<PAGE>
 
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                                  UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549

                                   FORM 10-Q/A
                                 AMENDMENT NO. 2

                                       TO

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

                  For the quarterly period ended March 31, 1996

                         Commission File Number 0-18217

                            TRANSCEND SERVICES, INC.
             (Exact name of registrant as specified in its charter)

            Delaware                                         33-0378756
   (State or other jurisdiction of                       (I.R.S Employer
    incorporation or organization)                       Identification No.)

          3353 Peachtree Road, N.E., Suite 1000, Atlanta, Georgia 30326 
             (Address of principal executive offices and zip code)
       Registrant's telephone number, including area code: (404) 364-8000

                                 Not applicable
  (Former name, former address and former fiscal year, if changed since last
                                    report)

The undersigned registrant hereby amends the following items, financial
statements, exhibits or other portions of its Quarterly Report on Form 10-Q for
the quarterly period ended March 31, 1996: (List all such items, financial
statements, exhibits or other portions amended)

                        Part I - Financial Information

Item 1.  Financial Statements.

Item 2.  Management's Discussion and Analysis of Financial Condition and Results
         of Operations.

                           Part II - Other Information

Item 1.  Legal Proceedings

Item 6.  Exhibits and Reports on Form 8-K

================================================================================
<PAGE>
 
                      PART I.  FINANCIAL INFORMATION     

    
ITEM 1.  FINANCIAL STATEMENTS      

                            TRANSCEND SERVICES, INC.
 
                          CONSOLIDATED BALANCE SHEETS
 
<TABLE>     
<CAPTION>
                                            DECEMBER 31,        MARCH 31,
                                               1995               1996
                                            ------------       -----------
                                                               (UNAUDITED)
<S>                                         <C>                <C>
                 ASSETS                   
CURRENT ASSETS:                           
  Cash and cash equivalents.............     $ 1,073,000        $   635,000
  Trade accounts receivable, net of 
   allowance for doubtful                   
   accounts of $42,000 and        
   $46,000, respectively................       3,056,000          2,815,000
  Prepaid expenses......................         309,000            721,000
                                             -----------        -----------
    Total current assets................       4,438,000          4,171,000
NET ASSETS RELATED TO DISCONTINUED                             
 OPERATIONS.............................       2,414,000          2,407,000
SECURITIES OF AMHEALTH..................       2,050,000          2,050,000
OFFICE FURNITURE AND EQUIPMENT, at cost,                       
 less accumulated depreciation of                              
 $1,059,000 and $1,235,000,                           
 respectively...........................       1,681,000          1,816,000
DEPOSITS AND OTHER ASSETS...............         408,000            381,000
GOODWILL AND OTHER INTANGIBLE ASSETS,                          
 less accumulated amortization of                              
 $1,301,000 and $1,446,000,
 respectively...........................       5,363,000          5,218,000
                                             -----------        -----------
                                             $16,354,000        $16,043,000
                                             ===========        ===========
  LIABILITIES AND SHAREHOLDERS' EQUITY                        
CURRENT LIABILITIES:                                          
  Current portion of long term debt.....         208,000            108,000
  Accounts payable......................       1,268,000          1,173,000
  Accrued compensation and employee                             
   benefits.............................       1,560,000          1,527,000
  Other accrued liabilities.............         808,000          1,276,000 
  Current portion of capital lease                           
   obligation...........................             --                 --
  Deferred income taxes.................         133,000            103,000
                                             -----------        -----------
    Total current liabilities...........       3,977,000          4,187,000
                                             -----------        -----------
LONG TERM DEBT..........................         392,000            368,000
CONVERTIBLE DEBENTURES:                                       
  Held by related parties...............         450,000            450,000
  Held by others........................       1,550,000          1,550,000
DEFERRED INCOME TAXES...................         543,000            540,000
COMMITMENTS AND CONTINGENCIES                                      
SHAREHOLDERS' EQUITY:                                               
  Preferred stock, $.01 par value;                                  
   21,000,000 shares authorized; none                               
   outstanding..........................             --                 --
  Common stock, $.01 par value,                                     
   31,000,000 shares authorized,                                    
   18,113,000 and 18,291,000                             
   shares issued and outstanding as of                              
   December 31, 1995 and March                             
   31, 1996, respectively...............         181,000            183,000
  Additional paid in capital............      16,643,000         16,799,000
  Accumulated deficit...................      (7,382,000)        (8,034,000)
                                             -----------        -----------
    Total shareholders' equity..........       9,442,000          8,948,000
                                             -----------        -----------
                                             $16,354,000        $16,043,000
                                             ===========        ===========
</TABLE>      
 
   The accompanying notes are an integral part of these consolidated balance
                                    sheets.
 

                                       2
<PAGE>
 
                            TRANSCEND SERVICES, INC.
 
                     CONSOLIDATED STATEMENTS OF OPERATIONS
 
<TABLE>     
<CAPTION>
                                         THREE MONTHS ENDED
                                             MARCH 31,
                                      ------------------------
                                         1995         1996
                                      -----------  -----------
                                            (UNAUDITED)
<S>                                   <C>          <C>
NET REVENUE.........................  $ 4,897,000  $ 8,688,000
DIRECT COSTS........................    4,346,000    7,260,000
                                      -----------  -----------
 Gross profit.......................      551,000    1,428,000
MARKETING AND SALES
 EXPENSES...........................      437,000      641,000
GENERAL AND
 ADMINISTRATIVE
 EXPENSES...........................    1,113,000    1,122,000
AMORTIZATION EXPENSE................      145,000      145,000
                                      -----------  -----------
 Operating loss.....................   (1,144,000)    (480,000)
OTHER INCOME
(EXPENSES):
 Interest expense...................          --       (52,000)
 Interest income....................       36,000        9,000
 Other..............................          --           --
                                      -----------  -----------
                                           36,000      (43,000)
                                      -----------  -----------
LOSS BEFORE PROVISION
 FOR INCOME TAXES...................   (1,108,000)    (523,000)
PROVISION FOR INCOME
 TAXES..............................          --           --
                                      -----------  -----------
LOSS FROM CONTINUING OPERATIONS.....  $(1,108,000)    (523,000)
LOSS FROM DISCONTINUED OPERATIONS...     (120,000)    (129,000)
                                      -----------  -----------
NET LOSS............................  $(1,228,000) $  (652,000)
                                      ===========  ===========

Loss per common share:
  Continuing operations.............  $      (.06) $      (.03)
  Discontinued operations...........         (.01)        (.01)
                                             -----        -----
Net loss............................  $      (.07) $      (.04)
                                             =====        =====
Weighted average common
 shares outstanding.................   17,533,000   18,217,000
                                      ===========  ===========
</TABLE>      
 
 The accompanying notes are an integral part of these consolidated statements.
 
<PAGE>
 
                            TRANSCEND SERVICES, INC.
 
                     CONSOLIDATED STATEMENTS OF CASH FLOWS
 
<TABLE>     
<CAPTION>
                                                     THREE MONTHS ENDED
                                                         MARCH 31,
                                                   ----------------------
                                                      1995        1996
                                                   -----------  ---------
                                                        (UNAUDITED)
<S>                                                <C>          <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
 Net loss.......................................   $(1,228,000) $(652,000)
 Adjustments to reconcile net loss to net cash
  provided by (used in) operating activities:
 Loss from discontinued operations..............       120,000    129,000
 Depreciation and amortization..................       255,000    322,000
 Changes in assets and liabilities, net of
  acquisitions:
 Receivables....................................      (145,000)   242,000
 Prepaid expenses...............................      (111,000)  (412,000)
 Deposits and other assets......................       (17,000)    27,000
 Accounts payable...............................      (929,000)   (95,000)
 Accounts compensation and benefits.............       359,000    (34,000)
 Accrued expenses and other liabilities.........      (189,000)   467,000
 Other..........................................       (36,000)   (30,000)
                                                   -----------  ---------
 Total adjustments..............................      (693,000)   616,000
                                                   -----------  ---------
 Net cash provided by (used in) continuing
  operations....................................    (1,921,000)   (36,000)
                                                   -----------  ---------
 Net cash provided by discontinued 
  operations....................................        79,000   (122,000)
                                                   -----------  ---------
 Net cash provided by (used in) operating
  activities....................................    (1,842,000)  (158,000)
                                                   -----------  ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
 Capital expenditures...........................      (472,000)  (313,000)
 Acquisitions...................................      (966,000)       --
 Cash acquired from acquisitions................     7,486,000        --
 Disposal and transfer of property..............           --         --
                                                   -----------  ---------
 Net cash used in investing activities..........    (6,048,000)  (313,000)
                                                   -----------  ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
 Principal payments on long-term debt...........           --     (24,000)
 Principal payments on short-term debt..........    (1,007,000)  (100,000)
 Principal payment on capital lease obligations.           --         --
 Repayments of line of credit...................    (1,020,000)       --
 Proceeds from stock options....................           --     157,000
                                                   -----------  ---------
Net cash provided by financing activities.......    (2,027,000)    33,000
                                                   -----------  ---------
NET INCREASE (DECREASE) IN CASH AND CASH
 EQUIVALENTS....................................    (2,179,000)  (438,000)
CASH AND CASH EQUIVALENTS AT BEGINNING OF
 PERIOD.........................................       150,000  1,073,000
                                                   -----------  ---------
CASH AND CASH EQUIVALENTS AT END OF PERIOD......   $ 2,329,000  $ 635,000
                                                   ===========  =========
</TABLE>      
 
 The accompanying notes are an integral part of these consolidated statements.
 
                                       4 
<PAGE>
 
          

    
                    TRANSCEND SERVICES, INC. AND AFFILIATES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                            MARCH 31, 1995 AND 1996      

    
  (1) The unaudited financial information furnished herein in the opinion of
  management reflects all adjustments which are necessary to fairly state the
  Company's financial position, the results of its operations and its cash
  flows.  For further information refer to the combined financial statements and
  footnotes thereto included in the Company's Form 10-K for the year ended
  December 31, 1995. Footnote disclosure which would substantially duplicate the
  disclosure contained in those documents have been omitted.      
    
  (2) Net loss per common share has been computed based on the weighted number
  of the Company's common shares and common share equivalents (dilutive stock
  options) outstanding.  The common stock equivalents related to stock options
  were not included in the computation due to their antidilutive effect.  Fully
  diluted net loss per share has not been presented since it is not materially
  different from primary net loss per share.      
     
  (3) On January 10, 1995, the Company acquired a Georgia corporation then known
  as "Transcend Services, Inc." by the merger of Transcend into First Western
  Health Corporation (the "Merger"). The Merger was treated for financial
  accounting purposes as the acquisition of the Company by the former Transcend
  and the historical financial statements of the former Transcend have become
  the financial statements of the Company and include the businesses of both
  companies after the effective date of the Merger.      
    
  (4) On May 31, 1995, Transcend Services, Inc., a California corporation
  following its January 10, 1995 merger into TriCare, and Veritas Healthcare
  Management, a California corporation owned by TriCare, merged into the TriCare
  corporation, whose name was then changed to "Transcend Services, Inc."      

                                       5
<PAGE>
 
              
ITEM 2.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND 
         RESULTS OF OPERATIONS      
OVERVIEW
    
  Transcend Services Inc. (the "Company" or Transcend") is a healthcare services
company focused on the emerging field of healthcare information management
("HIM") services to hospitals and other associated healthcare providers. The
Company provides a range of HIM services, including: (i) contract management
("outsourcing") of the healthcare information or medical records function, as
well as the admissions function; (ii) transcription of physicians' dictated
medical notes; and (iii) consulting services relating to medical records and
reimbursement coding. As of March 31, 1996, the Company operated on a contract
management basis, the medical records and certain other HIM functions of 15
general acute care hospitals located in ten states and the District of Columbia.
The Company also provides case management and disability management services to
insurance carriers, third party administrators and self-insured employers.      
     
  The Company intends to expand the range of its contract management services
to include management of other functional areas of hospitals, such as
management of patient access (admissions), utilization review, quality
assurance and the business office. The Company presently provides full
contract management outsourcing services in the admissions departments for
five of the 15 hospitals it manages. The Company is actively seeking to
provide this expanded range of services to its current and future hospital
customers. The Company also provides, through outsourcing as well as other
contracts, medical records transcription services through computer and
telephone links from centralized facilities to approximately 100 hospital
customers.      
     
  Approximately 3,000 hospitals in the United States have more than 100 beds
and constitute the Company's first tier of market opportunity. The Company
currently has contract management contracts covering the medical records
departments of 15 hospitals ranging in bed size from 56 beds to 541 beds, with
the average contract size of approximately $1.5 million. The initial contract
terms of the Company's current contracts range from two to five years and are
generally terminable without cause upon expiration of the initial term or for
cause at any time during the initial term thereof. The Company's existing
contracts currently have remaining terms ranging from approximately one to five
years. Due to its limited operating history in medical records management, the
Company is unable at the present time to assess or predict its contract renewal
rate.       
 
  The Company negotiates its contract management fees on a fixed installment
basis which represents, at contract inception, an immediate savings to the
contracting hospital as compared to its historical costs. In the early term of
such a contract, the Company's expenses in providing the contract services
remain relatively high, as a percentage of contract revenues received, as set-
up and training costs are incurred, new procedures are implemented and
departmental reorganizations are initiated. Completion of such steps should
result in lower operating expenses, which in turn should increase the profit
margin of a constant revenue stream over time. Due to the Company's limited
operating history in the contract management business, however, there can be
no assurances that operating expenses will sufficiently decrease over the life
of such contracts to achieve profitability.
 
  The Company is considering an alternative volume-based pricing structure,
based upon a hospital's activity levels such as weighted average number of
annual patient discharges, or a "per member per month" ("PMPM") capitated
pricing option similar to current pricing mechanisms used by managed
healthcare groups. The Company has signed one contract based on a volume
oriented pricing structure tied to weighted annual patient discharges. There
is an opportunity to realize higher margins on an activity-based pricing
structure. The principal advantage of a volume-based pricing mechanism is that
as a hospital's volume of business increases, the Company's revenues will
increase at a faster rate than operating expenses. However, if a customer's
business volume decreases, the Company's revenues will also decrease at a
faster rate than its operating expenses.
 
                                      6
<PAGE>
 
  The Company is typically paid for its transcription services on a production
basis at rates determined on a per-line-transcribed basis. Where transcription
services are included as part of the services provided in the Company's
outsourcing contracts, however, the services are provided by the Company as
part of a set contract fee. The Company is paid for its consulting and coding
services on a negotiated fee for services basis. In addition, the Company is
paid for its healthcare case management services primarily on an hourly basis.
     
  On January 10, 1995, the Company acquired a Georgia corporation then known
as "Transcend Services, Inc." by the merger of Transcend Services into a
subsidiary of the Company. The merger was treated for financial accounting
purposes as the acquisition of the Company by the former Transcend Services
and the historical financial statements of the former Transcend Services have
become the financial statements of the Company and include the business of
both companies after the effective date of the merger.      
 
RESULTS OF OPERATIONS
 
          
    
  The Company's loss from operations for the quarter ended March 31, 1996 was
$480,000. Management believes that the Company's operating losses are primarily
attributable to the significant expenses incurred by the Company to build a
larger sales and management organization to support an increased number of
outsourcing contracts and the expansion of the Company's services to healthcare
institutions. For the quarter ended March 31, 1996, the Company's marketing and
sales expenses were $641,000 and the Company's general and administrative
expenses for the quarter ended March 31, 1996 amounted to $1,122,000. The
buildup of the Company's management infrastructure has been necessary in order
for the Company to manage the planned growth in its outsourcing business and
will allow it to grow revenues significantly from current levels without
increasing selling, general and administrative costs by the same proportion. At
the present time, the Company's revenues are not sufficient to support these
expenses and generate profits. The Company will be required to increase its
revenues from contract management and other services and effectively manage its 
costs to achieve profitability. In addition, the Company's pricing mechanism on
most of its outsourcing contracts requires the Company to increase operating
efficiencies over the life of the contract in order to increase profit margins.
The Company will also be required to procure a critical mass of such contracts
and be able to renew such contracts on favorable terms. There can be no
assurance that the Company will be able to attain the required operating
efficiencies or increase the number of outsourcing contracts to the level needed
to become profitable.


                                       7
<PAGE>
 
 Three Months Ended March 31, 1996 Compared to Three Months Ended March 31,
1995
    
  Total revenues for the Company increased from $4,897,000 for the quarter
ended March 31, 1995 to $8,688,000 for the quarter ended March 31, 1996, an
increase of 77.4%. Contract management revenues were the largest single service
class revenue source for the Company in each of these three month periods,
representing 57.3% of total revenues in the 1995 quarter and 61.0% in the 1996
quarter. Contract management revenues increased from $2,805,000 in the quarter
ended March 31, 1995 to $5,297,000 in the comparable 1996 quarter, an increase
of 88.7%. Medical transcription revenues were the second largest source of
revenues for the Company for the quarters ended March 31, 1995 and 1996,
representing 24.7% of total revenues in the 1995 quarter and 23.0% of total
revenues in the 1996 quarter. Medical transcription revenues grew from
$1,210,000 for the quarter ended March 31, 1995 to $2,000,000 for the quarter
ended March 31, 1996, an increase of 65.6%. Consulting and coding revenues
represented 3.2% of the Company's total revenues for the period ending March 31,
1995 and 2.5% of the Company's total revenues for the period ending March 31,
1996. Consulting and coding revenues increased 38.6% from the quarter ended
March 31, 1995 compared to the quarter ended March 31, 1996. Case management
revenues represented 14.8% of the Company's total revenues in the quarter ended
March 31, 1995 as compared with the 13.5% of total revenues in the quarter ended
March 31, 1996. Case management revenues grew from $725,000 in the quarter ended
March 31, 1995 to $1,173,000 in the quarter ended March 31, 1996, an increase of
61.7%.      
 
  The increase in total revenues for the quarter ended March 31, 1996 is
primarily attributable to (i) the increased contract management outsourcing
revenues of approximately $2,608,000 attributable to six contract management
contracts signed in August and September 1995 and revenues of approximately
$270,000 attributable to two contracts signed in February and March 1996 (with
respect to which the Company began rendering services upon execution of the
contracts); (ii) increased medical transcription operations revenues of
approximately $793,000 resulting from the April 1995 acquisition of Medical
Transcription of Atlanta, Inc. ("MTA"); and (iii) the increase in case
management and rehabilitation revenues of approximately $447,000 resulting
from enhanced sales and marketing efforts in 1995 that resulted in new
customers as well as the expansion of case management services into Texas by
means of an acquisition made in July 1995.
 
  Gross profit increased 159.2% to $1,428,000 for the quarter ended March 31,
1996 from $551,000 in the first quarter of the prior year. Gross profit as a
percentage of revenues increased to 16.4% for the quarter ended March 31, 1996
from 11.2% in the same prior year period. This increase was primarily
attributable to the contract management outsourcing division which expanded
its gross margin from 13.3% in 1995 to 16.6% in 1996, as a result of increased
efficiencies and lower operating costs following the Company's re-engineering
efforts, and the medical transcription business which expanded its gross
margin from 11.6% in the quarter ended March 31, 1995, to 17.3% in the quarter
ended March 31, 1996. The margin improvement in transcription is a result of
increased efficiencies and lower operating costs following the continued
deployment of digital technology and the improved productivity of the
Company's transcriptionists. The Company's overall gross margin was further
enhanced in the 1995 to 1996 quarter comparison by the increase in case
management's gross margin from 13.4% for the quarter ended March 31, 1995 to
27.1% for the quarter ended March 31, 1996. This gain in case management gross
margin is the result of increased operating efficiencies and lower direct
costs across a larger customer base.
 
  Marketing and sales expenses increased 46.7% to $641,000 in the quarter
ended March 31, 1996 from $437,000 in the same prior year period and decreased
as a percentage of revenues to 7.4% for the quarter ended March 31, 1996 from
8.9% for the quarter ended March 31, 1995. The increase in sales and marketing
expenses from the first quarter 1995 to 1996 is primarily attributable to (i)
a larger national sales force (an increase of one person) in place in the 1996
quarter; (ii) increased expenditures of approximately $66,000 for
telemarketing and market analysis implemented to provide the Company better
sales lead qualification and more accurate target marketing opportunities; and
(iii) sales commissions of approximately $20,000 paid on two new sales in the
first quarter 1996 as compared to only one sale in the first quarter 1995. The
Company typically pays and expenses 100% of its sales commission upon contract
signing. With much of the Company's investment in a national sales force,
telemarketing and marketing/advertising now in place, the Company anticipates
that sales and marketing expenses, as a percentage of revenues, will decline,
as revenues increase.
     
  General and administrative expenses remained relatively constant at $1,122,000
for the quarter ended March 31, 1996 and $1,113,000 in the same prior year
period and decreased as a percentage of revenues to 12.9% for the quarter ended
March 31, 1995 from 22.7% in the first quarter of the prior year. General and
administrative expenses remained constant in the quarter-to-quarter comparison
and declined as a percentage of revenues due to the Company's investment over
the past 18 to 24 months in building a larger sales and management organization
to support an increased number of outsourcing contracts and the expansion of the
Company's services to healthcare institutions for the foreseeable future.     
 
  The Company's loss from operations decreased to $480,000 for the quarter
ended March 31, 1996 from $1,144,000 in the first quarter of the prior year
period. This $480,000 quarterly loss compares to an operating loss of $502,000
for the quarter ended December 31, 1995 and an operating loss of $834,000 for
the quarter ended September 30, 1995.
 
  Other expenses increased to $43,000 for the quarter ended March 31, 1996
from other income of $36,000 in the first quarter of the prior year period,
primarily due to the impact of interest expense incurred in connection with
the August 15, 1995 private placement of 8% Subordinated Convertible
Debentures.
 
  The Company's loss from discontinued operations of $120,000 and $129,000 for 
the quarters ended March 31, 1996 and March 31, 1995, respectively, is due to 
legal expenses incurred in connection with the Lawsuit.  See "Part II.  Other 
Information -- Item 1.  Legal Proceedings."


                                      8
<PAGE>
 
    
DISCONTINUED OPERATIONS       
    
  At March 31, 1996, the net assets related to the discontinued operations of
the Company's healthcare subsidiaries, First Western and Veritas, both of which
ceased operations as of April 30, 1993, were $2,407,000 in net accounts
receivable. The collection liabilities of First Western and Veritas have been
deducted in determining net accounts receivable. In October 1995, the Company
sold approximately 38% of the gross accounts receivable to a third party with
which the Company has also contracted with to service and manage the remaining
accounts receivable balance for a set fee. The net accounts receivable from the
discontinued operations represent reimbursements that are owed the Company by
certain insurance companies for applicant medical/legal evaluation services
provided by FWHC Medical Group, Inc. and Veritas Medical Group, Inc., two
managed medical groups associated with the Company's former subsidiaries, First
Western Health Corporation and Veritas Healthcare Management. The Company
expects to collect the accounts receivable from discontinued operations over the
next several years under the provisions of the sale and service agreement that
the Company has entered into with the third party for servicing and managing the
remaining accounts receivable balance. Payment of a portion of the remaining
gross receivables, however, is contested by the insurance companies. The
collection of these contested accounts receivable is therefore subject to
resolution by the California Workers Compensation Appeals Board, an
administrative body charged with determining an insurance company's liability
for the payment of medical/legal evaluation services. In estimating net accounts
receivable, the Company believes that it has made adequate provisions as to the
estimated amount of gross receivables that the Company can expect to collect
upon resolution by the California Workers Compensation Appeals Board of the
collectibility of the disputed portion of the receivables. The Company will
continue to re-evaluate the net realizability of the net assets related to
discontinued operations on an ongoing basis. Any such re-evaluation could result
in an adjustment that may potentially be material to the carrying value of the
asset.
    
  In September 1994, the Company sold substantially all of the assets and
liabilities of its wholly-owned subsidiary, Occu-Care, Inc., which operated
industrial medical clinics, to AmHealth, Inc. ("AmHealth") for a purchase price
of $4,000,000. The purchase price included $1,500,000 in cash paid at closing
and the issuance of two promissory notes bearing interest at 8% per annum.
AmHealth defaulted on the first interest payments on the two notes. In
conjunction with the Merger on January 10, 1995, the Company recorded these
notes as one due for $2,050,000, which was the Company's estimate of their fair
value (using a discounted cash flow approach). AmHealth defaulted on a December
1, 1995 mandatory redemption of a portion of this obligation. However, in
December 1995, AmHealth executed a Letter of Intent with CORE, Inc., a public
company pursuant to which, in exchange for CORE stock, CORE would purchase
substantially all the assets of AmHealth in a transaction expected to close by
July 1996. If the above transaction occurs, the Company would likely settle
AmHealth's $2.5 million obligation to Transcend in exchange for CORE stock.
There can be no assurance that the CORE/AmHealth transaction will close and
there can be no assurance that the amount the Company will ultimately realize on
the notes will not be materially less than the carrying value of the investment
as reflected in the Company's financial statements.
   
Subsequent Event

     On May 10, 1996, AmHealth executed a definitive agreement with CORE, Inc.,
a public company, pursuant to which CORE would purchase for cash substantially
all the assets of AmHealth in a transaction expected to close by July 1996. In
anticipation of the consummation of the foregoing transaction, on June 17, 1996,
AmHealth and the Company executed a definitive settlement agreement pursuant
to which AmHealth has agreed to pay the Company the sum of $2,050,000 (the
current carrying value of the asset) plus $5,287 in attorneys' fees in full
satisfaction of AmHealth's obligations to the Company arising out to the sale of
all of the assets and liabilities of Occu-Care, Inc. Under the terms of the
settlement agreement, the Company agreed to extend the maturity of the note
through July 31, 1996 and to accept payment under the note simultaneously with
the closing of the aquisition of AmHealth by CORE. The Company dismissed its
lawsuit against AmHealth without prejudice on June 26, 1996. The consummation of
the settlement will not represent a gain or loss to the Company. There can be no
assurance that the CORE/AmHealth transaction will close and there can be no
assurance that the Company will be paid should the CORE/AmHealth transaction
fail to close.    
 
LIQUIDITY AND CAPITAL RESOURCES
     
  The Company's cash flows from continuing operations provided net cash of
$437,000 in 1993 but required the use of cash of $579,000 and $3,445,000 in
1994 and 1995, respectively. For the quarter ended March 31, 1996, cash flows
from continuing operations used $36,000. Cash has been used to continue
funding the Company's operating losses and, in 1995, to finance the growth of
certain of the Company's acquisitions' working capital needs.       
     
  Discontinued operations contributed cash of $202,000 for 1995 and used cash of
$122,000 in the first quarter of 1996. The primary reason for the increase in
net assets related to discontinued operations in the first quarter of 1996 was
the payment of legal expenses related to the lawsuit of the Company against
certain insurance companies. The net accounts receivable from the discontinued
operations represent reimbursements that are owed the Company by certain
insurance companies for applicant medical/legal evaluation services provided by
FWHC Medical Group, Inc. and Veritas Medical Group, Inc., two managed medical
groups associated with the Company's former subsidiaries, First Western Health
Corporation and Veritas Healthcare Management. The Company expects to collect
the accounts receivable from discontinued operations over the next several years
under the provisions of the sale and service agreement that the Company
has entered into with a third party for servicing and managing the remaining
accounts receivable balance. See "Discontinued Operations."
    
 
  The Company's working capital position decreased during the quarter ended
March 31, 1996 from $461,000 at December 31, 1995 to $(16,000) at March 31,
1996. This decrease in the Company's working capital position arises from a
combination of several factors including the financing from current cash
sources of capital expenditures for equipment of $313,000 during the quarter
ended March 31, 1996 and the continued funding of losses from the Company's
operations. The Company established two credit facilities, described below, to
help fund its operations. Although the Company has a negative cash flow, the
Company's accounts receivable turn faster than related payables, allowing the
Company to operate and grow its business. Under the terms of its contract
management fixed-fee pricing schedules, the Company receives the annual fee in
monthly payments in advance (due on the first day of the month), prior to
actually incurring any of the month's fixed and/or variable operating
expenses. This results in accounts receivables for contract management turning
in approximately seven days. The Company also receives an up-front
implementation fee prior to incurring any costs associated with the actual
start-up of a contract management site.
 
  The Company's cash flows from investing activities used cash of $1,043,000
and $1,438,000 in 1993 and 1994, respectively, and provided cash of $4,873,000
in 1995. The Company's principal uses of cash for investing purposes are for
capital expenditures and for acquisitions. The Company does not currently have
any material commitments for capital expenditures. In 1995, in connection with
the Company's acquisition of TriCare, it acquired approximately $7.5 million
of cash. For the quarter ended March 31, 1996, investing activities used
$313,000 of cash for the purchase of capital expenditures.
 
  In 1995 the Company expended $1,232,000 in cash to acquire the medical
transcription businesses of IDS and MTA. In connection with these
acquisitions, on August 15, 1995, the Company raised $2 million in cash
through the private placement of 8% Subordinated Convertible Debentures. The
Debentures are unsecured and
 
                                       9
<PAGE>
 
subordinated to all other debt of the Company. The interest rate on the
Debentures is 8%, payable semi-annually, and the principal amount is due in
full on August 15, 2000. The Debentures are convertible into Common Stock by
the holder at any time prior to August 15, 2000 at a rate of 286 shares of
Common Stock for each $1,000 in principal amount and are convertible by the
Company at any time when the Common Stock trades at $10.50 per share for 30
consecutive trading days. The Company may redeem the Debentures at any time
upon 30 to 60 days notice to the holder of a Debenture.
 
  Cash flows from financing activities provided $446,000, $2,036,000, and
$183,000 in 1993, 1994, and 1995, respectively. For the quarter ended March
31, 1996, investing activities provided cash of $33,000. The Company's primary
sources of cash over the past several years have been proceeds from a line of
credit and pursuant to the exercise of stock options. In 1995, the Company
retired its line of credit and issued $2 million of convertible debentures as
discussed above.
     
  On April 30, 1996, the Company established two separate credit-facilities with
Silicon Valley East (Wellesley, Massachusetts), a division of Silicon Valley
Bank, a California-chartered bank (Santa Clara, CA). The aggregate credit
available to the Company (under both facilities) is $5.75 million. The banking
facilities are secured by all of the Company's assets. One of the facilities is
a $5.0 million working capital credit line subject to an initial cap of $3.0
million that will be removed if the Company's net income for the quarter ended
June 30, 1996 is at least $50,000. Because the Company was still experiencing
losses as of June 30, 1996, this facility remains capped at $3.0 million. The
second facility is a $750,000 term facility set up to help the Company meet its
capital investment requirements in the near term which will include the purchase
of computers and transcription--related equipment. This term note is subject to
an initial cap of $250,000, with the cap being removed during such periods that
the Company maintains a debt service ratio of at least 1.5 to 1.0, where debt
service is defined as earnings, before interest and taxes plus depreciation and
amortization, divided by total interest plus current portion of long term debt.
As of July 30, 1996, the Company was not maintaining the required debt service
ratio. Both facilities will mature on April 30, 1997.            
     
  The Company anticipates that cash on hand, together with internally generated
funds and cash collected from discontinued operations should be sufficient to
finance continuing operations for at least the next 24 months as well as the
civil litigation action against certain insurance carriers.       
 
IMPACT OF INFLATION
 
  Inflation has not had a material effect on the Company to date. However, the
effects of inflation on future operating results will depend in part, on the
Company's ability to increase prices and/or lower expenses in amounts
offsetting inflationary cost increases.

           
                                      10 
<PAGE>
 
                         PART II--OTHER INFORMATION         
 
         

    
ITEM 1.  LEGAL PROCEEDINGS      

  The Company is subject to certain claims in the ordinary course of business
which are not material.
    
  On September 17, 1993, the Company and its healthcare subsidiaries, First
Western Health Corporation and Veritas Healthcare Management, and the
physician-owned medical groups, FWHC Medical Group, Inc. and Veritas Medical
Group, Inc., which had contracts with the health care subsidiaries, initiated
a lawsuit in the Superior Court of the State of California, County of Los
Angeles, against 22 of the largest California workers' compensation insurance
carriers, which lawsuit was subsequently amended to name 16 defendants
(including State Compensation Insurance Fund, Continental Casualty Company,
California Compensation Insurance Company, Zenith National Insurance
Corporation and Pacific Rim Assurance Company). The action seeks $115 million
in compensatory damages plus punitive damages. The plaintiffs claim abuse of
process, intentional interference with contractual and prospective business
relations, negligent interference and unlawful or unfair business practices
which led to the discontinuation in April 1993 of the former business of the
Company's healthcare subsidiaries and their contracting associated medical
groups (the "Lawsuit"). The claims arise out of the Company's former business,
which prior to the merger with Transcend Services, Inc., included the business
of providing medical/legal evaluations and medical treatment services (in
association with managed medical groups) in the workers' compensation industry
in California. Seven defendants in the Lawsuit have filed cross complaints
against the plaintiffs seeking restitution, accounting from the plaintiffs for
monies previously paid by the defendants, disgorgement of profits, injunctive
relief, attorneys' fees and punitive damages, based upon allegations of
illegal corporate practice of medicine, illegal referral arrangements,
specific statutory violations and related improper conduct. The case is
presently in the early stages of discovery. The defendants have filed various
motions to dismiss and other motions seeking the failure of the plaintiffs'
cause of action, none of which have been successful. The Company and its
counsel do not believe that it is likely that the Company will be held liable
on any of the cross complaints; however, there can be no assurance that the
Company will be successful in the defense of the cross complaints. In
addition, there can be no assurance as to the recovery by the Company of the
damages sought in its complaint against the defendants. The costs associated
with the conduct of the Lawsuit cannot be ascertained with certainty but are
expected to be substantial. Based upon facts and circumstances known to date, in
the opinion of management, final resolution of the Lawsuit will not have a
material adverse effect on the Company's financial condition, results of
operations or liquidity.
 
  On June 22, 1995, an action was filed by Timothy S. Priest in his capacity
as administrator of the estate of Robert V. Taylor against Carol Brown, Debbie
Ostwald, the Company's subsidiary Sullivan, and Fireman's Fund Insurance
Company, in the Circuit Court of Franklin County, Tennessee, alleging breach
of the duty to provide reasonably competent nursing care to an injured
individual. The plaintiff demands compensatory damages in the amount of $1
million and punitive damages in the amount of $2 million, plus costs.
Management of the Company believes that the Company has meritorious defenses
to the allegations and intends to vigorously contest liability in this matter.
At the present time, management of the Company cannot predict the outcome of
this litigation, but does not believe that the resolution of the litigation
will have a material adverse effect on the Company's financial condition,
results of operations or liquidity.
 
ITEM 6.  EXHIBITS AND REPORTS ON FORM 8-k

    (a)  Exhibits:

         11   Computation of Per Share Earnings
         27.1 Financial Data Schedule

    (b)  Reports on Form 8-K:

         No reports on Form 8-K were filed during the quarter ended 
         March 31, 1996.

                                       11
<PAGE>
 
                                  SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned hereunto duly authorized.



                                       TRANSCEND SERVICES, INC.



Dated:  February 20, 1997           By:  /s/ David W. Murphy
                                       -------------------------------
                                       David W. Murphy
                                       (Chief Financial and Accounting Officer)