##### Table of Contents

---

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549



---

FORM 10-Q



---



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

For the quarterly period ended March 31, 2007

OR



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

For the transition period from  to

Commission File Number 000-18217



---

TRANSCEND
SERVICES, INC.

(Exact name of registrant as specified in its charter)



---



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

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 by check mark whether the registrant is a large accelerated
filer, an accelerated filer, or a non-accelerated filer. (See definition of accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer ̈Accelerated filer ̈Non-accelerated filer   x

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

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



|                             |  |                              
|---------------------------- |  | -----------------------------
|Class                        |  | Outstanding at April 30, 2007
|Common Stock, $.05 par value |  | 8,158,302                    



---



---

##### Table of Contents

INDEX



|           |  |                                                                                          |  |            
|---------- |  | ---------------------------------------------------------------------------------------- |  | -----------
|           |  |                                                                                          |  | Page Number
|PART I.    |  | FINANCIAL INFORMATION                                                                    |  | 3          
|           |  |                                                                                         
|Item 1.    |  | Financial Statements                                                                     |  | 3          
|           |  |                                                                                         
|           |  | Consolidated Balance Sheets as of March 31, 2007 and December 31, 2006                   |  | 3          
|           |  |                                                                                         
|           |  | Consolidated Statements of Operations for the Three Months Ended March 31, 2007 and 2006 |  | 4          
|           |  |                                                                                         
|           |  | Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2007 and 2006 |  | 5          
|           |  |                                                                                         
|           |  | Notes to Consolidated Financial Statements                                               |  | 6          
|           |  |                                                                                         
|Item 2     |  | Managements Discussion and Analysis of Financial Condition and Results of Operations    |  | 10         
|           |  |                                                                                         
|Item 3.    |  | Quantitative and Qualitative Disclosures About Market Risk                               |  | 12         
|           |  |                                                                                         
|Item 4.    |  | Controls and Procedures                                                                  |  | 13         
|           |  |                                                                                         
|PART II.   |  | OTHER INFORMATION                                                                        |  | 13         
|           |  |                                                                                         
|Item 1.    |  | Legal Proceedings                                                                        |  | 13         
|           |  |                                                                                         
|Item 1A.   |  | Risk Factors                                                                             |  | 13         
|           |  |                                                                                         
|Item 6.    |  | Exhibits                                                                                 |  | 13         
|           | 
|SIGNATURES |  | 15                                                                                      



2



---

##### Table of Contents

PART I. FINANCIAL INFORMATION



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

TRANSCEND SERVICES, INC.

CONSOLIDATED BALANCE SHEETS

(Unaudited and rounded to the nearest thousand)



|                                                                                                                                                                                                                 |  |                |             |   |                   |   |             |  
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | -------------- | ----------- | - | ----------------- | - | ----------- | -
|                                                                                                                                                                                                                 |  | March 31, 2007 |             |   | December 31, 2006 |  
|ASSETS                                                                                                                                                                                                           |  |                |             |   |                   |   |             |  
|                                                                                                                                                                                                                 |  |               
|Current assets:                                                                                                                                                                                                  |  |                |             |   |                   |   |             |  
|Cash and cash equivalents                                                                                                                                                                                        |  | $              | 653,000     |   |                   | $ | 215,000     |  
|Accounts receivable, net of allowance for doubtful accounts of $162,000 and $115,000 at March 31, 2007 and December 31, 2006,
respectively                                                                       |  |                | 4,807,000   |   |                   |   | 4,578,000   |  
|Prepaid expenses and other current assets                                                                                                                                                                        |  |                | 184,000     |   |                   |   | 78,000      |  
|                                                                                                                                                                                                                 |  |                |             |   |                   |   |             |  
|Total current assets                                                                                                                                                                                             |  |                | 5,644,000   |   |                   |   | 4,871,000   |  
|                                                                                                                                                                                                                 |  |               
|Property and equipment:                                                                                                                                                                                          |  |                |             |   |                   |   |             |  
|Computer equipment                                                                                                                                                                                               |  |                | 3,386,000   |   |                   |   | 3,371,000   |  
|Software                                                                                                                                                                                                         |  |                | 3,018,000   |   |                   |   | 2,907,000   |  
|Furniture and fixtures                                                                                                                                                                                           |  |                | 291,000     |   |                   |   | 291,000     |  
|                                                                                                                                                                                                                 |  |                |             |   |                   |   |             |  
|Total property and equipment                                                                                                                                                                                     |  |                | 6,695,000   |   |                   |   | 6,569,000   |  
|Accumulated depreciation and amortization                                                                                                                                                                        |  |                | (5,396,000  | ) |                   |   | (5,235,000  | )
|                                                                                                                                                                                                                 |  |                |             |   |                   |   |             |  
|Property and equipment, net                                                                                                                                                                                      |  |                | 1,299,000   |   |                   |   | 1,334,000   |  
|                                                                                                                                                                                                                 |  |               
|Intangible assets:                                                                                                                                                                                               |  |                |             |   |                   |   |             |  
|Goodwill                                                                                                                                                                                                         |  |                | 4,536,000   |   |                   |   | 3,686,000   |  
|Other intangible assets                                                                                                                                                                                          |  |                | 855,000     |   |                   |   | 575,000     |  
|                                                                                                                                                                                                                 |  |                |             |   |                   |   |             |  
|Total intangible assets                                                                                                                                                                                          |  |                | 5,391,000   |   |                   |   | 4,261,000   |  
|Accumulated amortization                                                                                                                                                                                         |  |                | (254,000    | ) |                   |   | (216,000    | )
|                                                                                                                                                                                                                 |  |                |             |   |                   |   |             |  
|Intangible assets, net                                                                                                                                                                                           |  |                | 5,137,000   |   |                   |   | 4,045,000   |  
|                                                                                                                                                                                                                 |  |               
|Other assets                                                                                                                                                                                                     |  |                | 389,000     |   |                   |   | 370,000     |  
|                                                                                                                                                                                                                 |  |                |             |   |                   |   |             |  
|Total assets                                                                                                                                                                                                     |  | $              | 12,469,000  |   |                   | $ | 10,620,000  |  
|                                                                                                                                                                                                                 |  |                |             |   |                   |   |             |  
|LIABILITIES AND STOCKHOLDERS EQUITY                                                                                                                                                                             |  |                |             |   |                   |   |             |  
|                                                                                                                                                                                                                 |  |               
|Current liabilities:                                                                                                                                                                                             |  |                |             |   |                   |   |             |  
|Term loan                                                                                                                                                                                                        |  | $              | 159,000     |   |                   | $ |            |  
|Promissory note payable to related parties                                                                                                                                                                       |  |                | 1,277,000   |   |                   |   | 1,209,000   |  
|Accounts payable                                                                                                                                                                                                 |  |                | 386,000     |   |                   |   | 250,000     |  
|Accrued compensation and benefits                                                                                                                                                                                |  |                | 1,474,000   |   |                   |   | 1,233,000   |  
|Other accrued liabilities                                                                                                                                                                                        |  |                | 652,000     |   |                   |   | 518,000     |  
|                                                                                                                                                                                                                 |  |                |             |   |                   |   |             |  
|Total current liabilities                                                                                                                                                                                        |  |                | 3,948,000   |   |                   |   | 3,210,000   |  
|                                                                                                                                                                                                                 |  |               
|Long term liabilities:                                                                                                                                                                                           |  |                |             |   |                   |   |             |  
|Line of credit                                                                                                                                                                                                   |  |                | 699,000     |   |                   |   | 1,163,000   |  
|Term loan                                                                                                                                                                                                        |  |                | 361,000     |   |                   |   |            |  
|Promissory note payable to related parties                                                                                                                                                                       |  |                | 220,000     |   |                   |   | 1,167,000   |  
|Promissory note payable                                                                                                                                                                                          |  |                | 726,000     |   |                   |   | 751,000     |  
|Other liabilities                                                                                                                                                                                                |  |                | 19,000      |   |                   |   | 22,000      |  
|                                                                                                                                                                                                                 |  |                |             |   |                   |   |             |  
|Total long term liabilities                                                                                                                                                                                      |  |                | 2,025,000   |   |                   |   | 3,103,000   |  
|                                                                                                                                                                                                                 |  |               
|Commitments and contingencies                                                                                                                                                                                    |  |                |             |   |                   |   |             |  
|                                                                                                                                                                                                                 |  |               
|Stockholders equity:                                                                                                                                                                                            |  |                |             |   |                   |   |             |  
|Preferred stock, $0.01 par value; 2,000,000 shares authorized and no shares outstanding at March 31, 2007 and December 31,
2006                                                                                  |  |                |            |   |                   |   |            |  
|Common Stock, $0.05 par value; 15,000,000 shares authorized at March 31, 2007 and December 31, 2006; 8,157,000 and 7,842,000 shares
issued and outstanding at March 31, 2007 and December 31, 2006, respectively |  |                | 408,000     |   |                   |   | 392,000     |  
|Additional paid-in capital                                                                                                                                                                                       |  |                | 29,231,000  |   |                   |   | 28,355,000  |  
|Retained deficit                                                                                                                                                                                                 |  |                | (23,143,000 | ) |                   |   | (24,440,000 | )
|                                                                                                                                                                                                                 |  |                |             |   |                   |   |             |  
|Total stockholders equity                                                                                                                                                                                       |  |                | 6,496,000   |   |                   |   | 4,307,000   |  
|                                                                                                                                                                                                                 |  |                |             |   |                   |   |             |  
|Total liabilities and stockholders equity                                                                                                                                                                       |  | $              | 12,469,000  |   |                   | $ | 10,620,000  |  
|                                                                                                                                                                                                                 |  |                |             |   |                   |   |             |  

See notes to consolidated financial statements.



3



---

##### Table of Contents

TRANSCEND SERVICES, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited and rounded to the nearest thousand)



|                                    |  |                              |            |      |   |          
|----------------------------------- |  | ---------------------------- | ---------- | ---- | - | ---------
|                                    |  | Three months ended March 31,
|                                    |  | 2007                         |            | 2006
|Revenue                             |  | $                            | 10,422,000 |      | $ | 8,012,000
|Direct costs                        |  |                              | 7,238,000  |      |   | 6,257,000
|                                    |  |                              |            |      |   |          
|Gross profit                        |  |                              | 3,184,000  |      |   | 1,755,000
|                                    |  |                              |            |      |   |          
|Operating expenses:                 |  |                              |            |      |   |          
|Sales and marketing                 |  |                              | 132,000    |      |   | 105,000  
|Research and development            |  |                              | 141,000    |      |   | 89,000   
|General and administrative          |  |                              | 1,282,000  |      |   | 1,071,000
|Depreciation and amortization       |  |                              | 200,000    |      |   | 199,000  
|                                    |  |                              |            |      |   |          
|Total operating expenses            |  |                              | 1,755,000  |      |   | 1,464,000
|                                    |  |                              |            |      |   |          
|Operating income                    |  |                              | 1,429,000  |      |   | 291,000  
|                                    |  |                             
|Interest expense, net               |  |                              | 115,000    |      |   | 120,000  
|Other expense                       |  |                              |           |      |   | 14,000   
|                                    |  |                              |            |      |   |          
|Total interest and other expense    |  |                              | 115,000    |      |   | 134,000  
|                                    |  |                              |            |      |   |          
|Income before income taxes          |  |                              | 1,314,000  |      |   | 157,000  
|                                    |  |                             
|Income taxes                        |  |                              | 17,000     |      |   | 7,000    
|                                    |  |                              |            |      |   |          
|Net income                          |  | $                            | 1,297,000  |      | $ | 150,000  
|                                    |  |                              |            |      |   |          
|Basic earnings per share:           |  |                              |            |      |   |          
|Net earnings per share              |  | $                            | 0.16       |      | $ | 0.02     
|                                    |  |                              |            |      |   |          
|Weighted average shares outstanding |  |                              | 8,053,000  |      |   | 7,906,000
|                                    |  |                              |            |      |   |          
|Diluted earnings per share:         |  |                              |            |      |   |          
|Net earnings per share              |  | $                            | 0.15       |      | $ | 0.02     
|                                    |  |                              |            |      |   |          
|Weighted average shares outstanding |  |                              | 8,549,000  |      |   | 7,942,000
|                                    |  |                              |            |      |   |          

See notes to consolidated financial statements.



4



---

##### Table of Contents

TRANSCEND SERVICES, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited and rounded to the nearest thousand)



|                                                                                            |  |                              |            |   |      |   |           |  
|------------------------------------------------------------------------------------------- |  | ---------------------------- | ---------- | - | ---- | - | --------- | -
|                                                                                            |  | Three months ended March 31, |           
|                                                                                            |  | 2007                         |            |   | 2006 |  
|Cash flows from operating activities:                                                       |  |                              |            |   |      |   |           |  
|Net income attributable to common stockholders                                              |  | $                            | 1,297,000  |   |      | $ | 150,000   |  
|Adjustments to reconcile net income to net cash provided by (used in) operating activities: |  |                              |            |   |      |   |           |  
|Depreciation and amortization                                                               |  |                              | 200,000    |   |      |   | 199,000   |  
|Equity based compensation                                                                   |  |                              | 72,000     |   |      |   | 86,000    |  
|Non-cash revenue                                                                            |  |                              | (25,000    | ) |      |   |          |  
|Changes in assets and liabilities                                                           |  |                              |            |   |      |   |           |  
|Accounts receivable, net                                                                    |  |                              | (289,000   | ) |      |   | (292,000  | )
|Prepaid expenses and other current assets                                                   |  |                              | (67,000    | ) |      |   | (14,000   | )
|Other assets                                                                                |  |                              | (19,000    | ) |      |   | 8,000     |  
|Accounts payable                                                                            |  |                              | 98,000     |   |      |   | 96,000    |  
|Accrued liabilities                                                                         |  |                              | 304,000    |   |      |   | (359,000  | )
|                                                                                            |  |                              |            |   |      |   |           |  
|Total adjustments                                                                           |  |                              | 274,000    |   |      |   | (276,000  | )
|                                                                                            |  |                              |            |   |      |   |           |  
|Net cash provided by (used in) operating activities                                         |  |                              | 1,571,000  |   |      |   | (126,000  | )
|                                                                                            |  |                              |            |   |      |   |           |  
|Cash flows from investing activities:                                                       |  |                              |            |   |      |   |           |  
|Capital expenditures, net                                                                   |  |                              | (126,000   | ) |      |   | (101,000  | )
|Purchase of business, net of cash acquired                                                  |  |                              | (38,000    | ) |      |   |          |  
|Adjustment to purchase price for previous acquisition                                       |  |                              |           |   |      |   | 8,000     |  
|                                                                                            |  |                              |            |   |      |   |           |  
|Net cash (used in) investing activities                                                     |  |                              | (164,000   | ) |      |   | (93,000   | )
|                                                                                            |  |                              |            |   |      |   |           |  
|Cash flows from financing activities:                                                       |  |                              |            |   |      |   |           |  
|Proceeds from stock options and other issuances                                             |  |                              | 600,000    |   |      |   | 3,000     |  
|(Repayment of) promissory notes                                                             |  |                              | (1,105,000 | ) |      |   | (828,000  | )
|Net (repayments) borrowings on line of credit                                               |  |                              | (464,000   | ) |      |   | 1,455,000 |  
|                                                                                            |  |                              |            |   |      |   |           |  
|Net cash (used in) provided by financing activities                                         |  |                              | (969,000   | ) |      |   | 630,000   |  
|                                                                                            |  |                              |            |   |      |   |           |  
|Net increase in cash and cash equivalents                                                   |  |                              | 438,000    |   |      |   | 411,000   |  
|Cash and cash equivalents at beginning of period                                            |  |                              | 215,000    |   |      |   | 762,000   |  
|                                                                                            |  |                              |            |   |      |   |           |  
|Cash and cash equivalents at end of period                                                  |  | $                            | 653,000    |   |      | $ | 1,173,000 |  
|                                                                                            |  |                              |            |   |      |   |           |  
|Supplemental cash flow information:                                                         |  |                              |            |   |      |   |           |  
|Cash paid for interest                                                                      |  | $                            | 191,000    |   |      | $ | 244,000   |  
|                                                                                            |  |                              |            |   |      |   |           |  
|Cash paid for income taxes                                                                  |  | $                            | 77,000     |   |      | $ | 32,000    |  
|                                                                                            |  |                              |            |   |      |   |           |  
|Non-cash investing and financing activities:                                                |  |                              |            |   |      |   |           |  
|Term loan draw in connection with acquisition of OTP                                        |  | $                            | 520,000    |   |      | $ |          |  
|Promissory note issued in connection with acquisition of OTP                                |  |                              | 330,000    |   |      |   |          |  
|Common stock issued in connection with the acquisition of OTP                               |  |                              | 220,000    |   |      |   |          |  
|                                                                                            |  |                              |            |   |      |   |           |  
|Non cash capital expenditures                                                               |  | $                            | 1,070,000  |   |      | $ |          |  
|                                                                                            |  |                              |            |   |      |   |           |  

See notes to consolidated financial statements.



5



---

##### Table of Contents

TRANSCEND SERVICES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2007 and 2006

(Unaudited)

1. BASIS OF PRESENTATION

The accompanying consolidated financial statements are unaudited and have been prepared by the management of Transcend Services, Inc. (the Company or Transcend) in accordance with the rules and regulations of the
Securities and Exchange Commission. In the opinion of management, all adjustments, consisting of normal recurring accruals, necessary for the fair presentation of the consolidated financial position, results of operations and cash flows, have been
included. For further information, refer to the consolidated financial statements and footnotes thereto included in the Companys Form 10-K for the year ended December 31, 2006. Footnote disclosure that substantially duplicates the
disclosure contained in that document has been omitted. Certain items previously reported in specific financial statement captions have been reclassified to conform to this presentation.

New Accounting Pronouncements

In February 2007, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standard (SFAS) No. 159, The Fair Value Option for Financial Assets and Financial Liabilities, including an amendment of SFAS No. 115. This statement, which is effective January 1, 2008, permits
companies to measure financial instruments and certain other items at fair value and provides the opportunity to mitigate volatility in earnings caused by measuring related assets and liabilities without having to apply complex hedge accounting
provisions. The Company believes that the adoption of this statement in 2008 will not have a material effect on its financial statements or results of operations.

2. ACQUISITIONS

Transcend purchased certain assets of OTP Technologies, Inc. (OTP), a Chicago area medical transcription
company, on January 16, 2007. Transcend purchased the assets to expand its medical transcription business in the Midwest, capitalize on the potential for the acquired business to grow and leverage Transcends fixed overhead costs across a
larger revenue base. Transcend paid $1.07 million, consisting of $520,000 in cash, a $330,000 promissory note and $220,000 (60,274 shares) of Transcend common stock. In addition, Transcend may pay up to $100,000 in additional consideration in
January 2008 based on revenue achieved in 2007. The promissory note bears interest at 5% and is payable in five installments, with the first installment due on February 28, 2008 and final installment due on January 16, 2010. The purchase
price was allocated between goodwill, customer relationships, covenants not to compete and property and equipment. All goodwill and intangible asset amortization related to the acquisition of the OTP assets are expected to be deductible for income
tax purposes. The results of operations of the OTP business have been included in Transcends financial statements from January 16, 2007 forward.

3. MAJOR CUSTOMERS

No single customer accounted for greater than 10% of total revenue for the quarters ended March 31, 2007 and 2006.
In addition, the Company provided medical transcription services for the three months ended March 31, 2007 and 2006 to individual customers that are members of a group of hospitals. Revenue attributable to members of this group comprised 22%
and 26% of the Companys total revenue for the three months ended March 31, 2007 and 2006, respectively.

4. GOODWILL AND OTHER INTANGIBLE
ASSETS

The Company accounts for goodwill and other intangible assets in accordance with the provisions of SFAS No. 142, Goodwill and Other
Intangible Assets.Under the provisions of this Statement, goodwill and intangible assets that have indefinite useful lives are tested at least annually for impairment rather than being amortized like intangible assets with finite useful lives,
which are amortized over their useful lives. A portion of the purchase price of the OTP acquisition was attributed to goodwill and other intangible assets. (See Note 2.)



6



---

##### Table of Contents

|                             |  |                     |  |                                   |         |                         |   |            |  |             |         |                         |   |            |  |   |         |  |   |        
|---------------------------- |  | ------------------- |  | --------------------------------- | ------- | ----------------------- | - | ---------- |  | ----------- | ------- | ----------------------- | - | ---------- |  | - | ------- |  | - | -------
|                             |  |                     |  | (rounded to the nearest thousand)
|                             |  | March 31, 2007      |  | March 31, 2006                   
|                             |  | Useful Lifein Years |  | GrossAssets                       |         | AccumulatedAmortization |   | Net Assets |  | GrossAssets |         | AccumulatedAmortization |   | Net Assets
|Amortized intangible assets: |  |                     |  |                                   |         |                         |   |            |  |             |         |                         |   |            |  |   |         |  |   |        
|Covenants-not-to-compete     |  | 5                   |  | $                                 | 50,000  |                         | $ | 22,000     |  | $           | 28,000  |                         | $ | 50,000     |  | $ | 12,000  |  | $ | 38,000 
|Customer relationships       |  | 5                   |  |                                   | 805,000 |                         |   | 232,000    |  |             | 573,000 |                         |   | 525,000    |  |   | 118,000 |  |   | 407,000
|                             |  |                     |  |                                   |         |                         |   |            |  |             |         |                         |   |            |  |   |         |  |   |        
|Total intangible assets      |  |                     |  | $                                 | 855,000 |                         | $ | 254,000    |  | $           | 601,000 |                         | $ | 575,000    |  | $ | 130,000 |  | $ | 445,000
|                             |  |                     |  |                                   |         |                         |   |            |  |             |         |                         |   |            |  |   |         |  |   |        

5. BORROWING ARRANGEMENTS

Line of Credit

On December 30, 2005, the Company entered into a four year, $5.6 million credit facility with
Healthcare Finance Group (HFG). The HFG facility matures on December 30, 2009 and is comprised of up to $3.6 million on a revolving accounts receivable-based line of credit and up to $2.0 million of term loans to fund acquisitions.
As a part of the agreement with HFG, the Company issued a warrant to HFG to purchase 100,000 shares of Transcend common stock at an exercise price of $2.25 per share. The fair value of the warrant at grant date was estimated to be $74,000 using the
Black Scholes option-pricing model and is being amortized into interest expense over the life of the credit facility. The warrant expires at the later of December 29, 2009 or 90 days after the date that the loans under the Loan Agreement are
paid in full. Borrowings on the line of credit and the term loan bear interest at LIBOR plus 4% (9.32% as of March 31, 2007), are secured by accounts receivable and certain other Company assets and require that the Company maintain certain
financial and other covenants. As of March 31, 2007, the Company was in compliance with all debt covenants. The loan agreement requires the Company to set aside a portion of its line of credit availability to fund the next installment of the
Medical Dictation, Inc. (MDI) Promissory Note due January 31, 2008 (see below). This set aside accumulates at the rate of $100,000 per month. As of March 31, 2007, $300,000 of the line of credit availability has been set aside
to pay the MDI Promissory Note. The balance outstanding on the line of credit was $699,000 as of March 31, 2007.

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

For the three months ending March 31, 2007, the weighted average debt outstanding under the HFG line of credit was $1.2 million at a weighted average interest rate
of 9.32%. At March 31, 2007, $1.5 million was available for borrowing under the HFG term loan and $2.6 million was available under the HFG line of credit after setting aside $300,000 toward the January 2008 installment on the MDI Promissory
Note.

MDI Promissory Note

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



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



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



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

On August 15, 2005, the holder of the $3.5 million promissory note reduced the principal amount of the note by $100,000 in consideration for 35,971 unregistered
shares of Transcends common stock issued at $2.78 per share, or 110% of fair market value. On December 26, 2005, the holder of the promissory note reduced the principal amount of the note by an additional $300,000 in consideration for
140,815 unregistered shares of Transcends common stock issued at $2.13 per share, or 105% of fair market value (See Note 8, Stockholders Equity). On January 31, 2006 the Company paid $828,000 plus interest as the first installment
of the promissory note. A portion of this principal payment, $61,000, was applied toward the second installment due on January 31, 2007. The Company paid $1.1 million plus interest as the second installment on January 31, 2007. As of
March 31, 2007, the balance of the note was $1.2 million, which is due on January 31, 2008.



7



---

##### Table of Contents

DCOA Promissory Note

On April 6, 2005, the Company fulfilled the prerequisites for receiving the proceeds under a Promissory Note dated March 1, 2005 payable to the Development Corporation of Abilene, Inc. (DCOA) in the principal amount of
$1.0 million (the Promissory Note). Transcend received $850,000 under the Promissory Note on April 7, 2005 and was pre-funded $150,000 under the Promissory Note on March 31, 2005. The Promissory Note was initially secured by a
$150,000 letter of credit from a bank and certain furniture and equipment. The letter of credit was released December 7, 2005 and the remaining collateral shall be released as the principal balance of the Promissory Note is reduced.

The Promissory Note relates to the Agreement for Financial Assistance by and between DCOA and Transcend effective as of March 1, 2005 that was approved by DCOA
on March 4, 2005 and amended on June 6, 2006 (collectively, the Agreement). Under the terms of the Agreement, DCOA shall provide up to $2 million of interest-free, secured loans to Transcend (the Loans). In return,
Transcend shall establish and operate a medical transcription training center and regional office in Abilene, Texas. In addition, Transcend shall recruit, hire and train up to 208 medical transcription professionals, the majority of whom shall be
recruited from Abilene or the area surrounding Abilene, as defined in the Agreement. DCOA shall offer the Loans to Transcend in two increments of $1 million each in return for Transcend recruiting, hiring and training up to 104 medical transcription
professionals for each Loan. The Promissory Note is the first such Loan. Through December 31, 2006, the latest date for which data has been certified by DCOA, Transcend has trained and hired 51 medical transcription professionals.

Transcend and DCOA intend for the Promissory Note to be paid by Transcend using quarterly training credits and annual job creation/retention incentive credits
provided to Transcend by DCOA as defined in the Agreement. Principal reductions of the Promissory Note shall be effected through quarterly training credits and annual earned job creation incentive credits, not cash, as follows: (1) $25,000 per
month for the first six months of the Agreement provided that 15 employees are hired by Transcend during that period; (2) a quarterly training credit equal to 50% of the total wages paid to newly hired Medical Language Specialists
(MLS) during their probationary period (not to exceed $4,000 per MLS); and (3) an annual job creation incentive credit of between 10% and 12% of compensation for the year for each full time equivalent employee (FTE), with cumulative
per FTE credits capped at 30% to 35% of the FTEs annual compensation (depending on the FTEs compensation band) for FTEs hired on or before March 31, 2010 including compensation paid through March 31, 2012.

Transcend has earned credits of $274,000 to date, of which $25,000 was earned in the quarter ending March 31, 2007, reducing the principal balance on the Promissory
Note to $726,000. In 2007, these credits are reported as reductions of direct operating costs. The principal balance of the Promissory Note, if any, remaining on March 1, 2013 is payable in cash by Transcend unless said balance is forgiven by
DCOA.

OTP Promissory Note

On January 16, 2007,
the Company entered into a three year, $330,000 unsecured promissory note in conjunction with the purchase of OTP. The note bears interest at 5.0% and the principal is to be repaid as follows:



| |  | $110,000 on January 16, 2008
|- |  | ----------------------------



| |  | $55,000 on July 16, 2008
|- |  | ------------------------



| |  | $55,000 on January 16, 2009
|- |  | ---------------------------



| |  | $55,000 on July 16, 2009
|- |  | ------------------------



| |  | $55,000 on January 16, 2010
|- |  | ---------------------------

6. COMMITMENTS
AND CONTINGENCIES

Litigation

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 19th Judicial District Court,
Parish of East Baton Rouge, 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. 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. All unpaid invoices were charged off against the allowance for doubtful accounts in 2001. OLOL subsequently added Transcends insurance carriers as defendants
to the lawsuit and later lost a court decision and related appeal in that regard. During June 2006, OLOL amended its lawsuit to add a claim for misrepresentation and an additional breach of contract claim. On June 26, 2006, the Company
responded by denying the allegations, and reasserting Transcends counterclaim against OLOL. The Company intends to vigorously defend all claims made by OLOL. The lawsuit is in an early procedural stage and



8



---

##### Table of Contents

therefore it is not possible at this time to determine the outcome of the actions or the effect, if any, that the 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 effect on the Companys results of operations and financial condition.

7. TRANSACTIONS WITH RELATED PARTIES

The Company purchased the
assets of OTP on January 16, 2007. The purchase was financed with $520,000 in cash, a $330,000 promissory note and $220,000 (60,274 shares) of Transcend common stock. In addition, Transcend may pay up to $100,000 in additional consideration in
January 2008 based on revenue achieved in 2007. The promissory note is payable to OTP. Since the date of purchase, the owners of OTP, James Vonderhaar and Sharon Vonderhaar, have been working for Transcend to facilitate the transition and both were
employees of the Company as of March 31, 2007.

Susan McGrogan is the Companys Chief Operating Officer. Ms. McGrogan is also the co-founder
of MDI, which was purchased by Transcend on January 31, 2005. In conjunction with the purchase of MDI, the Company entered into a $3.5 million promissory note the terms of which are fully described in Note 5, Borrowing Arrangements.
On January 31, 2007 the Company paid $1.1 million as the second installment on the note and $113,000 of accrued interest.

8. STOCK-BASED
COMPENSATION

The Company has four stockholder-approved stock option plans for its key employees, directors and key consultants (the Plans).
The Plans provide for the grant of incentive stock options, nonqualified stock options and restricted stock awards. The options are granted at fair market value, as defined in the option agreement, on the date of grant. Also, 10,000 shares of
restricted stock awards were granted and outstanding under the Plans as of March 31, 2007.

As of March 31, 2007, the total number of options
issued and outstanding, the weighted average exercise price and number of options available for future issuance under approved equity compensation plans was as follows. All equity compensation plans have been approved by shareholders.



|                                                |  |   |        
|----------------------------------------------- |  | - | -------
|Number of securities to be issued upon exercise |  |   | 732,700
|Weighted average exercise price                 |  | $ | 3.03   
|Number of options available for future issuance |  |   | 75,340 

On January 1, 2006, the Company adopted, using a modified version of prospective application, SFAS
No. 123(R), Share Based Payment (SFAS 123(R)). This statement requires all share-based payments to employees, including grants of employee stock options, to be recognized in the financial statements based on their fair values
at the date of grant. SFAS 123(R) did not change the accounting guidance for share-based payment transactions with parties other than employees provided in SFAS 123, Accounting for Stock Based Compensation (SFAS 123), as
originally issued and Emerging Issues Task Force (EITF) 96-18, Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services.

The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following assumptions used for all options
granted during the quarter ending March 31, 2007: dividend yield of 0%; volatility of 41.95%; risk-free interest rate of 4.67%; expected forfeiture rate of 25%; exercise price of $6.80; and expected life of 1 year.

The Company recognized equity-based compensation expense of approximately $72,000 and $86,000 for the quarters ended March 31, 2007 and 2006, respectively. As of
March 31, 2007, the Company had approximately $279,000 of future compensation expense which it expects to record in its statements of operations through 2010.

9. STOCKHOLDERS EQUITY

On January 16, 2007, as part of the OTP acquisition, the Company issued $220,000 of unregistered common
stock (60,274 shares) to OTP.

During the quarter ended March 31, 2007, 254,500 options were exercised at a weighted average price of $2.36. The
exercise of these options increased common stock outstanding and additional paid in capital by $13,000 and $587,000 respectively.

The Company had
8,156,720 shares of Common Stock and no shares of Preferred Stock outstanding as of March 31, 2007.



9



---

##### Table of Contents

10. INCOME TAXES

At
March 31, 2007 and 2006, the Company had net operating loss carryforwards of approximately $16.4 million and $19.4 million, respectively, which may be used to reduce future income taxes. As a result, the Company had no current federal income
taxes due. The Company has established a valuation allowance against the deferred tax asset that results from the net operating loss carryforwards. Provisions or benefits for all federal and certain state income taxes were offset by changes in the
deferred tax asset valuation allowance.

At March 31, 2007 and 2006, the Company had net deferred tax assets of approximately $6.3 million and $7.6
million, respectively. The Company has established valuation allowances of 100% of the net deferred tax assets due to the uncertainty regarding the realizability of its net operating loss carryforwards.



|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. Among the important factors that could cause actual results to differ materially from those indicated by such forward-looking statements are competitive pricing pressures, loss of significant customers, the mix of revenue, changes in
pricing policies, delays in revenue recognition, lower-than-expected demand for the Companys products and services, business conditions in the integrated health care delivery network market, difficulties in implementing the Companys
offshore outsourcing objectives, the effect of future acquisitions, if any, and the risk factors detailed from time to time in the Companys periodic reports and registration statements filed with the Securities and Exchange Commission. 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. (the Company) utilizes a combination of its proprietary internet-based voice and data
distribution technology, customer-based technology and home-based medical language specialists to convert physicians voice recordings into electronic documents.

Critical Accounting Estimates which are Material to Registrant

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

Goodwill and
Intangible Assets.As of March 31, 2007, we had goodwill and intangible assets at carrying amounts of $4.5 million and $601,000, respectively. The total of $5.1 million represents approximately 41% of total assets as of March 31, 2007.
Our intangible assets are amortized over their estimated useful lives.

We review goodwill and intangibles for impairment annually and whenever events or
changes in circumstances indicate that the carrying value may not be recoverable. In testing for impairment, we calculate the fair value of the reporting units to which the goodwill and intangibles relate based on the present value of estimated
future cash flows. The approach utilized is dependent on a number of factors including estimates of future revenues and costs, appropriate discount rates and other variables. We base our estimates on assumptions that we believe to be reasonable, but
which are unpredictable and inherently uncertain. Therefore, future impairments could result if actual results differ from those estimates.

Deferred
Tax Asset.As of March 31, 2007, we have net deferred tax assets of $6.3 million resulting primarily from net operating loss carryforwards of approximately $16.4 million. Deferred income tax assets represent future tax benefits we expect to
be able to apply against future taxable income. Our ability to utilize the deferred tax benefits is dependent upon our ability to generate future taxable income. SFAS 109, Accounting for Income Taxes requires us to record a
valuation allowance against any deferred income tax benefits that we believe may expire before we generate sufficient taxable income to use them. We use current estimates of future



10



---

##### Table of Contents

taxable income to determine whether a valuation allowance is needed. Projecting our future taxable income requires us to use significant judgment regarding
expected future revenues and expenses. In addition, we must assume that tax laws will not change sufficiently to materially impact the expected tax liability associated with our expected taxable income. As of March 31, 2007, we have determined
that it is likely that we will be able to utilize $35,000 of our deferred tax benefits in the future and accordingly, we have established a valuation allowance of $6.3 million. We adjust the asset and allowance each quarter. If we were to determine
that the operating loss carryforwards could be used and that the valuation allowance could be reduced, our net income would increase.

Three Months
Ended March 31, 2007 Compared to Three Months Ended March 31, 2006

Revenue increased $2.4 million, or 30%, to $10.4 million in the
quarter ended March 31, 2007 compared to revenue of $8.0 million in the same period in 2006. The $2.4 million increase in revenue consisted of revenue from new customers of $1.9 million, revenue from the acquisition of OTP of $341,000 and
increased revenue from existing customers of $593,000, partially offset by revenue of $409,000 from customers who cancelled their contracts in the first half of 2006 and a decrease in other revenue of $13,000.

Direct costs increased $981,000, or 16%, to $7.2 million in the quarter ended March 31, 2007 compared to $6.3 million in the same period in 2006. Direct costs
include costs attributable to compensation for transcriptionists, recruiting, production management, customer service, technical support for production operations, fees paid for speech recognition processing, telephone expenses and implementation of
transcription services. Transcription compensation is a variable cost based on lines transcribed or edited multiplied by specified per-line pay rates that vary by individual as well as type of work. Speech recognition processing is a variable cost
based on the minutes of dictation processed. All other direct costs referred to above are semi-variable production infrastructure costs that periodically change in anticipation of or in response to the overall level of production activity.

As a percentage of revenue, direct costs decreased to 69% in the quarter ended March 31, 2007 from 78% in the same period of 2006. The net decrease
in costs as a percentage of revenue is due primarily to cost savings that resulted from the rollout of the Companys speech recognition-enabled BeyondTXT platform, growth of relatively fixed other direct costs of operations at a slower rate
than the rate of revenue growth and the use of offshore transcription resources.

Gross profit increased $1.4 million, or 81%, to $3.2 million in the
quarter ended March 31, 2007 compared to $1.8 million in the same period in 2006. Gross profit as a percentage of revenue increased to 31% in the quarter ended March 31, 2007 compared to 22% in the same period in 2006 (see direct costs
discussion). The increase is due primarily to cost savings that resulted from the rollout of the Companys speech recognition-enabled BeyondTXT platform, growth of relatively fixed indirect cost of operations expenses at a slower rate than the
rate of revenue growth and the use of offshore transcription resources.

Sales and marketing expenses increased $27,000, or 26%, to $132,000 in the quarter
ended March 31, 2007, compared to $105,000 in the same period in 2006. Sales and marketing expenses as a percentage of revenue were 1% in the quarters ended March 31, 2007 and 2006. The net increase in sales and marketing expense is
primarily due to the use of a lead-generating telemarketing firm in the quarter ended March 31, 2007, with no corresponding expense in the same quarter of 2006.

Research and development expenses increased $52,000, or 58%, to $141,000 in the quarter ended March 31, 2007 compared to $89,000 in the same period in 2006. Research and development expenses as a percentage of
revenue were 1% in the quarters ended March 31, 2007 and 2006. The increase is primarily due to an increase in compensation related expenses.

General
and administrative expenses increased $211,000, or 20%, to $1.3 million in the quarter ended March 31, 2007 compared to $1.1 million in the same period in 2006. General and administrative expenses as a percentage of revenue were 12% and 13% in
the quarters ended March 31, 2007 and 2006, respectively. The increase was due primarily to the Companys match to its employees 401(k) retirement plan contributions of $61,000 and directors fees of $27,000 recognized in 2007 with no
corresponding 401(k) match or director fees recorded in 2006. (Directors fees were suspended indefinitely in December 2005 and later reinstated in August 2006.) The remaining increase consists of numerous other small variances.

The Company reported an income tax provision of $17,000 in the quarter ended March 31, 2007 and $7,000 in 2006 due to net operating loss carryforwards not allowed
in certain states. The Company has net operating loss carryforwards of approximately $16.4 million as of March 31, 2007. Deferred income tax expenses of $483,000 and $56,000 in the quarters ended March 31, 2007 and 2006, respectively, were
offset by corresponding changes in the valuation allowance.



11



---

##### Table of Contents

Contractual Obligations

The Company has leases for the rental of office space and operating leases related to the purchase of computer and other equipment. The operating leases contain renewal options at lease termination and purchase
options at amounts approximating fair market value at lease termination. The table below summarizes the total lease obligations and other obligations outstanding and the payments due by period.



|                            |       |                                                          |                 |  |             |           |             |   |                  |  |   |   |  |   |        
|--------------------------- | ----- | -------------------------------------------------------- | --------------- |  | ----------- | --------- | ----------- | - | ---------------- |  | - | - |  | - | -------
|Contractual Obligations     |       | Payments due by period (rounded to the nearest thousand)
|                            | Total |                                                          | Less than 1Year |  | 1  3 Years |           | 3  5 Years |   | More than 5Years
|Long-Term Debt Obligations  |       | $                                                        | 3,442,000       |  | $           | 1,436,000 |             | $ | 1,280,000        |  | $ | 0 |  | $ | 726,000
|Capital Lease Obligations   |       |                                                          | 0               |  |             | 0         |             |   | 0                |  |   | 0 |  |   | 0      
|Operating Lease Obligations |       |                                                          | 1,481,000       |  |             | 849,000   |             |   | 632,000          |  |   | 0 |  |   | 0      
|Purchase Obligations        |       |                                                          | 0               |  |             | 0         |             |   | 0                |  |   | 0 |  |   | 0      
|Other Long-Term Liabilities |       |                                                          | 0               |  |             | 0         |             |   | 0                |  |   | 0 |  |   | 0      
|                            |       |                                                          |                 |  |             |           |             |   |                  |  |   |   |  |   |        
|Total                       |       | $                                                        | 4,923,000       |  | $           | 2,285,000 |             | $ | 1,912,000        |  | $ | 0 |  | $ | 726,000
|                            |       |                                                          |                 |  |             |           |             |   |                  |  |   |   |  |   |        

Liquidity and Capital Resources

As of March 31, 2007, the Company had cash and cash equivalents of $653,000, working capital of $1.7 million, availability of approximately $2.6 million on its line
of credit based on eligible accounts receivable (after setting aside $300,000 toward the January 2008 installment on the MDI promissory note), and $1.5 million on its acquisition line of credit, both of which expire on December 30, 2009. See
Note 5 to the Consolidated Financial Statements.

Cash provided by operating activities was $1.6 million for the quarter ended March 31, 2007 compared
to cash used in operating activities of $126,000 for the quarter ended March 31, 2006. The improvement was due primarily to an increase in net income and accrued liabilities.

Cash used in investing activities was $164,000 for the quarter ended March 31 2007, compared to $93,000 for the quarter ended March 31, 2006. The increase was due primarily to the incremental cash used to
acquire the assets of OTP and an increase in the amount of computer related equipment purchased in the quarter ended March 31, 2007 as compared to the quarter ended March 31, 2006.

Cash used in financing activities was $969,000 for the quarter ended March 31, 2007, consisting of a $1.1 million principal repayment on the MDI promissory note and
net repayments of $464,000 on the line of credit, offset by proceeds of $600,000 from the exercise of stock options. For the quarter ended March 31, 2006, cash provided by financing activities was $630,000, consisting primarily of net
borrowings of $1.5 million on the line of credit offset by an $828,000 principal repayment on the MDI promissory note.

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

Part of the growth strategy for Transcend is the completion of acquisitions. Management believes that the $1.5 million available on the term
loan from HFG together with other acquisition options, such as owner financing, are insufficient to execute its acquisition strategy and additional financing will be required. The Company has engaged an investment banker to help locate potential
acquisition candidates and financing for these acquisitions either through debt or equity or a combination thereof.



|Item 3. | Quantitative and Qualitative Disclosures About Market Risk
|------- | ----------------------------------------------------------

The
Company had no material exposure to market risk from derivatives or other financial instruments as of March 31, 2007.



12



---

##### Table of Contents

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

The SEC defines the term disclosure
controls and procedures to mean a companys controls and other procedures that are designed to ensure that information required to be disclosed in the reports that it files or submits under the Securities Exchange Act of 1934 is recorded,
processed, summarized and reported, within the time periods specified in the SECs rules and forms. The Companys principal executive officer and principal financial officer, based on their evaluation of the Companys disclosure
controls and procedures as of the end of the quarterly period covered by this report, have concluded that the Companys disclosure controls and procedures were effective for this purpose.

Internal control over financial reporting consists of control processes designed to provide reasonable assurance regarding the reliability of financial reporting and the
preparation of the Companys financial statements for external purposes in accordance with GAAP. To the extent that components of the Companys internal control over financial reporting are included in the Companys disclosure
controls, they are included in the scope of the evaluation by the Companys principal executive officer and principal financial officer referenced above. There were no changes in the Companys internal control over financial reporting
during the Companys last fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Companys internal control over financial reporting.

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 19th Judicial District Court, Parish of East Baton Rouge, 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. 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. All unpaid invoices were charged off against the allowance for doubtful accounts in 2001. OLOL subsequently added Transcends insurance carriers as defendants to the lawsuit and later lost a court
decision and related appeal in that regard. During June 2006, OLOL amended its lawsuit to add a claim for misrepresentation and an additional breach of contract claim. On June 26, 2006, the Company responded by denying the allegations, and
reasserting Transcends counterclaim against OLOL. The Company intends to vigorously defend all claims made by OLOL. The lawsuit is in an early procedural stage and therefore it is not possible at this time to determine the outcome of the
actions or the effect, if any, that the 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 effect on the Companys results of operations
and financial condition.



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

There have been no material changes in the risk
factors previously disclosed in our Annual Report on Form 10-K for the year ended December 31, 2006.



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

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

Incorporation by Reference



|               |  |                                                                                                                                                                            |  |      |  |            |  |         |  |                
|-------------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ---- |  | ---------- |  | ------- |  | ---------------
|Exhibit Number |  | Exhibit Description                                                                                                                                                        |  | Form |  | File No.   |  | Exhibit |  | Filing Date    
|3.1            |  | Certificate of Incorporation                                                                                                                                               |  | S-3  |  | 333-106446 |  | 4.1     |  | June 25, 2003  
|               |  |                                                                                                                                                                            |  |      | 
|3.2            |  | Restated Bylaws                                                                                                                                                            |  | 10-K |  | 0-18217    |  | 3 (a)   |  | August 27, 1993
|               |  |                                                                                                                                                                            |  |      | 
|31.1           |  | Certification of Chief Executive Officer of the Registrant Pursuant to Rule 13a-14(a) or Rule 15d-14(a), promulgated under the Securities Exchange Act of 1934, as amended |  |      |  |            |  |         |  |                



13



---

##### Table of Contents

Incorporation by Reference



|        |  |                                                                                                                                                                            |  |  |  |  |  |  |  | 
|------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  |  |  |  |  |  |  | 
|Exhibit |  |                                                                                                                                                                            |  |  |  |  |  |  |  | 
|31.2    |  | Certification of Chief Financial Officer of the Registrant Pursuant to Rule 13a-14(a) or Rule 15d-14(a), promulgated under the Securities Exchange Act of 1934, as amended |  |  |  |  |  |  |  | 
|        |  |                                                                                                                                                                            |  |  | 
|*32.1   |  | Certification of Chief Executive Officer of the Registrant Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002                                                       |  |  |  |  |  |  |  | 
|        |  |                                                                                                                                                                            |  |  | 
|*32.2   |  | Certification of Chief Financial Officer of the Registrant Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002                                                       |  |  |  |  |  |  |  | 

---

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



14



---

##### Table of Contents

SIGNATURES

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



|            |  |  |  |                          |  |                                      
|----------- |  |  |  | ------------------------ |  | -------------------------------------
|            |  |  |  | TRANSCEND SERVICES, INC.
|            |  |  | 
|May 1, 2007 |  |  |  | By:                      |  | /s/ Larry G. Gerdes                  
|            |  |  |  |                          |  | Larry G. Gerdes,                     
|            |  |  |  |                          |  | President and Chief Executive Officer
|            |  |  |  |                          |  | (Principal Executive Officer)        
|            |  |  | 
|            |  |  |  | By:                      |  | /s/ Lance Cornell                    
|            |  |  |  |                          |  | Lance Cornell,                       
|            |  |  |  |                          |  | Chief Financial Officer              
|            |  |  |  |                          |  | (Principal Financial Officer)        



15