  |   | 6,090,000  |  
|                                                                      |  |                             |            |   |                           |   |            |      |  |   |            |   |  |   |            |  
|Operating income                                                      |  |                             | 2,692,000  |   |                           |   | 2,822,000  |      |  |   | 5,136,000  |   |  |   | 5,368,000  |  
|Interest and other income                                             |  |                             | 17,000     |   |                           |   | 3,000      |      |  |   | 31,000     |   |  |   | 15,000     |  
|Interest and other (expenses)                                         |  |                             | (40,000    | ) |                           |   | (33,000    | )    |  |   | (81,000    | ) |  |   | (76,000    | )
|                                                                      |  |                             |            |   |                           |   |            |      |  |   |            |   |  |   |            |  
|Net other income (expense)                                            |  |                             | (23,000    | ) |                           |   | (30,000    | )    |  |   | (50,000    | ) |  |   | (61,000    | )
|Income before income taxes                                            |  |                             | 2,669,000  |   |                           |   | 2,792,000  |      |  |   | 5,086,000  |   |  |   | 5,307,000  |  
|Income tax provision                                                  |  |                             | 1,101,000  |   |                           |   | 1,036,000  |      |  |   | 2,039,000  |   |  |   | 1,973,000  |  
|                                                                      |  |                             |            |   |                           |   |            |      |  |   |            |   |  |   |            |  
|Net income                                                            |  | $                           | 1,568,000  |   |                           | $ | 1,756,000  |      |  | $ | 3,047,000  |   |  | $ | 3,334,000  |  
|                                                                      |  |                             |            |   |                           |   |            |      |  |   |            |   |  |   |            |  
|Basic earnings per share:                                             |  |                             |            |   |                           |   |            |      |  |   |            |   |  |   |            |  
|Net earnings per share                                                |  | $                           | 0.15       |   |                           | $ | 0.21       |      |  | $ | 0.29       |   |  | $ | 0.39       |  
|                                                                      |  |                             |            |   |                           |   |            |      |  |   |            |   |  |   |            |  
|Weighted average shares outstanding                                   |  |                             | 10,489,000 |   |                           |   | 8,483,000  |      |  |   | 10,486,000 |   |  |   | 8,476,000  |  
|                                                                      |  |                             |            |   |                           |   |            |      |  |   |            |   |  |   |            |  
|Diluted earnings per share:                                           |  |                             |            |   |                           |   |            |      |  |   |            |   |  |   |            |  
|Net earnings per share                                                |  | $                           | 0.15       |   |                           | $ | 0.20       |      |  | $ | 0.28       |   |  | $ | 0.38       |  
|                                                                      |  |                             |            |   |                           |   |            |      |  |   |            |   |  |   |            |  
|Weighted average shares outstanding                                   |  |                             | 10,793,000 |   |                           |   | 8,874,000  |      |  |   | 10,839,000 |   |  |   | 8,831,000  |  
|                                                                      |  |                             |            |   |                           |   |            |      |  |   |            |   |  |   |            |  

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



4



---

##### Table of Contents

TRANSCEND SERVICES, INC.

CONSOLIDATED STATEMENT OF STOCKHOLDERS EQUITY

FOR THE SIX MONTHS ENDED JUNE 30, 2010

(Unaudited and rounded to the nearest thousand)



|                                                                         |  |                                          |  |                        |   |                               |            |             |   |                          |  |   |                           |   |  |                     |            |   |  |   |            |  
|------------------------------------------------------------------------ |  | ---------------------------------------- |  | ---------------------- | - | ----------------------------- | ---------- | ----------- | - | ------------------------ |  | - | ------------------------- | - |  | ------------------- | ---------- | - |  | - | ---------- | -
|                                                                         |  | Number ofShares ofSeries APreferredStock |  | Series APreferredStock |   | Number ofShares ofCommonStock |            | CommonStock |   | AdditionalPaid-inCapital |  |   | Retained(Deficit)Earnings |   |  | StockholdersEquity |           
|Balance, December 31, 2009                                               |  |                                         |  | $                      |  |                               | 10,477,000 |             | $ | 524,000                  |  | $ | 61,086,000                |   |  | $                   | (2,253,000 | ) |  | $ | 59,357,000 |  
|Net income                                                               |  |                                          |  |                        |   |                               |            |             |   |                          |  |   |                           |   |  |                     | 3,047,000  |   |  |   | 3,047,000  |  
|Issuance of common stock from stock incentive plans                      |  |                                          |  |                        |   |                               | 9,000      |             |   | 1,000                    |  |   | 42,000                    |   |  |                     |            |   |  |   | 43,000     |  
|Stock-based compensation expense                                         |  |                                          |  |                        |   |                               |            |             |   |                          |  |   | 1,085,000                 |   |  |                     |            |   |  |   | 1,085,000  |  
|Revision of estimate for capitalized expenses of stock offering          |  |                                          |  |                        |   |                               |            |             |   |                          |  |   | 56,000                    |   |  |                     |            |   |  |   | 56,000     |  
|Tax effect from disqualifying dispositions of stock options and warrants |  |                                          |  |                        |   |                               |            |             |   |                          |  |   | (32,000                   | ) |  |                     |            |   |  |   | (32,000    | )
|                                                                         |  |                                          |  |                        |   |                               |            |             |   |                          |  |   |                           |   |  |                     |            |   |  |   |            |  
|Balance, June 30, 2010                                                   |  |                                         |  | $                      |  |                               | 10,486,000 |             | $ | 525,000                  |  | $ | 62,237,000                |   |  | $                   | 794,000    |   |  | $ | 63,556,000 |  
|                                                                         |  |                                          |  |                        |   |                               |            |             |   |                          |  |   |                           |   |  |                     |            |   |  |   |            |  

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



5



---

##### Table of Contents

TRANSCEND SERVICES, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited and rounded to the nearest thousand)



|                                                                                  |  |                           |             |   |      |   |            |  
|--------------------------------------------------------------------------------- |  | ------------------------- | ----------- | - | ---- | - | ---------- | -
|                                                                                  |  | Six months ended June 30, |            
|                                                                                  |  | 2010                      |             |   | 2009 |  
|Cash flows from operating activities:                                             |  |                           |             |   |      |   |            |  
|Net income                                                                        |  | $                         | 3,047,000   |   |      | $ | 3,334,000  |  
|Adjustments to reconcile net income to net cash provided by operating activities: |  |                           |             |   |      |   |            |  
|Deferred income taxes                                                             |  |                           | 126,000     |   |      |   | 487,000    |  
|Depreciation and amortization                                                     |  |                           | 908,000     |   |      |   | 564,000    |  
|Stock-based compensation                                                          |  |                           | 1,085,000   |   |      |   | 258,000    |  
|Changes in assets and liabilities:                                                |  |                           |             |   |      |   |            |  
|Accounts receivable, net                                                          |  |                           | (117,000    | ) |      |   | (168,000   | )
|Prepaid income taxes, excluding tax benefit for stock based payments              |  |                           | (317,000    | ) |      |   | 380,000    |  
|Tax benefit for stock based payments                                              |  |                           | 32,000      |   |      |   | (1,228,000 | )
|Prepaid expenses and other current assets                                         |  |                           | (244,000    | ) |      |   | (7,000     | )
|Other assets                                                                      |  |                           | 73,000      |   |      |   | 14,000     |  
|Accounts payable                                                                  |  |                           | (826,000    | ) |      |   | 137,000    |  
|Accrued and other liabilities                                                     |  |                           | (252,000    | ) |      |   | (131,000   | )
|                                                                                  |  |                           |             |   |      |   |            |  
|Total adjustments                                                                 |  |                           | 468,000     |   |      |   | 306,000    |  
|                                                                                  |  |                           |             |   |      |   |            |  
|Net cash provided by operating activities                                         |  |                           | 3,515,000   |   |      |   | 3,640,000  |  
|Cash flows from investing activities:                                             |  |                           |             |   |      |   |            |  
|Capital expenditures                                                              |  |                           | (1,112,000  | ) |      |   | (372,000   | )
|Capitalized software development costs                                            |  |                           | (1,635,000  | ) |      |   |           |  
|Purchase of investments                                                           |  |                           | (20,587,000 | ) |      |   |           |  
|Sale and maturity of investments                                                  |  |                           | 5,655,000   |   |      |   |           |  
|Purchase of businesses, net of cash acquired                                      |  |                           |            |   |      |   | (8,814,000 | )
|                                                                                  |  |                           |             |   |      |   |            |  
|Net cash used in investing activities                                             |  |                           | (17,679,000 | ) |      |   | (9,186,000 | )
|Cash flows from financing activities:                                             |  |                           |             |   |      |   |            |  
|Proceeds from stock options and other issuances of stock                          |  |                           | 43,000      |   |      |   | 83,000     |  
|Revision of estimate for capitalized expenses of stock offering                   |  |                           | 56,000      |   |      |   |           |  
|Tax benefit for stock based payments                                              |  |                           | (32,000     | ) |      |   | 1,228,000  |  
|Repayment of promissory notes payable                                             |  |                           | (832,000    | ) |      |   | (238,000   | )
|Repayment of revolving promissory note                                            |  |                           |            |   |      |   | (2,000     | )
|                                                                                  |  |                           |             |   |      |   |            |  
|Net cash (used in) provided by financing activities                               |  |                           | (765,000    | ) |      |   | 1,071,000  |  
|                                                                                  |  |                           |             |   |      |   |            |  
|Net change in cash and cash equivalents                                           |  |                           | (14,929,000 | ) |      |   | (4,475,000 | )
|Cash and cash equivalents at beginning of period                                  |  |                           | 25,732,000  |   |      |   | 12,282,000 |  
|                                                                                  |  |                           |             |   |      |   |            |  
|Cash and cash equivalents at end of period                                        |  | $                         | 10,803,000  |   |      | $ | 7,807,000  |  
|                                                                                  |  |                           |             |   |      |   |            |  
|                                                                                  |  |                          
|Supplemental cash flow information:                                               |  |                           |             |   |      |   |            |  
|Cash paid for interest                                                            |  | $                         | 19,000      |   |      | $ | 22,000     |  
|Cash paid for income taxes                                                        |  | $                         | 2,245,000   |   |      | $ | 1,376,000  |  
|                                                                                  |  |                          
|Non-cash investing and financing activities:                                      |  |                           |             |   |      |   |            |  
|Additional contingent consideration accrued for previous acquisition              |  |                           |            |   |      | $ | 475,000    |  

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



6



---

##### Table of Contents

TRANSCEND SERVICES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation

The accompanying consolidated financial statements include the accounts of Transcend Services, Inc. (the Company or Transcend) and
for the periods after August 31, 2009, our wholly-owned subsidiary, Medical Dictation Services, Inc. (MDSI). All intercompany accounts and transactions have been eliminated in consolidation.

The accompanying consolidated financial statements are unaudited and have been prepared by our management in accordance with the rules and regulations of
the Securities and Exchange Commission (the SEC). 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 our Annual Report on Form 10-K for the year ended December 31, 2009. Footnote disclosure that
substantially duplicates the disclosure contained in that document has been omitted.

During the second quarter of 2010, we determined that
$231,000 of stock-based compensation expense should have been recorded in the first quarter of 2010. The adjustment was posted to the first quarter financial statements. We evaluated the materiality of the error and determined that a restatement of
the Companys Quarterly Report on Form 10-Q for the first quarter of 2010 was unnecessary. The amounts for the six months ended June 30, 2010 presented in this report reflect this adjustment to the first quarter of 2010.

Capitalized Software

We account for
computer software development costs for products to be licensed or otherwise marketed to third parties in accordance with ASC Topic 985  Accounting for the Costs of Computer Software to be Sold, Leased or Otherwise Marketed.
As such, all costs incurred prior to the product achieving technological feasibility are expensed as research and development costs. Technological feasibility is established upon completion of all planning, designing, and testing activities that are
necessary to establish that the product can be produced to meet its design specifications including functions, features, and technical performance requirements. Upon achieving technological feasibility, programming costs are capitalized until the
product is made available for general release to customers. The capitalized costs are amortized over the economic useful life of the product. At the end of 2009 we began to capitalize costs associated with the development of our next generation
transcription platform. The product which we intend to license or otherwise market to third parties is still in development and thus amortization of capitalized costs has not begun. All additional capitalized software is reported in property and
equipment since the software is for internal use only.

NET EARNINGS PER SHARE

We follow FASB ASC Topic 260Earnings per Share. Topic 260 requires the disclosure of basic net earnings per share and diluted net
earnings per share. Basic net earnings per share is computed by dividing net income available to common shareholders by the weighted average number of common shares outstanding during the period and does not include any other potentially dilutive
securities. Diluted net income per share gives effect to all potentially dilutive securities. Our stock options are potentially dilutive securities. Stock options with exercise prices that are greater than the average market price are excluded from
the calculation of diluted earnings per share because their effect would be anti-dilutive.

The reconciliations of the numerators and
denominators of the basic and diluted EPS calculations are shown below:



|                                                                                                                                        |  |                            |            |                           |   |           |  |      |            |  |   |          
|--------------------------------------------------------------------------------------------------------------------------------------- |  | -------------------------- | ---------- | ------------------------- | - | --------- |  | ---- | ---------- |  | - | ---------
|                                                                                                                                        |  | Three months endedJune 30, |            | Six months endedJune 
30,
|                                                                                                                                        |  | 2010                       |            | 2009                      |   | 2010      |  | 2009
|Numerator:                                                                                                                              |  |                            |            |                           |   |           |  |      |            |  |   |          
|Net income                                                                                                                              |  | $                          | 1,568,000  |                           | $ | 1,756,000 |  | $    | 3,047,000  |  | $ | 3,334,000
|                                                                                                                                        |  |                            |            |                           |   |           |  |      |            |  |   |          
|Denominator:                                                                                                                            |  |                            |            |                           |   |           |  |      |            |  |   |          
|Weighted average shares outstanding                                                                                                     |  |                            | 10,489,000 |                           |   | 8,483,000 |  |      | 10,486,000 |  |   | 8,476,000
|Effect of dilutive securities                                                                                                           |  |                            |            |                           |   |           |  |      |            |  |   |          
|Common stock options                                                                                                                    |  |                            | 304,000    |                           |   | 391,000   |  |      | 353,000    |  |   | 355,000  
|                                                                                                                                        |  |                            |            |                           |   |           |  |      |            |  |   |          
|Denominator for diluted calculation                                                                                                     |  |                            | 10,793,000 |                           |   | 8,874,000 |  |      | 10,839,000 |  |   | 8,831,000
|                                                                                                                                        |  |                            |            |                           |   |           |  |      |            |  |   |          
|                                                                                                                                        |  |                            |            |                          
|Basic earnings per share                                                                                                                |  | $                          | 0.15       |                           | $ | 0.21      |  | $    | 0.29       |  | $ | 0.39     
|Diluted earnings per share                                                                                                              |  | $                          | 0.15       |                           | $ | 0.20      |  | $    | 0.28       |  | $ | 0.38     
|Weighted-average outstanding stock options not included in diluted net income per share calculation as they had an anti-dilutive
effect |  |                            | 238,000    |                           |   | 83,000    |  |      | 74,000     |  |   | 188,000  

2. RECENT ACCOUNTING
PRONOUNCEMENTS

Recently Adopted Accounting Pronouncements

In January 2010, the FASB issued update 2010-06 to Topic 820  Fair Value Measurements and Disclosures. This update provided
requirements of new disclosures of significant transfers in and out of Levels 1 and 2, and expanded disclosure of activity in Level 3 (see Note 7). This update also clarified existing disclosures around the level of disaggregation of each class of
assets and liabilities, and about fair value inputs and valuation techniques for Level 2 and Level 3. This update was effective for interim and annual reporting periods beginning after December 15, 2009. Adoption of this update did not have a
material impact on our financial statements.

Recently Issued Accounting Pronouncements Not Yet Adopted

None.



7



---

##### Table of Contents

3. ACQUISITIONS

On January 1, 2009, we completed the acquisition of DeVenture Global Partners, Inc. (DeVenture) in accordance with the Asset Purchase
Agreement entered into on December 26, 2008. We purchased substantially all of the assets and assumed certain liabilities of DeVenture to expand our market share, capitalize on the potential for the acquired business to grow and leverage our
fixed overhead costs across a larger revenue base. DeVentures debt was not assumed. Including the contingent payment, the total purchase price was $4,375,000. Goodwill of $3,049,000 was recorded for the DeVenture acquisition. Goodwill
consisted primarily of the synergies and economies of scale expected from combining the operations of Transcend and DeVenture and the value of the DeVenture assembled workforce.

On April 1, 2009, we completed the acquisition of the domestic medical transcription business of Transcription Relief Services, Inc.
(TRS) in accordance with the Asset Purchase Agreement entered into on March 26, 2009. We purchased the TRS assets and assumed certain liabilities of TRS to expand our market share, capitalize on the potential for the acquired
business to grow and leverage our fixed overhead costs across a larger revenue base. TRSs debt was not assumed. A contingent payment in the amount of $1,123,000 was paid in February 2010 (see Note 11 of the Notes to Consolidated Financial
Statements). Including the contingent payment, the purchase price was $5,623,000. Goodwill of $2,773,000 was recorded for the TRS acquisition. This consisted primarily of the synergies and economies of scale expected from combining the operations of
Transcend and TRS and the value of the TRS assembled workforce.

A contingent consideration payment was part of the agreement in connection
with the acquisition of TRS. We estimated the fair value of this payable as of the purchase date of the acquisition. FASB ASC, Topic 805 Business Combinationsrequires that this estimate be re-measured to fair value at each reporting
date until the contingency is resolved. These interim changes in estimated fair value, along with any differences in the final settlement, are recognized in operating expense. The purchase date fair value of the TRS contingent consideration was
$353,000. As of December 31, 2009, the value was calculated as $1,123,000. The $770,000 difference was recognized as operating expense in the fourth quarter of 2009 and the total amount of $1,123,000 was paid in February 2010.

On August 31, 2009, we purchased from the selling shareholder, Dorothy K. Fitzgerald, all issued and outstanding shares of common stock of MDSI.
Headquartered in Gaithersburg, Maryland, MDSI was a leading medical transcription company with approximately 450 transcriptionists and employees providing service to approximately 30 customers located predominantly in the Mid-Atlantic region of the
United States. We purchased MDSI to capitalize on the potential for the acquired business to grow, leverage our fixed overhead costs across a larger revenue base and increase our presence in the Mid-Atlantic region of the United States. The total
purchase price was $15,487,000. Goodwill of $13.1 million was recorded for the MDSI acquisition. This consisted primarily of the synergies and economies of scale expected from combining the operations of Transcend and MDSI and the value of the MDSI
assembled workforce.

4. MAJOR CUSTOMERS

In September 2009, we announced that we had entered into a five-year single-source contract to provide medical transcription services to hospitals that
are members of Health Management Associates (HMA) effective October 1, 2009. Prior to signing this agreement, we had individual contracts with approximately 45 of HMAs 54 hospitals. The agreement expanded our existing
relationship with HMA to include the HMA hospitals which were using other transcription service providers. As of June 30, 2010, we have transitioned all but two of the existing HMA hospitals. In addition, pursuant to the terms of the agreement,
any future hospitals acquired or managed by HMA will transition to us as soon as practicable.

Revenue attributable to our contract with HMA
comprised 18.0% and 16.0% of our total revenue for the three months ended June 30, 2010 and 2009, respectively, and 18.2% and 18.0% of total revenue for the six months ended June 30, 2010 and 2009, respectively.

Our top 10 customers (a customer is an individual hospital) accounted for approximately 16.4% of our transcription revenue for the three months ended
June 30, 2010, averaging $1.5 million of annualized revenue per customer, with no one customer accounting for greater than 10% of revenue. Our average annual revenue per customer was approximately $349,000 for the 2009 fiscal year and $345,000
for the first six months of 2010.



8



---

##### Table of Contents

5. INVESTMENTS

Short-term investments consist of government notes and fully insured certificates of deposit with original maturities of 91 to 227 days. These
investments are classified as available-for-sale.



|                             |  |               |            |                   |   |          
|---------------------------- |  | ------------- | ---------- | ----------------- | - | ---------
|Description                  |  | June 30, 2010 |            | December 31, 2009
|Available-for-sale           |  |               |            |                   |   |          
|Certificates of deposit      |  | $             | 4,934,000  |                   | $ | 2,000,000
|U.S. Treasury Securities     |  |               | 11,998,000 |                   |   |         
|                             |  |               |            |                   |   |          
|Total short-term investments |  | $             | 16,932,000 |                   | $ | 2,000,000
|                             |  |               |            |                   |   |          

6. GOODWILL AND OTHER INTANGIBLE ASSETS

We account for goodwill and other intangible assets in accordance with the provisions of FASB ASC Topic 350  Intangibles-Goodwill and
Other. Under this Topic, 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. A portion of the respective purchase prices of the acquisitions of Medical Dictation, Inc. (MDI) and PracticeXpert, acquired in 2005, OTP Technologies, Inc. (OTP), acquired in 2007 and DeVenture, TRS and MDSI,
all acquired in 2009, were attributed to goodwill and other intangible assets.

Other Intangible Assets

(Rounded to the nearest thousand)



|                             |  |                     |  |               |           |                         |   |           |  |             |           |                         |   |           |  |   |           |  |   |          
|---------------------------- |  | ------------------- |  | ------------- | --------- | ----------------------- | - | --------- |  | ----------- | --------- | ----------------------- | - | --------- |  | - | --------- |  | - | ---------
|                             |  |                     |  | June 30, 2010 |           | December 31, 2009      
|                             |  | Useful Lifein Years |  | GrossAssets   |           | AccumulatedAmortization |   | NetAssets |  | GrossAssets |           | AccumulatedAmortization |   | NetAssets
|Amortized intangible assets: |  |                     |  |               |           |                         |   |           |  |             |           |                         |   |           |  |   |           |  |   |          
|Covenants not to compete     |  | 5                   |  | $             | 218,000   |                         | $ | 85,000    |  | $           | 133,000   |                         | $ | 218,000   |  | $ | 67,000    |  | $ | 151,000  
|Customer relationships       |  | 10                  |  |               | 6,481,000 |                         |   | 1,266,000 |  |             | 5,215,000 |                         |   | 6,481,000 |  |   | 947,000   |  |   | 5,534,000
|                             |  |                     |  |               |           |                         |   |           |  |             |           |                         |   |           |  |   |           |  |   |          
|Total intangible assets      |  |                     |  | $             | 6,699,000 |                         | $ | 1,351,000 |  | $           | 5,348,000 |                         | $ | 6,699,000 |  | $ | 1,014,000 |  | $ | 5,685,000
|                             |  |                     |  |               |           |                         |   |           |  |             |           |                         |   |           |  |   |           |  |   |          

7. FAIR VALUE OF FINANCIAL INSTRUMENTS

FASB ASC Topic 820  Fair Value Measurements and Disclosures, establishes a framework for measuring fair value and expands financial
statement disclosures about fair value measurements. Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. This topic requires
that assets and liabilities carried at fair value be classified and disclosed in one of the following three categories:

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

Level 2: Observable market based inputs or
unobservable inputs that are corroborated by market data

Level 3: Unobservable inputs that are not corroborated by market data

In accordance with FASB ASC Topic 825  Financial Instruments, the carrying value of short-term debt, which totaled
$2,067,000 as of June 30, 2010 and $2,899,000 as of December 31, 2009, was estimated to approximate its fair value. The fair value of debt is estimated based on approximate market interest rates for similar issues. Our other financial
instruments, including cash and cash equivalents, accounts receivable and accounts payable, approximate fair value due to the short-term nature of those assets and liabilities.



9



---

##### Table of Contents

At December 31, 2009 our short-term investments consisted of fully-insured certificates of deposits
with maturities of less than four months. These investments were valued using Level 1 inputs and carrying value approximated fair value.

At
June 30, 2010 our short-term investments consisted of government notes and fully-insured certificates of deposits. These investments are classified as available-for-sale and valued using Level 1 inputs (quoted prices in active markets) and
carrying value approximates fair value. The following table summarizes the carrying amounts and fair values of short-term investments at June 30, 2010:



|                             |  |              |            |                                                             |   |                                             |  |                                         |   |  |   |  
|---------------------------- |  | ------------ | ---------- | ----------------------------------------------------------- | - | ------------------------------------------- |  | --------------------------------------- | - |  | - | -
|Description                  |  | June 30,2010 |            | Quoted Prices inActive Markets forIdentical Assets(Level 1) |   | Significant 
OtherObservableInputs(Level 2) |  | SignificantUnobservableInputs(Level
 3)
|Available-for-sale           |  |              |            |                                                             |   |                                             |  |                                         |   |  |   |  
|Certificates of deposit      |  | $            | 4,934,000  |                                                             | $ | 4,934,000                                   |  | $                                       |  |  | $ | 
|U.S. Treasury Securities     |  |              | 11,998,000 |                                                             |   | 11,998,000                                  |  |                                         |  |  |   | 
|                             |  |              |            |                                                             |   |                                             |  |                                         |   |  |   |  
|Total short-term investments |  | $            | 16,932,000 |                                                             | $ | 16,932,000                                  |  | $                                       |  |  | $ | 
|                             |  |              |            |                                                             |   |                                             |  |                                         |   |  |   |  

8. BORROWING ARRANGEMENTS

Credit Facility

We maintained a
four-year credit facility with Healthcare Finance Group (HFG) through August 31, 2009. The HFG facility was due to mature on December 31, 2009 and was initially 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. The term loan portion expired on December 31, 2007. On August 31, 2009, we terminated our credit facility with HFG in order to secure new financing from
Regions Bank. In the third quarter of 2009, we wrote off the unamortized financing costs related to the HFG facility and incurred an early termination fee of $10,000 that was paid to HFG upon termination. HFG released all claims to our assets held
as security for the facility.

On August 31, 2009, Transcend and MDSI entered into a loan and security agreement with Regions Bank.
Transcend and MDSI are both borrowers under the loan and security agreement, which replaced our previous credit facility with HFG. The loan and security agreement includes a one-time, four-year term loan of $7.0 million for the costs and
expenses of, and, to the extent necessary, a portion of the purchase price for MDSI. The loan and security agreement also provides for up to $5.0 million in a revolving loan commitment based on eligible accounts receivable. We may use proceeds of
the revolving loan only for working capital, general corporate purposes, and for specified acquisitions. The maximum amount of the revolving loan may be increased at the discretion of Regions Bank to $8.0 million. We used $4.0 million of the
proceeds from the follow-on offering completed in the fourth quarter of 2009 to pay down the term loan. The revolving loan commitment expires in August, 2010. Borrowings bear interest at a rate based on the current LIBOR (3.75% as of June 30,
2010), and are secured by substantially all of our assets. The outstanding balance on the term loan was $67,000 and the balance on the revolver was $0 as of June 30, 2010.

The loan and security agreement contains representations and warranties, as well as affirmative, reporting and negative covenants customary for
financings of this type. Among other things, the loan and security agreement restricts us from incurring certain additional debt, prohibits us from creating, permitting or allowing certain liens on our property, restricts the payment of dividends,
distributions and other specified equity related transactions, and prohibits certain borrowings and specified transactions with affiliates. The loan and security agreement also requires the maintenance of a specified minimum fixed charge coverage
ratio, tangible net worth, and cash flow leverage, as defined in the agreement. As of June 30, 2010, we were in compliance with all covenants of the agreement.

On April 8, 2010, Transcend and MDSI entered into a commitment letter for a senior secured credit facility in an aggregate principal amount of up to
$65,000,000 with Regions Business Capital, Regions Capital Markets and Regions Bank (collectively, Regions). We intended to use part of the proceeds from the credit facility to fund our bid for substantially all of the assets of Spheris,
Inc. (Spheris) and the stock of its subsidiary, Spheris India Private



10



---

##### Table of Contents

Limited (Spheris India). Spheris declared bankruptcy under Chapter 11 and an auction under Section 363 of the United States Bankruptcy Code was held for substantially all of the
assets of Spheris and the stock of Spheris India, subject to the terms of a stock and asset purchase agreement. The United States Bankruptcy Court for the District of Delaware established a bid process whereby interested parties, including us,
submitted qualified bids on April 8, 2010. Qualified bidders participated in the auction held on April 13, 2010. We were not the successful bidder in the auction and did not enter into the new credit facility. In accordance with the
commitment letter, the commitment terminated on May 28, 2010 because the definitive credit agreement and other legal documents related to the senior credit facility were not executed by that date. We expensed approximately $300,000 and $61,000
of costs related to the credit facility in the first quarter and second quarter of 2010, respectively, that would have been capitalized if the credit facility had closed. In addition to these credit facility costs, we also expensed $378,000 and
$540,000 of attorney and advisor costs related to the bid for Spheris in the first quarter and second quarter of 2010, respectively.

OTP
Promissory Note

On January 16, 2007, we entered into a three year, $330,000 unsecured promissory note in conjunction with the
purchase of OTP. The note bore interest at 5.0% and the principal was 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. The final payment on this note was made in January 2010.

MDSI Promissory Note

On August 31, 2009, we entered into a one year $2,000,000 unsecured promissory note at 5% interest, payable to Dorothy Fitzgerald, in conjunction
with the purchase of MDSI. All principal and interest are due and payable at maturity on August 31, 2010.

9. TRANSACTIONS WITH
RELATED PARTIES

We acquired all issued and outstanding shares of MDSI common stock from Dorothy Fitzgerald for an estimated purchase price
of $15,487,000. Payment of the purchase price included a $2,000,000 payment due at the delivery of audited financial statements and a $2,000,000 promissory note payable to Ms. Fitzgerald, the terms of which are described in Note 8
Borrowing Arrangements. In addition, we entered into a registration rights agreement dated August 31, 2009, providing Ms. Fitzgerald with piggyback registration rights. Ms. Fitzgerald is currently employed by
us.

10. STOCK-BASED COMPENSATION

General

We have six stockholder-approved
stock incentive plans (Plans), for our 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 plans approved
by the shareholders on May 10, 2007 and May 19, 2009, restricted stock units and stock appreciation rights. We intend to grant new awards under only the 2009 Stock Incentive Plan (the 2009 Plan). The options are granted at fair
market value, as defined in the option agreement, on the date of grant. There are 245,924 shares available for issuance at June 30, 2010.

Our stock-based awards are accounted for under the provisions of FASB ASC Topic 718 Stock Compensation. We measure and recognize
stock-based compensation expense based on the fair value measurement for all stock-based payment awards made to our employees and directors over the service period for which the awards are expected to vest. We calculated the fair value of each
restricted stock award based on our stock price on the date of grant. We calculated the fair value of each stock option award on the date of grant using the Black-Scholes-Merton option pricing model. The determination of fair value of stock option
awards on the date of grant using an option-pricing model is affected by our stock price as well as a number of assumptions including expected life, expected volatility, risk free interest rate and dividend yield. As a result, the future stock-based
compensation expense may differ from our historical amounts.



11



---

##### Table of Contents

In June 2010, we implemented an equity tracking software system. In the course of that implementation, it
came to our attention that we had three issues with our historical expense calculations that we have broken into two categories: (1) cumulative adjustments and (2) first quarter 2010 restricted stock vesting. We concluded that these
adjustments should be considered correction of errors as opposed to changes in estimates based on the definitions set out in FASB ASC Topic 250  Accounting Changes and Error Corrections. We performed an analysis
under SAB108 Considering the Effects of Prior Year Misstatements When Quantifying Misstatements in Current Year Financial Statements (SAB108), and used the materiality guidance of SAB99  Materiality (SAB99) to determine
whether or not the impact to any one period or the cumulative impact on a given period was material enough to require a restatement to previously filed financial statements.

The cumulative adjustment is the result of netting two offsetting issues. The first issue involved the use of estimated forfeiture rates and the required
true-up to actual forfeiture rates for all awards issued between 2006 and 2010, and the second issue was a mathematical error in the calculation of the volatility rate used to establish the grant date fair value of awards issued from 2008 to 2010.
Since both adjustments impact the same financial statement item, stock-based compensation expense, we determined that they could be combined into one net adjustment of additional expense of $445,000.Based on our analysis, it was determined
that the adjustment was not material to any prior reporting periods and that the correction of the error in 2010 does not materially impact the expected annual results for 2010. The adjustment was recorded in the second quarter of 2010.

The second category relates to the vesting of certain restricted stock awards in the first quarter of 2010. At the time of vesting in the first quarter
of 2010, only $124,000 of the total stock-based compensation expense of $355,000 had been recorded. The difference of $231,000 should have been recorded as additional compensation expense in the first quarter of 2010. Based on our analysis, it was
determined that the adjustment was not material to the first quarter and did not require a restatement of our Quarterly Report on Form 10-Q for the first quarter of 2010. In accordance with SAB108, the entry was recorded in the first quarter of 2010
and is reflected in the financial statements as of June 30, 2010 and will be reflected in any future filing of the financial information for the period ending March 31, 2010. The following table shows the impact of the adjustment and the
revised financial information for the quarter ended March 31, 2010.



|                                   |  |                                        |            |            |   |          |                                       |  |   |           
|---------------------------------- |  | -------------------------------------- | ---------- | ---------- | - | -------- | ------------------------------------- |  | - | ----------
|                                   |  | Quarter endedMarch 31, 2010as reported |            | Adjustment |   |          | Quarter endedMarch 31, 2010as revised
|Revenue                            |  | $                                      | 22,206,000 |            | $ |          |                                       |  | $ | 22,206,000
|Gross profit                       |  |                                        | 7,480,000  |            |   |          |                                       |  |   | 7,480,000 
|General and administrative expense |  |                                        | 3,528,000  |            |   | 231,000  |                                       |  |   | 3,759,000 
|Operating expense                  |  |                                        | 4,805,000  |            |   | 231,000  |                                       |  |   | 5,036,000 
|Operating income                   |  |                                        | 2,675,000  |            |   | (231,000 | )                                     |  |   | 2,444,000 
|Income tax provision               |  |                                        | 1,016,000  |            |   | (78,000  | )                                     |  |   | 938,000   
|Net income                         |  |                                        | 1,632,000  |            |   | (153,000 | )                                     |  |   | 1,479,000 
|Earnings per share - basic         |  |                                        | 0.16       |            |   | (0.02    | )                                     |  |   | 0.14      
|Earnings per share - diluted       |  |                                        | 0.15       |            |   | (0.01    | )                                     |  |   | 0.14      

Activity for the period presented

The fair value of each option grant is estimated on the date of grant using the Black-Scholes-Merton option pricing model that uses the
assumptions or range of assumptions. The weighted average grant date fair value of options granted in the quarter ended June 30, 2010 was $5.14. The risk-free interest rate for the period matching the expected term of the option is based on the
U.S. Treasury yield curve in effect at the time of the grant. The dividend yield is the calculated yield on our stock at the time of grant. The expected term of the options represents the period of time that options granted are expected to be
outstanding and is derived by analyzing historic exercise behavior along with currently outstanding options. The maximum contractual term of these options is ten years. Expected volatilities are based on historical volatility of our common stock.
The expected forfeiture rates are based on historical forfeiture rates. The following assumptions were used for all options granted during the quarter ending June 30, 2010 (all were issued to members of the Board of Directors):



|                                 |  |   |        
|-------------------------------- |  | - | -------
|Risk-free interest rate          |  |   | 1.50%  
|Expected dividend yield          |  |   | 0%     
|Expected term                    |  |   | 3 years
|Expected volatility              |  |   | 57.34% 
|Expected forfeiture rate         |  |   | 0%     
|Exercise price of options issued |  | $ | 13.03  



12



---

##### Table of Contents

Transactions involving our stock options for the six months ended June 30, 2010 were as follows:



|                                 |  |                                        |   |  |                               |       |                                         |           |                          |   |          
|-------------------------------- |  | -------------------------------------- | - |  | ----------------------------- | ----- | --------------------------------------- | --------- | ------------------------ | - | ---------
|                                 |  | Number ofSharesSubject toStock Options |   |  | WeightedAverageExercise Price |       | WeightedAverageRemainingContractualLife |           | AggregateIntrinsicValue*
|Outstanding at December 31, 2009 |  | 863,517                                |   |  | $                             | 7.75  |                                         | 7.0 years |                          |   |          
|Granted                          |  | 45,000                                 |   |  | $                             | 16.45 |                                         |           |                          |   |          
|Forfeited                        |  | (17,000                                | ) |  | $                             | 15.48 |                                         |           |                          |   |          
|Exercised                        |  | (9,000                                 | ) |  | $                             | 4.68  |                                         |           |                          |   |          
|Outstanding at June 30, 2010     |  | 882,517                                |   |  | $                             | 8.07  |                                         | 6.7 years |                          | $ | 4,792,067



|* | The aggregate intrinsic value is based on a closing stock price of $13.50 as of June 30, 2010.
|- | ----------------------------------------------------------------------------------------------

In the first quarter of 2010, we issued restricted stock to certain participants under the 2009 Plan. We use the average of the grant date high and low
stock price to calculate fair value. These shares were performance based and it was determined in the second quarter that performance measures were not achieved and the grant was forfeited. Transactions involving the Companys restricted stock
for the six months ended June 30, 2010 were as follows:



|                                                  |  |                 |   |  |                                     |      
|------------------------------------------------- |  | --------------- | - |  | ----------------------------------- | -----
|                                                  |  | Number ofShares |   |  | WeightedAverageGrant DateFair Value
|Non-vested stock outstanding at December 31, 2009 |  | 87,000          |   |  | $                                   | 16.34
|Granted                                           |  | 10,000          |   |  |                                     | 20.72
|Forfeited                                         |  | (10,000         | ) |  |                                     | 20.72
|Vested                                            |  | (21,750         | ) |  |                                     | 16.34
|Non-vested stock outstanding at June 30, 2010     |  | 65,250          |   |  |                                     | 16.34

We recognized stock-based
compensation expense under FASB ASC Topic 718 Compensation-Stock Compensation of approximately $640,000 and $147,000 for the three months ended June 30, 2010 and 2009, respectively, and approximately $1,085,000 and $258,000 for
the six months ended June 30, 2010 and 2009, respectively. These totals include the adjustments to stock-based compensation expense in the first and second quarters of 2010 discussed above. As of June 30, 2010, we had approximately
$1,394,000 of future equity-based compensation expense which we expect to record in our statements of operations through 2014.

11.
CONTINGENCIES

From time to time in the normal course of business, we are involved in legal proceedings. We evaluate the need for loss
accruals under the requirements of FASB ASC 450 Contingencies. We record an estimated loss for any claim, lawsuit, investigation or proceeding when it is probable that a liability has been incurred and the amount of the loss can reasonably be
estimated. If the reasonable estimate of a probable loss is a range, and no amount within the range is a better estimate, then we record the minimum amount in the range as our loss accrual. If a loss is not probable or a probable loss cannot be
reasonably estimated, no liability is recorded.

On June 10, 2005, we entered into a master equipment lease agreement with Farnam Street
Financial, Inc. (Farnam Street). On April 22, 2009, we filed a complaint in the United States District Court for the District of Minnesota against Farnam Street, alleging breach of contract, fraud and violation of the Deceptive
Trade Practices Act, among other things. Farnam Street answered the complaint and filed a counter-claim against us, alleging breach of contract, among other things. The dispute centered on lease renewal, lease termination and lease buy-out
provisions. On May 12, 2010, we finalized a settlement with Farnam Street and paid $720,000 to buy out the equipment leases.

The TRS
asset purchase agreement provided for a contingent consideration payment of up to $3.0 million based on TRS fourth quarter 2009 revenue and TRS December 31, 2009 backlog. We calculated a fourth quarter 2009 revenue contingent consideration
payment of $1,123,000, which was paid in February 2010. On February 26, 2010, we received notice that TRS disputed our calculation and claimed an additional payment of $1,877,000. We responded on March 10, 2010, stating that TRSs
objections were without merit and asking that the dispute be



13



---

##### Table of Contents

postponed pending delivery of the backlog contingent payment calculation. TRS agreed to the postponement. On March 30, 2010, we delivered the backlog contingent payment calculation to TRS
showing an amount payable of $0. TRS objected to our backlog contingent payment calculation. Under the terms of the asset purchase agreement, in the case of a disagreement over the calculation of the contingent payment, the parties were to select an
independent auditor to review the calculation. On May 6, 2010, TRS filed a civil action against us in the United States District Court for the Middle District of North Carolina. TRS generally alleges that we frustrated their ability to maximize
the contingent payment. TRS seeks compensatory damages of approximately $1,877,000, unspecified damages, attorneys fees, interest and costs. On July 6, 2010, we filed a motion to compel arbitration and dismiss the lawsuit. On
July 23, 2010, TRS filed an objection to our motion. The lawsuit is in the early procedural stages and the ultimate outcome cannot be determined at this time. We have evaluated this claim and the civil action and believe that no additional
payments are due under the calculations outlined in the asset purchase agreement.

12. INCOME TAXES

We determine our periodic income tax provision based upon the current period taxable income and our annual estimated tax rate adjusted for any change to
prior period estimates. The estimated tax rate is revised, if necessary, as of the end of each successive interim period during the fiscal year to our current annual estimated tax rate.

Our pre-2009 federal net operating loss carryforwards have been fully utilized in 2009. We acquired federal net operating loss carryforwards in the
acquisition of MDSI of $894,000, which we expect to utilize by the end of 2011. These losses are subject to Internal Revenue Code Section 382, Limitation On Net Operating Loss Carryforwards and Certain Built-in Losses Following Ownership
Change. The carryforwards would be forfeited if the subsidiary is merged into Transcend, but we currently expect to continue to operate the subsidiary until all carryforwards can be utilized.

Our effective income tax rate was approximately 41.25% and 37.11% for the three months ended June 30, 2010 and 2009, respectively, and 40.09% and
37.18% for the six months ended June 30, 2010 and 2009, respectively. The increased rates in 2010 are mainly due to the permanent difference created by the adjustment for stock-based compensation expense and the acquisition of MDSI which had a
historical rate higher than ours.

13. SUBSEQUENT EVENT

In accordance with FASB ASC Topic 855-Subsequent Events, the Company evaluated all events or transactions that occurred after June 30, 2010 up
through the date these financial statements were issued.



|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, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, 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 made under the provisions of the Private Securities
Litigation Reform Act of 1995. 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 risks and uncertainties described in greater detail under the caption Risk Factors in Item 1A of Part I of our Annual Report on Form 10-K for
the year ended December 31, 2009, in subsequently filed Quarterly Reports on Form 10-Q and in other filings that we make with the Securities Exchange Commission (SEC). Our SEC filings are available from us and are also available at
the SECs website at 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 Quarterly Report on Form 10-Q. We undertake no obligation to make any revisions to the forward-looking statements or to reflect events or circumstances after the date of this Quarterly Report on Form 10-Q, except as required by
applicable law.



14



---

##### Table of Contents

Overview

We are the second largest medical transcription company in the United States based on revenue. We serve approximately 260 customers nationwide. We
estimate that our primary target market is approximately $2.5 billion, comprised primarily of approximately 5,000 community-based hospitals (hospitals accessible by the general public) in the United States. Our mission is to provide accurate and
timely documentation of the patient/ medical provider encounter at a competitive price. Customer service is crucial to our success, and we have consistently been ranked among the top medical transcription service organizations in the industry. Our
approximately 1,870 home-based domestic medical language specialists, supplemented by our offshore partners, provide high quality medical documents and fast turnaround times, resulting in high customer retention rates, which have averaged more than
94% (measured by revenue) over the last three years. We develop and utilize an array of technology solutions to support the transcription process, including robust voice capture systems, state-of-the-art speech recognition technology, our
proprietary BeyondTXT transcription platform and various customer-specific systems. We believe we are well-positioned to benefit from the increasing adoption and use of electronic medical record, or EMR, solutions because the data and narrative
content we create comprise key portions of EMRs.

Hospitals have the flexibility of choosing between our two primary service delivery options.
Customers with in-house transcription platforms can partner with us to provide medical transcription services directly on their platform. Customers deciding to outsource this function can outsource the entire transcription process to us, in which
case we provide our services using our BeyondTXT transcription workflow platform.

Our revenue is recurring in nature, which we believe
results from our customers ongoing, mission-critical need to document each doctor-patient encounter and our consistently high service levels, resulting in high customer retention rates. Since we are paid directly by hospitals and other
providers, we have no insurance-related reimbursement risk.

Outlook

The U.S. economy has deteriorated significantly since the fall of 2008, stemming primarily from disruption in the global credit markets. If the economy
were to further deteriorate, we could see deterioration in the financial condition of our customers and collection of our accounts receivable. The decrease in availability of consumer credit resulting from the financial crisis, as well as general
unfavorable economic conditions, could cause consumers to reduce their discretionary spending, including spending for medical care. Job losses and the resulting losses of healthcare benefits could further reduce demand for healthcare services. We
have not experienced any noticeable deterioration in accounts receivable or transcription volume to date. It is also uncertain what effect the credit crisis may have on the security of the U.S. banking system, and specifically the bank where our
cash and cash equivalents are deposited. This could impact our access to and cost of capital. In addition, FDIC insurance does not fully insure deposits. We had $5.7 million of uninsured cash and cash equivalents at June 30, 2010. In addition
to the impact of the overall economic environment, the following trends and uncertainties could have a material future impact on our financial results:



| |  |  | The aging of the baby boomers will create increased demand for healthcare services, which should in turn create increased demand for
medical transcription services. Over the next 20 years, the U.S. population over the age of 65 is expected to increase from roughly 40 million to 70 million, according to the U.S. Census Bureau.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Increased adoption of EMR solutions could result in greater demand for electronic documentation, including transcription of reports that are currently
hand-written. Alternatively, EMR solutions could reduce the demand for traditional transcription since physicians could be required to point and click to complete a template rather than dictate to document portions of their patient
encounters. Management believes that dictation is more efficient and produces a more robust record than using only templates, and we anticipate that in the future, hybrid solutions will become more common. We believe that the pace of change in the
healthcare industry has increased, particularly as it relates to adoption of the EMR, and we expect this trend to continue. We are addressing this opportunity and risk by exploring opportunities to make the data in our reports more useful to
hospitals and by exploring the opportunity to partner with firms to more deeply integrate our service offering into total documentation solutions for hospitals.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



15



---

##### Table of Contents

| |  |  | Increased use of speech recognition technology and offshore resources in the future could result in higher profitability for us. At the same time,
competition within the medical transcription industry, combined with use of offshore resources and speech recognition technology by our competitors, could create downward pricing pressure in the industry. The potential net impact of these two trends
is difficult to predict with certainty.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | In March 2010, U.S. federal legislation was enacted which is likely to have a significant impact on, among other things, access to and the cost of
healthcare in the United States. The legislation provides for extensive health insurance reforms and expands coverage to approximately 32 million Americans which will result in expanded access to healthcare. In addition, the legislation
eliminates patient cost-sharing for certain prevention and wellness benefits. We believe these changes will benefit our industry by leading to increased utilization of our services. These benefits are expected to be partially offset by provisions of
the legislation aimed at reducing the overall cost of healthcare. It is uncertain at this time what additional healthcare reform initiatives, if any, will be implemented, or whether there will be other changes in the administration of governmental
healthcare programs or interpretations of governmental policies or other changes affecting the healthcare system. The ultimate content or timing of any future legislation, and its impact on us, is impossible to predict. If significant reforms are
made to the healthcare system in the United States, or in other jurisdictions, those reforms may have an adverse effect on our financial condition and results of operations.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Historically, our new customer sales have predominantly come from replacing incumbent medical transcription firms. A significant portion of medical
transcription work in hospitals is still performed by hospital employees. Management sees a trend toward outsourcing medical transcription services that could have a positive impact on our financial results if the trend accelerates and we are able
to successfully compete for the business.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | We have not historically had difficulty in staffing to meet demand as we have grown. However, looking at the industry as a whole, we do not expect the
domestic labor market for medical transcriptionists to grow fast enough to meet increased demand. We are addressing this challenge by increasing employee productivity through the use of speech recognition technology, utilizing offshore resources and
by attempting to develop a reputation as one of the best places to work in the industry. It is possible that in the future a tightening labor market could result in upward pressure on wages, but to date we have not seen evidence of this and we do
not anticipate this occurring in the short-term.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | We completed three acquisitions in 2009, which have had a material impact on our financial statements. Acquisitions involve significant risk, including
integration risk, and it is possible that we will not realize the anticipated benefits of the acquisitions we have made.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | We have experienced annual operating losses in prior years, the most recent occurring in 2005. While we have increased our level of net income in
recent years, there can be no assurance that operating losses will not occur in the future. Over the short term, excluding the impact of acquisitions, the variability in our earnings and cash flow is mitigated by the fact that our revenue is
recurring in nature and our largest expense, the cost of the transcriptionists, is variable in relation to revenue.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

For a
more complete understanding of trends and uncertainties relevant to Transcend, please see Item 1 Business of our Annual Report on Form 10-K for the fiscal year ended December 31, 2009, including the section titled
Industry Overview and Item 1A Risk Factors to the Annual Report on Form 10-K and this Quarterly Report on Form 10-Q, as well as risk factors detailed in our other reports filed with the SEC.

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. The preparation of consolidated
financial statements requires that management make estimates and assumptions based on knowledge of current events and actions; however, actual results may ultimately differ from estimates and assumptions. Our critical accounting estimates are as
follows:

Goodwill and Intangible Assets. We account for goodwill and other intangible assets in accordance with the provisions of FASB
ASC Topic 350  Intangibles-Goodwill and Other. Under the provisions of this Topic, goodwill



16



---

##### Table of Contents

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. We had goodwill of $23.6 million at June 30, 2010 and December 31, 2009 and net intangible assets related to acquisitions of $5.3 million and $5.7 million at June 30, 2010 and December 31, 2009,
respectively. Management reviews 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, management calculates the fair
value of the reporting units to which the goodwill and intangibles relate based on market capitalization of the company as a whole. We have concluded that we operate in one reporting unitmedical transcription servicessince all of our
revenue is derived from medical transcription services and since we have one organization dedicated to the provision of our service.

In
connection with certain of our acquisitions, we allocated a portion of the purchase price to acquired customer relationships and covenants-not-to-compete using appraisals based on discounted cash flow analysis. The estimated fair values attributed
to the relationships and covenants are being amortized over a period of five to ten years, which represented the estimated average remaining lives of the contracts and relationships. We account for long-lived assets such as purchased intangible
assets with finite lives under The Impairment or Disposal of Long-Lived Assets Subsections of Topic 360  Property, Plant and Equipment. This Subtopic requires that such long-lived assets be reviewed for impairment whenever
events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to future undiscounted net cash
flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the estimated fair value of the assets based on a
discounted cash flow approach or, when available and appropriate, to comparable market values. Assets to be disposed of are reported at the lower of the carrying amount or fair value less cost to sell.

There were no impairments recognized to goodwill or intangible assets in the six months ended June 30, 2010.

Contingent Consideration Payable.A contingent consideration payment was part of the asset purchase agreement for our acquisition of TRS. We
estimated the fair value of this payable as of the purchase date of the acquisition. FASB ASC, Topic 805 Business Combinationsrequires that this estimate is re-measured to fair value at each reporting date until the
contingency is resolved. These interim changes in estimated fair value, along with any differences in the final settlement, are recognized in operating expense. The purchase date fair value of the TRS contingent consideration was $353,000. As of
December 31, 2009, the value was calculated as $1,123,000. The $770,000 difference was recognized as operating expense in the fourth quarter of 2009 and the total amount of $1,123,000 was paid in February 2010.

Deferred Tax Assets and Liabilities. We account for our income taxes in accordance with FASB ASC Topic 740  Income Taxes.
Deferred tax assets and liabilities are recognized for the expected tax consequences of temporary differences between the tax basis of assets and liabilities and their reported amounts for financial reporting purposes. As of June 30, 2010, we
had net current deferred tax assets of $42,000 and net non-current deferred tax liabilities of $934,000. 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. FASB ASC Topic 740  Income Taxes requires us to record a valuation allowance against any deferred income tax benefits that we believe may not be realized. We estimate 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. We have valuation allowances against net operating loss carryforwards in certain states in which future taxable income in those states may not
be sufficient to utilize the net operating loss carryforwards in those states prior to their expiration.

Stock-Based
Compensation. Our stock-based awards are accounted for under the provisions of FASB ASC Topic 718  Stock Compensation. We measure and recognize stock-based compensation expense based on the fair value measurement for
all stock-based payment awards made to our employees and directors, including stock options and restricted stock awards over the service period for which the awards are expected to vest. We calculate the fair value of each restricted stock award
based on our stock price on the date of grant. We calculate the fair value of each stock option award on the date of grant using the Black-Scholes-Merton option pricing model. The determination of fair value of stock option awards on the date of
grant using an option-pricing model is affected by our stock price as well



17



---

##### Table of Contents

as a number of assumptions including expected term, expected volatility, risk-free interest rate and dividend yield. As a result, the future stock-based compensation expense may differ from our
historical amounts.

Legal Proceedings.From time to time in the normal course of business, we are involved in legal proceedings. We
evaluate the need for loss accruals under the requirements of FASB ASC 450 Contingencies. We record an estimated loss for any claim, lawsuit, investigation or proceeding when it is probable that a liability has been incurred and the amount of
the loss can reasonably be estimated. If the reasonable estimate of a probable loss is a range, and no amount within the range is a better estimate, then we record the minimum amount in the range as our loss accrual. If a loss is not probable or a
probable loss cannot be reasonably estimated, no liability is recorded.

Three Months Ended June 30, 2010 Compared to Three Months
Ended June 30, 2009

Revenue increased $5,243,000, or 31%, to $22,209,000 in the quarter ended June 30, 2010 compared to
revenue of $16,966,000 in the same period in 2009. The $5,243,000 increase in revenue is attributable to revenue from new customers of $1,651,000, revenue contributed by the acquisition of MDSI of $4,012,000, and increased revenue from existing
customers of $198,000, offset by a decrease in revenue of $511,000 from the acquisition of TRS and a decrease of $107,000 from customers who terminated their contracts since the second quarter of 2009.

Direct costs increased $3,327,000, or 31%, to $14,178,000 in the quarter ended June 30, 2010 compared to $10,851,000 in the same period in 2009.
Direct costs attributable to MDSI contributed $3,031,000 of this increase. Direct costs include costs attributable to compensation for transcriptionists, fees paid for speech recognition processing, telephone expenses, recruiting, management,
customer service, technical support for operations, and implementation of transcription services. Transcription compensation is a variable cost based on lines transcribed or edited multiplied by specified per-line pay rates that vary by individual
as well as type of work. Speech recognition processing is a variable cost based on the minutes of dictation processed. All other direct costs referred to above are semi-variable operations infrastructure costs that periodically change in
anticipation of or in response to the overall level of production activity.

As a percentage of revenue, direct costs remained constant at 64%
for the quarter ended June 30, 2010 and 2009. The constant costs as a percentage of revenue was due primarily to a decrease in the percentage of work processed on our BeyondTXT transcription platform versus other platforms from 55% of total
revenue in the second quarter of 2009 to 50% in the second quarter of 2010, offset by increased utilization of speech recognition technology on our BeyondTXT platform. The percentage of BeyondTXT volume that was edited using speech recognition
technology increased from 61% in the second quarter of 2009 to 72% in the second quarter of 2010. Work processed on BeyondTXT has lower costs due to the use of speech recognition technology to produce drafts of reports which are then edited by our
medical language specialists. The decrease in the percentage of work processed on our BeyondTXT platform is due primarily to the impact of additional non-BeyondTXT work processed for customers from the acquisitions completed in 2009. Excluding the
impact of the MDSI acquisition, direct costs decreased to 61% of revenue for the quarter ended June 30, 2010 compared to 64% for the same period of 2009. In addition, direct costs as a percentage of revenue were higher for the acquired
businesses and implementation and support costs have grown in order to manage conversion of some acquired customers onto BeyondTXT and to support the larger customer base.

Gross profit increased $1,916,000, or 31%, to $8,031,000 in the quarter ended June 30, 2010 compared to $6,115,000 in the same period in 2009. Gross
profit as a percentage of revenue remained the same at 36% in the quarter ended June 30, 2010 compared to the same period in 2009 (see direct costs discussion).

Sales and marketing expenses increased $89,000, or 20%, to $535,000 in the quarter ended June 30, 2010, compared to $446,000 in the same period in
2009. Sales and marketing expense as a percentage of revenue was 2% in the quarter ended June 30, 2010 compared to 3% in the second quarter of 2009. The increase in sales and marketing expense and a decrease in such expense as a percentage of
revenue were primarily due to increases in marketing and advertising efforts partially offset by a decrease in commission expense.

Research
and development expenses increased $44,000, or 12%, to $408,000 in the quarter ended June 30, 2010, compared to $364,000 in the same period in 2009. Research and development expense as a percentage of revenue was 2% in both the quarters ended
June 30, 2010 and 2009. The increase in expense was primarily due to an



18



---

##### Table of Contents

increase in compensation-related expenses and telephone expense, partially offset by increased capitalization of software development costs related to the development of our next generation
transcription workflow platform.

General and administrative expenses increased $1,762,000, or 81%, to $3,936,000 in the quarter ended
June 30, 2010, compared to $2,174,000 in the same period in 2009. Included in such increase are acquisition-related costs of $601,000 in 2010 related to our unsuccessful bid to acquire substantially all of the assets of Spheris and the stock of
Spheris India. Also included in the increase is $445,000 increase in stock-based compensation expense due to a cumulative adjustment made in 2010. Excluding these two costs, general and administrative expenses increased $716,000, or 33% in the
quarter ended June 30, 2010, compared to the same period in 2009. General and administrative expenses for MDSI contributed $336,000 of the increase. The balance of the increase was due primarily to increased compensation, employee benefits,
legal and accounting and stock-based compensation expense. Excluding one-time acquisition-related costs and the stock-based compensation cumulative adjustment, general and administrative expenses as a percentage of revenue were 13% in both the
quarters ended June 30, 2010 and 2009.

Depreciation and amortization expense was $460,000 in the quarter ended June 30, 2010,
compared to $309,000 in the same period in 2009, an increase of $151,000. Amortization of intangible assets resulting from the acquisition of MDSI contributed $96,000 of the increase. The remainder was due to higher capital expenditures resulting in
increased depreciable assets.

Operating income decreased $130,000, or 5%, to $2,692,000 in the quarter ended June 30, 2010, compared to
$2,822,000 in the same period in 2009.

Interest and other expenses decreased $7,000 to $23,000 of net expense in the quarter ended
June 30, 2010 compared to $30,000 of net expense in the same period in 2009. The decrease was due to an increase in interest income related to investment of the proceeds from our December 2009 follow-on offering of our common stock, slightly
offset by a small increase in interest expense.

The income tax provision increased $65,000 to $1,101,000 for the three months ended
June 30, 2010, compared to $1,036,000 for the same period in 2009. The provision increased primarily due to higher pre-tax income and a higher effective tax rate of 41.25% for the quarter ended June 30, 2010 compared to 37.11% for the
quarter ended June 30, 2009. The increased rates in 2010 are mainly due to the permanent difference created by the adjustment for stock-based compensation expense and the acquisition of MDSI which had a historical tax rate higher than ours.

Net income decreased $188,000, or 11%, to $1,568,000 in the quarter ended June 30, 2010, compared to $1,756,000 in the same period in
2009. Fully diluted earnings per share decreased $0.05, or 27%, to $0.15 for the quarter ended June 30, 2010, compared to $0.20 for the same period in 2009.

Six Months Ended June 30, 2010 Compared to Six Months Ended June 30, 2009

Revenue increased $12,519,000, or 39%, to $44,415,000 in the six months ended June 30, 2010 compared to revenue of $31,896,000 in the same period in
2009. The $12,519,000 increase in revenue is attributable to revenue from new customers of $3,743,000, revenue contributed by the acquisition of TRS of $986,000, revenue contributed by the acquisition of MDSI of $7,882,000, and increased revenue
from existing customers of $317,000, offset by a decrease in revenue of $409,000 from customers who terminated their contracts since the first six months of 2009.

Direct costs increased $8,466,000, or 41%, to $28,904,000 in the six months ended June 30, 2010 compared to $20,438,000 in the same period in 2009.
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 increased to 65% of revenue in the six months ended June 30, 2010 compared to 64% for the same period of 2009. Costs as a
percentage of revenue increased slightly due primarily to higher direct costs as a



19



---

##### Table of Contents

percentage of revenue for MDSI, partially offset by the cost savings that resulted from the increased use of speech recognition technology integrated into our BeyondTXT platform and the use of
offshore transcription resources.

Gross profit increased $4,053,000, or 35%, to $15,511,000 in the six months ended June 30, 2010
compared to $11,458,000 in the same period in 2010. Gross profit as a percentage of revenue decreased to 35% in the six months ended June 30, 2010 compared to 36% for the same period in 2009 (see direct costs discussion).

Sales and marketing expenses increased $85,000, or 10%, to $938,000 in the six months ended June 30, 2010, compared to $853,000 in the same period
of 2009. Sales and marketing expenses as a percentage of revenue were 2% and 3% in the six months ended June 30, 2010 and 2009, respectively. The increase in sales and marketing expense and a decrease in such expense as a percentage of revenue
were primarily due to increases in marketing and advertising efforts partially offset by a decrease in commission expense.

Research and
development expenses increased $101,000, or 14%, to $834,000 in the six months ended June 30, 2010 compared to $733,000 in the same period in 2009. Research and development expenses as a percentage of revenue were 2% in both the six-month
periods ended June 30, 2010 and 2009. The increase is primarily due to increases in compensation offset by an increase in capitalized research and development costs, telephone expense and hardware and software maintenance costs related to new
information technology initiatives.

General and administrative expenses increased $3,755,000, or 95%, to $7,695,000 in the six months ended
June 30, 2010, compared to $3,940,000 in the same period in 2009. Included in the increase are acquisition-related costs of $1,279,000 in 2010 related to our unsuccessful bid to acquire substantially all of the assets of Spheris and the stock
of Spheris India. Also included in the increase is a $676,000 cumulative adjustment for stock-based compensation expense. Excluding these two items, general and administrative expenses increased $1,800,000, or 46% in the six months ended
June 30, 2010, compared to the same period in 2009. General and administrative expenses for MDSI contributed $641,000 of the increase. The balance of the increase was due primarily to increased compensation, contract services, employee benefits
costs, legal and accounting expense and stock-based compensation expense. Excluding one-time acquisition-related costs and the stock-based compensation adjustment, general and administrative expenses as a percentage of revenue were 13% and 12% in
the six months ended June 30, 2010, and 2009, respectively.

Depreciation and amortization expense increased $344,000, or 61%, to
$908,000 in the six months ended June 30, 2010 compared to $564,000 in the same period in 2009. Amortization of intangible assets resulting from the acquisitions of MDSI contributed $192,000 of the increase. The remainder was due to a large
increase in capital expenditures resulting in increased depreciable assets.

Operating income decreased $232,000, or 4%, to $5,136,000 in the
six months ended June 30, 2010, compared to $5,368,000 in the same period in 2009.

Interest and other expenses decreased $11,000, or
18%, to $50,000 in the six months ended June 30, 2010 compared to $61,000 in the same period in 2009. The decrease was due to an increase in interest income related to investment of the proceeds from our December 2009 follow-on offering of our
common stock, slightly offset by a smaller increase in interest expense.

The income tax provision increased $66,000 to $2,039,000 for the six
months ended June 30, 2010 compared to $1,973,000 in the same period in 2009. The provision increased primarily due to higher pre-tax income and a higher effective tax rate of 40.09% for the six months ended June 30, 2010 compared to
37.18% for the six months ended June 30, 2009. The increased rates in 2010 are mainly due to the permanent difference created by the adjustment for stock-based compensation expense and the acquisition of MDSI which had a historical rate higher
than ours.

Net income decreased $287,000, or 9%, to $3,047,000 in the six months ended June 30, 2010, compared to $3,334,000 in the same
period in 2009. Fully diluted earnings per share decreased $0.10, or 26%, to $0.28 for the six months ended June 30, 2010, compared to $0.38 for the same period in 2009.

Liquidity and Capital Resources

As of
June 30, 2010, we had cash, cash equivalents and short-term investments of $27,735,000, working capital of $31,344,000, and availability of approximately $5,000,000 on our revolving line of credit based on eligible accounts



20



---

##### Table of Contents

receivable (see Note 8 of the Notes to Consolidated Financial Statements). We had $2,067,000 of debt outstanding as of June 30, 2010 and did not utilize our available line of credit in the
first six months of 2010.

Cash provided by operating activities was $3,515,000 for the six months ended June 30, 2010, compared to
$3,640,000 for the six months ended June 30, 2009. The decrease was due primarily to a decrease in deferred taxes and other working capital changes, partially offset by higher net income (adjusted for depreciation, amortization and stock based
compensation) and changes in the tax benefit from stock-based compensation.

Cash used in investing activities was $17,679,000 for the six
months ended June 30, 2010, compared to $9,186,000 for the six months ended June 30, 2009. During the first six months of 2010, we purchased $1,112,000 of equipment and software, capitalized $1,635,000 of software development costs and
invested a net of $14,932,000 in certificates of deposit and other short-term investments. We are investing significant resources in the next generation of our transcription platform and expect this level of capitalization will continue through the
remainder of 2010. For the first six months of 2009, investing activities were related primarily to the acquisition of DeVenture and TRS.

Cash used in financing activities was $765,000 for the six months ended June 30, 2010, compared to cash provided by financing activities of
$1,071,000 in the same period in 2009. Cash used in financing activities during the first six months of 2010 was due primarily to the repayment of debt.

We maintained a four-year credit facility with Healthcare Finance Group, or HFG, that was due to mature on December 31, 2009 and was initially
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. The term loan portion expired on December 31, 2007. On August 31, 2009, we terminated our
credit facility with HFG in order to secure new financing from Regions Bank.

On August 31, 2009, Transcend and MDSI entered into a loan
and security agreement with Regions Bank. Transcend and MDSI are both borrowers under the loan and security agreement, which replaced our credit facility with HFG. The loan and security agreement with Regions Bank includes a one-time
term loan of $7.0 million for the costs and expenses of, and to the extent necessary a portion of the purchase price for MDSI. The loan and security agreement also provides for up to $5.0 million in a revolving loan commitment based on eligible
accounts receivable. We may use proceeds of the revolving loan only for working capital, general corporate purposes, and for specified acquisitions. The maximum amount of the revolving loan may be increased at the discretion of Regions Bank to $8.0
million. The revolving loan commitment expires in August 2010. Borrowings bear interest at a rate based on the current LIBOR (3.75% as of June 30, 2010), and are secured by substantially all of the borrowers assets. The outstanding
balance on the four-year term loan was $67,000 as of June 30, 2010 and the balance on the revolver was $0 as of June 30, 2010.

The
loan and security agreement contains representations and warranties, as well as affirmative, reporting and negative covenants customary for financings of this type. Among other things, the loan and security agreement restricts the borrowers from
incurring certain additional debt, prohibits the borrowers from creating, permitting or allowing certain liens on their property, restricts the payment of dividends, distributions and other specified equity related transactions by us, and prohibits
certain borrowings and specified transactions with affiliates. The loan and security agreement also requires the maintenance of a specified minimum fixed charge coverage ratio, tangible net worth, and cash flow leverage, as defined in the agreement.
As of June 30, 2010, we were in compliance with all covenants of the agreement.

We anticipate that cash on hand, together with cash flow
from operations, 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 our growth strategy is the completion of acquisitions. Management believes that available cash and our credit facility together with other
acquisition options, such as seller financing, are only sufficient to complete small to medium-sized acquisitions. Additional financing will be required for larger acquisitions.



21



---

##### Table of Contents

|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 June 30, 2010.



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



| | a) | Evaluation of disclosure controls and procedures
| | -- | ------------------------------------------------

As of the end of the period covered by this quarterly report, our management, with the participation of our Chief Executive Officer (CEO) and
Chief Financial Officer (CFO), conducted an evaluation of the effectiveness of our disclosure controls and procedures in accordance with Rule 13a-15(e) under the Exchange Act. Based on the evaluation of our disclosure controls and
procedures as of the end of the period covered by this quarterly report, our CEO and CFO concluded that, as of such date, our disclosure controls and procedures were effective to ensure that information required to be disclosed by us in the reports
that we file or submit under the Exchange Act is (a) accumulated and communicated to our management, including our CEO and CFO, as appropriate to allow timely decisions regarding required disclosure, and (b) recorded, processed, summarized
and reported within the time periods specified in the SECs rules and forms.

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.



| | b) | 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 our financial statements for external purposes in accordance with generally accepted accounting principles. To the extent that components of our internal control over financial reporting are included in our
disclosure controls, they are included in the scope of the evaluation by our principal executive officer and principal financial officer referenced above. The financial operations of our recent acquisition of MDSI have been substantially, but not
fully, integrated into our internal control over financial reporting. The operations of MDSI will be fully integrated in 2010.

In the quarter
ended June 30, 2010, we implemented an equity award tracking system which significantly increased our internal controls over stock-based compensation expense and equity award reporting. There were no other changes in our internal control over
financial reporting that occurred during the quarter ended June 30, 2010 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II. OTHER INFORMATION



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

From time to time in
the normal course of business, we are involved in legal proceedings. We evaluate the need for loss accruals under the requirements of FASB ASC 450 Contingencies. We record an estimated loss for any claim, lawsuit, investigation or proceeding
when it is probable that a liability has been incurred and the amount of the loss can reasonably be estimated. If the reasonable estimate of a probable loss is a range, and no amount within the range is a better estimate, then we record the minimum
amount in the range as our loss accrual. If a loss is not probable or a probable loss cannot be reasonably estimated, no liability is recorded.

On June 10, 2005, we entered into a master equipment lease agreement with Farnam Street Financial, Inc. (Farnam Street). On
April 22, 2009, we filed a complaint in the United States District Court for the District of Minnesota against Farnam Street, alleging breach of contract, fraud and violation of the Deceptive Trade Practices Act, among other things. Farnam
Street answered the complaint and filed a counter-claim against us, alleging breach of contract, among other things. The dispute centered on lease renewal, lease termination and lease buy-out provisions. On May 12, 2010, we finalized
a settlement with Farnam Street and paid them $720,000 to buy out the equipment leases.

On May 6, 2010, Transcription Relief Services,
Inc., or TRS, which we acquired in May 2009, filed a civil action against us in the United States District Court for the Middle District of North Carolina. The dispute centers around



22



---

##### Table of Contents

the contingent consideration payable under the TRS asset purchase agreement. The TRS asset purchase agreement provided for a contingent consideration payment of up to $3.0 million based on TRS
fourth quarter 2009 revenue and TRS December 31, 2009 backlog. We calculated a fourth quarter 2009 revenue contingent consideration payment of $1,123,000, which was paid in February 2010. On February 26, 2010, we received notice that TRS
disputed our calculation and claimed an additional payment of $1,877,000. We responded on March 10, 2010, stating that TRSs objections were without merit and asking that the dispute be postponed pending delivery of the backlog contingent
payment calculation. TRS agreed to the postponement. On March 30, 2010, we delivered the backlog contingent payment calculation to TRS showing an amount payable of $0. TRS objected to our backlog contingent payment calculation. Under the terms
of the asset purchase agreement, in the case of a disagreement over the calculation of the contingent payment, the parties were to select an independent auditor to review the calculation. In the civil action filed on May 6, 2010, TRS generally
alleged that we frustrated their ability to maximize the contingent payment under the TRS asset purchase agreement. TRS seeks compensatory damages of approximately $1,877,000, unspecified damages, attorneys fees, interest and costs. On
July 6, 2010, we filed a motion to compel arbitration and dismiss the lawsuit. On July 23, 2010, TRS filed an objection to our motion. The lawsuit is in the early procedural stages and the ultimate outcome cannot be determined at this
time. We have evaluated this claim and the civil action and believe that no additional payments are due under the calculations outlined in the asset purchase agreement.



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

All of the risk factors
previously disclosed in the Annual Report on Form 10-K for the year ended December 31, 2009 still apply to the Company with the following material changes and additions:

Recently enacted health care reform legislation could adversely impact us.

The recently enacted Patient Protection and Affordable Care Act and the Health Care and Education Reconciliation Act completely reform the U.S. healthcare
system. Among other things, the legislation significantly increases governmental involvement in healthcare, requires most Americans to carry health insurance coverage, with federal subsidies to help many afford the premiums (insurance companies
would be barred from denying coverage to people with medical problems or charging them more); and completely overhauls the environment in which healthcare industry constituents operate. This legislation impacts most employers, virtually all tax
payers and all segments of the healthcare industry. It is impossible to predict the ultimate impact that this new legislation will have on the healthcare industry. Possible outcomes may be that healthcare industry constituents may reduce
their expenditures or postpone expenditure decisions, including expenditures for our service offerings. Such a response, and others that we cannot predict or foresee at this time, could have a significant and material adverse impact on our
current and future business operations and, thus, our financial condition and results of operations.



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

The exhibits listed in the
accompanying exhibit index are filed as part of this quarterly report.



23



---

##### Table of Contents

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.
|               |  |                         
|August 9, 2010 |  | 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)        



24



---

##### Table of Contents

EXHIBIT INDEX



|              |  |                                                                                                                                                                                                    |  |                            |  |           |  |         |  |             
|------------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | -------------------------- |  | --------- |  | ------- |  | ------------
|              |  |                                                                                                                                                                                                    |  | Incorporation by Reference
|ExhibitNumber |  | Exhibit Description                                                                                                                                                                                |  | Form                       |  | File No.  |  | Exhibit |  | Filing Date 
|3.1           |  | Amendment to Certificate of Incorporation, dated May 27, 2010                                                                                                                                      |  | 8-K                        |  | 000-18217 |  | 3.3     |  | May 28, 2010
|              |  |                                                                                                                                                                                                    |  |                            | 
|10.1          |  | Commitment Letter, dated as of April 12, 2010, by and between Transcend Services, Inc. and Medical Dictation Services, Inc. and Regions Business Capital, Regions Bank and Regions
Capital Markets |  | 10-Q                       |  | 000-18217 |  | 10.1    |  | May 7, 2010 
|              |  |                                                                                                                                                                                                    |  |                            | 
|31.1          |  | Certification of Chief Executive Officer of the Registrant Pursuant to Rule 13a-14(a) and Rule 15d-14(a), promulgated under the Securities Exchange Act of 1934, as
amended                        |  |                            |  |           |  |         |  |             
|              |  |                                                                                                                                                                                                    |  |                            | 
|31.2          |  | Certification of Chief Financial Officer of the Registrant Pursuant to Rule 13a-14(a) and Rule 15d-14(a), promulgated under the Securities Exchange Act of 1934, as
amended                        |  |                            |  |           |  |         |  |             
|              |  |                                                                                                                                                                                                    |  |                            | 
|*32.1         |  | Certification of Chief Executive Officer of the Registrant Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002                                                                               |  |                            |  |           |  |         |  |             
|              |  |                                                                                                                                                                                                    |  |                            | 
|*32.2         |  | Certification of Chief Financial Officer of the Registrant Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002                                                                               |  |                            |  |           |  |         |  |             



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



25