---




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, 2002





OR





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




For the transition period from  to





Commission
File Number 0-18217





TRANSCEND SERVICES, INC.


(Exact name of registrant as specified in its charter)





Delaware

33-0378756(State or other jurisdiction of

(I.R.S Employerincorporation or organization)

Identification No.)





945 East Paces Ferry Rd, Suite 1475, Atlanta, Georgia 30326


(Address of principal executive offices and zip code)





Registrants telephone number, including area code:(404) 364-8000





N/A


(Former name, former address, and former fiscal year, if changed since last report)





Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or
15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90
days.    Yes  x    No  ̈





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





Class

Outstanding at July 15, 2002Common Stock, $.05 par value

4,513,143 Shares





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1




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INDEX





Page NumberPART I.

FINANCIAL INFORMATIONItem 1.

Financial StatementsConsolidated Balance Sheets as of June 30, 2002 and December 31, 2001

3Consolidated Statements of Operations for the Three and Six Months Ended June 30, 2002 and 2001

4Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2002 and 2001

5Notes to Consolidated Financial Statements

6Item 2.

Managements Discussion and Analysis of Financial Condition and Results of Operations

8Item 3.

Quantitative and Qualitative Disclosures About Market Risk

10PART II.

OTHER INFORMATION

11Item 1.

Legal Proceedings

11Item 4.

Submission of Matters to a Vote of Security Holders

11Item 6.

Exhibits and Reports on Form 8-K

11SIGNATURES

12




2




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PART I.    
FINANCIAL INFORMATION


Item 1.    
Financial Statements





TRANSCEND SERVICES, INC.


CONSOLIDATED BALANCE SHEETS


(Unaudited)





June 30, 2002


December 31, 2001ASSETSCurrent assets:Cash and cash equivalents

$
697,000


$
304,000Accounts receivable, net of allowance for doubtful accounts of $61,000 at June 30, 2002 and $89,000 at December 31,
2001


966,000



1,016,000Prepaid expenses and other current assets


85,000



116,000Total current assets


1,748,000



1,436,000Property and equipment:Computer equipment


1,447,000



3,071,000Software development


1,630,000



1,566,000Furniture and fixtures


143,000



275,000Property and equipment


3,220,000



4,912,000Accumulated depreciation


(1,804,000
)


(3,218,000
)Property and equipment, net


1,416,000



1,694,000Note receivable and other assets


56,000



46,000Total assets

$
3,220,000


$
3,176,000LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilities:Accounts payable

$
115,000


$
174,000Accrued compensation and benefits


362,000



327,000Other accrued liabilities


259,000



366,000Total current liabilities


736,000



867,000Net liabilities of discontinued operations


0



300,000Commitments and contingenciesStockholders equity:Preferred stock, $.01 par value; 21,000,000 shares authorized:Series A convertible preferred stock; 212,800 shares issued and outstanding at June 30, 2002 and December 31,
2001


2,000



2,000Series B convertible preferred stock; 60,000 shares issued and outstanding at June 30, 2002 and December 31,
2001


1,000



1,000Common Stock, $.05 par value; 6,000,000 shares authorized, 4,513,000 shares issued and outstanding at June 30, 2002 and
December 31, 2001


225,000



225,000Additional paid-in capital


28,141,000



28,141,000Subscription receivable for the purchase of 100,000 shares of common stock


(126,000
)


(126,000
)Accumulated deficit


(25,759,000
)


(26,234,000
)Total stockholders equity


2,484,000



2,009,000Total liabilities and stockholders equity

$
3,220,000


$
3,176,000





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




3




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TRANSCEND SERVICES, INC.


CONSOLIDATED STATEMENTS OF OPERATIONS


(Unaudited)


Three Months Ended


Six Months Ended6/30/02


6/30/01


6/30/02


6/30/01Revenue

$
2,989,000


$
2,916,000


$
5,902,000


$
5,817,000Direct costs


2,275,000



2,221,000



4,405,000



4,360,000Gross profit


714,000



695,000



1,497,000



1,457,000Operating expenses:Sales and marketing


116,000



108,000



200,000



200,000Research and development


86,000



80,000



170,000



157,000General and administrative


673,000



602,000



1,263,000



1,186,000Total operating expenses


875,000



790,000



1,633,000



1,543,000Operating loss


(161,000
)


(95,000
)


(136,000
)


(86,000
)Gain on sale of assets


962,000



0



962,000



0Loss on legal settlement


0



(576,000
)


0



(576,000
)Interest expense, net


(1,000
)


(15,000
)


(2,000
)


(38,000
)Income (loss) before income tax and discontinued operations


800,000



(686,000
)


824,000



(700,000
)Income tax (expense) benefit


0



(5,000
)


0



116,000Income (loss) from continuing operations


800,000



(691,000
)


824,000



(584,000
)Income (loss) from discontinued operations


24,000



(205,000
)


(109,000
)


(124,000
)Net income (loss)


824,000



(896,000
)


715,000



(708,000
)Dividends on preferred stock


(120,000
)


(120,000
)


(240,000
)


(239,000
)Net income (loss) attributable to common stockholders

$
704,000


$
(1,016,000
)

$
475,000


$
(947,000
)Basic income (loss) per share:From continuing operations

$
0.15


$
(0.18
)

$
0.13


$
(0.19
)From discontinued operations


0.01



(0.05
)


(0.02
)


(0.03
)Net income (loss) attributable to common stockholders

$
0.16


$
(0.23
)

$
0.11


$
(0.22
)Weighted average shares outstanding


4,513,000



4,403,000



4,513,000



4,393,000Diluted income (loss) per shareFrom continuing operations

$
0.15


$
(0.18
)

$
0.13


$
(0.19
)From discontinued operations


0.01



(0.05
)


(0.02
)


(0.03
)Net income (loss) attributable to common stockholders

$
0.16


$
(0.23
)

$
0.10


$
(0.22
)Weighted average shares outstanding


4,525,000



4,403,000



4,526,000



4,393,000





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




4




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TRANSCEND SERVICES, INC.


CONSOLIDATED STATEMENTS OF CASH FLOWS


(Unaudited)





Six Months Ended June 30,2002


2001Cash flows from operating activities:Net income (loss) attributable to common stockholders

$
475,000


$
(947,000
)Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:Depreciation and amortization


341,000



404,000Gain on sale of assets


(962,000
)


0Loss on legal settlement


0



576,000Loss from discontinued operations


109,000



124,000Preferred stock dividends


240,000



239,000Changes in assets and liabilities:Short-term investment


0



1,160,000Accounts receivable, net


50,000



427,000Prepaid expenses


31,000



117,000Note receivable and other assets


(10,000
)


(1,000
)Accounts payable


(82,000
)


(755,000
)Accrued liabilities


(93,000
)


(780,000
)Total adjustments


(376,000
)


1,511,000Net cash provided by continuing operations


99,000



564,000Net cash provided by (used in) discontinued operations


(197,000
)


122,000Net cash provided by (used in) operating activities


(98,000
)


686,000Cash flows from investing activities:Capital expenditures


(180,000
)


(170,000
)Proceeds from disposition of assets


911,000



0Net cash provided by (used in) investing activities


731,000



(170,000
)Cash flows from financing activities:Repayments of borrowings under line of credit agreement, net


0



(219,000
)Preferred stock dividends


(240,000
)


(239,000
)Proceeds from the exercise of stock options and other issuances


0



34,000Net cash used in financing activities


(240,000
)


(424,000
)Net increase in cash and cash equivalents


393,000



92,000Cash and cash equivalents, at beginning of period


304,000



6,000Cash and cash equivalents, at end of period

$
697,000


$
98,000Supplemental cash flow information:Cash paid for interest expense

$
2,000


$
38,000





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




5




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TRANSCEND SERVICES, INC.


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


June 30, 2002 and 2001


(Unaudited)





(1)    The accompanying consolidated financial statements are unaudited
and have been prepared by the management of Transcend Services, Inc. (the Company or Transcend) in accordance with the rules and regulations of the Securities and Exchange Commission. In the opinion of management, all
adjustments, consisting of normal recurring accruals necessary for the fair presentation of the consolidated financial position, results of operations and cash flows, have been included. For further information, refer to the consolidated financial
statements and footnotes thereto included in the Companys Form 10-K for the year ended December 31, 2001. Footnote disclosure that substantially duplicates the disclosure contained in that document has been omitted.





(2)    On May 31, 2002, the Company sold certain assets and the operations of Cascade Health Information Software, Inc.
(Cascade), a wholly owned subsidiary of the Company, to QuadraMed Corporation for $911,000 in cash, which resulted in a gain on the sale of assets of $962,000. All information presented in the accompanying consolidated financial
statements has been restated to classify Cascade as discontinued operations. As a result of the sale of Cascade, the Company now operates in one, and only one, reportable business segment as a provider of medical transcription services. The
operating results for Cascade were as follows:





Three Months Ended June 30,


Six Months Ended June 30,2002*

2001


2002*


2001Revenue

$
296,000

$
347,000


$
641,000


$
1,005,000Net income (loss)

$
24,000

$
(205,000
)

$
(109,000
)

$
(124,000
)





| | * |  | Represents Cascades results for the two and five months ended May 31, 2002 (the date of sale).
| | - |  | -----------------------------------------------------------------------------------------------




(3)    Effective April 1, 2002, the Company changed the estimated useful life of its proprietary T2K transcription system from four to six
years to reflect the success of the Companys on-going software maintenance and enhancement efforts, which are expensed as incurred, in extending the useful life of the system. This change reduced amortization expense by approximately $17,000
per month, or $51,000 (approximately $0.01 per share) for the three and six months ended June 30, 2002. In addition, during the first quarter of 2002, the Company wrote off fully depreciated computer equipment of $1,710,000 and furniture and
fixtures of $162,000 that were no longer in productive use.





(4)    The source of cash from short-term investment of
$1,160,000, net of commission expense of $10,000, presented in the accompanying consolidated statement of cash flows for the six months ended June 30, 2001 and the loss on legal settlement of $576,000 presented in the accompanying consolidated
statements of operations for the three and six months ended June 30, 2001 relate to the sale of a short-term investment in the open market on April 2, 2001. This short-term investment, which consisted of 248,703 unregistered shares of common stock
of Core, Inc. with resale restrictions that expired on April 1, 2001, was received in a legal settlement on March 31, 2000 at which time the fair market value of said common stock was $1,736,000. A portion of the proceeds from this sale was used to
reduce borrowings under the Companys line of credit during the second quarter of 2001.





(5)    The Company
accounts for its income taxes in accordance with Statement of Financial Accounting Standards (SFAS) No. 109. Certain deferred tax liabilities established in prior years related to the expected tax consequences of temporary differences
between the tax basis of assets and liabilities and their related reported amounts are no longer required. Accordingly, an income tax benefit of $121,000 during the first quarter of 2001 is included in the consolidated statement of operations for
the six months ended June 30, 2001. An unrelated income tax expense of $5,000 for state income taxes is included in the consolidated statements of operations for the three and six months ended June 30, 2001.





(6)    The Company follows SFAS No. 128, Earnings per Share. That statement requires the disclosure of basic net income (loss)
per share and diluted net income (loss) per share. Basic net income (loss) per share is computed by dividing net income (loss) available to common shareholders by the weighted average number of common shares outstanding during the period and does
not include any other potentially dilutive securities. Diluted net income per share gives effect to all potentially dilutive securities. Potentially dilutive securities were antidilutive and therefore are not included in diluted loss per share
calculations in the accompanying statements of operations for the three and six months ended June 30, 2001.




6




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(7)    The Company accounts for comprehensive income (loss) under the provisions of
SFAS No. 130, Reporting Comprehensive Income.The Companys comprehensive income (loss) is presented below for the periods indicated:





Three Months Ended June 30,


Six Months Ended June 30,2002

2001


2002

2001Net income (loss) attributable to common stockholders

$
704,000

$
(1,016,000
)

$
475,000

$
(947,000
)Unrealized gain (loss) on short-term investment


0


559,000



0


866,000Comprehensive income (loss)

$
704,000

$
(457,000
)

$
475,000

$
(81,000
)





(8)    On March 25, 2002, the Company extended the maturity date of
its $1.5 million line of credit to March 31, 2003. Repayment of borrowings, if any, under this line of credit are personally guaranteed by the Companys Chief Executive Officer and one of its Directors.





(9)    On April 5, 2001, Our Lady of the Lakes Hospital, Inc. (OLOL) filed a lawsuit against the Company. The lawsuit, styled
Our Lady of the Lakes Hospital, Inc. v. Transcend Services, Inc. was filed in the 19 th Judicial District Court, Parish of East, State of Louisiana, Civil Case Number 482775, Div. A. The lawsuit alleges, among other things, that the Company breached certain contracts entered into between OLOL and the Company, including a staffing and
management servicing contract, a transcription platform agreement and a marketing agreement. OLOL is seeking an unspecified amount of monetary damages. On May 30, 2001, the Company filed a timely Answer that generally denied all liability, and the
Company filed a counterclaim against OLOL primarily seeking fees owed by OLOL for services performed by the Company and interest on unpaid invoices. OLOL has subsequently added Transcends insurance carriers as defendants to the lawsuit.





The Company intends to vigorously defend all claims made by OLOL. The lawsuit is in an early procedural stage, however, and therefore it
is not possible at this time to determine the outcome of the actions or the effect, if any, that their outcome may have on the Companys results of operations and financial condition. There can be no assurances that this litigation will not
have a material adverse effect on the Companys results of operations and financial condition.





On July 9, 2001, Provider HealthNet
Services, Inc. (PHNS) made a written demand for payment from Transcend in the amount of approximately $750,000. The demand was based on allegations that Transcend had breached certain representations and warranties contained in an Asset
Purchase Agreement between PHNS and Transcend entered into on October 13, 2000. Thereafter, Transcend made a counter-demand against PHNS for payment of approximately $93,000 owed under that same Asset Purchase Agreement. The parties subsequently
submitted all disputes in this matter to binding arbitration, which was held on January 23 and 24, 2002. On March 11, 2002, the Final Order of the Arbitrator awarded a net settlement in the amount of approximately $13,000 to PHNS, pending an appeal
to the Arbitrator by Transcend for a credit of approximately $7,000 for interest income due to Transcend from PHNS. On June 13, 2002, Transcend paid approximately $6,000 to PHNS as final settlement of the dispute.





On September 14, 2001, the Company filed a lawsuit against Palmer & Cay Consulting Group, Inc. (P&C), the Companys former insurance
broker. The lawsuit, styled Transcend Services, Inc. v. Palmer & Cay Consulting Group, Inc. was filed in the Superior Court of Fulton County, State of Georgia, Civil Action File No.: 2001-CV-42725. The lawsuit alleged that P&C
negligently failed to advise Transcend of, or otherwise failed to make arrangements to cover, Transcends potential liability for certain health care claims submitted by Transcends employees. Transcend sought damages of $450,000,
attorneys fees and interest. On April 10, 2002, Transcend filed a voluntary dismissal of the lawsuit in the Superior Court of Fulton County.





The Company is involved in a dispute with the Internal Revenue Service regarding the timely payment of payroll taxes in prior years. The Company believes that it has meritorious defenses to the related claims and assertions; however,
there can be no assurance that the Company will be successful in defending such claims and assertions. Further, there can be no assurances that this dispute will not have a material adverse effect on the Companys results of operations and
financial condition.




7




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





Certain
information included in this Quarterly Report on Form 10-Q contains, and other reports or materials filed or to be filed by the Company with the Securities and Exchange Commission (as well as information included in oral statements or other written
statements made or to be made by the Company or its management) contain or will contain, forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, Section 27A of the Securities Act
of 1933, as amended and pursuant to the Private Securities Litigation Reform Act of 1995. Such forward-looking statements may relate to financial results and plans for future business activities, and are thus prospective. Such forward-looking
statements are subject to risks, uncertainties and other factors that could cause actual results to differ materially from future results expressed or implied by such forward-looking statements. Potential risks and uncertainties include, but are not
limited to, general economic conditions, competition and other uncertainties detailed in this report and detailed from time to time in other filings by the Company with the Securities and Exchange Commission (as well as information included in oral
statements or other written statements made or to be made by the Company or its management). Any forward-looking statements are made pursuant to the Private Securities Litigation Reform Act of 1995 and, as such speak only as of the date made.





Results of Operations





On May 31, 2002, the Company sold certain assets and the operations of Cascade Health Information Software, Inc. (Cascade), a wholly owned subsidiary of the Company, to QuadraMed Corporation. All information presented in
the accompanying consolidated financial statements has been restated to classify Cascade as discontinued operations. As a result of the sale of Cascade, the Company now operates in one, and only one, reportable business segment that provides medical
transcription services to the healthcare industry. The Companys home-based medical transcription professionals, utilizing web-based voice and data distribution technology, document patient care by converting physicians voice recordings
into electronic medical record documents. Unless otherwise indicated, the following discussion of the results of operations focuses on the continuing operations of the Company.





Three Months Ended June 30, 2002 Compared to Three Months Ended June 30, 2001





Revenue increased $73,000, or 3%, to $3.0 million for the three months ended June 30, 2002 when compared to revenue of $2.9 million for the three months ended June 30, 2001 due primarily to the net addition of two new customers that
contributed relatively little revenue in the second quarter of 2002.





While gross profit increased $19,000, or 3%, to $714,000 for the
three months ended June 30, 2002 when compared to the amount in the comparable prior year period, gross profit as a percentage of revenue remained the same at 24% for both periods.





Sales and marketing expenses increased only $8,000, or 7%, to $116,000 in the second quarter of 2002 when compared to the amount in the prior year period and were 4% of revenue in both periods.





Research and development expenses increased only $6,000, or 8%, to $86,000 in the second quarter of 2002 when compared to the amount in
the prior year period and were 3% of revenue in both periods. The Company believes that the size of its current research and development staff is sufficient to accomplish its planned development activities for the remainder of the year.





General and administrative expenses increased $71,000, or 12%, to $673,000 in the second quarter of 2002 when compared to the amount in
the prior year period as a result of the Company increasing its reserve for certain legal matters. See Note 9 to the Consolidated Financial Statements included with this report.





The gain on sale of assets of $962,000 represents the gain on the sale of certain assets and the operations of Cascade for which the Company received $911,000 in cash.





The loss on legal settlement of $576,000 in the second quarter of 2001 was attributable to the sale of publicly held securities in April 2001 that were acquired
in a legal settlement related to ceasing the operations of Transcend Case Management, Inc., a former wholly owned subsidiary of the Company, in 1999. See Note 4 to the Consolidated Financial Statements included with this report.




8




---




Net interest expense decreased $14,000 to $1,000 in the second quarter of 2002 from $15,000 in the
second quarter of 2001 due to: (1) the reduction in borrowings under the Companys line of credit using a portion of the proceeds received during December 2001 from the collection of a note receivable and an earn-out payment, both of which
related to a sale of assets in 1999; and (2) the nation-wide reduction in the prime interest rate.





The Company incurred an insignificant
amount of state income taxes in the second quarter of 2001 despite having net operating loss carry-forwards in excess of approximately $20 million.





The Company reported income from discontinued operations of $24,000 for the second quarter of 2002 and a loss from discontinued operations of $205,000 in the second quarter of 2001, both solely attributable to Cascades
operations. The variation between periods is primarily due to: (1) relatively low software license fee revenue in the second quarter of 2001; and (2) capitalized software development costs of $71,000 in the second quarter of 2002.





Six Months Ended June 30, 2002 Compared to Six Months Ended June 30, 2001





Revenue increased $85,000, or 1%, to $5.9 million for the six months ended June 30, 2002 when compared to revenue of $5.8 million for the six months ended June 30, 2001 due primarily to the
net addition of six new customers that contributed relatively little revenue in the first half of 2002.





While gross profit increased
$40,000, or 3%, to $1.5 million for the six months ended June 30, 2002 when compared to the amount in the comparable prior year period, gross profit as a percentage of revenue remained the same at 25% for both periods.





Sales and marketing expenses were $200,000, or 3% of revenue, for both the first half of 2002 and 2001.





Research and development expenses increased only $13,000, or 8%, to $170,000 in the first half of 2002 when compared to the amount in the prior year period and were 3% of revenue in both
periods. The Company believes that the size of its current research and development staff is sufficient to accomplish its planned development activities for the remainder of the year.





General and administrative expenses increased $77,000, or 6%, to $1.3 million for the six months ended June 30, 2002 when compared to the amount in the prior year period as a result of the Company
increasing its reserve for certain legal matters. See Note 9 to the Consolidated Financial Statements included with this report.





The
gain on sale of assets of $962,000 represents the gain on the sale of certain assets and the operations of Cascade for which the Company received $911,000 in cash.





The loss on legal settlement of $576,000 in the first half of 2001 were attributable to the sale of publicly held securities in April 2001 that were acquired in a legal settlement related to ceasing
the operations of Transcend Case Management, Inc., a former wholly owned subsidiary of the Company, in 1999.





Net interest expense
decreased $36,000 to $2,000 in the six months ended June 30, 2002 from $38,000 in the six months ended June 30, 2001 due to: (1) the reduction in borrowings under the Companys line of credit using a portion of the proceeds received during
December 2001 from the collection of a note receivable and an earn-out payment, both of which related to a sale of assets in 1999; and (2) the nation-wide reduction in the prime interest rate.





The Company reported an income tax benefit of $121,000 in the first half of 2001 due to the elimination of deferred tax liabilities established in prior years that are no longer required.
This tax benefit was partially offset by an insignificant amount of state income taxes in the second quarter of 2001 despite having net operating loss carry-forwards in excess of approximately $20 million.





The Company reported losses from discontinued operations of $109,000 and $124,000 for the six months ended June 30, 2002 and 2001, respectively, both solely
attributable to Cascades operations. While the amount of the losses from discontinued operations in each period were comparable, the effect upon the determination of the respective losses of capitalized software development costs of $169,000
in the first half of 2002 offset the relatively higher amount of software license fee revenue in the first half of 2001.




9




---




Liquidity and Capital Resources





As of June 30, 2002, the Company had cash and cash equivalents of $697,000, working capital of $1,012,000, no debt and full availability of its $1.5 million line of credit, which expires on March 31,
2003.





The Companys financial condition was significantly enhanced during the second quarter of 2002 by the proceeds of $911,000
from the sale of certain assets and the operations of Cascade. In addition, the related gain on the sale of said assets in the amount of $962,000 is primarily responsible for increasing the Companys net tangible assets from $1,780,000 as of
March 31, 2002 to $2,484,000 as of June 30, 2002. As a result, the Company now exceeds the minimum net tangible assets requirement of $2 million for continued listing on the Nasdaq SmallCap Market System (Nasdaq). Further, management
projects that its stockholders equity will exceed $2.5 million by November 1, 2002 when Nasdaqs requirement for continued listing changes from minimum net tangible assets of $2 million to minimum stockholders equity of $2.5
million.





Other than the gain on the sale of assets of $962,000 referred to above and the loss from discontinued operations of $109,000
attributable to Cascade, there were no unusual items or amounts included in the determination of net cash provided by continuing operations of $99,000 for the six months ended June 30, 2002. Net cash used by Cascade was $197,000 in 2002 prior to its
disposition on May 31, 2002.





Other than the proceeds from the sale of Cascade of $911,000 referred to above, the only other investing
activities of the Company during the first half of 2002 were capital expenditures of $180,000, primarily for computer hardware and software upgrades and enhancements.





The only financing activities of the Company during the first half of 2002 were the payments of the two quarterly preferred stock dividends of $120,000 each.





Aside from cash available under its $1.5 million line of credit referred to above, during the fourth quarter of each year between 2002 and 2005 inclusive, the
Company has potential cash resources of an undetermined amount of earn-out payments, if any, payable by Provider HealthNet Services, Inc. (PHNS) based on a fixed percentage of certain defined future revenue recognized by PHNS from the
Co-Sourcing and CodeRemote businesses sold to PHNS by Transcend in October 2000.





The Company is a defendant in the OLOL lawsuit. In
addition, the Company is involved in a dispute with the Internal Revenue Service (IRS) regarding the timely payment of payroll taxes in prior years. See Note 9 to the Consolidated Financial Statements included with this report and
Legal Proceedings. It is unlikely that either the outcome of the OLOL matter or the IRS dispute will be known in 2002. Further, if either or both outcomes were unfavorable to Transcend, the Company would most likely appeal the verdict or
decision. Nonetheless, either or both issues could have a material adverse effect on the Companys results of operations and financial condition in the future.





The Company anticipates that cash on hand, together with internally generated funds, cash available under its line of credit and potential cash from the PHNS earn-out agreement, if any, should be
sufficient to finance continuing operations, make capital investments in the normal and ordinary course of its business and meet its Series A Convertible Preferred Stock dividend payment requirements during the remainder of 2002 and for the
foreseeable future.





Impact of Inflation





Inflation has not had a material effect on the Company to date. However, the effects of inflation on future operating results will depend in part, on the Companys ability to increase prices or lower expenses, or both,
in amounts that offset inflationary cost increases.





Item 3.    
Quantitative and Qualitative Disclosures About Market Risk





The Company has no material exposure to market risk
from derivatives or other financial instruments as of June 30, 2002. See Note 4 to the Consolidated Financial Statements included in with this report.




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PART II.    
OTHER INFORMATION





Item 1.    
Legal Proceedings





On April 5, 2001, Our Lady of the Lakes Hospital, Inc. (OLOL) filed a lawsuit
against the Company. The lawsuit, styled Our Lady of the Lakes Hospital, Inc. v. Transcend Services, Inc. was filed in the 19 th Judicial District Court, Parish of East, State of Louisiana, Civil Case Number 482775, Div. A. The lawsuit alleges, among other things, that the Company breached certain contracts entered into between OLOL and
the Company, including a staffing and management servicing contract, a transcription platform agreement and a marketing agreement. OLOL is seeking an unspecified amount of monetary damages. On May 30, 2001, the Company filed a timely Answer that
generally denied all liability, and the Company filed a counterclaim against OLOL primarily seeking fees owed by OLOL for services performed by the Company and interest on unpaid invoices. OLOL has subsequently added Transcends insurance
carriers as defendants to the lawsuit.





The Company intends to vigorously defend all claims made by OLOL. The lawsuit is in an early
procedural stage, however, and therefore it is not possible at this time to determine the outcome of the actions or the effect, if any, that their outcome may have on the Companys results of operations and financial condition. There can be no
assurances that this litigation will not have a material adverse effect on the Companys results of operations and financial condition.





The Company is involved in a dispute with the Internal Revenue Service regarding the timely payment of payroll taxes in prior years. The Company believes that it has meritorious defenses to the related claims and assertions and
intends to vigorously defend all claims; however, there can be no assurance that the Company will be successful in defending such claims and assertions. Further, there can be no assurances that this dispute will not have a material adverse effect on
the Companys results of operations and financial condition.





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





The Company held its Annual Meeting of Stockholders on
May 7, 2002. The Stockholders voted on the following two proposals and the results of the voting are presented below.





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




Nominee

Votes For

Votes WithheldJoseph P. Clayton

4,858,831

41,459Larry G. Gerdes

4,805,636

94,654Walter S. Huff, Jr.

4,832,758

67,532Charles E. Thoele

4,858,991

41,299





|2. |  | To ratify the appointment of Miller Ray & Houser LLP as independent public accountants to audit the accounts of the Company and its subsidiaries for the
year ending December 31, 2002. The Stockholders ratified said appointment with 4,847,366 votes FOR, 50,718 votes AGAINST and 2,206 ABSTAINING.
|-- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




Item 6.    
Exhibits and Reports on Form 8-K





| | (a) |  | No exhibits are required to be filed with this report.
| | --- |  | ------------------------------------------------------




| | (b) |  | Reports on Form 8-K:
| | --- |  | --------------------




The following report on Form 8-K was filed during the three months ended June 30, 2002:





(1) Form
8-K, dated May 31, 2002 and filed on June 14, 2002, relating to the sale of certain assets and the operations of Cascade Health Information Software, Inc., a wholly owned subsidiary of the Company.




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SIGNATURES





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








TRANSCEND SERVICES, INCJuly 26, 2002





By:

/s/    LARRY G. GERDESLarry G. Gerdes, President, Chief Executive Officer and
Chief Financial Officer (Principal Executive and Financial Officer)




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