<PAGE>
 
================================================================================


                                 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, 1998


                                      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 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


     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 August 13, 1998
          -----                     ------------------------------
Common Stock, $.01 par value                   21,488,000

================================================================================
<PAGE>
 
                                 INDEX

                                                                          PAGE
                                                                          ---- 
PART  I.  FINANCIAL INFORMATION


Item 1.   Financial Statements


            Consolidated Balance Sheets as of
            June 30, 1998 and December 31, 1997...........................   3


            Consolidated Statements of Operations for the
            Three Months and Six Months Ended
            June 30, 1998 and 1997........................................   4


            Consolidated Statements of Cash Flows for the
            Six Months Ended June 30, 1998 and 1997.......................   5

            Notes to Consolidated Financial Statements....................   6



Item 2.   Management's Discussion and Analysis of
            Financial Condition and Results of Operations.................   7



PART II.  OTHER INFORMATION
 
Item 1.   Legal Proceedings...............................................  14
 
Item 2.   Changes in Securities and Use of Proceeds.......................  15
 
Item 4.   Submission of Matters to a Vote of Security Holders.............  15
 
Item 5.   Other Information...............................................  16
 
Item 6.   Exhibits and Reports on Form 8-K................................  16



SIGNATURES..................................................................17

                                       2
<PAGE>
 
PART I.  FINANCIAL INFORMATION

ITEM 1.  FINANCIAL STATEMENTS


                           TRANSCEND SERVICES, INC.
                          CONSOLIDATED BALANCE SHEETS
                                  (UNAUDITED)

<TABLE>
<CAPTION>
 
 
                                                           JUNE 30,    DECEMBER 31
                                                             1998         1997 
                                                           --------    -----------
<S>                                                       <C>           <C> 
                    ASSETS
                    ------
Current assets:
 
 Cash and cash equivalents...........................     $ 3,068,000   $ 5,541,000
 Accounts receivable, net of allowance for doubtful                                
  accounts of $169,000 at June 30, 1998 and                                        
  $163,000 at December 31, 1997......................       6,157,000     4,965,000
 Prepaid expenses and other current assets...........       1,447,000       979,000
                                                          -----------   -----------
                                                                                   
Total current assets.................................      10,672,000    11,485,000
                                                          -----------   -----------
                                                                                   
Property and equipment:..............................                              
                                                                                   
 Property and equipment..............................       8,394,000     6,699,000
 Accumulated depreciation............................      (3,425,000)   (3,277,000)
                                                          -----------   -----------
                                                                                   
Property and equipment, net..........................       4,969,000     3,422,000
                                                                                   
Deposits and other assets............................         793,000       510,000
Investment...........................................       1,259,000           --
Goodwill and other intangible assets, net............       1,593,000     2,587,000
Net assets from discontinued operations..............       2,696,000     2,646,000
                                                          -----------   -----------
                                                                                   
Total assets.........................................     $21,982,000   $20,650,000
                                                          ===========   =========== 
                                                     
                     LIABILITIES AND STOCKHOLDERS' EQUITY
                     ------------------------------------
 
Current liabilities:

  Current maturities of long term debt..................  $   409,000   $   108,000
  Accounts payable......................................    1,248,000       843,000
  Accrued compensation and benefits.....................    2,092,000     2,399,000
  Other accrued liabilities.............................    2,257,000     1,751,000
  Deferred income taxes.................................      131,000       113,000
                                                          -----------   -----------
 
Total current liabilities...............................   6,137,,000     5,214,000
                                                          -----------   -----------
 
Long term debt, net of current maturities...............    5,270,000     4,983,000
 
Deferred income taxes...................................      540,000       540,000
 
Convertible debentures..................................    2,000,000     2,000,000
 
Commitments and contingencies
 
Stockholders' equity:
 
  Preferred stock, $.01 par value; 21,000,000 shares
      authorized Series A convertible preferred stock,
      212,800 shares issued at June 30, 1998 and
      December 31, 1997.................................        2,000         2,000
  Common stock, $.01 par value, 30,000,000 shares
      authorized, 21,488,000 shares and 20,500,000
       shares issued at June 30, 1998 and
       December 31, 1997 respectively...................      216,000       205,000
  Additional paid-in capital............................   26,183,000    26,208,000
 
  Retained deficit......................................  (18,366,000)  (18,502,000)
                                                          -----------   -----------
 Total stockholders' equity.............................    8,035,000     7,913,000
                                                          -----------   -----------
 Total liabilities and stockholders' equity.............  $21,982,000   $20,650,000
                                                          ===========   ===========
-------------------
</TABLE>
The accompanying notes are an integral part of these consolidated balance
sheets.

                                       3
<PAGE>
 
                           TRANSCEND SERVICES, INC.
                                        
                     CONSOLIDATED STATEMENTS OF OPERATIONS
                                  (UNAUDITED)

<TABLE>
<CAPTION>
                                                                   THREE MONTHS                   SIX MONTHS
                                                                  ENDED JUNE  30                ENDED JUNE  30
                                                          ---------------------------     --------------------------
                                                              1998            1997             1998        1997
                                                              -----          -----             ----        ----
<S>                                                       <C>             <C>              <C>          <C>
Net revenues............................................  $12,831,000     $10,360,000     $25,205,000    $21,105,000
Direct costs............................................   10,636,000       8,950,000      20,941,000     17,976,000
                                                          -----------     -----------     -----------    -----------
    Gross profit........................................    2,195,000       1,410,000       4,264,000      3,129,000

Marketing and sales expenses............................      502,000         503,000         981,000        919,000
General and administrative expenses.....................    1,058,000       1,159,000       2,165,000      2,292,000
Amortization expenses...................................       50,000         114,000         122,000        233,000
Research and development expenses.......................       29,000              --          29,000             --
                                                          -----------     -----------     -----------    -----------

Income (loss)  from operations..........................      556,000        (366,000)        967,000       (315,000)

Other income (expense):

   Interest expense, net................................     (101,000)       (124,000)       (205,000)      (213,000)
   Other................................................      (60,000)             --         (60,000)            --
                                                          -----------     -----------     -----------    -----------

                                                             (161,000)       (124,000)       (265,000)      (213,000)


Income (loss) before taxes and discontinued operations..      395,000        (490,000)        702,000       (528,000)

Income taxes............................................           --              --              --             --
                                                          -----------     -----------     -----------    -----------

Income (loss) before discontinued operations............      395,000        (490,000)        702,000       (528,000)

Loss from discontinued operations.......................      (17,000)        (75,000)        (32,000)      (109,000)
                                                          -----------     -----------     -----------    -----------

Net income (loss).......................................  $   378,000     $  (565,000)    $   670,000    $  (637,000)
                                                          ===========     ===========     ===========    ===========


Dividends on preferred stock............................     (120,000)             --        (239,000)            --

Net income (loss) to common stockholders................  $   258,000     $  (565,000)    $   431,000    $  (637,000)
                                                          ===========     ===========     ===========    ===========

Basic income (loss) per share:

  From continuing operations............................  $      0.01     $     (0.02)    $      0.02    $     (0.02)
  From discontinued operations..........................  $    ( 0.00)    $     (0.01)    $     (0.00)   $     (0.01)
                                                          -----------     -----------     -----------    -----------

Net income (loss).......................................  $      0.01     $     (0.03)    $     (0.02)   $     (0.03)
                                                          ===========     ===========     ===========    ===========

Weighted average common shares outstanding..............   20,871,000      20,130,000      20,721,000     20,115,000
                                                          ===========     ===========     ===========    ===========

Diluted income (loss) per share:

  From continuing operations...........................   $      0.01     $     (0.02)    $      0.02    $     (0.02)
  From discontinued operations.........................   $     (0.00)    $     (0.01)    $     (0.00)   $     (0.01)
                                                          -----------     -----------     -----------    -----------

Net income (loss)......................................   $      0.01     $     (0.03)    $      0.02    $     (0.03)
                                                          ===========     ===========     ===========    ===========

Weighted average common shares outstanding.............    21,125,000      20,130,000      20,975,000     20,115,000
                                                          ===========     ===========     ===========    ===========
--------------------
</TABLE>
 The accompanying notes are an integral part of these consolidated statements.

                                       4
<PAGE>
 
                           TRANSCEND SERVICES, INC.
                     CONSOLIDATED STATEMENTS OF CASH FLOWS
                                  (UNAUDITED)
 
<TABLE> 
<CAPTION> 
                                                                                                SIX MONTHS
                                                                                               ENDED JUNE 30,
                                                                                               --------------
                                                                                                1998     1997
                                                                                                ----     ----
<S>                                                                                     <C>           <C>
Cash flows from operating activities:
Net income (loss).....................................................................  $   431,000   $  (637,000)
Adjustments to reconcile net income (loss) to net cash used in operating activities:
 
   Depreciation and amortization......................................................      805,000       801,000
   Loss related to discontinued operations............................................       32,000       109,000
Changes in assets and liabilities:
 
   Accounts receivable, net...........................................................   (1,127,000)     (621,000)
 
   Prepaid expenses and other current assets..........................................     (476,000)     (286,000)
 
   Deposits and other assets..........................................................     (284,000)        6,000
   Accounts payable...................................................................      312,000      (213,000)
 
   Accrued liabilities................................................................     (395,000)     (212,000)
                                                                                        -----------   -----------
 
Total adjustments.....................................................................   (1,133,000)     (416,000)
                                                                                        -----------   -----------
Net cash used in continuing operations................................................     (702,000)   (1,053,000)
Net cash used in discontinued operations..............................................      (83,000)     (128,000)
                                                                                        -----------   -----------
Net cash used in operating activities.................................................     (785,000)   (1,181,000)
Cash flows from investing activities:

   Capital expenditures...............................................................   (2,210,000)     (819,000)
   Cash acquired from acquisitions....................................................       31,000            --
   Distribution to former stockholder/owners..........................................           --      (284,000)
                                                                                       ------------   -----------
Net cash used in investing activities.................................................   (2,179,000)   (1,103,000)
                                                                                       ------------   -----------
Cash flows from financing activities:                                                                             
   Borrowings under line of credit agreements.........................................       29,000       398,000
   Borrowings from long term debt.....................................................      517,000       189,000
   Principal payments long-term debt..................................................      (55,000)     (232,000)
   Proceeds from  stock options and other issuances...................................           --       648,000
                                                                                       ------------   -----------
Net cash provided by (used in)  financing activities..................................      491,000     1,003,000
                                                                                       ------------   -----------
                                                                                                                  
Net change in cash and cash equivalents...............................................   (2,473,000)   (1,281,000)
Cash and cash equivalents, at beginning of period.....................................    5,541,000     1,663,000
                                                                                       ------------   -----------
Cash and cash equivalents, at end of period...........................................  $ 3,068,000   $   382,000
                                                                                        ============  ============
Supplemental cash flow information:                                                                               
Cash paid for interest expense........................................................  $   231,000     $ 239,000           
</TABLE> 
---------------------------

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

                                       5
<PAGE>
 
                           TRANSCEND SERVICES, INC.
                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                            JUNE, 30, 1998 AND 1997

                                  (UNAUDITED)
                                        



(1) The accompanying consolidated financial statements are unaudited and have
been prepared by management of Transcend Services, Inc. ("the Company") in
accordance with the rules and regulations of the Securities and Exchange
Commission.  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 consolidated financial statements and
footnotes thereto included in the Company's Form 10-K for the year ended
December 31, 1997.  Footnote disclosure which would substantially duplicate the
disclosure contained in those documents has been omitted.


(2) In June 1997, the Financial Accounting Standards Board issued SFAS No. 130,
"Reporting Comprehensive Income," which establishes standards for reporting and
display of comprehensive income that includes all changes in equity during a
period from transactions and events from nonowner sources. The Company has no
components of comprehensive income other than net income for the six month
periods ended June 30, 1998 and 1997.


   In June 1997, the Financial Accounting Standards Board issued SFAS No. 131,
"Disclosures about Segments of an Enterprise and Related Information" which
establishes accounting standards for reporting information about operating
segments in annual financial statements.   SFAS No. 131 is effective for fiscal
years beginning after December 15, 1997 and has not yet been adopted by the
Company.


(3)   In March 1998, the Company completed the sale of the net assets of its
wholly owned subsidiary, Transcend Case Management, Inc. ("TCM") to CORE, Inc
("CORE").  Transcend will receive CORE stock with the value based on the future
annual revenues from CORE's operation of TCM as of a date to be determined at
the Company's discretion between April 1, 1999 and February 28, 2001.  The
carrying amount of the Company's future interest in CORE is recorded on the
balance sheet based on the net book value of TCM on March 16, 1998.

(4).  On June 1, 1998, the Company acquired 100% of the capital stock of  Health
Care Information Systems, Inc. ("HCIS") for 920,000 shares of unregistered
common stock of the Company.  The consolidated financial statements reflect the
acquisition of  HCIS under the pooling of interests method of accounting,
however, the financial statements were not restated for the pre-acquisition
results of HCIS, as the amounts are immaterial.

                                       6
<PAGE>
 
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 which 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.


OVERVIEW
--------

  Transcend Services, Inc.  ("Transcend" or the "Company") provides healthcare
information management ("HIM") solutions to hospitals and other associated
healthcare providers. The Company's range of HIM services includes (i) contract
management, or "Co-Sourcing", of medical records and other HIM functions; (ii)
transcription of physicians' dictated medical notes; (iii) consulting services
relating to medical records and reimbursement coding; and (iv) software
solutions for the collection, abstraction, effective medical coding and
reporting of clinical data. The Company currently operates the medical records
and certain other HIM functions of 24 general acute care hospitals located in 13
states and the District of Columbia.


RESULTS OF OPERATIONS


  Results of operations include the results from Transcend Case Management 
("TCM") during 1997. TCM was sold in March 1998 and therefore affects the 
comparability of 1998 results to 1997. On June 1, 1998, the Company acquired
100% of the capital stock of Health Care Information Systems, Inc. and formed a
wholly owned subsidiary of the Company hereinafter referred to as "Cascade".
Cascade provides information management software and related services to
approximately 65 hospitals concentrated in eight western states. Cascade has
recently released a new set of Windows based products, a state of the art set of
tools for the management and reporting of health care information. Transcend
plans to implement these tools in each of its hospitals and will utilize them in
its Information Delivery Center ("IDC") operations. The IDC provides for the
offsite medical coding from electronic records over Transcend's private network.



                                       7
<PAGE>
 


THREE MONTHS ENDED JUNE 30, 1998 COMPARED TO THREE MONTHS ENDED JUNE 30, 1997


  Net revenues for the Company increased to $12,831,000 for the three months
ended June 30, 1998 from $10,360,000 for the three months ended June 30, 1997,
an increase of 23.9%.  The increase in net revenues results from new Co-Sourcing
contracts and implementation fees of $294,000 related to new contracts to
implement electronic document management systems.

  Excluding TCM, net revenues for the Company increased from $9,937,000 for the
three months ended June 30, 1997 to $12,831,000 for the three months ended June
30, 1998, an increase of 29.1%.

  Gross profit increased 55.7% to $2,195,000 for the three months ended June 30,
1998 from $1,410,000 in the same prior year period. The increase in gross profit
was attributable to the increase in net revenues from Co-Sourcing contracts and
improvements in gross profit margins from existing Co-Sourcing contracts. Gross
profit margins (as a percentage of net revenues) expanded to 17.1% for the three
months ended June 30, 1998 from 13.6% for the three months ended June 30, 1997
period.

  Excluding TCM, gross profits were $2,195,000 for the quarter ended June 30,
1998, an increase of 63.4% over the same prior year period in 1997.  Gross
margins, excluding TCM, were 17.1% for the three months ended June 30, 1998
compared to 13.5% for the same prior year period.

  Marketing and sales expenses decreased to $502,000 for the three months ended
June 30, 1998 from $503,000 in the same prior year period and decreased 1.0% as
a percentage of net revenues to 3.9%.  The decrease is due to the sale of TCM in
March 1998. Excluding TCM, marketing and sales expenses increased $146,000 or 
41% reflecting the hiring of 3 new sales executives.

  General and administrative expenses decreased 8.7% to $1,058,000 for the three
months ended June 30, 1998, from the $1,159,000 incurred in the same prior year
period. General and administrative expenses decreased as a percentage of net
revenues to 8.2% for the three months ended June 30, 1998 from 11.2% for the
prior year quarter.  This decrease is also attributable to the sale of TCM in
March.

  Amortization expenses decreased to $50,000 or 0.4% of net revenues for the
three months ended June 30, 1998 from $114,000 or 1.1% of net revenues for the
three months ended June 30, 1997, reflecting the impact of the 1993 acquisition
of dataLogix, Inc. being fully amortized and the write down of intangible assets
related to TCM in December 1997  and its sale in March 1998.

                                       8
<PAGE>
 
  The Company's income from operations increased to $556,000 for the three
months ended June 30, 1998 from a loss of $366,000 for the same prior year
period due to increased gross profits from revenue growth and from the sale of
TCM which produced an operating loss of $242,000 in 1997.

  Other expense, net increased to $161,000 for the three months ended June 30,
1998 as compared to $124,000 for the same prior year period, primarily due to
the impact of legal expenses incurred in connection with the acquisition of
Cascade.  Other expense, net was 1.3% of net revenues for the three months ended
June 30, 1998 and 1.2% for the same prior year period.

   The Company's income before discontinued operations increased to $395,000 for
the three months ended June 30, 1998 from a loss of $490,000 for the three
months ended June 30, 1997.

  The Company's loss from discontinued operations decreased to $17,000 from
$75,000 for the three months ended June 30, 1998 and June 30, 1997,
respectively, representing legal expenses incurred in connection with the
Lawsuit (hereinafter defined).  See Part II, Item 1.  Legal Proceedings.

  The following charts reflect the results of operations for the three months
ended June 30, 1998 and 1997 excluding TCM, which was sold by the Company in
March 1998.


<TABLE>
<CAPTION>
 
                                                   THREE MONTHS ENDED JUNE 30
------------------------------------------------------------------------------------------------
                                         1998           1997            CHANGE        % CHANGE
------------------------------------------------------------------------------------------------
<S>                                     <C>            <C>             <C>            <C>
Net revenues                               $12,831     $9,937          $2,894           29.1%
------------------------------------------------------------------------------------------------
Gross profit                                 2,195      1,343             852           63.4%
------------------------------------------------------------------------------------------------
Gross margin                                  17.1%      13.5%              -            3.6%
------------------------------------------------------------------------------------------------
Marketing and sales expenses                   502        356             146           41.0%
------------------------------------------------------------------------------------------------
General and administrative expenses          1,058      1,028              30            2.9%
------------------------------------------------------------------------------------------------
Amortization expenses                           50         75             (25)         (33.3%)
------------------------------------------------------------------------------------------------
Research and development expenses               29         --              29             N/A
------------------------------------------------------------------------------------------------
Income (loss) from operations                  556       (116)            672          579.3%
------------------------------------------------------------------------------------------------

 
------------------------------------------------------------------------------------------------
                                                    THREE MONTHS ENDED JUNE 30
------------------------------------------------------------------------------------------------
                                              1998                1997               CHANGE
------------------------------------------------------------------------------------------------
<S>                                        <C>                  <C>                 <C>
Net revenues                                 100.0%              100.0%                  -
------------------------------------------------------------------------------------------------
Direct costs                                  82.9%               86.5%              ( 3.6%)
------------------------------------------------------------------------------------------------
Gross profit                                  17.1%               13.5%                3.6%
------------------------------------------------------------------------------------------------
Marketing and sales expenses                   3.9%                3.6%                0.3%
------------------------------------------------------------------------------------------------
General and administrative expenses            8.2%               10.3%               (2.1%)
------------------------------------------------------------------------------------------------
Research and development                       0.2%                 --                 0.2%
------------------------------------------------------------------------------------------------
Amortization expense                           0.4%                0.8%               (0.4%)
------------------------------------------------------------------------------------------------
Income  (loss) from operations                 4.3%               (1.2%)               5.5%
------------------------------------------------------------------------------------------------
</TABLE>

                                       9
<PAGE>
 
SIX MONTHS ENDED JUNE 30, 1998 COMPARED TO SIX MONTHS ENDED JUNE 30, 1997

  Net revenues increased to $25,205,000 for the six months ended June 30,1998
from $21,105,000 for the six months ended June 30,1997, an increase of 19.4%.
The increase in net revenues results from new Co-Sourcing contracts and
implementation fees of $522,000 related to new contracts to implement electronic
document management systems.

  Gross profit increased to $4,264,000 for the six month period ended June 30,
1998 from $3,129,000 in the same prior year period. The increase in gross profit
was attributable to the increase in net revenues from Co-Sourcing contracts and
improvements in gross profit margins from existing Co-Sourcing contracts.  Gross
profit as a percentage of net revenues increased to 16.9% for the six months
ended June 30, 1998 from 14.8% in the same prior year period.

  Marketing and sales expenses increased 6.7% to $981,000 in the six month
period ended June 30,1998 from $919,000 in the same prior year period and
decreased as a percentage of net revenues to 3.9% for the six month period ended
June 30, 1998 from 4.4% for the six month period ended June 30, 1997.

  General and administrative expenses decreased 5.5% to $2,165,000 for the six
months ended June 30, 1998 from the $2,292,000 incurred in the same prior year
period.  Corporate general and administrative expenses decreased as a percentage
of net revenues to 8.6% for the six months ended June 30, 1998 from 10.9% in the
same prior year period.

  Amortization expenses decreased to $122,000 for the six months ended June 30,
1998 from $233,000 for the six months ended June 30, 1997, reflecting the impact
of the 1993 acquisition of dataLogix, Inc. being fully amortized and the write
down of intangible assets related to TCM in December 1997 and its ale in March
1998.

  The Company's income from operations increased to $967,000 for the six months
ended June 30, 1998, a $1,282,000 improvement from a loss of $315,000 in the
same prior year period.

   Other expenses, net increased to $265,000 for the six months ended June
30,1998 as compared to $213,000 for the six months ended June 30, 1997,
primarily due to legal expenses incurred in connection with the acquisition of
Cascade.

  The Company's income before discontinued operations increased to $702,000 for
the six months ended June 30, 1998 from a loss of $528,000 for the six months
ended June 30, 1997.  This improvement is due to the increase in gross profit
for existing customers, new business and the sale of TCM in March, 1998.

  The Company's loss from discontinued operations of $32,000 and $109,000 for
the six months ended June 30, 1998 and June 30, 1997, respectively, is due to
legal expenses incurred in connection with the Lawsuit (hereinafter defined).
See Part II, Item 1.  Legal Proceedings.

                                       10
<PAGE>
 
  The following charts reflect the results of operations for the six months
ended June 30, 1998 and 1997 excluding TCM, which was sold by the Company in
March 1998.

<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------------
                                                         SIX MONTHS ENDED JUNE 30
-----------------------------------------------------------------------------------------------
<S>                                       <C>           <C>             <C>          <C> 
                                             1998         1997           CHANGE        % CHANGE
-----------------------------------------------------------------------------------------------
Net revenues                               $24,859        $20,128        $4,731          23.5%
-----------------------------------------------------------------------------------------------
Gross profit                                 4,177          3,013         1,164          38.6%
-----------------------------------------------------------------------------------------------
Gross margin                                  16.8%          15.0%           --           1.8%
-----------------------------------------------------------------------------------------------
Marketing and sales expense                    922            641           281          43.8%
-----------------------------------------------------------------------------------------------
General and administrative expense           2,165          2,009           156           7.8%
-----------------------------------------------------------------------------------------------
Amortization expense                           122            155            33         (21.3%)
-----------------------------------------------------------------------------------------------
Research and development expense                29             --            29            --
-----------------------------------------------------------------------------------------------
Income from operations                         939            208           731         351.4%
-----------------------------------------------------------------------------------------------
</TABLE> 

<TABLE> 
<CAPTION> 
 
-----------------------------------------------------------------------------------------------
                                                       SIX MONTHS ENDED JUNE 30
-----------------------------------------------------------------------------------------------
<S>                                              <C>              <C>             <C> 
                                                  1998               1997           CHANGE
-----------------------------------------------------------------------------------------------
Net revenue                                     100.0%              100.0%  
-----------------------------------------------------------------------------------------------
Direct costs                                     83.2%               85.0%          (1.8%)
-----------------------------------------------------------------------------------------------
Gross profit                                     16.8%               15.0%           1.8%
-----------------------------------------------------------------------------------------------
Marketing and sales expense                       3.7%                3.2%           0.5%
-----------------------------------------------------------------------------------------------
General and administrative expenses               8.7%               10.0%          (1.3%)
-----------------------------------------------------------------------------------------------
Research and development                          0.1%                 --           0.1%
-----------------------------------------------------------------------------------------------
Amortization expenses                             0.5%                 .8%          (0.3%)
-----------------------------------------------------------------------------------------------
Income from operations                            3.8%                1.0%           2.8%
-----------------------------------------------------------------------------------------------
</TABLE> 

                                       11
<PAGE>
 
LIQUIDITY AND CAPITAL RESOURCES


   For the six months ended June 30, 1998, continuing operations used $702,000
of cash. Cash has been used to fund the investment in capital assets and to fund
changes in the Company's assets and liabilities.   See also Part I, Item 1.
Financial Statements.  Consolidated Statements of Cash Flows.

  The Company had net working capital of $4,535,000 at June 30, 1998, compared
to $6,271,000 at December 31, 1997.  The decrease in working capital of
$1,736,000 is primarily attributable to capital expenditures.

  For the six months ended June 30, 1998, the Company's principal use of cash of
$2,179,000 for investing purposes was for capital expenditures in association
with the implementation of dictation, transcription, and electronic document
management systems to support new contracts.

  For the six months ended June 30, 1998, financing activities provided cash of
$491,000 due to the proceeds received from the credit facility with DVI
Financial Services, Inc. for the financing of electronic medical record systems.

  The Company has a $5.0 million  revolving credit agreement with Coast Business
Credit ("Coast"), an asset based lender (and a division of Southern Pacific
Thrift and Loan Association) which matures May 31, 2000.  The agreement provides
the Company with a $4.7 million working capital facility and a $300,000 capital
expenditure facility secured by substantially all of the Company's assets.  The
Coast facilities do not contain any financial covenants but contain restrictions
from paying dividends and entering into financing arrangements without consent.
As of June 30, 1998 the capacity of the credit line based on the funding formula
was $4.9 million.

  These facilities bear interest at prime plus 2.25% declining to prime plus
1.75% upon two consecutive quarters of achievement and ongoing maintenance of a
debt service coverage ratio of not less than 1.5 measured on an earnings before
interest, taxes, and amortization ("EBITDA") basis minus the unfinanced portion
of capital expenditures.  EBITDA is used by Coast as an indicator of a company's
ability to incur and service debt.  EBITDA should not be considered an
alternative to operating income, net income, cashflows, or any other measure of
performance as determined in accordance with generally accepted accounting
principles, as an indicator of operating performance, or as a measure of
liquidity.  These facilities are secured by a first security interest on all
Company assets.

   On February 19, 1998, the Company signed a master lease agreement
providing up to $5.0 million in lease financing with Information Leasing
Corporation, a subsidiary of Provident Bank, Cincinnati, Ohio at interest rates
equal to Provident Bank prime rate plus two percent.  Subject to a review of the
underlying customer contract, the master lease agreement calls for equal monthly
payments over the term of the lease, typically the life of the underlying
contract, not to exceed five years.  The facility is intended to provide
financing for new electronic document management systems and transcription
systems required for new contracts.  There were no borrowings outstanding as of
June 30, 1998.
 
  On April 13, 1998 the Company signed a new $10.0 million equipment loan
facility with DVI  Financial Services Inc.  This facility provides additional
financing for electronic document management

                                       12
<PAGE>
 
systems and transcription systems required for new contracts.  The master loan
agreement calls for monthly payments which fully amortize the cost of the
equipment over the life of the customer contract, not to exceed 60 months, at a
current interest rate of 10.2%. The total borrowings outstanding at June 30, 
1998 was $518,000.

  The Company anticipates that cash on hand, together with internally generated
funds and cash available under its credit facilities, will be sufficient to
finance continuing operations, make capital investments in the normal and
ordinary course of its business, and fund the out-of-pocket expenses and certain
legal fees of its civil litigation action against certain insurance carriers for
the remainder of fiscal 1998.


YEAR 2000 COMPLIANCE

  The Company has performed an assessment on the year 2000 readiness of its
operations and the corporate financial systems and has begun to implement its
plan to become year 2000 compliant.

  The Company is currently in the process of converting or upgrading its
transcription systems to become year 2000 compliant.  The Company expects to
invest $1.5 million in new year 2000 compliant dictation and transcription
systems over the next 15 months.

  In July 1998, the first of the Company's transcription operations went live on
the Company's new national transcription platform, Transcription 2000, or "T2K".
The Company plans to install T2K to service substantially all of the Company's 
new contracts and is assessing a plan to convert its existing operations to T2K.
T2K utilizes Windows NT and allows for the digital movement of dictated voice 
files significantly reducing the cost of remote processing.

   The Company's Co-Sourcing operations and software systems are dependant upon
the hospital's systems. The Company is in the process in making written
inquiries to its existing customers to determine  their readiness and their
plans to become year 2000 compliant. The majority of the Company's Co-Sourcing
contracts require that the hospital provide certain services, including access
to electronic information,  in order for Transcend to provide the services that
the Company is contractually obligated to supply.  If such services are not
provided by the hospital, the Company has the contractual ability to receive
reimbursement from the hospital for any additional expenses incurred due to the
inability of the hospital to provide a functional software system.

  Cascade's new software product is year 2000 compliant.  The software for
existing customers has been modified to be year 2000 compliant.  Cascade plans
to upgrade or convert all of its customers to be year 2000 compliant by October
1998.  The cost to be incurred for the upgrade is immaterial.

  The Company plans to upgrade its corporate financial systems by the end of
1998 to be year 2000 compliant.  The cost to be incurred for the upgrade is
estimated at $50,000.

                                       13
<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 former 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 healthcare 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 (the "Lawsuit".)
The Lawsuit was subsequently amended to name 13 defendant insurance groups
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
subsidiaries and their contracting associated medical groups.  Nine 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 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.

  On March 21, 1997, the Los Angeles County Superior Court sustained the
defendant insurance companies= demurrer to the Third Amended and Supplemental
Complaint of the Company and certain of its subsidiaries, without leave to
further amend the complaint.  The Court determined in such ruling that exclusive
jurisdiction with respect to the claims contained in the Lawsuit resides with
the California Workers' Compensation Appeals Board and that the Superior Court
of the State of California is an improper forum.  The Company has been advised
by counsel that there is no remedy for the damages claimed in the Lawsuit from
the California Workers' Compensation Appeals Board.  A final order dismissing
the Lawsuit was issued by the Court on June 18, 1997.  The Company appealed the
ruling in the California Court of Appeals on June 25, 1997.

  On June 25, 1998 the California Court of Appeals affirmed the Superior Court
of the State of California's decision dismissing its lawsuit against 22 of the
largest California worker's compensation insurance carriers.  The lawsuit had
sought damages for abuse of process, intentional interference with contractual
and prospective business relationships, negligent interference and unlawful or
unfair business practices which led to the discontinuation in April 1993 of the
former business of the Company's subsidiaries and their contracting associated
medical groups.  The Superior Court of  the State of California had dismissed
the lawsuit in June 1997 holding that exclusive jurisdiction of these claims
reside with the California Workers' Compensation Appeals Board.  Notwithstanding
the Court of Appeals ruling, the Company continues to believe the lawsuit should
be heard in the Superior Court and

                                       14
<PAGE>
 
the Company filed Petition for Review with the California Supreme Court on July
28, 1998.  However, should the appeal be denied, the Company may be held
responsible for approximately $200,000 in court costs and will seek dismissal of
all cross complaints.  If the Company is unsuccessful in obtaining dismissal of
all cross complaints, the costs of defending such claims could be substantial.

  For the six months ended June 30, 1998, the Company expensed approximately
$32,000 of legal expenses connected with the Lawsuit.   Under the original
agreement with the Company's counsel of record in the Lawsuit, there was a cap
on legal expenses and after December 1996, with respect to expenses incurred at
the trial court level, the Company would only be responsible for out-of-pocket
expenses and the payment to counsel of a percentage of any recovery of damages
by the Company.  However, in May 1997, the Company was notified that the partner
principally responsible for the case was leaving the firm with which the Company
contracted to handle the case.  The Company has moved the representation to new
counsel, which resulted in negotiation of a new fee arrangement requiring the
Company to pay additional legal expenses incurred in connection with the appeal
and the cross complaints.



ITEM 2.  CHANGES IN SECURITIES AND USE OF PROCEEDS.

(c)  On June 1, 1998, the Company acquired 100% of the outstanding capital stock
     of Health Care Information Systems, Inc. ("HCIS") in exchange for 920,000
     shares of common stock of the Company. The shares of common stock of the
     Company were issued pursuant to an exemption from registration under the
     Securities Act of 1933, as provided in Section 4(2) thereunder and Section
     506 of Regulation D promulgated under the Securities Act.


ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.

(a)  The Company held its Annual Meeting of Stockholders on April 28, 1998. The
     following Directors were elected to serve until the next Annual Meeting of
     Stockholders or until their Successors are elected and qualified:
<TABLE> 
<CAPTION> 
                                                 VOTES         VOTES
                                                  FOR         WITHHELD
                                                 ------       --------
             <S>                               <C>            <C>       
             Donald L. Lucas                   20,071,495       254,084    
             Larry G. Gerdes                   20,068,936       256,643    
             George B. Caldwell                20,071,495       254,084    
             Walter S. Huff, Jr.               20,071,095       254,484    
             Charles E. Thoele                 20,072,095       253,484    
             B. Frederick Becker               20,071,795       253,784    
</TABLE>
The stockholders also ratified the appointment of Arthur Andersen, LLP as
independent accountants for the Company for the year ending December 31, 1998
with 20,251,132 votes FOR, 14,046 votes AGAINST and 60,401 ABSTAINING.

The stockholders also approved an amendment to the Company's 1992 Stock Option
Plan, As Amended, to increase the number of shares available for issuance under
the plan by 750,000 shares from 2,000,000

                                       15
<PAGE>
 
shares to 2,750,000 shares.  The results of voting with respect to this proposal
were as follows:  19,825,630 voted FOR, 424,176 shares voted AGAINST, and 75,773
shares ABSTAINING.


ITEM 5.  OTHER INFORMATION.

  As stated in the Company's 1998 Proxy Statement, proposals by stockholders
intended to be presented at the 1999 Annual Meeting must be received at the
offices of the Company no later than December 1, 1998 for consideration for
inclusion in the Company's Proxy Statement for the 1999 Annual Meeting.

  In connection with the Company's Annual Meeting of Shareholders to be held in
1999, if the Company does not receive notice of a matter or proposal to be
considered by February 10, 1999, then the persons appointed by the Board of
Directors to act as the proxies for such Annual Meeting (named in the form of
proxy) will be allowed to use their discretionary voting authority with respect
to any such matter or proposal at the Annual Meeting, if such matter or proposal
is raised at the Annual Meeting.

ITEM 6.  EXHIBITS AND REPORTS ON FORM 8-K.

 The following exhibits are filed herewith:



               11    Computation of Per Share Earnings



               27.1  Financial Data Schedule 1998  (for SEC use only)


(b)  Reports on Form 8-K: During the quarter ended June 30, 1998, the Company
     filed a Form 8-K dated June 15, 1998 reporting under Item 2 the acquisition
     of Health Care Information Systems, Inc.

                                       16
<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.



August 14, 1998                     By: /s/ Larry G. Gerdes
                                        -------------------------------
                                        Larry G. Gerdes,
                                        President and Chief Executive Officer
                                        (Principal Executive Officer)



August 14, 1998                     By: /s/ Doug Shamon
                                        -------------------------------
                                        Doug Shamon
                                        Executive Vice President,
                                        Chief Financial Officer (Principal
                                        Financial and Accounting Officer)

                                       17