<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 March 31, 1998

                                      OR

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

 
       For the transition period from ________________ to _______________

                        Commission File Number 0-18217



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



               DELAWARE                                   33-0378756
     (State or other jurisdiction of                    (I.R.S Employer
     incorporation or organization)                   Identification No.)
 
        3353 PEACHTREE ROAD, N.E., SUITE 1000, ATLANTA, GEORGIA  30326
             (Address of principal executive offices and zip code)
      Registrant's telephone number, including area code: (404) 364-8000


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


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

               Class                              Outstanding at May 11, 1998
               -----                              --------------------------- 
     Common Stock, $.01 par value                        20,567,739

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

<TABLE> 
<CAPTION> 
 
                                                                            PAGE
                                                                            ----
<S>                                                                         <C> 
PART  I.  FINANCIAL INFORMATION

 
Item 1.   Financial Statements

 
               Consolidated Balance Sheets as of
               March 31, 1998 and December 31, 1997....................        3
 
               Consolidated Statements of Operations for the
               Three Months Ended March 31, 1998 and 1997..............        4
 
               Consolidated Statements of Cash Flows for the
               Three Months Ended March 31, 1998 and 1997..............        5

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

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


 
 
PART II.       OTHER INFORMATION

 
Item 1.        Legal Proceedings.......................................       12
 
Item 6.        Exhibits and Reports on Form 8-K .......................       13
 
SIGNATURES        .....................................................       14
</TABLE>
 
<PAGE>
 
PART I.    FINANCIAL INFORMATION
ITEM 1.    FINANCIAL STATEMENTS

                            TRANSCEND SERVICES, INC.
                          CONSOLIDATED BALANCE SHEETS
                                  (UNAUDITED)
<TABLE>
<CAPTION>
                                                                   MARCH 31,                    DECEMBER 31 
                                                                     1998                          1997     
                                                                 -------------                 -------------
<S>                                                              <C>                           <C>          
                                 ASSETS                                                                     
                                 ------                                                                     
Current assets:                                                                                             
   Cash and cash equivalents............................         $  2,481,000                  $  5,541,000 
   Accounts receivable, net of allowance for doubtful                                                       
    accounts of $163,000 at March 31, 1998 and 
    December 31, 1997                                               4,985,000                     4,965,000 
   Prepaid expenses and other current assets............            1,524,000                       979,000 
                                                                 ------------                  ------------ 
Total current assets....................................            8,990,000                    11,485,000 
                                                                 ------------                  ------------ 
                                                                                                            
Property and equipment:.................................                                                    
   Property and equipment...............................            6,867,000                     6,699,000 
   Accumulated depreciation.............................           (2,980,000)                   (3,277,000)
                                                                 ------------                  ------------ 
   Property and equipment, net..........................            3,887,000                     3,422,000 
                                                                                                            
Deposits and other assets...............................              820,000                       510,000 
Investment  (Note 3)....................................            1,259,000                            -- 
Goodwill and other intangible assets, net...............            1,643,000                     2,587,000 
Net assets from discontinued operations.................            2,649,000                     2,646,000 
                                                                 ------------                  ------------ 
                                                                                                            
Total assets............................................         $ 19,248,000                  $ 20,650,000 
                                                                 ============                  ============ 
                                                                                                            
              LIABILITIES AND STOCKHOLDERS' EQUITY                                                          
              ------------------------------------                                                          
                                                                                                            
Current liabilities:                                                                                        
   Current maturities of long term debt.................         $    116,000                  $    108,000 
   Accounts payable.....................................              348,000                       843,000 
   Accrued compensation and benefits....................            1,846,000                     2,399,000 
   Other accrued liabilities............................            1,461,000                     1,751,000 
   Deferred income taxes................................              113,000                       113,000 
                                                                 ------------                  ------------ 
Total current liabilities...............................            3,884,000                     5,214,000 
                                                                 ------------                  ------------ 
                                                                                                            
Long term debt, net of current maturities...............            4,753,000                     4,983,000 
                                                                                                            
Deferred income taxes...................................              540,000                       540,000 
                                                                                                            
Convertible debentures..................................            2,000,000                     2,000,000 
                                                                                                            
Commitments and contingencies                                                                               
                                                                                                            
Stockholders' equity:                                                                                       
   Preferred stock, $.01 par value; 21,000,000 shares                                                       
     authorized Series A convertible preferred stock,                                                       
     212,800 shares issued at March 31, 1998 and                                                            
     December 31, 1997..................................                2,000                         2,000 
   Common stock, $.01 par value, 30,000,000 shares                                                          
     authorized, 20,568,000 shares and 20,500,000                                                           
      shares issued at March 31, 1998 and                                                                   
      December 31, 1997, respectively...................              206,000                       205,000 
   Additional paid-in capital...........................           26,191,000                    26,208,000 
   Retained deficit.....................................          (18,328,000)                  (18,502,000)
                                                                 ------------                  ------------ 
 Total stockholders' equity.............................            8,071,000                     7,913,000 
                                                                 ------------                  ------------ 
 Total liabilities and stockholders' equity.............         $ 19,248,000                  $ 20,650,000 
                                                                 ============                  ============
</TABLE>

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

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

<TABLE>  
<CAPTION> 
                                                                         THREE MONTHS          
                                                                        ENDED MARCH 31         
                                                                        --------------          
                                                                                           
                                                                      1998          1997    
                                                                      ----          ----     
<S>                                                               <C>           <C>
Net revenues.........................................             $12,374,000   $10,745,000
Direct costs.........................................              10,305,000     9,026,000
                                                                  -----------   -----------
   Gross profit......................................               2,069,000     1,719,000
 
Marketing and sales expenses.........................                 479,000       416,000
General and administrative expenses..................               1,107,000     1,133,000
Amortization expenses................................                  72,000       119,000
                                                                  -----------   -----------
 
   Income from operations............................                 411,000        51,000
 
Interest expense, net................................                (104,000)     ( 89,000)
                                                                  -----------   -----------
Income (loss) before taxes and
     discontinued operations.........................                 307,000       (38,000)
Income taxes.........................................                      --            --
                                                                  -----------   -----------
Income (loss) before discontinued operations.........                 307,000       (38,000)
Loss from discontinued operations....................                 (15,000)      (34,000)
                                                                  -----------   -----------
Net income (loss)....................................             $   292,000   $   (72,000)
                                                                  ===========   ===========
 
Dividends on preferred stock.........................                (119,000)           --
 
Net income (loss) to common stockholders.............             $   173,000   $   (72,000)
                                                                  ===========   ===========
 
Basic income (loss) per share:
     From continuing operations......................             $      0.01   $     (0.00)
     From discontinued operations....................             $    ( 0.00)  $     (0.00)
                                                                  -----------   -----------  
Net income (loss)....................................             $      0.01   $     (0.00)
                                                                  ===========   ===========
 
Weighted Average Common Shares Outstanding...........              20,568,000    20,103,000
                                                                  ===========   ===========
 
Diluted income (loss) per share:
     From continuing operations......................             $      0.01   $     (0.00)
     From discontinued operations....................             $     (0.00)  $     (0.00)
                                                                  -----------   ----------- 
Net income (loss)....................................             $      0.01   $     (0.00)
                                                                  ===========   ===========
 
Weighted Average Common Shares Outstanding...........              20,778,000    20,103,000
                                                                  ===========   ===========
</TABLE> 

____________

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

                                       4
<PAGE>
 
                           TRANSCEND SERVICES, INC.
                     CONSOLIDATED STATEMENTS OF CASH FLOWS
                                  (UNAUDITED)

<TABLE>  
<CAPTION>  
                                                                                                      THREE MONTHS           
                                                                                                      ENDED MARCH 31,        
                                                                                                 -------------------------   
                                                                                                                             
                                                                                                1998                   1997  
                                                                                                ----                   ----  
<S>                                                                                             <C>                 <C>       
Cash flows from operating activities:


Net income (loss).....................................................................          $   173,000         $  (72,000)
Adjustments to reconcile net income (loss) to net cash used in operating activities:
   Depreciation and amortization......................................................              398,000            390,000
   Loss related to discontinued operations............................................               15,000             34,000
Changes in assets and liabilities:
   Accounts receivable, net...........................................................             (332,000)          (185,000)
   Prepaid expenses and other current assets..........................................             (554,000)           (14,000)
   Deposits and other assets..........................................................             (311,000)            10,000
   Accounts payable...................................................................             (531,000)          (791,000)
   Accrued liabilities................................................................             (833,000)          (250,000)
                                                                                                -----------        -----------
Total adjustments.....................................................................           (2,148,000)          (806,000) 
                                                                                                -----------        -----------  
Net cash used in continuing operations................................................           (1,975,000)          (878,000)
Net cash used in discontinued operations..............................................              (19,000)           (40,000)
                                                                                                -----------        ----------- 
Net cash used in operating activities.................................................           (1,994,000)          (918,000)
                                                                                                -----------        -----------
 
Cash flows from investing activities:
   Capital expenditures...............................................................             (845,000)          (158,000)
                                                                                                -----------        -----------
Net cash used in investing activities.................................................             (845,000)          (158,000)
                                                                                                -----------        -----------
 
Cash flows from financing activities:
   Borrowings under line of credit agreements.........................................                   --            110,000
   Repayments on line of credit agreements............................................             (193,000)           (83,000)
   Principal payments long-term debt..................................................              (28,000)                --
   Proceeds from  stock options and other issuances...................................                   --              7,000
                                                                                                -----------        -----------
Net cash provided by (used in)  financing activities..................................             (221,000)            34,000
                                                                                                -----------        -----------
Net change in cash and cash equivalents...............................................           (3,060,000)        (1,042,000)
Cash and cash equivalents, at beginning of period.....................................            5,541,000          1,663,000
                                                                                                -----------        -----------
Cash and cash equivalents, at end of period...........................................          $ 2,481,000        $   621,000
                                                                                                ===========        ===========
 
Supplemental cash flow information:
Cash paid for interest expense........................................................          $   170,000        $   155,000
</TABLE>

_________________

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

                                       5
<PAGE>
 
                           TRANSCEND SERVICES, INC.
                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                            MARCH 31, 1998 AND 1997
                                  (UNAUDITED)


(1)  The accompanying consolidated financial statements are unaudited and have
been prepared by management of Transcend Services, Inc. ("the Company") in
accordance with the rules and regulations of the Securities and Exchange
Commission.  The unaudited financial information furnished herein in the opinion
of management reflects all adjustments which are necessary to fairly state the
Company's financial position, the results of its operations and its cash flows.
For further information refer to the consolidated financial statements and
footnotes thereto included in the Company's Form 10-K for the year ended
December 31, 1997.  Footnote disclosure which would substantially duplicate the
disclosure contained in those documents has been omitted.

(2)  In June 1997, the Financial Accounting Standards Board issued SFAS No. 130,
"Reporting Comprehensive Income," which establishes standards for reporting and
display of comprehensive income that includes all changes in equity during a
period from transactions and events from nonowner sources. The Company has no
components of comprehensive income other than net income for the three month
periods ended March 31, 1998 and 1997.

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

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

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

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

OVERVIEW
--------
 
     Transcend Services, Inc. ("Transcend" or the "Company") provides healthcare
information management (''HIM'') solutions to hospitals and other associated
healthcare providers. The Company's range of HIM services includes (i) contract
management, or "Co-Sourcing", of medical records and other HIM functions; (ii)
transcription of physicians' dictated medical notes; and (iii) consulting
relating to medical records and reimbursement coding. The Company currently
operates the medical records and certain other HIM functions of 22 general acute
care hospitals located in 11 states and the District of Columbia. The Company,
through its wholly-owned subsidiary Transcend Case Management, Inc. ("TCM"),
also provided case management and disability management services to insurance
carriers, third party administrators and self-insured employers; however, the
net assets of TCM were sold in March 1998.

     On April 29, 1998 the Company signed a definitive agreement to acquire
Health Care Information Systems, Inc. ("HCIS") of Beaverton, Oregon. HCIS
provides information management software and related services to approximately
65 hospitals concentrated in the eight western states. HCIS has recently
released a new set of Windows based products, a state of the art set of tools
for the management and reporting of health care information. Transcend plans to
implement these tools in each of its 22 hospitals over the next two years and
will utilize them in its Information Delivery Center ("IDC") operations. The IDC
provides for the offsite medical coding from electronic records over Transcend's
private network.

                                       7
<PAGE>
 
RESULTS OF OPERATIONS


THREE MONTHS ENDED MARCH 31, 1998 COMPARED TO THREE MONTHS ENDED MARCH 31, 1997

<TABLE>
<CAPTION>
                                                  THREE MONTHS ENDED MARCH 31                                     
                                                        (IN THOUSANDS)                             
     ----------------------------------------------------------------------------------------------
                              1998            %             1997        %            % CHANGE      
     ----------------------------------------------------------------------------------------------
     <S>                      <C>          <C>              <C>        <C>          <C>            
     NET REVENUES                                                                                  
     ----------------------------------------------------------------------------------------------
     Co-Sourcing              $ 6,965       56.3%           $ 5,717     53.2%        21.8%         
     ----------------------------------------------------------------------------------------------
     Transcription              4,981       40.3%             4,326     40.3%        15.2%         
     ----------------------------------------------------------------------------------------------
     Case Management              346        2.8%               554      5.2%       (37.5%)        
     ----------------------------------------------------------------------------------------------
     Other                         82        0.7%               148      1.4%       (44.6%)        
     ----------------------------------------------------------------------------------------------
     TOTAL                    $12,374      100.0%           $10,745    100.0%        15.2%         
     ----------------------------------------------------------------------------------------------
                                                                                                   
     ----------------------------------------------------------------------------------------------
     GROSS MARGIN                                                                                  
     ----------------------------------------------------------------------------------------------
     Co-Sourcing              $ 1,208       17.3%           $   968     16.9%        24.8%         
     ----------------------------------------------------------------------------------------------
     Transcription                891       17.9%               719     16.6%        23.9%         
     ----------------------------------------------------------------------------------------------
     Case Management               83       24.0%                49      8.8%        69.4%         
     ----------------------------------------------------------------------------------------------
     Other                       (113)    (137.8%)              (17)   (11.5%)     (564.7%)        
     ----------------------------------------------------------------------------------------------
     TOTAL                    $ 2,069       16.7%           $ 1,719     16.0%        20.4%         
     ---------------------------------------------------------------------------------------------- 
</TABLE>


     Net revenues for the Company increased to $12,374,000 for the three months
ended March 31, 1998 from $10,745,000 for the three months ended March 31, 1997,
an increase of 15.2%. Co-Sourcing revenues were the largest single service class
revenue source for the Company in each of these three month periods,
representing 56.3% of total revenues in the 1998 period and 53.2% in the 1997
period. Co-Sourcing revenues increased to $6,965,000 for the three months ended
March 31, 1998 from $5,717,000 in the comparable 1997 period, an increase of
21.8% as a result of new contracts signed in 1997 and 1998. Medical
transcription revenues, represented 40.3% of the total revenues for the Company
for the three months ended March 31, 1998 and 1997. Medical transcription
revenues increased to $4,981,000 from $4,326,000 for the three months ended
March 31, 1998 and 1997, an increase of 15.2% resulting from new customers and
volume increases from existing customers. Other revenues represented 0.7% of the
Company's net revenues for the three months ended ended March 31, 1998 and 1.4%
of the Company's net revenues for the three months ending March 31, 1997. Other
revenues decreased $66,000 or 44.6% to $82,000 for the three months ended March
31, 1998 from $148,000 for the three months ended March 31, 1997. TCM revenues
decreased to $346,000 for the three months ended March 31, 1998 from $554,000
for the three months ended March 31, 1997 a decrease of 37.5% due to the loss of
several key customer accounts at TCM.

                                       8
<PAGE>
 
     Excluding TCM, net revenues for the Company increased from $10,191,000 for
the three months ended March 31, 1997 to $12,028,000 for the three months ended
March 31, 1998, an increase of 18.0%.
 
     Gross profit increased 20.4% to $2,069,000 for the three months ended March
31, 1998 from $1,719,000 in the same prior year period. Gross profit margins (as
a percentage of net revenues) expanded to 16.7% for the three months ended March
31, 1998 from 16.0% for the three months ended March 31, 1997 period. The
increase in gross profit margin was primarily attributable to margin expansion
in TCM as a result of restructuring the business in December 1997.

     Excluding TCM, gross profits were $1,986,000 for the quarter ended March
31, 1998, an increase of 18.9% over the same prior year period in 1997. Gross
margins, excluding TCM, were 16.5% for the three months ended March 31, 1998
compared to 16.4% for the same prior year period.

 
<TABLE>
<CAPTION>
                                                     THREE MONTHS ENDED
----------------------------------------------------------------------------------------
                                        MARCH 31,1998    MARCH 31, 1997    DIFFERENCE
----------------------------------------------------------------------------------------
<S>                                     <C>              <C>               <C>
Net revenues                                100.0%           100.0%           --
----------------------------------------------------------------------------------------
Direct costs                                 83.3%            84.0%         (0.7%)
----------------------------------------------------------------------------------------
Gross profit                                 16.7%            16.0%          0.7%
----------------------------------------------------------------------------------------
Marketing and sales expenses                  3.9%             3.9%          0.0%
----------------------------------------------------------------------------------------
General and administrative expenses           8.9%            10.5%         (1.6%)
----------------------------------------------------------------------------------------
Amortization expense                           .6%             1.1%         (0.5%)
----------------------------------------------------------------------------------------
Income  from operations                       3.3%             0.5%          2.8%
----------------------------------------------------------------------------------------
Interest expense, net                         0.8%             0.8%          0.0%
----------------------------------------------------------------------------------------
Income (loss) before discontinued             2.5%            (0.4%)         2.9%
 operations
----------------------------------------------------------------------------------------
Loss from discontinued operations            (0.1%)           (0.3%)         0.2%
----------------------------------------------------------------------------------------
Net income (loss)                             2.4%            (0.7%)         3.1%
----------------------------------------------------------------------------------------
</TABLE>


     Marketing and sales expenses increased 15.1% to $479,000 for the three
months ended March 31, 1998 from $416,000 in the same prior period but remained
constant as a percentage of net revenues at 3.9%.

     General and administrative expenses decreased 2.3% to $1,107,000 for
the three months ended March 31, 1998, from the $1,133,000 incurred in the same
prior year period.  Corporate general and administrative expenses decreased as a
percentage of net revenues to 8.9% for the three months ended March 31, 1998
from 10.5% for the prior year quarter.

     Amortization expenses decreased to $72,000 or .6% of net revenues for
the three months ended March 31, 1998 from $119,000 or 1.1% of net revenues for
the three months ended March 31, 1997, reflecting the impact of the 1993
acquisition of dataLogix, Inc. being fully amortized and the write down of
intangible assets related to TCM in December 1997.

     The Company's income from operations increased to $411,000 for the three
months ended March 31, 1998 from $51,000 for the same prior year quarter due to
increased gross profits from revenue growth.

                                       9
<PAGE>
 
     Interest expense, net increased to $104,000 for the three months ended
March 31, 1998 as compared to $89,000 for the same prior year period, primarily
due to the impact of interest expense incurred in connection with the Company's
increased borrowings, loan fees, and higher interest rates associated with the
credit facility. Interest expense, net was .8% of net revenues for the three
months ended March 31, 1998 and 1997.

     The Company's income before discontinued operations increased to $307,000
for the three months ended March 31, 1998 from a loss of $38,000 for the three
months ended March 31, 1997. Excluding TCM for 1998 and 1997, the Company's
income before discontinued operations was $292,000 in 1998 and $235,000 in 1997,
an improvement of 24.3%.

     The Company's loss from discontinued operations decreased to $15,000 from
$34,000 for the three months ended March 31, 1998 and March 31, 1997,
respectively, representing legal expenses incurred in connection with the
Lawsuit (hereinafter defined). See Part II, Item 1. Legal Proceedings.

 
LIQUIDITY AND CAPITAL RESOURCES

     For the three months ended March 31, 1998, continuing operations used
$1,975,000 of cash. Cash has been used to fund the investment in capital assets
and to fund changes in the Company's assets and liabilities. See also Part I,
Item 1. Financial Statements. Consolidated Statements of Cash Flows.

     The Company had net working capital of $5,106,000 at March 31, 1998,
compared to $6,271,000 at December 31, 1997. The decrease in working capital of
$1,165,000 is attributable to the investment in capital assets and the reduction
of a line of credit facility.

     For the three months ended March 31, 1998, the Company's principal use of
cash of $845,000 for investing purposes was for capital expenditures in
association with the implementation of electronic document management systems in
new customer sites.
 
     For the three months ended March 31, 1998, financing activities used cash
of $221,000 due to reductions of the Company's line of credit facility.

     On April 3, 1997, the Company entered into a $5.0 million credit agreement
with Coast Business Credit ("Coast"), an asset based lender (and a division of
Southern Pacific Thrift and Loan Association). The agreement provides the
Company with a $4.7 million working capital facility and a $300,000 capital
expenditure facility secured by substantially all of the Company's assets. The
Coast facilities do not contain any financial covenants but contain restrictions
from paying dividends and entering into financing arrangements without consent.
As of March 31, 1998 the capacity of the credit line based on the funding
formula was $5.0 million.

                                       10
<PAGE>

     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.

     On February 19, 1998, the Company signed a master lease agreement providing
up to $5.0 million in lease financing with Information Leasing Corporation, a
subsidiary of Provident Bank, Cincinnati, Ohio at interest rates equal to
Provident Bank prime rate plus two percent. Subject to a review of the
underlying customer contract, the master lease agreement calls for equal monthly
payments over the term of the lease, typically the life of the underlying
contract, not to exceed five years. The facility is intended to provide
financing for new electronic document management systems and transcription
systems required for new contracts.

     On April 13, 1998 the Company signed a new $10.0 million equipment loan
facility with DVI Financial Services Inc. This facility, provides additional
financing for electronic document management systems and transcription systems
required for new contracts. The master loan agreement calls for monthly payments
which fully amortize the cost of the equipment over the life of the customer
contract, not to exceed 60 months, at a current interest rate of 10.2%.

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

                                       11
<PAGE>
 
PART II.  OTHER INFORMATION


ITEM 1.  LEGAL PROCEEDINGS

     The Company is subject to certain claims in the ordinary course of business
which are not material.

     On September 17, 1993, the Company and its former subsidiaries, First
Western Health Corporation and Veritas Healthcare Management, and the physician-
owned medical groups, FWHC Medical Group, Inc. and Veritas Medical Group, Inc.,
which had contracts with the healthcare subsidiaries, initiated a lawsuit in the
Superior Court of the State of California, County of Los Angeles, against 22 of
the largest California workers' compensation insurance carriers (the "Lawsuit".)
The Lawsuit was subsequently amended to name 13 defendant insurance groups
including State Compensation Insurance Fund, Continental Casualty Company,
California Compensation Insurance Company, Zenith National Insurance Corporation
and Pacific Rim Assurance Company. The action seeks $115 million in compensatory
damages plus punitive damages. The plaintiffs claim abuse of process,
intentional interference with contractual and prospective business relations,
negligent interference and unlawful or unfair business practices which led to
the discontinuation in April 1993 of the former business of the Company's
subsidiaries and their contracting associated medical groups.  Nine defendants
in the Lawsuit have filed cross complaints against the plaintiffs seeking
restitution, accounting from the plaintiffs for monies previously paid by the
defendants, disgorgement of profits, injunctive relief, attorneys' fees and
punitive damages, based upon allegations of illegal corporate practice of
medicine, illegal referral arrangements, specific statutory violations and
related improper conduct.  The Company and its counsel do not believe that it is
likely that the Company will be held liable on any of the cross complaints;
however, there can be no assurance that the Company will be successful in the
defense of the cross complaints. In addition, there can be no assurance as to
the recovery by the Company of the damages sought in its complaint against the
defendants.

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

     For the three months ended March 31, 1998, the Company expensed
approximately $15,000 of legal expenses connected with the Lawsuit. Under the
original agreement with the Company's counsel of

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<PAGE>
 
record in the Lawsuit, there was a cap on legal expenses and after December
1996, with respect to expenses incurred at the trial court level, the Company
would only be responsible for out-of-pocket expenses and the payment to counsel
of a percentage of any recovery of damages by the Company. However, in May 1997,
the Company was notified that the partner principally responsible for the case
was leaving the firm with which the Company contracted to handle the case.  The
Company has moved the representation to new counsel, which resulted in
negotiation of a new fee arrangement requiring the Company to pay additional
legal expenses incurred in connection with the appeal.




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

     The following exhibits are filed herewith:
 
                    10.14.1   DVI Financial Services Inc. Loan & Security
                              Agreement

                    11        Computation of Per Share Earnings

                    27.1      Financial Data Schedule 1998  (for SEC use only)
                    27.2      Financial Data Schedule 1997 (for SEC use only)
 
          (b)       Reports on Form 8-K: there were no filings on Form 8-K
                    during the quarter ended March 31, 1998.

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<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.

 

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


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

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