<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, 1997

                                       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 6, 1997
-----------------------------              -----------------------------
Common Stock, $.01 par value                        20,409,829
================================================================================
<PAGE>
 
                                     INDEX

                                                                     PAGE
                                                                     ----

PART  I.  FINANCIAL INFORMATION
 
Item 1. Financial Statements
 
          Consolidated Balance Sheets as of
          December 31, 1996 and June 30, 1997.......................  3
 
          Consolidated Statements of Operations for the
          Three Months and Six Months Ended June 30, 1996 and 1997..  4
 
          Consolidated Statements of Cash Flows for the
          Six Months Ended June 30, 1996 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.......................................... 13
 
Item 2.  Changes in Securities...................................... 14
 
Item 4.  Submission of Matters to a Vote of Stockholders............ 15

Item 5.  Other Information.......................................... 15
 
Item 6.  Exhibits and Reports on Form 8-K........................... 15
 
SIGNATURES.......................................................... 16
 
 
<PAGE>
 
PART I.    FINANCIAL INFORMATION

ITEM 1.    FINANCIAL STATEMENTS


                            TRANSCEND SERVICES, INC.
                          CONSOLIDATED BALANCE SHEETS
                                  (UNAUDITED)
<TABLE>
<CAPTION>
                                                                   DECEMBER 31,     JUNE 30,
                                                                  -------------  -------------
                                                                       1996           1997
                                                                  -------------  -------------
<S>                                                                <C>            <C>
       ASSETS
       ------
 
CURRENT ASSETS:
   Cash and cash equivalents....................................  $  1,663,000   $    382,000
   Accounts receivable, net of allowance for doubtful
     accounts of $147,000 and $88,000 in 1996
     and 1997, respectively.....................................     3,804,000      4,425,000
   Other........................................................       548,000        834,000
                                                                  ------------   ------------
   Total current assets.........................................     6,015,000      5,641,000
                                                                  ------------   ------------
NET ASSETS RELATED TO DISCONTINUED
   OPERATIONS...................................................     2,577,000      2,596,000
SECURITIES OF AMHEALTH..........................................       350,000        350,000
PROPERTY AND EQUIPMENT, net.....................................     2,615,000      2,866,000
DEPOSITS AND OTHER ASSETS.......................................       172,000        166,000
GOODWILL AND OTHER INTANGIBLE ASSETS, net.......................     4,828,000      4,596,000
                                                                  ------------   ------------
   Total assets.................................................  $ 16,557,000   $ 16,215,000
                                                                  ============   ============
 
                  LIABILITIES AND SHAREHOLDERS' EQUITY
                  ------------------------------------
 
CURRENT LIABILITIES:
   Current maturities of long term debt and note payable........  $  2,285,000   $    108,000
   Accounts payable.............................................     2,053,000      1,840,000
   Accrued compensation and employee benefits...................     1,797,000      1,883,000
   Other accrued liabilities....................................     1,343,000      1,046,000
   Deferred income taxes........................................       113,000        113,000
                                                                  ------------   ------------
   Total current liabilities....................................     7,591,000      4,990,000
                                                                  ------------   ------------
 
CONVERTIBLE DEBENTURES..........................................     2,000,000      2,000,000
                                                                  ------------   ------------
 
LONG TERM DEBT, net of current maturities.......................       464,000      2,996,000
                                                                  ------------   ------------
 
DEFERRED INCOME TAXES...........................................       541,000        541,000
                                                                  ------------   ------------
 
SHAREHOLDERS' EQUITY:
   Preferred stock, $.01 par value; 21,000,000 shares
   authorized; none outstanding.................................            --             --
   Common stock, $.01 par value, 30,000,000 shares
   authorized, 20,078,000 shares and 20,409,000
   shares  issued and outstanding as of December 31, 1996, and
   June 30, 1997, respectively..................................       200,000        205,000
   Additional paid-in capital...................................    19,980,000     20,623,000
   Retained deficit.............................................   (14,219,000)   (15,140,000)
                                                                  ------------   ------------
     Total shareholders' equity.................................     5,961,000      5,688,000
                                                                  ------------   ------------
     Total liabilities and shareholders' equity.................  $ 16,557,000   $ 16,215,000
                                                                  ============   ============
--------------------
</TABLE>

All prior period amounts have been restated to reflect the 1996 acquisition of
Express Medical Transcription, Inc. and the 1997 acquisition of DocuMedX, Inc.
which are accounted for under the pooling method of accounting.

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,
                                              -------------------------   -------------------------
                                                  1996         1997          1996          1997
                                              -----------   -----------   -----------   -----------
<S>                                           <C>           <C>           <C>           <C>
NET REVENUE.................................  $10,940,000   $10,360,000   $19,988,000   $21,105,000
DIRECT COSTS................................    9,550,000     8,950,000    17,176,000    17,976,000
                                              -----------   -----------   -----------   -----------
 Gross profit...............................    1,390,000     1,410,000     2,812,000     3,129,000
 
MARKETING AND SALES EXPENSES................      594,000       503,000     1,235,000       919,000
GENERAL AND ADMINISTRATIVE EXPENSES.........    1,310,000     1,159,000     2,432,000     2,292,000
AMORTIZATION EXPENSE........................      132,000       114,000       277,000       233,000
                                              -----------   -----------   -----------   -----------
 Loss from Operations.......................     (646,000)     (366,000)   (1,132,000)     (315,000)
 
OTHER INCOME (EXPENSE):
 Interest income............................       17,000            --        26,000         7,000
 Interest expense...........................      (69,000)     (124,000)     (121,000)     (220,000)
                                              -----------   -----------   -----------   -----------
                                                  (52,000)     (124,000)      (95,000)     (213,000)
                                              -----------   -----------   -----------   -----------
 
LOSS BEFORE PROVISION FOR INCOME TAXES AND
  DISCONTINUED OPERATIONS...................     (698,000)     (490,000)   (1,227,000)     (528,000)
PROVISION FOR INCOME TAXES..................           --            --            --            --
                                              -----------   -----------   -----------   -----------
LOSS BEFORE DISCONTINUED OPERATIONS.........     (698,000)     (490,000)   (1,227,000)     (528,000)
LOSS FROM DISCONTINUED OPERATIONS...........     (271,000)      (75,000)     (400,000)     (109,000)
                                              -----------   -----------   -----------   -----------
NET LOSS....................................     (969,000)  $  (565,000)  $(1,627,000)  $  (637,000)
                                              ===========   ===========   ===========   ===========
 
NET LOSS PER COMMON SHARE:
BEFORE DISCONTINUED OPERATIONS..............  $     (0.04)  $     (0.02)  $     (0.07)  $     (0.02)
DISCONTINUED OPERATIONS.....................        (0.01)        (0.01)        (0.02)        (0.01)
                                              -----------   -----------   -----------   -----------
NET LOSS....................................  $     (0.05)  $     (0.03)  $     (0.09)  $     (0.03)
                                              ===========   ===========   ===========   ===========
 
Weighted average common shares outstanding..   19,248,000    20,130,000    19,125,000    20,115,000
                                              ===========   ===========   ===========   ===========
 
--------------------
</TABLE>

All prior period amounts have been restated to reflect the 1996 acquisition of
Express Medical Transcription, Inc. and the 1997 acquisition of DocuMedX, Inc.
which are accounted for under the pooling method of accounting.

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,
                                                                               -------------------------
                                                                                   1996          1997
                                                                               -----------   -----------
<S>                                                                            <C>           <C>  
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Loss.....................................................................  $(1,627,000)  $  (637,000)
Adjustments to reconcile net loss to net cash used in operating activities:
 Depreciation and amortization...............................................      697,000       801,000
 Loss related to Discontinued Operations.....................................      400,000       109,000
Changes in assets and liabilities:
 Accounts receivable.........................................................     (646,000)     (621,000)
 Prepaid expenses............................................................     (569,000)     (286,000)
 Deposits and other assets...................................................      202,000         6,000
 Accounts payable............................................................       39,000      (213,000)
 Accrued liabilities.........................................................      132,000      (212,000)
 Other.......................................................................      (30,000)           --
                                                                               -----------   -----------
Total adjustments............................................................      225,000      (416,000)
Net Cash used in continuing operations.......................................   (1,402,000)   (1,053,000)
Net Cash used in discontinued operations.....................................     (354,000)     (128,000)
                                                                               -----------   -----------
Net Cash used in operating activities........................................   (1,756,000)   (1,181,000)
                                                                               -----------   -----------
 
CASH FLOWS FROM INVESTING ACTIVITIES:
 Capital expenditures........................................................     (832,000)     (819,000)
 Cash acquired from acquisitions.............................................       37,000            --
 Distribution of retained earnings by Express Medical Transcription, Inc.....     (121,000)           --
 Cash paid to dissenting shareholders of DocuMedX, Inc.......................           --      (284,000)
                                                                               -----------   -----------
Net cash used in investing activities........................................     (916,000)   (1,103,000)
                                                                               -----------   -----------
 
CASH FLOWS FROM FINANCING ACTIVITIES:
 Repayments on short-term debt...............................................     (100,000)           --
 Repayments on line of credit agreement......................................      (98,000)   (2,177,000)
 Borrowings under line of credit agreement...................................    1,699,000     2,575,000
 Principal payments long-term debt...........................................           --      (232,000)
 Borrowings from long-term debt..............................................       55,000       189,000
 Proceeds - stock options and other issuances................................      500,000       648,000
                                                                               -----------   -----------
  Net cash provided by financing activities..................................    2,056,000     1,003,000
                                                                               -----------   -----------
 
NET DECREASE  IN CASH AND CASH EQUIVALENTS...................................     (616,000)   (1,281,000)
CASH AND CASH EQUIVALENTS, at beginning of period............................    1,124,000     1,663,000
                                                                               -----------   -----------
CASH AND CASH EQUIVALENTS, at end of period..................................  $   508,000   $   382,000
                                                                               ===========   ===========
 
---------------------------
</TABLE>

All prior period amounts have been restated to reflect the 1996 acquisition of
Express Medical Transcription, Inc. and the 1997 acquisition of DocuMedX, Inc.
which are accounted for under the pooling method of accounting.

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

                                       5
<PAGE>
 
                            TRANSCEND SERVICES, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                             JUNE 30, 1996 AND 1997
                                  (UNAUDITED)

(1) The accompanying consolidated financial statements are unaudited and have
been prepared by management of 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 combined financial statements and footnotes thereto
included in the Company's Form 10-K for the year ended December 31, 1996.
Footnote disclosure which would substantially duplicate the disclosure contained
in those documents has been omitted.

(2) Net loss per common share has been computed based on the weighted number of
the Company's common shares and common share equivalents (dilutive stock
options) outstanding.  The common stock equivalents related to stock options
were not included in the computation due to their antidilutive effect. Fully
diluted net loss per share has not been presented since it is not materially
different from primary net loss per share.

(3) On June 28, 1996 the Company acquired 100% of the capital stock of Express
Medical Transcription, Inc. For 230,000 shares of Transcend common stock.  On
April 16, 1997, the Company acquired 100% of the capital stock of DocuMedX,
Inc., a Washington corporation for 608,800 shares of Transcend common stock.
The consolidated financial statements have been restated to reflect the
acquisitions of Express Medical Transcription, Inc. and DocuMedX, Inc. under the
pooling of interests method of accounting.

(4) In March 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 128 ("SFAS No.128"), Earnings per Share.
SFAS No. 128 requires primary earnings per share to be replaced with basic
earnings per share.  There are no differences between basic and primary earnings
per share for the three month and six month periods ended June 30, 1997 as the
impact of stock options is anti-dilutive.

                                       6
<PAGE>
 
ITEM 2.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS


          Certain statements contained in this filing are "forward-looking
statements" within the meaning of the Private Securities Litigation Reform Act
of 1995, such as statements relating to financial results and plans for future
business development 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, economic conditions, competition and other
uncertainties detailed from time to time in the Company's Securities and
Exchange Commission filings.

          Transcend Services Inc. (the "Company" or "Transcend") provides
healthcare information management ("HIM") services to hospitals and other
associated healthcare providers. The Company's range of HIM services include
contract management of medical records and other HIM operations, transcription
of physicians' dictated medical notes; and consulting relating to medical
records management and reimbursement coding.  The Company also provides case
management and disability  management services to insurance carriers, third
party administrators and self-insured employers.

          The Company currently has contract management contracts covering the
medical records departments of 17 hospitals with the average contract size of
approximately $1.4 million ranging in bed size from 49 beds to 678 beds, in 12
states and the District of Columbia.  The Company's existing contract management
contracts have remaining terms ranging up to five years. The Company also
provides medical records transcription services through computer and telephone
links from nine regional facilities to approximately 150 healthcare providers.

          The Company recently signed two new contract management contracts
which require the installation and operation of electronic document management
("EDM") systems.  The Company believes there is a significant opportunity to
enhance the value of its contract management services and, at the same time,
improve its profit margins by implementing EDM solutions.  The Company currently
has commitments to implement EDM solutions with one existing contract management
customer and one potential customer currently under letter of intent, in
addition to its two new customers.  These commitments require an up-front
investment by the Company to procure the hardware, software, training and
implementation, and are expected to produce savings over the course of the
contract term, typically five years.

          The Company continues to develop its first Information Delivery Center
("IDC"), a centralized, remote center designed to initially support and
eventually replace entirely certain of the critical functions being performed on
site in a medical records department through off-site, electronic processing of
health information.  The Company is beta testing Phase I of its first IDC  which
is designed specifically to allow for off-site, image enabled coding services.
The beta testing is expected to be completed during the fourth quarter of 1997.

                                       7
<PAGE>
 
RESULTS OF OPERATIONS - GENERAL

          The Company's loss from operations for the quarter ended June 30,1997
was $366,000.   The Company's wholly-owned subsidiary, Transcend Case Management
("TCM"), formerly Sullivan Health Management, realized a second quarter 1997
operating loss of $211,000.  In addition, the Company experienced a decline in
contract management gross profits of $297,000 as compared with the first quarter
ended March 31, 1997 primarily attributable to higher performance based
supplemental fees during the first quarter.  The Company also experienced a
second quarter loss of $53,000 in its consulting and coding operation resulting
from project cost over-runs.

THREE MONTHS ENDED JUNE 30, 1997 COMPARED TO THREE MONTHS ENDED JUNE 30, 1996

          Total revenues for the Company decreased to $10,360,000 for the three
months ended June 30,1997 from $10,940,000 for the three months ended June
30,1996, a decrease of 5.3%.   Contract management revenues were the largest
single service class revenue source for the Company in each of these three month
periods, representing 52.9% of total revenues in the 1997 period and 54.7% in
the 1996 period.  Contract management revenues decreased to $5,481,000 for the
three months ended June 30,1997 from $5,986,000 in the comparable 1996 period, a
decrease of 8.4%.  Medical transcription revenues were the second largest source
of revenues for the Company for the three months ended June 30, 1997 and 1996,
representing 42.2% of  the total revenue for the quarter ended June 30, 1997,
and 28.6% of total revenue in the comparable  1996 period.   Medical
transcription revenues increased to $4,369,000 from $3,126,000 for the quarter
ended June 30, 1996, an increase of 39.8%.  Consulting and coding revenues
represented 0.8% of the Company's total revenues for the period ending June
30,1997 and 1.9% of the Company's total revenues for the period ending June
30,1996.   Consulting and coding revenues decreased $126,000 or 59.2% to $87,000
for the quarter ended June 30,1997 from $213,000 for the quarter ended June
30,1996. Case management revenues represented 4.1% of the Company's total
revenues for the quarter ended June 30,1997 as compared with 8.6% of total
revenues in the same prior year period.  Case management revenues decreased to
$423,000 in the quarter ended June 30,1997 from $937,000 for the quarter ended
June 30, 1996, a decrease of 54.9% due to the loss of several key customer
accounts at TCM.

          The decrease in total revenues for the quarter ended June 30, 1997, is
primarily attributable to unusual non-recurring revenues in June of 1996 of
$678,000 from the sale of an imaging system, a decrease in case management
revenues  of approximately $514,000, and a net decrease in contract management
outsourcing revenues of approximately $505,000, offset by an increase in medical
transcription operation revenues of approximately $1,243,000.

          Gross profit increased to $1,410,000 for the quarter ended June
30,1997 from $1,390,000 in the same prior year period. Gross profit as a
percentage of revenues increased to 13.6% for the quarter ended June 30, 1997
from 12.7% for the quarter ended June 30, 1996. This increase was primarily
attributable to the transcription division which expanded its gross margin to
16.6% in the quarter ended June 30,1997 from 10.5% in the same prior year
period. The margin improvement in transcription is a result of increased
efficiencies and lower operating costs following the continued deployment of
digital technology and the leveraging of fixed costs while revenues grew 39.8%.
The Company's overall improvement in gross margin from transcription was offset
in the 1997 to 1996 quarter comparison by a decrease in contract management
margins of 3.6 percentage points and, the decrease in case management margins of
3.2 percentage points.

                                       8
<PAGE>
 
          Marketing and sales expenses decreased 15.3% to $503,000 in the
quarter ended June 30,1997 from $594,000 in the same prior quarter and decreased
as a percentage of revenues to 4.9% for the quarter ended June 30,1997 from 5.4%
for the quarter ended June 30,1996.   This decrease is a result of the
restructuring and internal reorganization efforts begun in late 1996 which
shifted resources and cost classifications from marketing and sales to general
and administrative.

          General and administrative expenses decreased 11.5% to $1,159,000 for
the quarter ended June 30,1997, from the $1,310,000 incurred in the same prior
year period.  Corporate general and administrative expenses decreased as a
percentage of revenues to 11.2% for the quarter ended June 30,1997 from 12.0%
for the prior year quarter. General and administrative expenses declined  as a
percentage of revenues due primarily to the Company's reorganization and
restructuring undertaken in July and August, 1996, resulting in a reduction and
stabilization in these expenses.

          Amortization expenses decreased to $114,000 for the quarter ended June
30,1997 from $132,000 for the quarter ended June 30, 1996, reflecting the impact
of the 1993 acquisition of dataLogix, Inc. being fully amortized.

          The Company's loss from operations decreased to $366,000 for the
quarter ended June 30, 1997 from $646,000 for the prior year quarter.

          Other expenses increased to $124,000 for the quarter ended June
30,1997 as compared to $52,000 for the same prior year period, primarily due to
the impact of interest expense incurred in connection with the Company's
borrowings against its working capital line of credit.

          The Company's loss before discontinued operations decreased to
$490,000 for the quarter ended June 30,1997 from $698,000 for the quarter ended
June 30,1996.  This decrease is due to the Company's reorganization and
restructuring and the growth of transcription offset by the decline in
profitability at TCM.

          The Company's loss from discontinued operations of $75,000 and
$271,000 for the quarters ended June 30, 1997 and June 30, 1996, respectively,
is due to legal expenses incurred in connection with the Lawsuit (hereinafter
defined).  See Part II, Item 1.  Legal Proceedings.

SIX MONTHS ENDED JUNE 30, 1997 COMPARED TO SIX MONTHS ENDED JUNE 30, 1996

          Total revenues for the Company increased to $21,105,000 for the six
months ended June 30,1997 from $19,988,000 for the six months ended June
30,1996, an  increase of 5.6%. Contract management revenues were the largest
single service class revenue source for the Company in each of these six month
periods, representing 53.1% of total revenues in the 1997 period and 56.4% in
the 1996 period. Contract management revenues decreased to $11,198,000 for the
six months ended June 30,1997 from $11,283,000 in the comparable 1996 period, a
decrease of 0.8%. Medical transcription revenues were the second largest source
of revenues for the Company for the six months ended June 30, 1997 and 1996,
representing 41.2% of total revenues in the 1997 period and 27.5% of total
revenues in the 1996 period. Medical transcription revenues increased to
$8,695,000 for the six months ended June 30,1997 from $5,487,000 for the  same
prior year period, an increase of 58.5%.  Consulting and coding revenues
represented 1.1% of the Company's total revenues for the six month period ending
June 30,1997 and 2.2% of the Company's total revenues for the period ending June
30,1996.  Consulting and coding revenues decreased $197,000 or 45.6% to $235,000
for the six months ended June 30, 1997 from $432,000 for the six months ended
June

                                       9
<PAGE>
 
30, 1996 due to implementation fees generated in 1996.   Case management
revenues represented 4.6% of the Company's total revenues in the six months
ended June 30,1997 as compared with 10.5% of total revenues in the prior year
period.  Case management revenues decreased to $977,000 in the six months ended
June 30,1997 from $2,108,000 for the six months ended June 30,1996, a decrease
of 53.7%.

          The increase in total revenues for the six months ended June 30,1997
is primarily attributable to the increased transcription revenues of
approximately $3,208,000 offset by the decrease in case management revenues of
approximately $1,131,000 and unusual non-recurring revenues in June of 1996 of
$678,000 from the sale of an imaging system.

          Gross profit increased to $3,129,000 for the six month period ended
June 30, 1997 from $2,812,000 in the same prior year period.  Gross profit as a
percentage of revenues increased to 14.8% for the six months ended June 30, 1997
from 14.1% in the same prior year period.  This increase was primarily
attributable to the transcription division which expanded its gross margin to
16.6% in the period ended June 30,1997 from 12.2% in the same period ended June
30,1996. The Company's overall gross margin was negatively impacted in the 1997
to 1996 six month comparison due to a decrease in contract management's gross
margin of 1.6 percentage points, and a decrease in case management gross margin
of 9 percentage points.

          Marketing and sales expenses decreased 25.6% to $919,000 in the six
month period ended June 30,1997 from $1,235,000 in the same prior year period
and decreased as a percentage of revenues to 4.4% for the six month period ended
June 30,1997 from 6.2% for the six month period ended June 30,1996.  This
decrease is a result of the restructuring and internal reorganization efforts
begun in late 1996 which shifted resources and cost classifications from
marketing and sales to general and administrative.  With much of the Company's
investment in a national sales force, telemarketing and marketing/advertising
programs now in place, the Company anticipates that sales and marketing
expenses, as a percentage of revenues, will stabilize or decrease as revenues
increase.

          General and administrative expenses decreased 5.8% to $2,292,000 for
the six months ended June 30, 1997 from the $2,432,000 incurred in the same
prior year period.  Corporate general and administrative expenses decreased as a
percentage of revenues to 10.9% for the six months ended June 30, 1997 from
12.2% in the same prior year period. General and administrative expenses
declined  as a percentage of revenues due primarily to the Company's
reorganization and restructuring undertaken in July and August, 1996, resulting
in a reduction and stabilization in these expenses.

          Amortization expenses decreased to $233,000 for the six months ended
June 30, 1997 from $277,000 for the six months ended June 30, 1996, reflecting
the impact of the 1993 acquisition of dataLogix, Inc. being fully amortized.

          The Company's loss from operations decreased to $315,000 for the six
months ended June 30, 1997, a $817,000 improvement from the $1,132,000 loss in
the same prior year period. 

          Other expenses increased to $213,000 for the six months ended June
30,1997 as compared to $95,000 for the six months ended June 30,1996, primarily
due to the impact of interest expense incurred in connection with the Company's
borrowings against its working capital line of credit.

                                       10
<PAGE>
 
          The Company's loss before discontinued operations decreased to
$528,000 for the six months ended June 30,1997 from $1,227,000 for the six
months ended June 30,1996.  This improvement is due to the Company's
reorganization and restructuring and the growth in transcription, offset by the
decline in profitability at TCM.

          The Company's loss from discontinued operations of $109,000 and
$400,000 for the six months ended June 30, 1997 and June 30, 1996, respectively,
is due to legal expenses incurred in connection with the Lawsuit (hereinafter
defined).   See Part II, Item 1.  Legal Proceedings.

LIQUIDITY AND CAPITAL RESOURCES

          For the six months ended June 30, 1997, cash flows from continuing
operations used $1,053,000, primarily to pay down accounts payable balances and
other accrued liabilities.  Cash has been used to fund the Company's operating
losses, increase its prepaid expenses and increase its outstanding accounts
receivable.   See also "Consolidated Statements of Cash Flows."

          Discontinued operations used cash of $128,000 for the six month period
ended June 30, 1997 representing cash expenditures of $84,000 for collection
costs and other discontinued operations liabilities and $109,000 for legal fees
and expenses incurred in connection with the Company's civil lawsuit filed
against certain insurance carriers in the Superior Court in California offset by
cash contributed from discontinued operations (through the collection of
accounts receivable) of $65,000.  See Part II, Item 1. Legal Proceedings.

          The Company had net working capital of $651,000 on June 30, 1997,
which compares to a deficit of $1,576,000 at December 31, 1996.  The increase in
working capital of $1,950,000 is attributable to a new credit facility
established on April 3, 1997 which resulted in the retirement of the outstanding
debt with Silicon Valley Bank.  The Silicon Valley Bank debt was classified as
under current liabilities while the new credit facility with Coast Business
Credit is classified as long term debt on the balance sheets.

          For the six months ended June 30, 1997, the Company's principal use of
cash of $1,103,000 for investing purposes was for capital expenditures in the
amount of $819,000 and the purchase of DocuMedX of $284,000.  In early 1997, the
Company made a commitment to fund its first IDC. 

          For the six months ended June 30, 1997, financing activities provided
cash of $1,003,000 primarily from proceeds from the exercise of stock options
and net borrowings under its line of credit agreements.
 
          On April 3, 1997, the Company closed on a new $5.0 million credit
facility with Coast Business Credit ("Coast"), a California-based asset based
lender (and a division of Southern Pacific Thrift and Loan Association) to
provide the Company a $4.7 million working capital facility and a $300,000
capital expenditure facility.   The working capital facility has been used to
pay off its previous credit relationship with Silicon Valley Bank in full.
These new Coast facilities do not contain any financial covenants and are based
on a funding formula (for determining funding limits) as follows:  1.5 times
monthly contractual contract management revenues, plus 80% of all medical
transcription receivables under 90 days (aging) under the working capital
facility; up to $300,000 on new capital expenditures under the capital
expenditure facility.

                                       11
<PAGE>
 
          On August 8, 1997, the Company agreed to amend its credit facility
with Coast.  Under the terms of the amendment, the term of the agreement will be
extended to May 31, 2000 and the funding formula modified to provide additional
liquidity to the Company by providing funding of 1.5 times average monthly
receipts under long term transcription contracts.  The amendment will also
provide for an increase in the 1.5 times multiple to 2.0 times monthly contract
revenues provided that the Company's tangible net worth exceeds $5.0 million for
five consecutive business days.  Based on current contract revenues and
receivables under 90 days, the credit facility, under its amended terms, will
provide a current funding capacity of  approximately $4.3 million.

          These facilities are priced 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 ("EBITA")  basis.  EBITA is used by
Coast as an indicator of a company's ability to incur and service debt.  EBITA
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.

          The Company anticipates that cash on hand, together with internally
generated funds,  cash collected from discontinued operations and cash available
under its new credit facilities, as amended, should 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 1997.

          Expanded capital requirements for the continued funding and
implementation of EDM systems other unusual capital investments will require
additional capital resources.  The Company is actively evaluating alternatives
to provide expansion of its capital resources.

                                       12
<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 healthcare
subsidiaries, First Western Health Corporation and Veritas Healthcare
Management, and the physician-owned medical groups, FWHC Medical Group, Inc. and
Veritas Medical Group, Inc., which had contracts with the 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, which  was subsequently amended to name 16
defendants (including State Compensation Insurance Fund, Continental Casualty
Company, California Compensation Insurance Company, Zenith National Insurance
Corporation and Pacific Rim Assurance Company). The action seeks $115 million in
compensatory damages plus punitive damages. The plaintiffs claim abuse of
process, intentional interference with contractual and prospective business
relations, negligent interference and unlawful or unfair business practices
which led to the discontinuation in April 1993 of the former business of the
Company's healthcare subsidiaries and their contracting associated medical
groups (the "Lawsuit"). The claims arise out of the Company's former business,
which prior to the merger with Transcend Services, Inc., included providing
medical/legal evaluations and medical treatment services (in association with
managed medical groups) in the workers' compensation industry in California.
Seven defendants in the Lawsuit have filed cross complaints against the
plaintiffs seeking restitution, accounting from the plaintiffs for monies
previously paid by the defendants, disgorgement of profits, injunctive relief,
attorneys' fees and punitive damages, based upon allegations of illegal
corporate practice of medicine, illegal referral arrangements, specific
statutory violations and related improper conduct.  The Company and its counsel
do not believe that it is likely that the Company will be held liable on any of
the cross complaints; however, there can be no assurance that the Company will
be successful in the defense of the cross complaints. In addition, there can be
no assurance as to the recovery by the Company of the damages sought in its
complaint against the defendants. The costs associated with the conduct of the
Lawsuit cannot be ascertained with certainty but are expected to be substantial.
Based upon facts and circumstances known to date, in the opinion of management,
final resolution of the Lawsuit will not have a material adverse effect on the
Company's financial condition or results of operations.

          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.  There can be no
assurance that the Company will be successful appealing such dismissal.  By
stipulation, the carriers' cross-complaints against the plaintiffs were stayed
pending resolution of the plaintiffs' appeal.  The Company believes that the
trial court's ruling, if upheld by the appellate court, also would result in
dismissal of the cross-complaints.  There can be no assurance, however, that
such cross complaints would be dismissed.  The cross complaints expose the
Company to risk of liability which, if the Company is unsuccessful in the
defense of such cross complaints, could have a materially adverse impact on the
Company's results of operations for a particular period.
 

                                       13
<PAGE>
 
          For the three months  and six months ended June 30,1997, the Company
expensed approximately $75,000 and $109,000 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 is considering moving the representation to new counsel, which would
result in negotiation of a new fee arrangement and the possible incurrence of
additional legal expenses if the Company is successful on appeal and the case is
remanded for trial.

          On June 22, 1995, an action was filed by Timothy S. Priest in his
capacity as administrator of the estate of Robert V. Taylor against Carol Brown,
Debbie Ostwald, the Company's subsidiary Sullivan, and Fireman's Fund Insurance
Company, in the Circuit Court of Franklin County, Tennessee, alleging breach of
the duty to provide reasonably competent nursing care to an injured individual.
The plaintiff demands compensatory damages in the amount of $1 million and
punitive damages in the amount of $2 million, plus costs. Management of the
Company believes that the Company has meritorious defenses to the allegations
and intends to vigorously contest liability in this matter. At the present time,
management of the Company cannot predict the outcome of this litigation, but
does not believe that the resolution of the litigation will have a material
adverse effect on the Company's financial condition or results of operations.

ITEM 2. CHANGES IN SECURITIES

          On April 3, 1997, the Company issued a warrant to purchase shares of
its Common Stock to Coast Business Credit ("Coast"), a California-based asset-
based lender (and a division of Southern Pacific Thrift and Loan Association),
in connection with the credit facilities the Company established with Coast. The
Warrant entitles the holder to purchase an aggregate of 15,000 shares of the
Company's Common Stock subject to certain adjustments, at an exercise price of
$4.625 per share. The Warrant is presently exercisable and expires not later
than April 3, 1999.

          In connection with a merger with DocuMedX, Inc. ("DocuMedX"), a
medical transcription service company with offices in Seattle, Washington and
Portland, Oregon, on April 16, 1997 the Company issued an aggregate of 608,800
shares of Common Stock to four shareholders of DocuMedX in exchange for their
shares of the common stock of DocuMedX.

          The issuance of the Securities described above was made in reliance on
the exemption from registration provided by Section 4(2) and Regulation D of the
Securities Act of 1933 as transactions by an issuer not involving a public
offering. Offers and sales were made without any public solicitation and the
Securities bear a restrictive legend. No underwriter was involved in the
transaction and no commissions were paid.

                                       14
<PAGE>
 
ITEM 4.   SUBMISSION OF MATTERS TO SHAREHOLDERS

(a) The Company held its Annual Meeting of Stockholders on April 29, 1997.  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        17,747,520   113,985  
         Larry G. Gerdes        17,747,520   113,985  
         George B. Caldwell     17,747,520   113,985  
         Walter S. Huff, Jr.    17,747,520   113,985  
         Charles E. Thoele      17,747,520   113,985   
</TABLE>

  The Stockholders also ratified the appointment of Arthur Andersen, LLP as
  independent accountants for the Company for the year ending December 31, 1997
  with 17,583,418 votes FOR, 248,650 Votes AGAINST, and 29,437 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 400,000 shares from 1,600,000 shares to 2,000,000 shares.
  The results of voting with respect to this proposal were as follows:
  11,201,414 voted FOR, 452,449 shares voted AGAINST, and 38,533 shares
  ABSTAINING.

ITEM 5.  OTHER INFORMATION

          On July 10, 1997, Transcend withdrew its Registration Statement on
Form S-3 [ File No. 333-19177, as amended by Amendment No. 1] covering 1,424,346
shares of its Common Stock to be offered and sold by certain shareholders of the
Company.  The Registration Statement was first filed with the Securities and
Exchange Commission on January 2, 1997.  The Company initially filed the
Registration Statement in order to fulfill its contractual obligations under the
terms and conditions of certain demand registration rights provided to the
former owners of two medical transcription companies acquired by the Company in
June, 1996.  The holders of such demand registration rights are now eligible to
sell shares pursuant to Rule 144 under the Securities Act of 1933, as amended,
and have waived their registration rights.

ITEM 6.  EXHIBITS.

          The following exhibits are filed herewith:

              11    Computation of Per Share Earnings

              27.1  Financial Data Schedule (for SEC use only)

       (b)    Reports on Form 8-K: there were no filings on Form 8-K during the
              quarter ended June 30,1997.

                                       15
<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 13, 1997                   By: /s/ Larry G. Gerdes
                                      -----------------------------------------
                                      Larry G. Gerdes,
                                      President and Chief Executive Officer
                                      (Principal Executive Officer)



August 13, 1997                   By: /s/ Doug Shamon
                                      -----------------------------------------
                                      Doug Shamon
                                      Executive Vice President,
                                      Chief Financial Officer (Principal
                                      Financial and Accounting Officer)

 

 


 

                                       16