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                                 UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                            WASHINGTON, D.C.  20549

                                   FORM 10-K

                                    MARK ONE
 (X) ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
                                  ACT OF 1934
                                 (FEE REQUIRED)

                  For the fiscal year ended December 31, 1996
                                       or

    ( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
                              EXCHANGE ACT OF 1934
                               (NO FEE REQUIRED)

               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                           (I.R.S Employer
    of incorporation)                                 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

       Securities registered pursuant to Section 12(b) of the Act:  None
          Securities registered pursuant to Section 12(g) of the Act:
                         Common Stock, $.01 par value
                                (Title of Class)

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

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
  of Regulation S-K is not contained herein, and will not be contained to the
 best of registrant's knowledge, in definitive proxy or information statements
           incorporated by reference in Parts III of this Form 10-K
                    or any amendment to this Form 10-K. [ ]

    Aggregate market value of the voting stock held by non-affiliates of the
      Registrant, computed using the last sale price as reported for the
          Registrant's common stock on March 3, 1997 was $58,778,592.

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

          Class                             Outstanding at March 3, 1997
          -----
Common Stock, $.01 par value                           19,495,202
                                              -----------------------------



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                                     PART I

ITEM 1. BUSINESS

  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.

GENERAL

  Transcend Services, Inc. (the "Company" or "Transcend") is a healthcare
services company focused on the emerging field of healthcare information
management ("HIM") services to hospitals and other associated healthcare
providers. The Company provides a range of HIM services, including: (i) contract
management ("outsourcing") of the healthcare information or medical records
function, as well as the admissions function; (ii) transcription of physicians'
dictated medical notes; and (iii) consulting services relating to medical
records and reimbursement coding. As of December 31, 1996, the Company operated,
on a contract management basis, the medical records and certain other HIM
functions of 20 general acute care hospitals located in 13 states and the
District of Columbia. The Company also provides, through its 100% wholly-owned
subsidiary, Sullivan Health Management Services, Inc., case management and
disability management services to insurance carriers, third party administrators
and self-insured employers.

  The healthcare industry is undergoing significant and rapid change. Hospitals
and other healthcare providers have come under increased scrutiny from
regulators and third party payors. As a result, hospitals are now looking to
outsource to third parties certain costly or complicated functions that are not
directly related to core competencies or where they are unable to achieve
economies of scale. In particular, patient information, and the delivery of such
information in a timely fashion, have become critical to improving productivity,
efficiency and cost containment, while maintaining a high level of patient care.
For instance, many hospitals are finding that their medical records departments
are inadequate, and to remedy the inadequacies of these functions, they are
beginning to turn to third party service providers which have expertise in
managing medical records, admissions and other affiliated departments.

  With over 5,000 hospitals in the United States, the market for outsourcing the
management of medical records departments and other affiliated departments is
sizable. Approximately 3,000 hospitals in the United States have more than 100
beds and constitute the Company's first tier of market opportunity. American
Hospital Publishing, Inc.'s annual contract management survey published on
October 4, 1996, revealed that in 1997 medical records contract management is
expected to grow 175%.   According to research conducted by Modern Healthcare
magazine  as of December 9, 1996, 67.5% of hospitals surveyed outsource one or
more departments. This survey also revealed that 33.8% of hospitals surveyed are
considering further outsourcing.

  The healthcare industry has recognized the need for improvement in the
processing of healthcare information, and to achieve this improvement, there has
been a dramatic increase in the development of technological solutions offered
by third party vendors of computer hardware and software. Although there have
been significant advances in the management of medical information in general,
little progress has been made introducing technology to the management of the
medical records departments, patient admissions or other affiliated departments
of hospitals that handle the flow of patient information. The Company believes
that there is a need, and therefore an emerging market, for third party service
providers to assist hospitals and other healthcare providers in (i) the
effective implementation of the available technological tools for healthcare
information management, (ii) the process of managing healthcare information
across the pre-admission to post-discharge continuum of the healthcare delivery
system and (iii) the management and training of personnel in healthcare
information departments. By managing the entire flow of patient information
through the hospital, errors, inefficiencies and their associated costs can be
minimized.

INDUSTRY OVERVIEW

  The healthcare industry is undergoing significant and rapid change. Hospitals
and other healthcare providers have come under increased scrutiny from
regulators and third party payors, which has forced the providers to examine
their cost structures and business practices. The industry has recognized the
need for improvement in the processing of healthcare information, and to achieve
this improvement, there has been a dramatic increase in the development of
technological solutions offered

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by third party vendors of computer hardware and software. Although there have
been significant advances in the management of medical information in general,
little progress has been made introducing technology to the management of the
medical records departments, patient admissions or other affiliated departments
of hospitals that handle the flow of patient information. Healthcare information
technology vendors have focused on developing information systems such as
"electronic medical records" that promise to move all patient information on-
line, giving all constituents immediate access to relevant information. However,
the development of such systems and more importantly the widespread adoption of
such systems is still several years away. The Company believes that
transitioning the medical record from paper to electronic format will require a
higher level of service in the performance of certain HIM functions, including
coding, record analysis and completion, transcription, as well as others.

  Many hospitals are finding that their medical records departments are in many
respects inadequate and that outsourcing healthcare information functions and
related departments can result in competitive advantages by reducing costs such
as employee training and technology and equipment upgrades.

  Hospitals have outsourced basic services including housekeeping, laundry and
food preparation for a number of years to reduce operating costs and ensure
quality of service and are now looking to outsource other costly or complicated
functions that are not directly related to core competencies or where they are
unable to achieve economies of scale. An increasing number of healthcare
providers are now outsourcing the pharmacy, emergency room staffing and physical
therapy staffing functions and have more recently started to outsource critical
administrative functions such as patient health information management of
medical records departments and related functions including patient admission,
utilization review, quality assurance and the business office.

  Many hospitals are now turning to third party providers to apply their
expertise in managing not only the medical records, but admissions and other
affiliated departments as well. This development is helping providers control
costs and allowing them to concentrate on the core business of providing high
quality patient care and at the same time creating a significant opportunity for
third party service providers to assist hospitals and other healthcare providers
in processing and managing healthcare information across the pre-admission to
post-discharge continuum.

HISTORY OF THE COMPANY

  The Company was incorporated in California in 1976 and was reorganized as a
Delaware corporation in 1988. On January 10, 1995, the Company, formerly known
as "TriCare, Inc.," acquired Transcend Services, Inc., then a Georgia
corporation, by the merger of Transcend Services, Inc. into First Western Health
Corporation ("First Western"), a subsidiary of the Company (the "Merger"). Prior
to the Merger, Transcend Services, Inc., which was originally organized in 1984,
provided consulting services for medical records management, quality and
utilization management, records coding and records management software. In 1992,
the former Transcend Services, Inc. developed, tested and marketed new lines of
business intended to capitalize on the increasing need for the outsourcing of
medical records, and by the end of 1992 had entered into its first long-term
agreement for the management of a hospital's medical records department. On May
31, 1995, Transcend Services, Inc. and Veritas Healthcare Management
("Veritas"), another subsidiary of the Company, merged into the Company, whose
name was then changed to "Transcend Services, Inc." The Merger was treated for
financial accounting purposes as the acquisition of TriCare, Inc. by Transcend
Services, Inc. and the historical financial statements of the former Transcend
Services, Inc. have become the financial statements of the Company and include
the businesses of both companies after the effective date of the Merger. The
Company has one wholly-owned operating subsidiary, Sullivan Health Management
Services, Inc. ("Sullivan").

BUSINESS STRATEGY

  The Company's business strategy focuses on the application of advanced
technological tools and HIM expertise to improve the efficiency and productivity
of HIM services from pre-admission of the patient through post-discharge. Key
elements of the Company's business strategy consist of the following:

  Increase Penetration of Outsourcing Market. The Company is focused on
increasing its penetration of the healthcare information outsourcing market
through the implementation of an enhanced sales, marketing and lead generation
program. The Company's initial target market is comprised of the approximate
3,000 hospitals in the United States with more than 100

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beds. The Company has substantially expanded its marketing efforts, evidenced by
the fact that the Company conducted 61 onsite detailed consultations with
potential customers ("operational assessments") during the twelve month period
ended December 31, 1996 as compared to a total of 16 operational assessments
during calendar year 1995. Furthermore, the Company intends to continue
expanding its marketing efforts to include large clinics, sub-acute care
facilities, HMOs, skilled nursing facilities and other healthcare providers as
part of the integrated healthcare delivery system.

  Apply Emerging Technology. Although the Company is a service company and
therefore does not intend to develop a proprietary software/hardware system, the
Company is technology oriented and intends to utilize the most effective
technology available to reshape the way information is managed across the
integrated healthcare delivery system to obtain new levels of cost
effectiveness. Through a strategic partnership with a small imaging company,
the Company has introduced an electronic document management ("EDM") product in
three of its contract management sites over the past two years. However, the
Company does not intend to invest in the research and development of EDM
systems, and to the extent that more effective technological products become
available, the Company will use such technology, or partner with qualified
technology companies, to establish the most effective optical scanning or
electronic imaging capabilities at its sites.  In March, 1997, the Company
signed a three year non-exclusive Agreement to enter into a marketing
relationship with MedPlus, Inc., which incorporates MedPlus' Chartmaxx
Electronic Patient Record System  into Transcend's medical records department
outsourcing service offerings.  MedPlus is a Cincinnati-based company that
develops, sells and supports hardware and software solutions to address the HIM
needs of healthcare organizations.  MedPlus' product offerings include
electronic patient records systems, optical document archival and retrieval
systems, intelligent bar coding solutions, object-oriented workflow and document
management systems and lab automation and physician office productivity
consulting.

  Develop Data Delivery Centers. The Company has developed the concept of a Data
Delivery Center as a business model for the provision of future outsourcing
services in a format designed to further reduce hospital costs and improve
efficiencies by reducing and moving staff off-site and taking advantage of
economies of scale. Under the model, once the Company has signed contracts with
a group of healthcare provider customers which are under common ownership and/or
located in a given geographic area, the Company plans to consolidate all of the
functional and technological aspects of HIM services into one centralized off-
site service center. The Company believes that the Data Delivery Center model
offers several benefits, including the ability to perform similar functions for
multiple clients, to offer outsourcing services to larger integrated delivery
systems and to provide geographically spaced healthcare providers with a central
location for the receipt of patient data.    As an initial step in 1997, the
Data Delivery Center will be set up (and operational) to provide a single
centralized, off-site service offering - coding - to multiple hospital customers
(prior to the expansion of full-service medical records outsourcing through the
Data Delivery Center).

  Expand Range of Contract Management Services. Once the Company has established
itself in a hospital by successfully managing the medical records department,
the Company believes it is well positioned to manage other aspects of the
hospital's operations related to health information, including patient admitting
and the business office. As of December 31, 1996, the Company managed patient
admissions for three hospitals, but managed no business office functions for any
customers. The Company intends to pursue additional outsourcing business from
existing as well as new customers. The Company believes that additional
efficiencies in information management can be achieved through the management of
the record creation process at its point of beginning (pre-registration,
admitting) through post-discharge (the business office).

  Pursue Acquisitions and Strategic Alliances. The Company has historically used
an acquisition strategy to fulfill part of its business plan, and will continue
to seek acquisition opportunities to complement, expand and diversify its
services portfolio. The Company will also pursue the formation of strategic
alliances in an effort to accelerate its growth through market expansion (i.e.,
such as the VHA Marketing Agreement signed in December, 1996).   See "  -- Sales
and Marketing."   The Company is presently pursuing joint marketing efforts with
other companies to establish more comprehensive outsourcing relationships to be
implemented over a larger shared client base.

SERVICES

  CONTRACT MANAGEMENT (OUTSOURCING). Contract management, or outsourcing, of
health information involves the management by the Company of patient
information, both clinical and financial, throughout the healthcare delivery
system beginning before a patient is admitted and continuing after the patient
is discharged. The Company's principal source of revenues is currently from
long-term contracts for outsourcing, or contract management, of the healthcare
information, or
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medical records, departments of hospitals. Under the terms of its outsourcing
contracts, the Company provides the contracting medical facility with complete
day-to-day management and operation of the facility's medical records
department, including maintenance of patient records, monitoring and reduction
of backlog in record keeping and chart completion, compliance with record
keeping and record retention requirements of governmental and other third-party
payors, implementation of record coding functions to optimize reimbursement,
medical record abstracting and maintenance of record storage and retrieval
systems.

  With respect to staffing requirements, the Company's outsourcing contracts are
of two types. The first is a "Management Only" contract by which the Company
provides a department director to supervise a hospital's medical records
department and employs the departmental supervisory personnel, while all other
employees of the department remain on the hospital's payroll.  As of December
31, 1996, the Company had only four  "Management Only" contracts out of a total
of 20.  The second type is a full contract management services agreement
(covering 16 of a total of 20 contracts) by which the Company provides not only
a records-management director but also hires all the employees of the department
as the Company's employees. The Company generally provides supplemental training
to these employees once it takes over the department. The Company prefers,
whenever possible, to maintain the employment of all of the employees of a
hospital's outsourced department and is rarely required to hire new employees.

  A significant feature of the Company's contract management services is the use
of a Professional Services Team, made up of highly skilled and experienced
professionals, whose responsibility is to act as an internal consulting team to
its outsourced customers. This team is used during initial implementation to
reengineer the outsourced department's work processes, to support the customer
sites at any time and to develop "Best Practices," the Company's quality
standards that are continuously updated to represent the best in the outsourcing
marketplace.  In December, 1996, the Company signed a consulting services
Agreement with Superior Consultant Company, Inc. (Southfield, Michigan) to
provide additional professional support for the implementation of new contract
management accounts.  The Agreement with Superior will allow the Company, in
coordination with its Professional Services Team, to implement several contract
management accounts simultaneously, if necessary, throughout 1997 by using
Superior's professional healthcare consultants throughout its new client
implementation processes.

  The Company believes that the application of better technology in contract
management will reshape the way information is managed across the healthcare
delivery system in the future and provide additional cost savings. Although the
Company does not intend to directly invest in research and development of EDM
systems, it will use the most effective technology available to the extent that
its customers desire to implement such systems. Such technology is designed to
provide simultaneous access to the medical record by multiple users.   From 1994
to 1996, the Company  worked with a small imaging company to develop and beta
test an EDM product, trademarked "TransChart(TM)," and has now installed this
optical scanning product in three of its contract management sites. The Company
has had a non-exclusive agreement with the imaging company to use such company's
hardware and software products, and obtain maintenance and support services,
pursuant to a set fee schedule, and such company has agreed to make certain
modifications to its products at the request of the Company. The Company
continues to seek to implement the most effective optical scanning capabilities
at its sites, and in March, 1997, signed a three year non-exclusive Agreement to
enter into a marketing relationship with MedPlus, Inc., which incorporates
MedPlus' Chartmaxx Electronic Patient Record System into Transcend's medical
records department outsourcing service offerings.  MedPlus is a Cincinnati-based
company that develops, sells and supports hardware and software solutions to
address the HIM needs of healthcare organizations.  Product offerings include
electronic patient records systems, optical document archival and retrieval
systems, intelligent bar coding solutions, object-oriented workflow and document
management systems and lab automation and physician office productivity
consulting.  The application of more advanced technologies is a key factor in
the Company's planned implementation of its Data Delivery Center concept.
"See --Future Outsourcing Services-- Data Delivery Centers."

  Management of the Company believes that through its services, it provides
immediate and long-term cost savings to its healthcare provider customers which
helps them compete in a managed care environment. The Company also believes that
healthcare providers have overlooked other services which are attractive
outsourcing candidates such as admissions, utilization review, quality assurance
and the business office.  Because such services are essential to the efficient
flow of information along the pre-admission to post-discharge continuum in the
healthcare delivery system, the Company believes that these services are suited
to outsourcing and are a natural extension of the outsourcing of the medical
records department.

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<PAGE>

  The Company believes that there is a significant outsourcing opportunity in
the healthcare industry to provide multiple information management and
processing functions on an integrated basis beginning before a patient is
admitted, through the creation and management of the medical record and
continuing after a patient is discharged, in the business office.  It is the
intention of the Company to seek more outsourcing contracts providing fully-
integrated health information management across multiple departments of the same
institution for a single fee. Under the terms of three of the Company's
outsourcing contracts, the Company has undertaken to provide not only medical
records management services, but also to manage that hospital's patient access
(admissions) function. The Company also manages the social services, utilization
management and quality management functions for two hospitals. Although  the
Company had no outsourcing contracts for the hospital business office as of
December 31, 1996, the Company may explore opportunities for contract management
of the business office later in fiscal 1997. Better management of the business
office benefits the hospital by both reducing costs and increasing the turnover
rate of accounts receivable. The Company has demonstrated that by more
effectively managing medical records, it has significantly reduced the level of
unbilled accounts receivable and has created a more efficient and accurate flow
of information to the business office.

  FUTURE OUTSOURCING SERVICES--DATA DELIVERY CENTERS. The Company has developed
the concept of a Data Delivery Center ("DDC") as a business model for the
provision of future outsourcing services in a format designed to reduce hospital
costs and improve efficiencies. The Company hired an outside consultant to
assist the Company in the development of a design for the work flow processes of
the DDC and related equipment requirements. The consultant's assessment has been
completed and the respective technology partners have been selected (Network
Imaging Corporation of Herndon, Virginia and Healthdyne Information Services,
"HIE", of Marietta, Georgia) to begin the implementation of the Company's first
DDC by June of 1997.  The first DDC will be set-up to process coding work from
hospital customers  in a single, centralized off-site DDC.  Going forward, under
the fully developed DDC model, once the Company has signed contracts with a
group of healthcare provider customers which are under common ownership and/or
located in a given geographic area, the Company plans to consolidate all of the
functional and technological aspects of HIM services into one centralized
service center. Specific areas of initial focus would include functions such as
chart assembly and analysis, coding, transcription and information retrieval and
storage. In order to streamline the flow of patient information as much as
possible, additional labor intensive services such as scheduling,
preregistration information assembly, benefit verification and procedure
precertification, and almost all patient accounting and billing functions, could
also be added. In contrast to current HIM operations under which most of the
personnel remains on site at the customer's facility, all of the staff
performing these functions would be relocated to the DDC, with the potential for
a significant portion of the personnel to become home-based "telecommuters."
Fewer than ten individuals would remain at the client hospital with
responsibilities for document scanning and customer service functions, as well
as to provide an administrative liaison role in the hospital, participate in
hospital committee functions, oversee compliance issues and other management
functions. The Company believes that the DDC model offers several benefits,
including the ability to (i) perform similar functions for multiple clients that
are common throughout the pre-admission to post-discharge healthcare continuum,
thereby increasing efficiency and reducing staffing needs, (ii) offer
outsourcing services to larger integrated delivery systems with multiple
facilities and to provide geographically spaced healthcare providers with a
central location from which they receive patient data, and (iii) increase the
scope of potential clients to include larger medical clinics, skilled nursing
facilities, long-term care facilities and, eventually, payors such as HMOs with
complex information management requirements.

  MEDICAL TRANSCRIPTION SERVICES. The Company entered the medical transcription
services business because it saw an opportunity to improve accuracy, reduce
turnaround time and improve margins for its contract management customers,
primarily through advances in technology. The market for medical transcription
is not formally tracked, but the Executive Director of the Medical Transcription
Industry Alliance has estimated that as of December, 1996, the total U.S. market
for medical transcription services is in excess of $1 billion and that the
market is continuing to experience growth as more hospitals outsource their
medical transcription needs. The medical transcription services market is highly
fragmented, with over 500 transcription companies nationally.

  The Company's transcription business provides a computer-based service for
transcription of physician dictation for hospitals. While its service
arrangements vary from institution to institution, some of which require
transcription to be performed on-site or by hospital employees, the
transcription division's services are primarily defined as transcription of
dictation at remote locations, and transmission via modem or similar telephone
link into the computer data base of the contracting hospital. As a result, while
it provides services to over 150 different medical institutions in the United
States, the transcription division is able to provide such services from seven
small regional offices and therefore many of its transcription employees are
able to work as "telecommuters" using networked computer terminals in their
homes.

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  The Company is typically paid for its transcription services on a production
basis at rates determined on a per-line-transcribed basis. The Company also
provides transcription services in connection with nine of its contract
management contracts. Where transcription services are included as part of the
services provided in the Company's outsourcing contracts, the services are
provided internally by the Company's transcription sites as part of the overall
services provided by the Company for a set contract fee. The Company seeks
wherever possible to cross-market its transcription services with its
outsourcing contract services, using the institutions with which it has
outsourcing contracts as a base for generation of additional transcription
business and using the institutions with which it has transcription contracts as
a basis for generating additional contract management business.

  CONSULTING AND CODING SERVICES. The Company continues to offer independent
consulting services to hospitals on a case by case basis, and believes that its
consulting services comprise an additional service offering to its existing
customer base. The Company provides advice with respect to management and
operations of medical records departments and related healthcare information
functions, particularly reimbursement coding or "optimization" services and Case
Mix Index Improvement, as well as consultation services regarding the health
information aspects of hospitals' utilization management and quality management
functions. Such services, which can also include interim medical records
department management and related services, are provided on a negotiated fee for
service basis. The Company's consulting and coding department includes
specialists in various aspects of records coding and management. The Company has
a medical doctor on its staff of consultants, which allows the Company to offer
consultation services to physicians who are interested in improving their coding
and reimbursement practices.

  HEALTHCARE CASE MANAGEMENT.  Medical case management provides assessment, care
planning, recommendations, and care coordination services for injured and ill
persons covered by insurance carriers or self-insured employers. The Company
employs or contracts with registered nurses who act as a coordinator between the
patient, the healthcare providers and the insurance carriers, seeking to ensure
the provision of optimal healthcare with an efficient use of resources. Case
management typically involves routine onsite visits to the patient and monthly
reporting to the insurance carriers. In addition, the Company provides
vocational evaluations and computerized skills assessments for clients covered
by insurance programs, workers' compensation, long-term disability and Social
Security disability. The Company faces a very competitive market on a national,
regional and local level, with all of the competition offering the full
continuum of cost containment products, including field case management,
telephonic case management, pre-certification utilization review, PPO networks,
bill repricing and managed care.

CUSTOMERS

  The Company's current customer base consists primarily of hospitals for which
the Company provides contract management or outsourcing of the medical records
department, medical transcription services and/or consulting services. However,
the Company believes that the outsourcing concept can meet the needs of many
other healthcare providers, and the Company's marketing efforts are designed to
eventually expand its customer profile to include larger clinics, sub-acute care
facilities, HMOs, skilled nursing facilities and others.

  With over 5,000 hospitals in the United States, the market for outsourcing the
management of medical records departments and other affiliated departments is
sizable. Approximately 3,000 of the hospitals in the United States have more
than 100 beds and constitute the Company's first tier opportunity. The Company
further screens potential hospitals through a variety of lead generation
methods, including a recently initiated telemarketing program, which helps
pinpoint those hospitals that may benefit most from outsourcing their medical
records department and focuses the Company's efforts on approximately 2,000
target hospitals.

  As the use of medical records management technology increases in the future,
the Company believes that three levels of healthcare provider customers will
emerge. The Company divides these customers into "No Tech," "Medium Tech," and
"High Tech" categories. The No Tech customer is one that has not embraced the
use of technology within the facility's medical records functions to enhance
productivity, quality and costs. This customer will either lack the financial
resources and/or vision to progress past the paper record. For this customer,
the Company will continue to reengineer the paper processes and continue to
guarantee the customer reduced costs and improved quality, timeliness and
service. The Medium Tech customer will be ready to begin to leverage technology,
primarily through the use of optical scanning to reduce costs, improve quality
and timeliness and provide multiple users access to the same record
simultaneously. This will also allow for the electronic completion of the
patient record by the physician, providing a significant productivity tool for
the physician as well. The High

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Tech customer will likely initially be large for-profit systems or not-for-
profit multi-hospital groups, which will be committed to the complete change of
the medical record process as it is known today. The Company believes that the
High Tech customer group will be the initial market for its Data Delivery Center
concept.

  PRINCIPAL CUSTOMERS.   Based on its revenues for the fiscal year ended
December 31, 1994, fees paid by each of the following hospitals accounted for
10% or more of the Company's revenues in such period: Good Samaritan Hospital,
Downers Grove, Illinois (14%); Greater Southeast Community Hospital, Washington,
D.C. (including Fort Washington Medical Center, Fort Washington, Maryland)
(15%); Tulane University Hospital and Clinic, New Orleans, Louisiana (16%); and
Memorial Medical Center of Jacksonville, Jacksonville, Florida (15%). Based on
revenues for the fiscal years ended December 31, 1995 and December 31, 1996, no
hospital paid fees to the Company which amounted to or exceeded 10% of the
Company's revenues in those periods.

SALES AND MARKETING

  As of December 31, 1996, the Company  employed eight full-time sales personnel
in the contract management area of its business. Because the Company's
outsourcing services are relatively new in the industry, marketing of those
services has proceeded principally on the basis of personal contacts by the
Company's sales personnel with senior hospital executives as well as referrals
from its consulting clients. Beginning in early 1996, the Company added a
telemarketing program, targeting hospital chief executive and chief financial
officers, in an effort to significantly improve qualified sales leads and
shorten the overall sales cycle.  Having established its initial base of
outsourcing contract clientele, the Company's sales force provides coverage in
virtually every major hospital market in the country, with sales representatives
in each of the principal geographic regions of the country (Southwest, West,
Midwest, Southeast, Mid-Atlantic and Northeast).  The Company's 1996 marketing
strategy also included targeted advertising in industry trade publications,
direct mailings, trade shows, customer testimonials, seminars and other
educational literature that emphasizes the Company's market leadership position,
its management expertise and its track record with current clients. The
Company expects to continue this sales and marketing strategy in 1997.  In
addition, on December 5, 1996, the Company signed a three-year Marketing
Agreement with VHA, Inc. ("VHA") whereby VHA agrees to exclusively promote and
sell Transcend's outsourcing services in medical records and patient access
contract management, coding and consulting services and medical transcription
services to its 1,400 hospital members throughout the United States, excluding
hospitals in certain excepted geographic territories.  VHA will have the
opportunity to earn equity in the Company in accordance with a restricted stock
agreement based solely on VHA's sourcing a specified amount of annual sales
revenues (from its active role in selling to its member hospitals) to the
Company.

  The Company's transcription and consulting services have historically been
marketed primarily through personal contacts and referrals from existing
clients. While management believes that this is an appropriate marketing
strategy, particularly for consulting services, the Company has begun to
implement a broader marketing campaign for its transcription services,
particularly in those markets in which its transcription offices are located.
The VHA Agreement also covers these services.

COMPETITION

  Management of the Company believes that the success of its outsourcing
business is dependant upon the acceptance by hospitals and other healthcare
providers of the concept of outsourcing medical records, admissions and other
affiliated departments. Because this is an emerging field in the healthcare
industry, the Company's greatest competition presently comes from existing,
internal medical records departments of hospitals, which often resist the
outsourcing concept. Acceptance by hospitals of the outsourcing of medical
records and related departments will depend in part on the ability of the
Company to alleviate concerns of hospital management related to outsourcing,
such as loss of control of the outsourced function, information quality and
integrity concerns, and a bias against outsourcing due to previous poor
experiences. As of December 31, 1996, there was one national firm, HealthTask,
Inc. (a 50/50 joint venture between Ernst & Young and Norrell) and one regional
firm, Pyramid, Inc. (Southern California based), engaged in the same business.
The Company expects that as the concept of outsourcing becomes more accepted, it
will encounter further competition from some or all of the following sources:
other traditional healthcare information management consultants; coding
consultants; multi-specialty healthcare services businesses which currently
provide contract management to clinical, housekeeping, dietary or other non-
medical services departments of hospitals; management information services
providers, particularly developers and vendors of management software; and other
parties in contract management businesses (for example, business or financial
management services) desiring to enter the healthcare field. The Company expects
that competitive factors will include reputation for expertise in health
information management, size and scope of referenceable accounts, prior
experience in outsourcing, and


                                       8
<PAGE>

pricing. Additionally, there are companies that operate in other areas of the
health information management spectrum, including admissions, the business
office and transcription. As the Company expands its scope into these other
areas of health information management, the Company expects to confront other,
perhaps better established, better capitalized and larger competitors.

  The Company experiences competition with respect to both its transcription and
consulting business from a variety of sources, including, in each case, both
local and national businesses. The markets both for medical transcription
services and for medical records coding and consultation services are highly
fragmented, and no competitor or identifiable group of competitors could be said
to be dominant. The Company believes the principal competitive factors in each
case include reputation and prior experience, and in the case of transcription
services, pricing, timeliness (i.e., turnaround times on transcribed documents)
and accuracy of performance. In both fields, the Company, in some cases,
competes with larger, better known and better capitalized competitors. With
respect to its case management business, the Company competes with several large
national vendors including CRA Managed Care, Inc., CorVel Corporation, Intracorp
and Genex, Inc., as well as many regional and local competitors that have
established a niche in the business. Additionally, many insurance carriers and
third party administrators have developed case management programs of their own
rather than outsourcing this business.

GOVERNMENT REGULATION

  Virtually all aspects of the practice of medicine and the provision of
healthcare services are regulated by federal or state statutes and regulations,
by rules and regulations of state medical boards and state and local boards of
health and by codes established by various medical associations. The Company has
attempted to structure its operations to comply with these regulations. The
Company is not presently subject to direct regulation as an outsourcing services
provider. Future government regulation of the practice of medicine and the
provision of healthcare services may impact the Company and require it to
restructure its operations in order to comply with such regulations. In
addition, in connection with its case management business, certain of the
Company's employees and independent contractors are registered nurses. These
individuals are subject to certain licensing standards in the states in which
they practice, and are responsible for maintaining their licenses. The Company's
case management division is not subject to any material governmental regulation,
although certain states in which the Company provides case management services
have established fee schedules under their workers' compensation laws which
apply to certain case management services provided by the Company.

EMPLOYEES

  As of December 31, 1996, the Company had approximately 746 full-time employees
and 148 part-time employees, including 20 administrative and executive employees
at its headquarters office in Atlanta, Georgia; 23 employees in sales and
marketing or consultative functions; and 416 employees at outsourcing sites as
well as 383 employees in its medical transcription operations. As of December
31, 1996, Sullivan had 47 full-time employees, five part-time employees and
contracts with over  23 registered nurses who are not employees of the Company.
The Company also supervises an additional 211 employees of contracting hospitals
at outsourcing sites, pursuant to the terms of its outsourcing agreements.
Neither the Company nor any of the employees it supervises is currently a party
to any collective bargaining agreement; the hospital employees at one
outsourcing site have been solicited by union representatives, but no definitive
action toward representation has been taken. The Company has not experienced any
strikes or work stoppages, and believes that its relations with its employees
are good.

DISCONTINUED OPERATIONS

  At December 31, 1996, the net assets related to the discontinued operations of
the Company's healthcare subsidiaries, First Western and Veritas, both of which
ceased operations as of April 30, 1993, totaled $2,577,000, consisting of
$5,992,000 of gross accounts receivable offset by $3,415,000 in collection
liabilities.  In October 1995, the Company sold approximately 38% of the gross
accounts receivable to a third party with which the Company has also contracted
with to service and manage the remaining accounts receivable balance for a set
fee. The net assets from the discontinued operations represent reimbursements
that are owed the Company by certain insurance companies for applicant
medical/legal evaluation services provided by FWHC Medical Group, Inc. and
Veritas Medical Group, Inc., two managed medical groups associated with the
Company's former subsidiaries, First Western and Veritas.   The  applicant/legal
evaluation services were provided to injured California workers who, under
Section 4620 of the California Labor Code (the "California Code"), are entitled
to

                                       9
<PAGE>

"medical-legal" testimony from a physician of his or her choosing in order to
provide medical evidence that he or she is entitled to benefits under
California's workers' compensation system.  Under section 4621 of the California
Code, employers are responsible for paying the employees' costs of such medical-
legal expenses that are reasonably, actually and necessarily incurred and
payment for such costs must be made or objected to within 60 days of receipt of
the billing from the provider. Notwithstanding the requirement for prompt
payment and objection, many insurance companies fail to pay promptly.

  In the event of non-payment, a lien is filed with the California Workers'
Compensation Appeals Board ("WCAB"), after which the medical-legal provider is
known as a "lien claimant." In connection with the accounts receivable owed the
Company, liens have been filed with the WCAB for all $5,992,000 of the gross
accounts receivable outstanding as of December 31, 1996. While lien claimants
are supposed to be paid immediately, they are not entitled to a determination as
to the collectibility on the lien by an administrative court hearing until there
has been a hearing on the employee's underlying case.  Accordingly, if an
insurer fails to pay a medical-legal provider's bill as required and continues
to dispute payment after the filing of a lien, the provider may have to wait
years until the injured worker's health status reaches the point that
entitlement to benefits may be determined.  In addition, even after an
employee's entitlement to benefits has been determined, backlogs in the system
often create delays of several years before an order for payment can be
obtained. The situation is analogous to the several years or longer that it
often takes in the civil court system to obtain judgement after filing an
action. Although it may take a number of years, the Company does not believe
that there is any dispute as to the Company's ability to attempt collection on
the liens and expects to collect the accounts receivable from discontinued
operations over the next several years under the provisions of the sale and
service agreement that the Company has entered into with the third party for
servicing and managing the remaining accounts receivable balance. During the
twelve months ended December 31, 1996, the Company collected approximately
$456,000 on the receivables and wrote off approximately $295,000.  As a further
delay to the Company obtaining an order of payment, four insurers that are
defendants in the Lawsuit (see "Item 3. Legal Proceedings.") have obtained stays
of the proceedings before the WCAB, pending resolution of the Lawsuit.  Such
stays relate to the collection of $5,528,000 of the total gross receivables.
Although over 92% of the accounts receivable are subject to the stays of
proceedings, the Company believes that it will be able to collect such accounts
as the stays of proceedings only impact the timing of the Company's collection,
not the insurance companies' legal obligation to pay for the services rendered.
In estimating net accounts receivable, the Company believes that it has made
adequate provisions as to the estimated amount of gross receivables that the
Company can expect to collect upon resolution by the California WCAB of the
collectibility of the disputed receivables. The Company will continue to re-
evaluate the net realizability of the net assets related to discontinued
operations on an ongoing basis. Any such re-evaluation could result in an
adjustment that may potentially be material to the carrying value of the asset.

  In September 1994, the Company sold substantially all the assets and
liabilities of its wholly-owned subsidiary, Occu-Care, Inc., which operated
industrial medical clinics, to AmHealth, Inc. ("AmHealth") for a price of
$4,000,000. The purchase price included $1,500,000 in cash paid at closing and
the issuance of two promissory notes bearing interest at 8% per annum. AmHealth
defaulted on the first interest payments on the two notes. In conjunction with
the Merger on January 10, 1995, the Company recorded these notes as one note due
for $2,050,000, which was the Company's estimate of fair market value (using a
discounted cash flow approach). AmHealth defaulted on a December 1, 1995
mandatory redemption of a portion this obligation.

  On May 10, 1996, AmHealth executed a definitive agreement with CORE, Inc., a
public company, pursuant to which CORE would purchase for cash substantially all
the assets of AmHealth in a transaction expected to close by July, 1996. In
anticipation of the consummation of the foregoing transaction, in June, 1996,
the Company executed a definitive settlement agreement pursuant to which
AmHealth had agreed to pay the Company the sum of $2,050,000 (the carrying value
of the asset) and $5,287 in attorney's fees in full satisfaction of AmHealth's
obligation to the Company arising out of the sale of all of the assets and
liabilities of Occu-Care, Inc. Under the terms of the settlement agreement, the
Company agreed to extend the maturity of the note through July 31, 1996 and to
accept payment under the note simultaneously with the closing of the acquisition
of AmHealth by CORE. The Company dismissed its lawsuit against AmHealth, filed
on June 6, 1996 for breach of AmHealth's mandatory redemptive obligation on the
$2.5 million owed to the Company, without prejudice on June 26, 1996.

  On or about July 23, 1996, CORE announced that it had terminated its agreement
to purchase, for cash, substantially all of the assets of AmHealth, citing
market conditions related to a public offering of stock by CORE. Since CORE's
decision to terminate the AmHealth Agreement, the Company investigated several
different means by which to ultimately collect its

                                      10
<PAGE>

monies due, as an unsecured creditor, from AmHealth. AmHealth officials reported
that AmHealth was running cash flow positive, prior to debt service, and that it
was currently negotiating with some of its secured creditors, as well as other
third parties who may have had an interest in acquiring certain of AmHealth's
assets, to determine future actions. While the Company will vigorously pursue
all of the assets to which it has a right (approximately $2.9 million inclusive
of accrued interest), it decided, in August, 1996, to take a $1.7 million write
down of the receivable from AmHealth to its estimated fair value.

  In November, 1996, AmHealth had its four Northern California operating
entities (three clinics and its Employee Services Division) foreclosed on by the
senior secured creditors.  The operations were turned over to the senior secured
creditors and the outstanding receivables for the four entities are now being
collected by the creditor who had the first lien position on all of the
outstanding accounts receivable.  There remain five clinics under AmHealth
ownership in Southern California, all of which are generating operating profits
according to AmHealth officials.  AmHealth is in the process of trying to sell
the remaining clinics and use the proceeds from the sale to negotiate a final
payout - at a substantially lower level than the current principal amount of
debt outstanding - to all of AmHealth's creditors.  As of December 31, 1996,
with all of the information the Company has received from AmHealth regarding the
likelihood of a final payment and the potential amount of that payment, the
Company believes the carrying value of the AmHealth receivable is valued
correctly as it is stated on the Company's December 31, 1996 balance sheet.

ITEM 2. PROPERTIES.

  The Company leases the space for its principal offices in Atlanta, Georgia.
It also leases space for its transcription offices in Chicago, Illinois;
Pittsburgh, Pennsylvania; Columbus, Ohio; Boston and Stoughton, Massachusetts;
Marietta, Georgia; Salt Lake City, Utah and Fullerton, California.  The Company
leases space for its case management business in Orlando, Florida and Dallas,
Texas.

ITEM 3. 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 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.   See Note 2 of "Notes to Consolidated Financial Statements."

  Following a hearing in November, 1996, the Los Angeles County Superior Court,
on December 20, 1996, sustained the defendants' demurrer to the Second Amended
Complaint of the plaintiffs (including the Company and certain of its

                                      11
<PAGE>

subsidiaries), with 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 WCAB 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 WCAB.  However, the plaintiffs will file a Third Amended Complaint
with the Superior Court and a hearing is expected to be held respecting the
Third Amended Complaint by the end of the second quarter of 1997. If the Court
sustains the defendants' demurrer at such hearing, a final order dismissing the
Lawsuit will be entered and the Company expects to appeal any such ruling.  If
the Superior Court's ruling is upheld on appeal, the cross complaints against
the plaintiffs also are likely to be dismissed.

  With respect to any future expenses related to the Lawsuit, commencing in
December 1996 and for the remainder of the case, the Company is only responsible
for out-of-pocket expenses and the payment to its legal counsel of a percentage
of any recovery awarded in the Lawsuit.  In 1996, the Company expensed
approximately $1,582,000 of legal expenses connected with the Lawsuit.  All
future out-of-pocket legal expenses, in excess of the capped legal fees, will
continue to be expensed on a current basis.

  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 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

  No matters were submitted to a vote of security holders during the fourth
quarter ended December 31, 1996.

ITEM 5.  MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

                                    PART II

  Transcend Common Stock is quoted on the National Market. As of March 1, 1997
there were approximately 522 holders of record of Transcend Common Stock. The
table below sets forth for the fiscal periods indicated the high and low bid
prices per share of Transcend Common Stock as reported on the National Market.
The policy of the Board of Directors of the Company is to retain earnings for
the expansion and development of the Company's business and the Board of
Directors does not anticipate paying cash dividends on the common Stock in the
foreseeable future. Future dividend policy and the payment of dividends, if any,
will be determined by the Board of Directors in light of circumstances then
existing, including among other things, future earnings, operations, capital
requirements, contractual restrictions, the general financial condition of the
Company, general business conditions and other factors deemed relevant by the
Board. Pursuant to the terms of certain financing agreements, the Company is
restricted from paying dividends to its shareholders.

                                               PRICE PER SHARE OF
                                                 COMMON STOCK
                                                 ------------
                                           HIGH                      LOW
Year Ended December 31,                    ----                      ---
 1996
 First Quarter.............            $  9-3/8                  $ 4-7/8
 Second Quarter............            $ 12-1/8                  $ 7-3/4
 Third Quarter.............            $ 10-3/4                  $ 3-5/8
 Fourth Quarter............            $  6-1/8                  $ 4-3/8

Year Ended December 31,
 1995
 First Quarter.............            $  4-1/8                  $1-9/16
 Second Quarter............            $3-11/16                  $ 2-1/2
 Third Quarter.............            $  7-1/2                  $ 2-1/2
 Fourth Quarter............            $  7-1/8                  $ 4-3/4

                                      12
<PAGE>

RECENT SALES OF UNREGISTERED SECURITIES

  On April 30, 1996, the Company granted a warrant to purchase shares of its
Common Stock to Silicon Valley Bank, a California-chartered bank (the "Silicon
Valley Warrant"), in connection with two credit facilities the Company
established with Silicon Valley East, a Division of Silicon Valley Bank. The
Silicon Valley Warrant entitles the holder to purchase an aggregate of 25,000
shares of the Company's Common Stock, subject to certain adjustments, at an
exercise price of $11.25 per share. The Silicon Valley Warrant expires April 30,
2001.

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

                                      13
<PAGE>

                                    PART II

ITEM 6. SELECTED FINANCIAL DATA

  The following table sets forth selected consolidated financial data of the
Company for the periods indicated, which data has been derived from the
Company's consolidated financial statements.  The report of Arthur Andersen LLP,
independent public accountants, with respect to such consolidated financial
statements as of December 31, 1995 and 1996 and for the three years in the
period ended December 31, 1996 is included on page 23.   This selected
consolidated financial data should be read in conjunction with the consolidated
financial statements, related notes and other financial information included and
incorporated by reference herein.
<TABLE>
<CAPTION>

                                                    YEARS ENDED DECEMBER 31,
                                       ---------------------------------------------------
                                         1992     1993       1994         1995      1996
                                       -------  -------  -------------  --------  --------
                                              (IN THOUSANDS, EXCEPT PER SHARE DATA)
<S>                                    <C>      <C>          <C>         <C>       <C>

STATEMENTS OF OPERATIONS
   DATA(1)(2):
Net revenues.........................  $1,702   $6,511      $12,886   $26,825   $37,970
   Direct costs......................     893    5,428       11,233    22,745    32,591
                                       ------   ------      -------   -------   -------
   Gross profit......................     809    1,083        1,653     4,080     5,379
Marketing and sales expense..........     209      378          929     2,186     2,480
General and administrative expense...     715    1,330        1,673     4,961     5,771
Write down of AmHealth...............      --       --           --        --     1,700
Amortization expense of
   intangible assets.................      --      310          357       633       535
                                       ------   ------      -------   -------   -------
Operating loss.......................    (115)    (935)      (1,306)   (3,700)   (5,107)
                                       ------   ------      -------   -------   -------
Interest, net........................     (16)    (132)         (65)      (21)     (262)
Other................................      (2)     101           25        --      (200)
                                       ------   ------      -------   -------   -------
Total other income (expenses)........     (18)     (31)         (40)      (21)     (462)
                                       ------   ------      -------   -------   -------

Loss before income tax provision
 and discontinued operations.......      (133)    (966)      (1,346)   (3,721)   (5,569)
Provision for income tax.............      --       --           13        --        --
                                       ------   ------        -------   -------   -------
Loss before discontinued operations..    (133)    (966)      (1,359)   (3,721)   (5,569)
Loss from discontinued operations....      --       --           --      (479)   (1,582)
                                       ------   ------      -------   -------   -------
Net Loss.............................  $ (133)  $ (966)     $(1,359)  $(4,200)  $(7,151)
                                       ======   ======      =======   =======   =======
Net loss per common share:
Loss before discontinued operations..   $(.02)   $(.11)       $(.14)    $(.20)    $(.30)
Loss from discontinued operations....      --       --           --      (.03)     (.08)
                                       ------   ------      -------   -------   -------
Net Loss.............................   $(.02)   $(.11)       $(.14)    $(.23)    $(.38)
                                       ======   ======      =======   =======   =======
Weighted average shares
   outstanding.......................   7,392    9,096        9,963    18,017    18,908

                                                         DECEMBER 31,
                                                         ------------

                                         1992     1993         1994      1995      1996
                                       ------   ------      -------   -------   -------
BALANCE SHEET DATA:
Working capital......................  $  202   $ (569)     $(2,983)  $   605   $(1,551)
Total assets.........................     790    1,200        2,751    16,592    16,144
Long-term debt and capital lease
   obligations.......................     300       --           --     2,431     2,284
Shareholders' equity.................     277      168       (1,180)    9,632     5,971
--------
</TABLE>
(1)  On January 10, 1995, the Company acquired a Georgia corporation then known
     as "Transcend Services, Inc." by the merger of Transcend into a subsidiary
     of the Company. The merger was treated for financial accounting purposes as
     the acquisition of the Company by the former Transcend and the historical
     financial statements of the former Transcend have become the financial
     statements of the Company and include the business of both companies after
     the effective date of the merger. See Note 1 of "Notes to Consolidated
     Financial Statements."
(2)  The Company has completed several acquisitions that could affect the
     comparability of the information reflected in the table. See Note 12 of
     "Notes to Consolidated Financial Statements."
<PAGE>

ITEM 7.   MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
          RESULTS OF OPERATIONS


  The following discussion should be read in conjunction with the consolidated
financial statements of the Company (including the notes thereto) contained
elsewhere in this Report.

OVERVIEW

  Transcend is a healthcare services company focused on the emerging field of
healthcare information management ("HIM") services to hospitals and other
associated healthcare providers. The Company provides a range of HIM services,
including: (i) contract management ("outsourcing") of the healthcare information
or medical records function, as well as the admissions function; (ii)
transcription of physicians' dictated medical notes; and (iii) consulting
services relating to medical records and reimbursement coding. As of December
31, 1996, the Company operated on a contract management basis, the medical
records and certain other HIM functions of 20 general acute care hospitals
located in 13 states and the District of Columbia. The Company also provides
through its 100% wholly owned subsidiary, Sullivan Health Management Services,
Inc., case management and disability management services to insurance carriers,
third party administrators and self-insured employers.

  The Company intends to expand the range of its contract management services to
include management of other functional areas of hospitals, such as management of
patient access (admissions), utilization review, quality assurance and the
business office. As of December 31, 1996, the Company provided full contract
management outsourcing services in the admissions departments for three of the
hospitals it manages. The Company is actively seeking to provide this expanded
range of services to its current and future hospital customers. The Company also
provides, through outsourcing as well as other contracts, medical records
transcription services through computer and telephone links from centralized
facilities to approximately 150 hospital customers.

  Approximately 3,000 hospitals in the United States have more than 100 beds and
constitute the Company's first tier of market opportunity. The Company had
contract management contracts covering the medical records departments of 15
hospitals as of December 31, 1995 and 20 hospitals as of December 31, 1996,
ranging in bed size from 56 beds to 541 beds, with the average contract size of
approximately $1.3 million. The initial contract terms of the Company's current
contracts range from two to five years and are generally terminable without
cause upon expiration of the initial term or for cause at any time during the
initial term thereof. The Company's existing contracts currently have remaining
terms ranging from approximately one to five years. Due to its limited operating
history in medical records management, the Company is unable at the present time
to assess or predict its contract renewal rate.

  The Company negotiates its contract management fees on a fixed installment
basis which represents, at contract inception, an immediate savings to the
contracting hospital as compared to its historical costs. In the early term of
such a contract, the Company's expenses in providing the contract services
remain relatively high, as a percentage of contract revenues received, as set-up
and training costs are incurred, new procedures are implemented and departmental
reorganizations are initiated. Completion of such steps should result in lower
operating expenses, which in turn should increase the profit margin of a
constant revenue stream over time. Due to the Company's limited operating
history in the contract management business, however, there can be no assurances
that operating expenses will sufficiently decrease over the life of such
contracts to achieve profitability.

  The Company is experimenting with an alternative volume-based pricing
structure, based upon a hospital's activity levels such as weighted average
number of annual patient discharges, or a "per member per month" ("PMPM")
capitated pricing option similar to current pricing mechanisms used by managed
healthcare groups. As of December 31, 1996, the Company had signed one contract
based on a volume oriented pricing structure tied to weighted annual patient
discharges. There is an opportunity to realize higher margins on an activity-
based pricing structure. The principal advantage of a volume-based pricing
mechanism is that as a hospital's volume of business increases, the Company's
revenues will increase at a faster rate than operating expenses. However, if a
customer's business volume decreases, the Company's revenues will also decrease
at a faster rate than its operating expenses.   The Company is also considering
pricing its contract management contracts, where possible, to provide for more
contingency sharing of either (i) the one-time cash flow savings that the
Company generates for its contract management customers through a reduction in
gross days receivables outstanding by processing bills being delayed

                                      15
<PAGE>

in the medical records department and/or (ii) increased revenues realized by
hospital customers as a result of the Company's favorable impact (through
enhanced coder and physician training) on the hospital's Case Mix Index (a
measurement of the hospital's severity/acuity level for DRG reimbursements under
Medicare).  Of its 20 contracts as of December 31, 1996, only one contract was
priced under a contingency sharing arrangement.

  The Company is typically paid for its transcription services on a production
basis at rates determined on a per-line-transcribed basis. Where transcription
services are included as part of the services provided in the Company's
outsourcing contracts, however, the services are provided by the Company as part
of a set contract fee. The Company is paid for its consulting and coding
services on a negotiated fee for services basis. In addition, the Company is
paid for its healthcare case management services primarily on an hourly basis.

RESULTS OF OPERATIONS

  The Company's losses from operations in 1994, 1995 and 1996 were $1,306,000,
$3,700,000 and $5,107,000, respectively. Management believes that the Company's
operating losses are primarily attributable to the significant expenses incurred
by the Company to build a larger sales and management organization to support an
increased number of outsourcing contracts and the expansion of the Company's
services to healthcare institutions. In fiscal 1994, 1995 and 1996, the
Company's marketing and sales expenses were $929,000, $2,186,000 and $2,480,000,
respectively. In addition, the Company's general and administrative expenses for
fiscal 1994, 1995 and 1996 were $1,673,000, $4,961,000 and $5,771,000,
respectively. The buildup of the Company's management infrastructure had been
put in place to match the anticipated rapid growth in its outsourcing business.
The Company's major reorganization, initiated in July/August of 1996, resulted
in significant cost reductions and helped the Company achieve a near break-even
result from continuing operations (operating loss prior to interest and
amortization expenses of approximately $100,000) in the fourth quarter of 1996.
The Company will be required to increase its revenues from contract management
and other services and effectively manage its costs to achieve profitability. In
addition, the Company's pricing mechanism on most of its outsourcing contracts
requires the Company to increase operating efficiencies over the life of the
contract in order to increase profit margins. The Company will also be required
to procure a critical mass of such contracts and be able to renew such contracts
on favorable terms. There can be no assurance that the Company will be able to
attain the required operating efficiencies or increase the number of outsourcing
contracts to the level needed to become profitable.

 Year Ended December 31, 1996 Compared to Year Ended December 31, 1995

  Net revenues for the Company increased from $26,825,000 in 1995 to $37,970,000
in 1996, an increase of 41.5%.  Contract management revenues were the largest
single service class revenue source for the Company representing 53.3% of total
revenues in 1995 and 57.3% in 1996.  Contract management revenues increased from
$14,300,000 in 1995 to $21,743,000 in 1996, an increase of 52.0%.  Medical
transcription revenues were the second largest source of revenues for the
Company for 1995 and 1996, representing 28.4% of total revenues in 1995 and
29.4% in the 1996. Medical transcription revenues grew from $7,605,000 in 1995
to $11,162,000 in 1996, an increase of 46.8%.  Consulting and coding revenues
represented 2.9% of the Company's total revenues for 1995 and 2.4% of the
Company's total revenues for 1996.  Consulting and coding revenues increased
20.6% from $768,000 in 1995 to $926,000 in 1996.  Case management revenues
represented 15.5% of the Company's total revenues in 1995 as compared to 9.1%
in 1996. Case management revenues decreased from $4,152,000 in 1995 to
$3,461,000 in 1996, a decrease of 16.6% due to a consolidation of certain sales
territories and the loss of several key accounts.

  The increase in total revenues for 1996 is primarily attributable to (i)
contract management outsourcing revenues of approximately $12,789,000 related to
16 contract management contracts signed in the second half of 1995 and for the
calendar year 1996 and (ii) increased medical transcription revenues, primarily
resulting from strong internal growth in existing locations and the acquisition
of two transcription businesses (Greiner Medical Transcription, "GMT", and
Express Medical Transcription, "EMT") in June of 1996.  GMT contributed
$782,000 and EMT contributed $1,277,000 in 1996 revenues, together representing
$2,059,000, or 58% of the total increase of $3,557,000 in medical transcription
revenues.  These increases were partially offset by the decrease in case
management revenues in the Company's wholly-owned subsidiary, Sullivan Health
Management, which has sustained the loss of several key accounts over the 1996
fiscal year.  In August, 1996, the Company hired an experienced sales and
operations manager to serve as President of Sullivan and lead a re-building
effort now underway to increase sales and improve the operations of Sullivan.
Sullivan experienced a net loss from continuing

                                      16
<PAGE>

operations of $726,000 for the year ended December 31, 1996 compared to a net
loss from continuing operations of $653,000 for the year ended December 31,
1995.

  Gross profit increased 31.8% to $5,379,000 for 1996 from $4,080,000 in the
prior year. Gross profit as a percentage of total Company revenues decreased to
14.2% for 1996 from 15.2 % in the prior year. This decrease was primarily
attributable to the medical transcription division, which experienced a decrease
in gross margins from 18.9% in 1995 to 14.6% for 1996.  The margin decrease in
transcription was a result of increased operating costs in several of the
Company's transcription sites, including the costs associated with opening a new
branch location; the start-up costs incurred with implementing several new
outsourcing contracts in transcription and the costs associated with the
Company's recently acquired transcription companies in Salt Lake City (EMT) and
Los Angeles (GMT).  Gross profit as a percentage of revenues increased in the
contract management division from 14.3% in 1995 to 17.5% in 1996 as a result of
(i) decreased operating expenses incurred in several contract management
accounts during the fourth quarter of 1996; (ii) more effective implementation
of new sites and (iii) favorable re-pricing of two of its twenty contracts.
The Company's overall gross margin was further eroded in the 1995 to 1996
comparison by the decrease in case management's gross profit margin from 21.0%
for the year ended December 31, 1995 to 16.1% for the year ended December 31,
1996.  This decline in case management gross margin is the result of a higher
case management operating cost structure in place while revenues declined.
Sullivan's cost structure has been restructured to more closely match its
current revenue stream.

  Marketing and sales expenses increased 13.4% to $2,480,000 in 1996 from
$2,186,000 in the prior year and decreased as a percentage of revenues to 6.5%
for 1996 from 8.1% for 1995.  The decrease in sales and marketing expenditures
as a percentage of revenues is attributable to the Company's investment in a
national sales force  and marketing program in 1995 and early 1996 which has led
to a significant increase in sales in 1996 without a material increase in
marketing and sales expenditures in the 1996 fiscal year.  The Company believes
that as revenues increase, marketing and sales expense, as a percentage of
revenues, should decline.

  General and administrative expenses of $5,771,000 for the 1996 fiscal year
increased approximately 16.3% over the $4,961,000 expended in the same prior
year period; however, this represents a decrease as measured as a percentage of
revenues in comparing 1995 and 1996.  The decline in general and administrative
expenses as a percentage of revenues from 18.5% in 1995 to 15.2% in 1996 is a
result of the Company's leveraging its relatively fixed sales and administrative
cost structure over a higher revenue base.  The Company expensed approximately
$1.0 million in one-time charges incurred in connection with the Company's
internal reorganization and restructuring efforts.  The Company believes that
the reorganization of its sales, operating and administrative functions
undertaken in the third quarter of 1996 should result in a significant reduction
of selling, general and administrative ("S,G&A") expenses in 1997. Specifically,
S,G&A expenses (inclusive of its Sullivan subsidiary's S,G&A costs) included
one-time costs in 1996 of approximately $630,000, of which approximately 35%
were severance costs for employees whose job positions were eliminated.  Reduced
employee expenses were realized in the fourth quarter of 1996 and will continue
to be realized in 1997 as a result of these actions.  The remaining non-
recurring costs included: (i) moving expenses incurred in Sullivan's corporate
office relocation; (ii) costs incurred in connection with the EMT and GMT
acquisitions; (iii) consulting fees incurred in connection with the Company's
Information Service Center concept; and (iv) costs, including legal, incurred in
connection with the settlement of a lease/buy-out transaction. The impact of the
reorganization has been realized in the fourth quarter of 1996 and the Company
anticipates that it will continue thereafter in 1997 on a comparative basis as
the cost reductions inherent in this reorganization were more or less permanent.
The Company also recognized in the fiscal year ended December 31, 1996, through
its reorganization, approximately $400,000 of one-time non-recurring costs in
its direct operating costs that negatively impacted gross margins for the
contract management, transcription and Sullivan operations. These costs
primarily related to the loss and transition from one contract management
account and the setting up of a new large (outsourced) transcription customer.
These costs, on a comparative quarter-to-quarter basis, will not be repeated
going forward.

  In a quarter to quarter comparison, the Company's general and administrative
expenses declined as a percentage or revenue from 23.9% in the third quarter
ended September 30, 1996 to 12.6% of revenue in the fourth quarter ended
December 31, 1996.  This decrease was primarily the result of the Company's
reorganization and restructuring undertaken in July and August, 1996, and the
fact that there were significant one-time charges incurred in connection with
the reorganization efforts that were realized in the third quarter ended
September 30, 1996.

  Amortization expenses decreased to $535,000 in 1996 from $633,000 in 1995
reflecting the impact of the 1993 acquisition

                                      17
<PAGE>

of dataLogix, Inc. being fully amortized.

  Other expenses increased to $462,000 for  1996 as compared to $21,000 for
1995, primarily due to the impact of interest expense incurred in connection
with (i) the August 15, 1995 private placement of 8% Subordinated Convertible
Debentures and (ii) the Company's borrowings against its working capital line of
credit totaling $2,118,000 as of December 31, 1996. Also, the Company expensed
$200,000 in the third quarter of 1996 to cover all of its legal, accounting and
printing costs incurred in connection with its filing of a registration
statement in May 1996 to raise additional capital through a public offering of
its Common Stock.  Due to adverse market conditions, the Company withdrew its
offering in July, 1996.

  The Company's loss before discontinued operations increased to $5,569,000 for
1996 from $3,721,000 in the prior year, inclusive of several one-time, non-
recurring charges; namely (i) the $1.7 million write down of the AmHealth
receivable; (ii) approximately $200,000 incurred in connection with the
Company's attempt to raise additional capital through a public offering of its
Common Stock in May of 1996; and (iii) approximately $1.0 million incurred in
connection with the Company's internal reorganization and restructuring.  The
Company's reorganization has resulted in a more streamlined management, sales
and implementation effort and has lowered the Company's overall selling,
general, administrative and operating costs. This was first evident in the three
month period ending December 31, 1996 where results from continuing operations,
before interest and amortization, were at a near break-even level (approximately
$100,000 loss) and this represented the Company's single best operating quarter
since September, 1994.

  The loss from discontinued operations increased to $1,582,000 for 1996 from
$479,000 in  1995 as a result of the charge for legal fees incurred in
connection with the Company's civil lawsuit against certain insurance companies
in the state of California.  With respect to any future expenses related to the
Lawsuit, commencing in December 1996 and for the remainder of the case, the
Company is only responsible for out-of-pocket expenses and the payment to its
legal counsel of a percentage of any recovery awarded in the Lawsuit.  All
future out-of-pocket legal expenses, in excess of the capped legal fees, will
continue to be expensed on a current basis.  See "Item 3. Legal Proceedings."

 Year Ended December 31, 1995 Compared with Year Ended December 31, 1994

  Net revenues increased 108.2% to $26,825,000 in 1995 from $12,886,000 in 1994.
The increase in net revenues is primarily attributable to operations in the
Company's contract management outsourcing division, contributing $5,058,000 of
the overall increase due to the addition of six new outsourcing contracts.
Contract management revenues grew 54.7% from 1994 to 1995 and represented 71.7%
of the Company's total revenues in 1994 as compared to 53.3% of total revenues
in 1995. Medical transcription revenues grew from $2,920,000 in 1994 to
$7,605,000 for 1995, where $1,676,000 of this increase was due to the
acquisition of International Dictating Services, Inc. ("IDS") and where
$1,584,000 of this increase was due to the Medical Transcription of Atlanta,
Inc. ("MTA") acquisition.  Medical transcription revenues represented 22.7% of
the Company's total revenues in 1994 as compared to 28.4% of total revenues in
1995. Sullivan's 1994 revenues are not included as they were prior to the
Merger; therefore, $4,152,000 of the $13,939,000 total revenue increase in the
Company's revenues between 1994 and 1995 is due to the inclusion of Sullivan in
1995.

  Gross profit increased 146.8% to $4,080,000 in 1995 from $1,653,000 in 1994.
Gross profit as a percentage of revenues increased to 15.2% in 1995 from 12.8%
in 1994. This increase was primarily attributable to the addition of Sullivan's
case management revenues reflecting an overall 21% gross margin. Gross margins
in contract management outsourcing increased to 14.3% from 11.5% in 1994.
Average transcription margins increased from 17.3% to 18.9%.

  Marketing and sales expenses increased 135% to $2,186,000 in 1995 from
$929,000 in 1994 and increased as a percentage of revenues to 8.1% from 7.2% in
1994. The increase is attributable to expenses of approximately $80,000
associated with the efforts to heighten market awareness of the Company and
contract outsourcing, the expansion of the Company's sales force by the addition
of one person, an increase in commission compensation of approximately $156,000
relating to the six new contract management contracts signed in the third
quarter and the additional sales costs of approximately $765,000 related to the
case management division.

  General and administrative expenses increased 196.5% to $4,961,000 in 1995
from $1,673,000 in 1994 and increased as a percentage of revenues to 18.5% from
13%. The increase reflects additional expense of approximately $874,000 for
expanded management and support staff incurred to position the Company for
future growth, as well as the additional

                                      18
<PAGE>

overhead of approximately $761,000 attributable to the Merger.

  Amortization expenses increased to $633,000 in 1995 from $357,000 in 1994
reflecting the additional amortization expense of $276,000 related to the full
impact of the intangible assets associated with the Company's acquisition of
three medical transcription businesses and the additional amortization expense
of $162,000 related to the Merger.

  Other expense decreased to $21,000 in 1995 from $50,000 in 1994, primarily as
the result of the Company's recognition of higher interest income as applied
against interest expense.

  The Company's loss before discontinued operations increased to $3,721,000 in
1995 from $1,359,000 in 1994; however, beginning in the second quarter of 1995,
the Company realized an improving trend with regard to minimizing its loss from
operations. The Company's loss from continuing operations was $1,387,000 in the
second quarter ending June 30, 1995. The loss from continuing operations for the
third quarter ended September 30, 1995 was $792,000, while the fourth quarter
ended December 31, 1995 loss from operations decreased to $439,000.

  The Company's loss from discontinued operations of $479,000 in 1995 represents
legal expenses incurred in connection with the Lawsuit.  "See Item 3.  Legal
Proceedings."

  Total current assets increased 384.3% to $4,591,000 in 1995 from $948,000 in
1994 and trade accounts receivable increased 330.0% to $3,165,000 in 1995 from
$736,000 in 1994. This increase in current assets and accounts receivable is
attributable to a number of factors including (i) the Merger, which accounted
for $955,000 and $782,000 of the increase in total current assets and trade
accounts receivable, respectively, (ii) the acquisition of Sullivan, which
accounted for $842,000 and $702,000 of the increase in total current assets and
trade accounts receivable, respectively, (iii) the addition of new outsourcing
contracts, which accounted for $810,000 and $630,000 of the increase in total
current assets and trade accounts receivable, respectively, and (iv) the growth
of the Company's transcription business following the acquisitions of MTA and
IDS, which accounted for $1,017,000 of the increase in total current assets and
trade accounts receivable.  In addition, in connection with the growth of the
Company's transcription and its consulting and coding businesses, accounts
receivable increased for fiscal 1995 because it took transcription and
consulting and coding accounts receivable approximately 30 days to turn in 1995
as compared to approximately 20 days in 1994.

LIQUIDITY AND CAPITAL RESOURCES

  The Company's cash flows from continuing operations required the use of cash
of $545,000 and $4,234,000 and $1,396,000 in 1994, 1995 and 1996, respectively.
Cash has been used to continue funding the Company's operating losses and, in
1995, to finance the growth of certain of the Company's acquisitions' working
capital needs. See "Consolidated Statements of Cash Flows."

  Discontinued operations used cash of $1,745,000 in 1996.   This is a net cash
total that includes cash contributed from discontinued operations (through the
collection of accounts receivable) of $456,000 and cash expenditures of
$2,201,000 for collection costs and legal fees and expenses incurred in
connection with the Company's civil lawsuit filed against certain insurance
carriers in the Superior Court in California.   "See Item 3.  Legal
Proceedings."   The accounts receivable from the discontinued operations
represent reimbursements that are owed the Company by certain insurance
companies for applicant medical/legal evaluation services provided by FWHC
Medical Group, Inc. and Veritas Medical Group, Inc., two managed medical groups
associated with the Company's former subsidiaries, First Western and Veritas.
The gross receivables, however, are subject to liens before the WCAB, an
administrative body charged with determining an insurance company's liability
for the payment of medical-legal evaluation services.   The Company expects to
collect the accounts receivable from discontinued operations over the next
several years under the provisions of the sale and service agreement that the
Company has entered into with a third party for servicing and managing the
remaining accounts receivable balance.   In estimating net accounts receivable,
the Company believes that it has made adequate provisions as to the estimated
amount of gross receivables that the Company can expect to collect upon
resolution by the California WCAB of the collectibility of the disputed portion
of the receivables. The Company will continue to re-evaluate the net
realizability of the net assets related to discontinued operations on an ongoing
basis. Any such re-evaluation could result in an adjustment that may potentially
be material to the carrying value of the assets.  "See Item 1.  Business-
Discontinued Operations."

                                      19
<PAGE>

  The Company's working capital position decreased during the twelve months
ended December 31, 1996, from $605,000 at December 31, 1995 to a negative
$1,551,000 at December 31, 1996. This decline in the Company's working capital
position is primarily the result of the Company having to increase its short
term debt (i.e., working capital credit facility provided by Silicon Valley
Bank) by $2.1 million to help finance the Company's large losses from continuing
and discontinued (i.e., lawsuit fees and expenses) operations.  Although the
Company has a negative cash flow, the Company's accounts receivables turn faster
than related payables, allowing the Company to operate and grow its business.
Under the terms of its contract management fixed-fee pricing schedules, the
Company receives the annual fee in monthly payments in advance (due on the first
day of the month), prior to actually incurring any of the month's fixed and/or
variable operating expenses.  This results in accounts receivables for contract
management turning in approximately seven days.  The Company also receives an
up-front implementation fee prior to incurring any costs associated with the
actual start-up of a contract management site.

  The Company's cash flows from investing activities used cash of $1,462,000 and
$1,411,000 in 1994 and 1996, respectively, and provided cash of $4,776,000 in
1995. The Company's principal uses of cash for investing purposes are for
capital expenditures and acquisitions.  In 1996, the Company incurred $1,338,000
in capital expenditures, primarily in its medical transcription division for
digital dictation equipment and related technology investments.  In early 1997,
the Company has made a commitment to fund its first Data Delivery Center.  The
total expenditure of approximately $400,000 is expected to be financed through
either the working capital facility with Coast Business Credit described below
or another third party financing relationship.  In 1995, in connection with the
Company's acquisition of TriCare, it acquired approximately $7.5 million of
cash.

  In 1995 the Company expended $1,232,000 in cash to acquire the medical
transcription businesses of IDS and MTA. In connection with these acquisitions,
on August 15, 1995, the Company raised $2 million in cash through the private
placement of 8% Subordinated Convertible Debentures. The Debentures are
unsecured and subordinated to all other debt of the Company. The interest rate
on the Debentures is 8%, payable semi-annually, and the principal amount is due
in full on August 15, 2000. The Debentures are convertible into Common Stock by
the holder at any time prior to August 15, 2000 at a rate of 286 shares of
Common Stock for each $1,000 in principal amount and are convertible by the
Company at any time when the Common Stock trades at $10.50 per share for 30
consecutive trading days. The Company may redeem the Debentures at any time upon
30 to 60 days notice to the holder of a Debenture.

  Cash flows from financing activities provided $2,038,000, $223,000 and
$5,095,000 in 1994, 1995, and 1996, respectively. The Company's primary sources
of cash over the past several years have been (i) proceeds from borrowings under
a line of credit facility (1994 and April, 1996); (ii) proceeds from the
issuance of convertible debentures (August, 1995); (iii) proceeds from the
issuance of common stock and warrants through a private placement in September,
1996 and (iv) proceeds from the exercise of incentive stock options.  In 1995,
the Company retired its line of credit and issued $2 million of convertible
debentures as discussed above.  During 1996, financing activities provided
$5,095,000, primarily from (i) the proceeds received on the exercise of
incentive stock options in the amount of $849,000; (ii) the utilization of
credit facilities (as described below) in the amount of $2,118,000; and (iii)
proceeds of $2,446,000 received in connection with the sale of common stock and
warrants (as described below).

  On April 30, 1996, the Company established two separate credit-facilities with
Silicon Valley East (Wellesley, Massachusetts) a division of Silicon Valley
Bank, a California-chartered bank (Santa Clara, California). The aggregate
credit available (under both facilities) is $5.75 million. The banking
facilities are secured by all of the Company's assets. One of the facilities is
a $5.0 million working capital credit line under which the Company may borrow a
certain percentage of its accounts receivable balance, subject to an initial cap
of $3.0 million that was to be removed if the Company realized net income of at
least $50,000 in the quarter ended September 30, 1996. Because the Company
recognized a loss in the third quarter as well as the fourth quarter, this
facility remains capped at $3.0 million. The second facility is a $750,000 term
facility set up to help the Company meet any of its capital investment
requirements in the near term which include the purchase of computers and
transcription related equipment. This term note is subject to an initial cap of
$250,000, with the cap being removed during such periods that the Company
maintains a minimum debt service ratio of 1.5 to 1.0, where debt service is
defined as earnings before interest and taxes plus depreciation and
amortization, divided by total interest plus current portion of long-term debt.
As of December 31, 1996 the Company was not maintaining the required debt
service ratio, therefore, the cap of $250,000 remains in place on this term
facility. As of December 31, 1996 total borrowings under both facilities totaled
$2,118,000. The stated interest rate on the working capital facility is prime
plus 0.5% and the stated interest rate on the term loan is prime plus 1.0%. Both
of these facilities will mature on April 30, 1997. Due to the Company's
financial losses, the

                                      20
<PAGE>

Company's borrowing capacity is currently capped at the $2,118,000 level of
debt.  The Company has been in negotiations with Silicon Valley to re-define all
of its major financial covenants and establish new borrowing capabilities with
Silicon Valley East as a result of its third and fourth quarter losses
(inclusive of all one-time, non-recurring balance sheet adjustments).

  On February 28, 1997, the Company received full loan committee approval from
Coast Business Credit, a California-based asset-based lender (and a division of
Southern Pacific Thrift and Loan Association) to provide the Company a $5.0
million working capital facility to be effective (funding capability) by early
April, 1997.  The facility will be used to pay off Silicon Valley in full upon
initial funding.  This new Coast facility does not contain any financial
covenants and is 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).  Based on
current monthly contractual contract management revenues and 80% of all medical
transcription receivables under 90 days as of February 28, 1997, this would
provide the Company with a current funding capacity of approximately $3.8
million.  The facility will have a term of two years and will be priced at prime
plus 2.25% declining to prime plus 1.75% upon two consecutive quarters of
achievement and ongoing maintenance of debt service coverage of not less than
1.5 times measured on an EBITA basis including all principal and interest
(excluding depreciation).  The facility will be secured by a first security
interest on all Company assets.

  On September 5, 1996, the Company raised $2.4 million in a private placement
of Common Stock and warrants to purchase common stock. A total of 522,000 shares
of Common Stock were sold at a price of $4.44 per share and a total of 522,000
warrants were sold at a price of $0.25 per warrant to 20 investors. The $4.44
price represents the ten day average of the closing price of the Company's
Common Stock prior to the board meeting approving the private placement. The
securities issued in the private placement were issued in reliance on certain
exemptions from registration under federal and state securities laws. The
warrants have a five-year term and are exercisable at a price of $4.44 per
share, are redeemable by the Company at any time with thirty days notice (during
which time the holder may exercise the warrants) at an exercise price of $4.44
and are non-transferrable. The shares of Common Stock underlying the warrants
and the Common Stock issued in the private placement carry piggy-back
registration rights, subject to certain limitations, in the event the Company
proposes to register the sale of any of its securities for its own account or
for the account of its shareholders.

  The Company anticipates that cash on hand, together with internally generated
funds,  cash collected from discontinued operations and cash available under its
new working capital facility with Coast Business Credit, 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 (legal fees
now capped) of its civil litigation action against certain insurance carriers
for 1997.  The Company will continue to pursue various alternatives to allow for
the effective use of cash (i.e., leasing for capital asset funding). This should
help the Company to (i) continue its rapid growth, (ii) achieve operating
profitability and positive cash flow from operations during 1997, and (iii)
continue to fund the out-of-pocket expenses to be incurred in connection with
its civil litigation against certain insurance carriers.

IMPACT OF INFLATION

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

                                      21
<PAGE>

ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.

 The following financial statements are filed with this report:

 Report of Arthur Andersen LLP, Independent Public Accountants

 Consolidated Balance Sheets at December 31, 1995 and 1996

 Consolidated Statements of Operations for the years ended December 31, 1994,
 1995 and 1996

  Consolidated Statements of Shareholders' Equity for the years ended December
  31, 1994, 1995 and 1996

 Consolidated Statements of Cash Flows for the years ended December 31, 1994,
 1995 and 1996

 Notes to Consolidated Financial Statements
                                      22

<PAGE>

REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS

TO THE BOARD OF DIRECTORS AND SHAREHOLDERS OF
TRANSCEND SERVICES, INC.:

  We have audited the accompanying consolidated balance sheets of Transcend
Services, Inc. (a Delaware corporation) and subsidiaries as of December 31, 1995
and 1996 and the related consolidated statements of operations, shareholders'
equity, and cash flows for each of the three years in the period ended December
31, 1996. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.

  We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

  In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Transcend Services, Inc. and
subsidiaries as of December 31, 1995 and 1996 and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1996 in conformity with generally accepted accounting principles.



                                                 ARTHUR ANDERSEN LLP



ATLANTA, GEORGIA
FEBRUARY 14, 1997

                                      23
<PAGE>

                            TRANSCEND SERVICES, INC.

                          CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>


                                                                                    DECEMBER 31,
                                                                            ----------------------------
                                                                                1995           1996
                                                                            -------------  -------------
<S>                                                                         <C>            <C>
        ASSETS
       -------

CURRENT ASSETS:
                   Cash and cash equivalents..............................   $ 1,117,000   $  1,660,000
                   Accounts receivable, net of allowance for doubtful
                   accounts of $42,000 and $147,000 in 1995
                   and 1996, respectively.................................     3,165,000      3,594,000
                   Other..................................................       309,000        543,000
                                                                             -----------   ------------
                   Total current assets...................................     4,591,000      5,797,000
                                                                             -----------   ------------

NET ASSETS RELATED TO DISCONTINUED OPER-
 ATIONS...................................................................     2,414,000      2,577,000
SECURITIES OF AMHEALTH....................................................     2,050,000        350,000
EQUIPMENT and LEASEHOLD IMPROVEMENTS, at
                   cost, less accumulated depreciation and amortization
                   of $1,085,000 and $2,040,000 in 1995 and 1996,
                   respectively...........................................     1,766,000      2,434,000
DEPOSITS AND OTHER ASSETS.................................................       408,000        158,000
GOODWILL AND OTHER INTANGIBLE ASSETS,
                    less accumulated amortization of $1,301,000 and
                    $1,836,000 in 1995 and 1996, respectively.............     5,363,000      4,828,000
                                                                             -----------   ------------
                   Total assets...........................................   $16,592,000   $ 16,144,000
                                                                             ===========   ============

                   LIABILITIES AND SHAREHOLDERS' EQUITY
                   ------------------------------------

CURRENT LIABILITIES:
                   Current maturities of long term debt and note payable..   $   208,000   $  2,226,000
                   Accounts payable.......................................     1,268,000      1,989,000
                   Accrued compensation and employee benefits.............     1,570,000      1,702,000
                   Other accrued liabilities..............................       807,000      1,318,000
                   Deferred income taxes..................................       133,000        113,000
                                                                             -----------   ------------
                   Total current liabilities..............................     3,986,000      7,348,000
                                                                             -----------   ------------

CONVERTIBLE DEBENTURES....................................................     2,000,000      2,000,000
                                                                             -----------   ------------

LONG TERM DEBT, net of current maturities.................................       431,000        284,000
                                                                             -----------   ------------

DEFERRED INCOME TAXES.....................................................       543,000        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, 18,343,000 and 19,469,000 shares issued
                   and outstanding as of December 31, 1995 and 1996,
                   respectively...........................................       183,000        194,000
                   Additional paid-in capital.............................    16,642,000     19,931,000
                   Retained deficit.......................................    (7,193,000)   (14,154,000)
                                                                             -----------   ------------
                      Total shareholders' equity..........................     9,632,000      5,971,000
                                                                             -----------   ------------
                      Total liabilities and shareholders' equity..........   $16,592,000   $ 16,144,000
                                                                             ===========   ============

--------------------
</TABLE>
 The accompanying notes are an integral part of these consolidated balance
sheets.

                                                                24
<PAGE>

                            TRANSCEND SERVICES, INC.

                     CONSOLIDATED STATEMENTS OF OPERATIONS



                                                   YEARS ENDED DECEMBER 31,
                                                   ------------------------
<TABLE>
<CAPTION>
                                                 1994          1995          1996
                                                 ----          ----          ----

<S>                                           <C>           <C>           <C>
NET REVENUE.................................  $12,886,000   $26,825,000   $37,970,000
DIRECT COSTS................................   11,233,000    22,745,000    32,591,000
                                              -----------   -----------   -----------
 Gross profit...............................    1,653,000     4,080,000     5,379,000

MARKETING AND SALES EXPENSES................      929,000     2,186,000     2,480,000
GENERAL AND ADMINISTRATIVE EXPENSES.........    1,673,000     4,961,000     5,771,000
WRITE DOWN OF AMHEALTH......................          -0-           -0-     1,700,000
AMORTIZATION EXPENSE........................      357,000       633,000       535,000
                                              -----------   -----------   -----------
 Loss from Operations.......................   (1,306,000)   (3,700,000)   (5,107,000)

OTHER INCOME (EXPENSE):
 Interest expense...........................      (66,000)      (96,000)     (320,000)
 Interest income............................        1,000        75,000        58,000
 Other......................................       25,000           -0-      (200,000)
                                              -----------   -----------   -----------
                                                  (40,000)      (21,000)     (462,000)
                                              -----------   -----------   -----------

LOSS BEFORE PROVISION FOR INCOME TAXES AND
  DISCONTINUED OPERATIONS...................   (1,346,000)   (3,721,000)   (5,569,000)
PROVISION FOR INCOME TAXES..................       13,000           -0-           -0-
                                              -----------   -----------   -----------
LOSS BEFORE DISCONTINUED OPERATIONS.........   (1,359,000)   (3,721,000)   (5,569,000)
LOSS FROM DISCONTINUED OPERATIONS...........          -0-      (479,000)   (1,582,000)
                                              -----------   -----------   -----------
NET LOSS....................................  $(1,359,000)  $(4,200,000)  $(7,151,000)
                                              ===========   ===========   ===========

NET LOSS PER COMMON SHARE:
BEFORE DISCONTINUED OPERATIONS..............       $(0.14)       $(0.20)  $     (0.30)
DISCONTINUED OPERATIONS.....................           --          (.03)        (0.08)
                                              -----------   -----------   -----------
NET LOSS....................................       $(0.14)       $(0.23)  $     (0.38)
                                              ===========   ===========   ===========

Weighted average common shares outstanding..    9,963,000    18,017,000    18,908,000
                                              ===========   ===========   ===========

-------------------
</TABLE>
 The accompanying notes are an integral part of these consolidated statements.

                                                                25
<PAGE>

                            TRANSCEND SERVICES, INC.

                CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
<TABLE>
<CAPTION>

                                                  ADDITIONAL                                TOTAL
                                         COMMON    PAID-IN    WARRANTS      RETAINED     SHAREHOLDERS'
                                         STOCK    CAPITAL    OUTSTANDING    DEFICIT        EQUITY
                                         -----    -------   -----------     -------        ------
<S>                                    <C>       <C>          <C>         <C>            <C>
BALANCE, December 31,1993............  $ 96,000  $ 1,564,000  $ 104,000   $ (1,596,000)  $   168,000
                                       --------  -----------  ---------   ------------   -----------
Issuance of 341,546
             shares of Common Stock
             from exercise of
             warrants................     3,000      101,000   (104,000)            --            --
 Other issuance of
             Common Stock............        --       11,000         --             --        11,000
 Net loss............................        --           --         --     (1,359,000)   (1,359,000)
                                       --------  -----------  ---------   ------------   -----------
BALANCE, December 31, 1994...........    99,000    1,676,000         --     (2,955,000)   (1,180,000)
                                       --------  -----------  ---------   ------------   -----------
Issuance of 7,792,446
             shares of Common Stock
             with Merger.............    78,000   14,533,000         --             --    14,611,000
Issuance of 60,000
             shares of Common Stock
             in Acquisition..........     1,000      171,000         --             --       172,000
Issuance of 527,130
             shares from exercise
             of options and other
             issuances...............     5,000      262,000         --             --       267,000
Net loss.............................        --           --         --     (4,200,000)   (4,200,000)
Distribution to Former Shareholder
    /Owner (1).......................        --           --         --        (38,000)      (38,000)
                                       --------  -----------  ---------   ------------   -----------
BALANCE, December 31, 1995...........   183,000   16,642,000         --     (7,193,000)    9,632,000
                                       --------  -----------  ---------   ------------   -----------
Issuance of 521,725
             shares of Common Stock
             in Private Placement....     5,000    2,441,000         --             --     2,446,000
 Issuance of 87,805
             shares of Common Stock
             in Acquisitions.........     1,000           --         --        311,000       312,000
Issuance of 476,054 shares of
    Common Stock from exercise
    of options and other issuances...     5,000      848,000         --             --       853,000
Net loss.............................        --           --         --     (7,151,000)   (7,151,000)
Distribution to Former Shareholder
   /Owner (1)........................        --           --         --       (121,000)     (121,000)
                                       --------  -----------  ---------   ------------   -----------
BALANCE, December 31, 1996...........  $194,000  $19,931,000  $     ---   $(14,154,000)  $ 5,971,000
                                       ========  ===========  =========   ============   ===========

--------------------
</TABLE>
The accompanying notes are an integral part of these consolidated statements.
(1) Distribution to former Shareholder/Owner of EMT prior to June, 1996
acquisition made by Transcend.
                                                                26

<PAGE>

                           TRANSCEND SERVICES, INC.

                     CONSOLIDATED STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
                                                                                           YEARS ENDED DECEMBER 31,
                                                                                           ------------------------
                                                                                     1994            1995           1996
                                                                                     ----            ----           ----
CASH FLOWS FROM OPERATING ACTIVITIES:
<S>                                                                               <C>            <C>           <C>
Net Loss........................................................................   $(1,359,000)  $(4,200,000)  $(7,151,000)
                                                                                   -----------   -----------   -----------
   Adjustments to reconcile net loss to net cash used in operating activities:
   Depreciation and amortization................................................       540,000     1,141,000     1,423,000
   Write down of AmHealth Securities............................................            --            --     1,700,000
   Loss related to Discontinued Operations......................................            --       479,000     1,582,000
Changes in assets and liabilities, net of acquisitions:
   Accounts receivable..........................................................      (262,000)   (1,485,000)     (262,000)
   Prepaid expenses.............................................................       (51,000)     (187,000)     (230,000)
   Deposits and other assets....................................................      (101,000)     (351,000)      255,000
   Accounts payable.............................................................       554,000       (52,000)      706,000
   Accrued liabilities..........................................................       253,000       298,000       601,000
   Other........................................................................      (119,000)      123,000       (20,000)
                                                                                   -----------   -----------   -----------
Total adjustments...............................................................       814,000       (34,000)    5,755,000
                                                                                   -----------   -----------   -----------
Net Cash used in continuing operations..........................................      (545,000)   (4,234,000)   (1,396,000)
                                                                                   -----------   -----------   -----------
Net Cash provided by (used in) discontinued operations..........................            --       202,000    (1,745,000)
                                                                                   -----------   -----------   -----------
Net Cash used in operating activities...........................................      (545,000)   (4,032,000)   (3,141,000)
                                                                                   -----------   -----------   -----------

CASH FLOWS FROM INVESTING ACTIVITIES:
   Capital expenditures.........................................................      (464,000)   (1,279,000)   (1,338,000)
   Disposal and transfer of property............................................            --        60,000        11,000
   Cash acquired from acquisitions..............................................         2,000     7,560,000        37,000
   Acquisitions.................................................................    (1,000,000)   (1,527,000)           --
   Distribution to former shareholder/owner (1).................................            --       (38,000)     (121,000)
                                                                                   -----------   -----------   -----------
Net Cash (used in) provided by investing activities.............................    (1,462,000)    4,776,000    (1,411,000)
                                                                                   -----------   -----------   -----------

CASH FLOWS FROM FINANCING ACTIVITIES:
   Borrowings from short-term debt..............................................     1,000,000            --            --
   Repayments on short-term debt................................................            --            --      (100,000)
   Borrowings under line of credit agreement....................................     1,025,000        40,000     2,118,000
   Repayments on line of credit agreement.......................................            --    (2,025,000)           --
   Principal payments long-term debt............................................            --       (60,000)     (218,000)
   Proceeds - Convertible Debentures............................................            --     2,000,000            --
   Proceeds from private placement of  Common stock.............................            --            --     2,446,000
   Proceeds - Stock options and other issuances.................................        13,000       268,000       849,000
                                                                                   -----------   -----------   -----------
Net cash provided by financing activities.......................................     2,038,000       223,000     5,095,000
                                                                                   -----------   -----------   -----------

NET INCREASE IN CASH AND CASH EQUIVALENTS.......................................        31,000       967,000       543,000
CASH AND CASH EQUIVALENTS, at beginning of year.................................       119,000       150,000     1,117,000
                                                                                   -----------   -----------   -----------
CASH AND CASH EQUIVALENTS, at end of year.......................................   $   150,000   $ 1,117,000   $ 1,660,000
                                                                                   ===========   ===========   ===========

---------------------------
</TABLE>
The accompanying notes are an integral part of these consolidated statements.
(1) Distribution to former Shareholder/Owner of EMT prior to June, 1996
acquisition made by Transcend.

                                      27
<PAGE>

                           TRANSCEND SERVICES, INC.

                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                       DECEMBER 31, 1994, 1995 AND 1996

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

NATURE OF BUSINESS

   Transcend Services, Inc. (the "Company") is engaged in the field of contract
outsourcing of the health information management/medical records and patient
access functions of hospitals. The Company offers operations evaluation,
consulting, reimbursement coding, transcription, and other services generally
resident in the medical records department of hospitals. Currently, it
emphasizes three- to five-year contractual relationships for management of the
entire hospital medical records and patient access departments. The Company's
three largest hospital contracts accounted for approximately 46%, 25% and 18% of
sales in 1994, 1995, and 1996, respectively.

   The Company was incorporated in 1976 and was reorganized as a Delaware
corporation in 1988. On January 10, 1995, the Company, formerly known as
TriCare, Inc., acquired Transcend Services, Inc., a Georgia corporation by the
merger of Transcend Services, Inc. into First Western Health Corporation
("Merger"), a subsidiary of the Company. On May 31, 1995, Transcend Services,
Inc., a California corporation following its January 10, 1995 merger into the
Company, and Veritas Healthcare Management, a California corporation owned by
the Company, merged into the Company, whose name was then changed to "Transcend
Services, Inc." The Merger was treated for financial accounting purposes as the
acquisition of TriCare by Transcend and the historical financial statements of
Transcend have become the financial statements of the Company and include the
businesses of both companies after the effective date of the Merger. The Company
has one wholly-owned operating subsidiary, Sullivan Health Management Services,
Inc. ("Sullivan") which provides case management and disability management
services.

BASIS OF PRESENTATION

   The consolidated financial statements include the accounts of the Company and
its wholly owned subsidiaries. All significant intercompany accounts and
transactions have been eliminated in consolidation.

   The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.

CASH AND CASH EQUIVALENTS

   The Company considers all highly-liquid debt instruments purchased with an
original maturity of three months or less to be cash equivalents.

ACCOUNTS RECEIVABLE

   An allowance for doubtful accounts has been established to provide for losses
on uncollectible accounts based on management's estimates and historical
collection. Bad debt expense amounted to $9,000, $0 and $101,000 in 1994, 1995
and 1996, respectively.

REVENUE AND COST RECOGNITION

   Revenue is recognized monthly as the work is performed.

   SERVICE LINE                            REVENUE RECOGNITION
   ------------                            -------------------

   Contract Management (Outsourcing):      Monthly; 1/12th of annual fixed fee.

                                      28
<PAGE>

                           TRANSCEND SERVICES, INC.

                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                       DECEMBER 31, 1994, 1995 AND 1996


  Transcription:          Monthly; revenue recognized on a per line/per
                          character basis for actual dictation .
  Consulting & Coding:    Monthly; revenue recognized for
                          work incurred on time and material basis.
  Case Management:        Monthly; revenue recognized as work is
                          incurred; usually on fixed cost per hour per case.

  One-time nonrefundable contract implementation fees have been amortized over
the first three months of a contract to match when the costs are incurred for
implementation. Direct costs are expensed as incurred and include contract labor
costs related to medical records processing, transcription, coding costs and
case management costs, as well as purchased services, such as microfilming,
record storage, software licenses, etc.

DEPRECIATION

  Depreciation is computed using the straight-line method over the estimated
useful lives of the respective assets which range from three to seven years.

INCOME TAXES

  The Company accounts for its income taxes in accordance with Statement of
Financial Accounting Standards ("SFAS") No 109. Under the asset and liability
approach, deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
basis and operating loss and tax credit carryforwards. Deferred tax assets and
liabilities are measured using enacted tax rates expected to apply to taxable
income in the years in which those temporary differences are expected to
reverse.

DEPOSITS AND OTHER ASSETS

  Deposits and other assets includes $144,000 in restricted cash used as
collateral for a letter of credit related to a contract outsourcing agreement
which expires in September, 1997.

GOODWILL AND OTHER INTANGIBLE ASSETS

  Goodwill and other intangible assets are currently being amortized over
periods ranging from three to thirty years. The Company periodically evaluates
whether events and circumstances since acquisition have occurred that indicate
that the remaining estimated useful life of goodwill may warrant revision or
that the remaining balance of goodwill may not be recoverable. When factors
(such as a change in law or regulatory environment or forecasts showing changing
long-term profitability) indicate that goodwill should be evaluated for possible
impairment, the Company uses an estimate of the related business unit's
undiscounted net income over the remaining life of the goodwill to measure
whether the goodwill is recoverable.

FAIR VALUE OF DEBT

  In accordance with SFAS No. 107, "Disclosures About Fair Value of Financial
Investments", the fair value of short-term debt is estimated to approximate its
carrying value. The fair value of long-term debt is estimated based on
approximate market interest rates for similar issues. The estimated fair value
of long-term debt at December 31, 1995 and 1996 was equal to the carrying amount
included in the accompanying balance sheet.

                                      29
<PAGE>

                           TRANSCEND SERVICES, INC.

                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                       DECEMBER 31, 1994, 1995 AND 1996

NET LOSS PER COMMON SHARE AND COMMON SHARE EQUIVALENT

   Net loss per common share has been computed based on the weighted average
number of the Company's common shares outstanding. Common equivalent shares from
stock options and warrants have not been included in the computation due to
their antidilutive effect.

NEW ACCOUNTING PRONOUNCEMENTS

   In March 1995, the Financial Accounting Standards Board issued SFAS No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
Be Disposed Of," which establishes accounting standards for the impairment of
long-lived assets, certain identifiable intangibles and goodwill related to
those assets to be held and used, as well as for long-lived assets and certain
identifiable intangibles to be disposed of. The Company adopted the new standard
on January 1, 1996. The impact of adopting this standard was not material.
Management periodically evaluates the carrying values of its long-lived assets,
based upon future cash flows and operating income generated by the underlying
assets in determining the carrying value.

   The Company accounts for its stock-based compensation plans under Accounting
Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to
Employees." Effective in 1996, the Company adopted the disclosure option of SFAS
No. 123, "Accounting for Stock-Based Compensation." SFAS No. 123 requires that
companies which do not choose to account for stock-based compensation as
prescribed by this statement shall disclose the pro forma effects on net income
and per share data as if SFAS No. 123 had been adopted. Additionally, certain
other disclosures are required with respect to stock compensation and the
assumptions used to determine the pro forma effects of SFAS No. 123 (Note 10).

RESTATEMENT OF PRIOR YEAR BALANCES

   Certain prior year balances have been restated to conform with current year
presentation.

2. DISCONTINUED OPERATIONS

   LEGAL PROCEEDINGS

   On September 17, 1993, the Company and its 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

                                      30
<PAGE>

                           TRANSCEND SERVICES, INC.

                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                       DECEMBER 31, 1994, 1995 AND 1996

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.

  Following a hearing in November, 1996, the Los Angeles County Superior Court,
on December 20, 1996, sustained the defendants' demurrer to the Second Amended
Complaint of the plaintiffs (including the Company and certain of its
subsidiaries), with 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.
However, the plaintiffs will file a Third Amended Complaint with the Superior
Court and a hearing is expected to be held respecting the Third Amended
Complaint by the end of the first quarter of 1997. If the Court sustains the
defendants' demurrer at such hearing, a final order dismissing the Lawsuit will
be entered and the Company expects to appeal any such ruling. If the Superior
Court's ruling is upheld on appeal, the cross complaints against the plaintiffs
also are likely to be dismissed.

  With respect to any future expenses related to the Lawsuit, commencing in
December 1996 and for the remainder of the case, the Company is only responsible
for out-of-pocket expenses and the payment to its legal counsel of a percentage
of any recovery awarded in the Lawsuit. In 1995 and 1996, the Company expensed
approximately $479,000 and $1,582,000, respectively, of legal expenses connected
with the Lawsuit. All future out-of-pocket legal expenses, in excess of the
capped legal fees, will continue to be expensed on a current basis going
forward.

  First Western/Veritas

  At December 31, 1996, the net assets related to the discontinued operations of
the Company's healthcare subsidiaries, First Western Health Corporation ("First
Western") and Veritas Healthcare Management ("Veritas") were $2,577,000,
consisting of $5,992,000 of gross accounts receivable offset by $3,415,000 in
collection liabilities. In October, 1995, the Company sold approximately 38% of
the gross accounts receivable to a third party with which the Company has also
contracted with to service and manage the remaining accounts receivable balance
for a set fee. The net accounts receivable from the discontinued operations
represent reimbursements that are owed the Company by certain insurance
companies from applicant/legal evaluation services provided by FWHC Medical
Group, Inc. and Veritas Medical Group, Inc., two managed medical groups
associated with the Company's former subsidiaries, First Western and Veritas.
The applicant/legal evaluation services were provided to injured California
workers who, under Section 4620 of the California Labor Code (the "California
Code"), are entitled to "medical-legal" testimony from a physician of his or her
choosing in order to provide medical evidence that he or she is entitled to
benefits under California's workers' compensation system. Under section 4621 of
the California Code, employers are responsible for paying the employees' costs
of such medical-legal expenses that are reasonably, actually and necessarily
incurred and payment for such costs must be made or objected to within 60 days
of receipt of the billing from the provider. Notwithstanding the requirement for
prompt payment and objection, many insurance companies fail to pay promptly.

  In the event of non-payment, a lien is filed with the California Workers'
Compensation Appeals Board ("WCAB"), after which the medical-legal provider is
known as a "lien claimant." In connection with the accounts receivable owed the
Company, liens have been filed with the WCAB for all $5,992,000 of the gross
accounts receivable outstanding as of December 31, 1996. While lien claimants
are supposed to be paid immediately, they are not entitled to a determination as
to the collectibility on the lien by an administrative court hearing until there
has been a hearing on the employee's underlying case. Accordingly, if an insurer
fails to pay a medical-legal provider's bill as required and continues to
dispute payment after the filing of a lien, the provider may have to wait years
until the injured worker's health status reaches the point that entitlement to
benefits may be determined. In addition, after the WCAB has made a determination
as to collectability, backlogs in the system often create delays of several
years before an order for payment can be obtained. The situation is analogous to
the several years or longer that it often takes in the civil court system to
obtain judgement after filing an action.

                                      31
<PAGE>

                           TRANSCEND SERVICES, INC.

                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                       DECEMBER 31, 1994, 1995 AND 1996

Although it may take a number of years, the Company does not believe that there
is any dispute as to the Company's ability to attempt collection on the liens
and expects to collect the accounts receivable from discontinued operations over
the next several years under the provisions of the sale and service agreement
that the Company has entered into with the third party for servicing and
managing the remaining accounts receivable balance. During the year  ended
December 31, 1996, the Company collected approximately $456,000 on the
receivables and wrote off approximately $295,000.  As a further delay to the
Company obtaining an order of payment, four insurers that are defendants in the
Lawsuit have obtained stays of the proceedings before the WCAB, pending
resolution of the Lawsuit.  Such stays relate to the collection of $5,528,000 of
the total gross receivables. Although over 92% of the accounts receivable are
subject to the stays of proceeds, the Company believes that it will be able to
collect such accounts as the stays of proceedings only impact the timing of the
Company's collection, not the insurance companies' legal obligation to pay for
the services rendered.  The sale of approximately 38% of the gross receivables
to a third party did not result in any gain or loss to the Company.  In
estimating net accounts receivable, the Company believes that it has made
adequate provisions as to the estimated amount of gross receivables that the
Company can expect to collect upon resolution by the California WCAB of the
collectibility of the disputed receivables. The Company will continue to re-
evaluate the net realizability of the net assets related to discontinued
operations on an ongoing basis. Any such re-evaluation could result in an
adjustment that may potentially be material to the carrying value of the asset.

3.   ASSET WRITEDOWN

   In September 1994, the Company sold substantially all the assets and
liabilities of its wholly-owned subsidiary, Occu-Care, Inc., which operated
industrial medical clinics, to AmHealth, Inc. ("AmHealth") for a price of
$4,000,000. The purchase price included $1,500,000 in cash paid at closing and
the issuance of two promissory notes bearing interest at 8% per annum.
AmHealth defaulted on the first interest payments on the two notes. In
conjunction with the Merger on January 10, 1995, the Company recorded these
notes as one note due for $2,050,000, which was the Company's estimate of fair
market value (using a discounted cash flow method). AmHealth defaulted on a
December 1, 1995 mandatory redemption of a portion this obligation.

   On May 10, 1996, AmHealth executed a definitive agreement with CORE, Inc., a
public company, pursuant to which CORE would purchase for cash substantially all
the assets of AmHealth in a transaction expected to close by July, 1996. In
anticipation of the consummation of the foregoing transaction, in June, 1996,
the Company executed a definitive settlement agreement pursuant to which
AmHealth had agreed to pay the Company the sum of $2,050,000 (the carrying value
of the asset) and $5,287 in attorney's fees in full satisfaction of AmHealth's
obligation to the Company arising out of the sale of all of the assets and
liabilities of Occu-Care, Inc. Under the terms of the settlement agreement, the
Company agreed to extend the maturity of the note through July 31, 1996 and to
accept payment under the note simultaneously with the closing of the acquisition
of AmHealth by CORE. The Company dismissed its lawsuit against AmHealth, filed
on June 6, 1996 for breach of AmHealth's mandatory redemptive obligation on the
$2.5 million owed to the Company, without prejudice on June 26, 1996.

   In July, 1996, CORE announced that it had terminated its agreement to
purchase, for cash, substantially all of the assets of AmHealth, citing market
conditions related to a public offering of stock by CORE. Since CORE's decision
to terminate the AmHealth Agreement, the Company investigated several different
means by which to ultimately collect its monies due, as an unsecured creditor,
from AmHealth. AmHealth officials reported that AmHealth was running cash flow
positive, prior to debt service, and that it was currently negotiating with some
of its secured creditors, as well as other third parties who may have had an
interest in acquiring certain of AmHealth's assets, to determine future actions.
While the Company will vigorously pursue all of the assets to which it has a
right (approximately $2.9 million inclusive of accrued interest), in August,
1996, the Company took a $1.7 million write down of the receivable from AmHealth
to its estimated fair value.

   In November, 1996, AmHealth had its four Northern California operating
entities (three clinics and its Employee Services Division) foreclosed on by the
senior creditors. The operations were turned over to the senior creditors and
the outstanding

                                      32
<PAGE>

                           TRANSCEND SERVICES, INC.

                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                       DECEMBER 31, 1994, 1995 AND 1996

receivables for those four entities are now being collected by the creditor who
had the first lien position on all of the outstanding accounts receivable.
There are five remaining clinics under AmHealth ownership in Southern
California, all of which are generating operating profits according to AmHealth
officials.   AmHealth is in the process of trying to sell the remaining clinics
and use the proceeds from the sale to negotiate a final payout - albeit
substantially lower than the current principal amount of debt outstanding to all
of AmHealth's creditors.   With all of the information the Company has received
from AmHealth regarding the likelihood of a final payment and the potential
amount of that payment, the Company believes the carrying value of the AmHealth
receivable is properly valued on the Company's December 31, 1996 balance sheet.

4. EQUIPMENT AND LEASEHOLD IMPROVEMENTS

   The summary of office furniture and equipment at December 31, 1995 and 1996
is as follows:
<TABLE>
<CAPTION>

                                                                                     1995            1996
                                                                                ---------------  ------------
<S>                                                                           <C>                <C>
 Office equipment and furniture.............................................       $ 2,851,000   $ 4,474,000
 Less accumulated depreciation..............................................        (1,085,000)   (2,040,000)
                                                                                   -----------   -----------
                                                                                   $ 1,766,000   $ 2,434,000
                                                                                   ===========   ===========

5. INDEBTEDNESS

    Long-term debt is summarized as follows at December 31, 1995 and 1996:

                                                                                       1995          1996
                                                                                   -----------   -----------
 Note payable, interest at 8.5%; paid in full  on
   January 1, 1996..........................................................           100,000            --
  Note payable, interest at 8.5% monthly payments
   of principal and interest of 11,284 maturing
   on May 19, 2000..........................................................           490,000       392,000
  $5,000,000 revolving line of credit, interest computed
   at prime plus 0.5 percent (8.75% at December 31, 1996),
   matures April 5, 1997....................................................                --     1,870,000
  $750,000 equipment line, interest computed at prime
   plus 1 percent (9.25% at December 31, 1996),
   matures June 5, 1999.....................................................                --       248,000
  Other.....................................................................            49,000            --
                                                                                   -----------   -----------
  Total Debt................................................................           639,000     2,510,000
  Less: Current Maturities of Long-Term Debt................................          (208,000)   (2,226.000)
                                                                                   -----------   -----------
                                                                                   $   431,000   $   284,000
                                                                                   ===========   ===========
</TABLE>

    The Company expended $1,232,000 in cash to acquire the medical transcription
businesses of IDS and MTA in 1995 and, as a result, the Company issued $2.0
million in Subordinated Convertible Debt, which took place on August 15, 1995.
Key terms of the debt are:

      Interest Rate:        8%
      Interest Paid:        Semi-annually
      Term:                 Five (5) Years, due in full at maturity if not
                            converted Secured Status: Unsecured and subordinated
                            to all other indebtedness Convertible Features:
      .  Convertible for five (5) years at $3.50 per share of Transcend's common
         stock as recorded on August 15, 1995, the "Closing Price".
      .  Convertible by the Company if Transcend's common stock trades at three
         (3) times the Closing Price for 30 consecutive trading days.

Subsequent to year end, the Company entered into a new working capital facility
with Coast Business Credit which provides for maximum borrowings of $5.0 million
and is based on 1.5 times monthly contractual contract management revenues, plus
80% of all medical transcription receivables under 90 days (aging).  The
facility will have a term of two years and will be priced at prime plus 2.25%
declining to prime plus 1.75% upon two consecutive quarters of achievement and
ongoing maintenance of debt service coverage of not less than 1.5 times measured
on an EBITA basis including all principal and interest (excluding depreciation).
The facility will be secured by a first security interest on all Company assets.
The Company will use the proceeds from this facility to pay off the balance on
the $5,000,000 revolver due and equipment line.


                                      33
<PAGE>


                            TRANSCEND SERVICES, INC.

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                        DECEMBER 31, 1994, 1995 AND 1996


      SUPPLEMENTAL CASH FLOW INFORMATION

      Cash paid for interest was approximately $36,000, $56,000 and $311,000 for
the three years ended December 31, 1994, 1995 and 1996, respectively.

6. COMMITMENTS AND CONTINGENCIES

LEASE COMMITMENTS

   The Company leases certain office facilities under noncancellable operating
leases. Future minimum annual rental obligations under noncancelable operating
leases as of December 31, 1996 are as follows:
<TABLE>
<CAPTION>

<S>           <C>
1997.......................................................  $535,000
1998.......................................................   508,000
1999.......................................................   434,000
2000.......................................................   270,000
2001.......................................................    74,000
Thereafter.................................................     4,000
                                                             --------
                                                           $1,825,000
                                                           ==========
</TABLE>

   Rent expense was approximately $150,000, $443,000 and $665,000 for the
three years ended December 31 1994, 1995 and 1996, respectively.

LITIGATION

   On September 17, 1993, the Company and its 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 lawsuit
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). (See Note 2 where discussed.)

   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, Sullivan Health & Rehabilitation Management, Inc. ("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 Company's subsidiary, Sullivan, and a former
employee of Sullivan are defendants in the case.  The Plaintiff seeks
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
Sullivan 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.

                                      34
<PAGE>

                           TRANSCEND SERVICES, INC.

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                        DECEMBER 31, 1994, 1995 AND 1996

7. RETIREMENT PLAN

      The Company maintains a 401(k) retirement plan that covers substantially
all eligible employees. Employees are eligible to contribute amounts to the plan
subject to certain minimum and maximum limitations. The Company matches employee
contributions on a discretionary basis as determined by the Company's board of
directors.  For 1994, 1995 and 1996, the Company contributions totaled
approximately $17,000, $0 and $0, respectively.

8. TRANSACTIONS WITH RELATED PARTIES

      Approximately 23% of the subordinated debt (Note 4) is held by parties
related to certain members of the board of directors.

      Approximately 69% of $2.4 million in a private placement of common stock
and warrants to purchase common stock was purchased by certain members of the
Board of Directors (See Note 9).

9. SHAREHOLDERS' EQUITY

      In 1995, the Company increased the authorized common stock to 30,000,000
shares. The Company has authorized 21,000,000 shares of preferred stock, $.01
par value.

      On September 5, 1996, the Company raised $2.4 million in a private
placement of common stock and warrants to purchase common stock. A total of
522,000 shares of common stock were sold at a price of $4.44 per share and a
total of 522,000 warrants were sold at a price of $0.25 per warrant to 20
investors. The $4.44 price represents the ten day average of the closing price
of the Company's common stock prior to the board meeting approving the private
placement. The securities issued in the private placement were issued in
reliance on certain exemptions from registration under federal and state
securities laws. The warrants have a five-year term and are exercisable at a
price of $4.44 per share, are redeemable by the Company at any time with thirty
days notice (during which time the holder may exercise the warrants) at an
exercise price of $4.44 and are non-transferrable. The shares of common stock
underlying the warrants and the common stock issued in the private placement
carry piggy-back registration rights, subject to certain limitations, in the
event the Company proposes to register the sale of any of its securities for its
own account or for the account of its shareholders.

10. STOCK OPTIONS AND WARRANTS

      The Company has established a stock option plan for the employees of the
Company. The plan provides for the issuance of incentive stock options and
nonstatutory options.  Under this plan, options are granted for the Company's
common stock at the approximate fair value, as defined in the option agreement.
The following is a summary of transactions:
<TABLE>
<CAPTION>

                                            AVERAGE PRICE                                                OPTIONS       PER SHARE
------------------------------------------------------------------------------------------------------  ----------  ---------------
<S>                                                                                                     <C>         <C>
                      OPTIONS OUTSTANDING, December 31, 1993..........................................    724,000   $ .07 to $ .30
                      Forfeited.......................................................................    (31,000)            $.07
                      Exercised.......................................................................    (10,000)            $.07
                                                                                                        ---------
                      OPTIONS OUTSTANDING, December 31, 1994..........................................    683,000   $ .07 to $ .30
                      Options issued in Merger (Note 1)...............................................  1,158,000   $1.87 to $3.75
                      Granted.........................................................................    331,000   $1.87 to $5.62
                      Forfeited.......................................................................   (161,000)  $ .07 to $3.13
                      Exercised.......................................................................   (511,000)  $ .07 to $3.13
                                                                                                        ---------
                      OPTIONS OUTSTANDING DECEMBER 31, 1995...........................................  1,500,000
                      Granted.........................................................................    152,000   $4.00 to $11.38
                      Forfeited.......................................................................   (202,000)  $ .30 to $7.13
                      Exercised.......................................................................   (436,000)  $ .07 to $3.50
                                                                                                        ---------
                      OPTIONS OUTSTANDING, DECEMBER 31, 1996..........................................  1,014,000
                                                                                                        =========
                      Options eligible for exercise at December 31, 1996                                  792,000   $ .07 to $11.25
</TABLE>

      At December 31, 1996 there were a total of 631,375 shares of common stock
available for grant.

                                      35

<PAGE>

                            TRANSCEND SERVICES, INC.

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                        DECEMBER 31, 1994, 1995 AND 1996

      On April 30, 1996, the Company granted a warrant to purchase shares of its
Common Stock to Silicon Valley Bank, a California-chartered bank (the "Silicon
Valley Warrant"), in connection with two credit facilities the Company
established with Silicon Valley East, a Division of Silicon Valley Bank.  The
Silicon Valley Warrant entitles the holder to purchase an aggregate of 25,000
shares of the Company's Common Stock, subject to certain adjustments, at an
exercise price of $11.25 per share.  The Silicon Valley Warrant expires April
30, 2001.

STATEMENT OF FINANCIAL ACCOUNTING STANDARDS NO. 123

      During 1995, the Financial Accounting Standards Board issued SFAS No. 123,
"Accounting for Stock-Based Compensation," which defined a fair value-based
method of accounting for an employee stock option or similar equity instrument
and encourages all entities to adopt that method of accounting for all of their
employee stock compensation plans. However, it also allows an entity to continue
to measure compensation cost for those plans using the method of accounting
prescribed by APB Opinion No. 25, "Accounting for Stock Issued to Employees."
Entities electing to remain with the accounting methodology required by APB
Opinion No. 25 must make pro forma disclosures of net income as if the fair
value-based method of accounting defined in SFAS No. 123 was used.

      The Company has elected to account for its stock-based compensation plans
under APB Opinion No. 25, under which no compensation cost has been recognized
by the Company.  However, the Company has computed, for pro forma disclosure
purposes, the value of all options for shares of the Company's common stock
granted during 1996 and 1995 to employees and non-employee directors of the
Company using the Black-Scholes option-pricing model prescribed by SFAS No. 123
and the following weighted average assumptions:

        Risk-free interest rate              5.08% - 7.89%
        Expected dividend yield              0%
        Expected lives                       Four years
        Expected volatility                  0.70

      The total fair value of the options granted during the years ended
December 31, 1996 and 1995 was computed as approximately $517,000 and $364,000,
respectively, which would be amortized over the vesting period of the options.
If the Company had accounted for these plans in accordance with SFAS No. 123,
the Company's reported pro forma net loss for the years ended December 31, 1996
and 1995 would have been as follows:
<TABLE>
<CAPTION>

                                  1996          1995
                              ------------  ------------
<S>                           <C>           <C>
Net Loss:
  As reported                  $(7,151,000)  $(4,200,000)
  Pro forma                     (7,443,000)  (4,314,000)
Net Loss per Common Share:
  As reported                        (0.38)        (0.23)
  Pro forma                          (0.39)        (0.24)

</TABLE>

   Because SFAS No. 123 method of accounting has not been applied to options
granted prior to January 1, 1995, the resulting pro forma compensation cost may
not be representative of that to be expected in future years.

                                      36
<PAGE>

                            TRANSCEND SERVICES, INC.

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                        DECEMBER 31, 1994, 1995 AND 1996

   The following table summarized the Company's portion of stock option
transactions under the Parent Company's stock option plan.
<TABLE>
<CAPTION>
                                                  Weighted
                                                   Number     Average
                                                     of        Price
                                                   Shares    Per Share
                                                 ----------  ---------
<S>                                              <C>         <C>
      Outstanding at December 31, 1994             683,000       $0.15
       Options transferred in Merger (Note 1)    1,158,000        2.22
       Granted                                     336,000        3.55
       Forfeited                                  (161,000)       1.38
       Exercised                                  (511,000)       0.52
                                                 ---------       -----
      Outstanding at December 31, 1995           1,505,000        2.43
       Granted                                     147,000        6.79
       Forfeited                                  (202,000)       5.01
       Exercised                                  (436,000)       1.75
                                                 ---------       -----
      Outstanding at December 31, 1996           1,014,000        2.83
                                                 =========       =====

</TABLE>

   The following table sets forth the exercise price range, number of shares,
weighted average exercise price, and remaining contractual lives by groups of
similar price and grant date:
<TABLE>
<CAPTION>


                                 Number      Weighted                 Number
                              Outstanding     Average    Weighted  Exercisable   Weighted
                 Actual            at        Remaining   Average        at       Average
                Range of      December 31,  Contractual  Exercise  December 31,  Exercise
              Exercise Price      1996         Life       Price        1996       Price
----------------------------  ------------  -----------  --------  ------------  --------
<S>                           <C>           <C>          <C>       <C>           <C>

            $  0.07 - $0.30         15,339          0.3    $ 0.14        11,504     $0.14
            $    1.88-$2.94        754,500          0.7      2.02       508,125      1.99
            $    3.50-$5.75        194,500          2.4      4.12        48,625      5.05
            $  10.63-$11.38         49,500          3.4     11.00             0      0.00
               -------------     ---------          ---    ------       -------     -----
            $  0.07-$11.38       1,013,839          1.2    $ 2.83       568,254     $2.22
               =============     =========          ===    ======       =======     =====

</TABLE>

11. INCOME TAXES

   The tax effects of temporary differences between the carrying amounts of
assets and liabilities in the financial statements and their respective tax
bases, which give rise to deferred tax assets and liabilities as of December 31,
1995 and 1996 were as follows:
<TABLE>
<CAPTION>

                                        1995          1996
                                    ------------  ------------
<S>                                 <C>           <C>
Deferred tax liabilities:
Equipment and leasehold...........  $   (44,000)  $   (71,000)
Intangibles Assets................     (290,000)     (234,000)
Discontinued Operations...........     (942,000)   (1,005,000)
Equity............................           --      (263,000)
                                    -----------   -----------
                                     (1,276,000)   (1,573,000)
                                    -----------   -----------

Deferred tax assets:
Net operating loss carryforwards..    3,122,000     6,525,000
Cash-basis deferral...............      330,000       220,000
Accrued Liabilities...............      331,000       226,000
Other.............................      186,000            --
Valuation allowance...............   (3,369,000)   (6,052,000)
                                    -----------   -----------
Net deferred tax (liabilities)....  $  (676,000)  $  (654,000)
                                    ===========   ===========
</TABLE>

          At December 31, 1996, the Company had net operating loss carryforwards
of approximately $16,731,000 which can be used to reduce future income taxes. If
not utilized these carryforwards will begin to expire in 2007.  The Company has

                                      37

<PAGE>


                            TRANSCEND SERVICES, INC.

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                        DECEMBER 31, 1994, 1995 AND 1996

established a valuation allowance of $3,369,000 and $6,052,000 at December 31,
1995 and 1996, respectively due to the uncertainty regarding the realizability
of certain deferred tax assets, including its net operating loss carryforward.

12. ACQUISITIONS

          On September 30, 1994, the Company acquired substantially all of the
assets of Script-Ease, Inc., a Pittsburgh-based medical transcription business
under the terms of an asset purchase agreement for approximately $1,000,000.
The acquisition was accounted for as a purchase in accordance with APB No. 16
and accordingly the purchase price has been allocated to the net assets acquired
based on the estimated fair values as of the acquisition  date.   The majority
of the excess purchase price over net tangible assets related to customer lists,
which is being amortized over seven years and a non-compete agreement that is
being amortized over a three year period. The balance of the additional
intangibles is goodwill which is being amortized over thirty years.

          On January 10, 1995, Transcend acquired TriCare, Inc. in a merger
accounted for as a reverse merger (Note 1). The acquisition was treated as a
purchase in accordance with APB No. 16. There were approximately 7.7 million
shares issued in the transaction resulting in goodwill of approximately $3.2
million. This goodwill is being amortized over twenty years. On June 15, 1994,
TriCare had completed the acquisition of Sullivan for an adjusted purchase price
of $3,285,000. Subsequent to the Merger, the Company issued a final payment of
$285,000 in lieu of the $1,260,000 obligation which was payable in stock in
January 1995 and July 1995, to the former owners of Sullivan Health and
Rehabilitation in full satisfaction of its long-term obligation related to the
acquisition of Sullivan and gave the former owners a release from any and all
further liabilities in connection therewith.

          On January 31, 1995, the Company acquired the assets of International
Dictating Services ("IDS"), a Boston based medical transcription business for
approximately $832,000, which consisted of approximately $682,000 paid in cash
at closing with the balance payable to the sellers over the next two years. The
Company accounted for the acquisition under the purchase method of accounting.
The results of operations for IDS are included in the statement of loss of the
Company beginning on the date of acquisition. The fair value of tangible assets
acquired and liabilities assumed was $245,000 and $86,000, respectively. The
intangible related to customer lists is being amortized over seven years and a
non-compete agreement is being amortized over a two year period. The balance of
the additional intangible asset is goodwill which is being amortized over twenty
years.

          On April 19, 1995, the Company acquired the assets of Medical
Transcription of Atlanta, Inc. ("MTA") for $1,372,000, consisting of $550,000
paid in cash at closing, promissory notes of $650,000, and 60,000 shares of
Transcend common stock valued at $172,000 at the time of the acquisition. The
Company accounted for the acquisition under the purchase method of accounting.
The results of operations for MTA are included in the statement of loss of the
Company beginning on the date of acquisition. The fair value of tangible assets
acquired and liabilities assumed was $363,000 and $27,000, respectively. The
intangible related to customer lists is being amortized over seven years and a
non-compete agreement is being amortized over a three-year period. The balance
of the additional intangible is goodwill which is being amortized over twenty
years.

          On June 19, 1996, the Company acquired the stock of Greiner's Medical
Transcription, Inc. ("GMT"), a California corporation, under the pooling of
interests method of accounting. Historical financial statements have not been
restated to reflect the combined operations of Transcend and GMT as the impact
of the results was not material.  The Company issued 87,805 shares of Transcend
Common stock at the time of acquisition.  The results of operations for GMT are
included in the statement of operations beginning on the date of acquisition.

          On June 28, 1996, the Company acquired the stock of Express Medical
Transcription, Inc. ("EMT"), a Utah corporation, under the pooling of interests
method of accounting.  Financial statements have been restated to reflect the
combined

                                      38

<PAGE>

                            TRANSCEND SERVICES, INC.

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                        DECEMBER 31, 1994, 1995 AND 1996

operations of Transcend and EMT.  The Company issued 230,000 shares of Transcend
common stock at the time of acquisition.

        The following pro-forma amounts presented below represent the results of
operations (excluding discontinued operations) of the Company adjusted to
include TriCare, Script-Ease, Inc. and MTA as if these transactions had been
consummated at the beginning of each period presented.
<TABLE>
<CAPTION>

                                                     YEAR ENDED DECEMBER 31
                                                    ------------------------
                                                       1995          1996
                                                    -----------  ------------
<S>                                     <C>                      <C>
 (UNAUDITED)
 Sales.................................             $28,554,000   $38,531,000
 Net Loss from  Continuing Operations..             $(3,586,000)  $(5,460,000)
 Net Loss per Common Share.............                  ($0.20)       ($0.29)
 Weighted Average Shares Outstanding                 18,154,000    18,908,000

</TABLE>

13.  SIGNIFICANT CUSTOMERS

          During 1994, Tulane University Hospital and Clinic, Memorial Medical
Center of Jacksonville, Greater Southeast Community Hospital, and Good Samaritan
Hospital made up 16%, 15%, 15%, and 14%, respectively of the Company's net
revenue. No individual customer made up greater than 10% of net revenue during
1995 and 1996.

                                      39
<PAGE>


ITEM 9.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
         FINANCIAL DISCLOSURE

         There has been no occurrence requiring a response to this item.

                                   PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

         The following table sets forth certain information regarding executive
officers and directors of the Company:
<TABLE>
<CAPTION>

                               NAME                                  AGE                  POSITION WITH THE COMPANY
-------------------------------------------------------------------  ---  ----------------------------------------------------------

<S>                                                                  <C>  <C>

Larry G. Gerdes                                                       48  President, Chief Executive Officer and Director
G. Scott Dillon                                                       46  Executive Vice President Outsourcing Services
Todd S. Mann                                                          43  Executive Vice President Services Group;
                                                                          President and CEO Sullivan Health
                                                                          Management Services, Inc.
David W. Murphy                                                       39  Executive Vice President Finance, Chief Financial Officer,
                                                                          Secretary and Treasurer
Donald L. Lucas                                                       67  Chairman of the Board
George B. Caldwell                                                    66  Director
Walter S. Huff, Jr                                                    62  Director
Charles E. Thoele                                                     61  Director
</TABLE>
DIRECTORS AND EXECUTIVE OFFICERS

          The following persons serve as the directors and executive officers of
the Company:

          Mr. Gerdes has served as a director of the Company since June 1985 and
as its President and Chief Executive Officer since May 1993. From 1991 to 1993,
Mr. Gerdes was a private investor and from May 1992 until the Merger Mr. Gerdes
was the Chairman of the Board of Directors of the former Transcend Services,
Inc. For the five years prior to 1991, Mr. Gerdes held various executive
positions with HBO & Company, a provider of information services to the
healthcare industry, including Chief Financial Officer and Executive Vice
President. Mr. Gerdes also serves as a Director of and Aksys, Ltd. and  Delphi
Information Systems, Inc.

          Mr. Dillon has served as the Company's Executive Vice President
Outsourcing Services since December 1996 and prior to that served as Chief
Development Officer since September 1995. From September 1992 to August 1995,
Mr. Dillon served as Executive Vice President and Chief Development Officer for
Coastal Physician Services. Prior to Coastal Physician Services, Mr. Dillon
served as Executive Vice President and Chief Operating Officer of the Fisher
Mangold Group from January 1991 to September 1992. Mr. Dillon's 17 years in the
healthcare industry also includes his service in various senior sales and
marketing positions with ARAMARK, Inc., EmCare Holdings and the Patient Care
Products division of Proctor and Gamble. Mr. Dillon is active in various
professional organizations including, the American Hospital Association, the
Healthcare Financial Management Association and the Center for Health
Information Management.

          Mr. Mann joined the Company in August 1996 as President and CEO of its
Sullivan Health Management Services division. In December 1996, he was named
Executive Vice President Services Group of Transcend with added responsibilities
for its consulting services, inclusive of its Data Delivery Center initiative.
From 1985 until joining Transcend, Mr. Mann served as Senior Vice President of
International Banking Technologies, which is recognized as creating the concept
of placing full-service bank branches in supermarkets, an $80.0 million company
Mr. Mann helped start in 1985.

          Mr. Murphy has served as the Company's Executive Vice President
Finance and Chief Financial Officer since December 1996 and prior to that served
as Chief Financial Officer since May 1995. Mr. Murphy joined the Company in
September 1994 as Vice-President of Acquisitions. Prior to joining the Company,
Mr. Murphy was a founder and General Partner of an investment company and served
in various financial, operating and mergers and acquisition positions with
companies such as Hutchinson SA (France), First Boston and International Paper
Company.

                                      40


<PAGE>

          Mr. Lucas has served as a director of the Company since December 1985
and has served as Chairman since August 1989. Mr. Lucas has been a venture
capitalist for more than 25 years. Mr. Lucas also serves on the boards of
directors of Amati Communications Corporation; Cadence Design Systems, Inc.;
Coulter Pharmaceutical, Inc.; Macromedia, Inc.; Oracle Corporation;  Racotek,
Inc. and Tricord Systems, Inc.

          Mr. Caldwell is presently the Chairman of The Collier Company, a
healthcare consulting company in Park Ridge, Illinois. He served as President
and Chief Executive Officer and President Emeritus of the Lutheran General
Health Care System in Park Ridge, Illinois, from 1979 to 1995.  Prior to 1979,
Mr. Caldwell served as the President and Chief Executive Officer of The Greater
Southeast Community Hospital Foundation of Washington, D. C., and as President
and Chief Executive Officer of Lake Forest Hospital, Lake Forest, Illinois.  Mr.
Caldwell is presently Chairman of The Hunter Group and a Director and Chairman
of the Executive Committee of MMI Companies.

          Mr. Huff has served as a director of the Company since October 1993.
Mr. Huff was the founder of HBO & Company, a provider of information services to
the healthcare industry and served as its Chairman from 1974 until 1990 and
Chief Executive Officer from 1974 to 1984 and from 1986 until 1989. Since 1990,
Mr. Huff has been a private investor.

          Mr. Thoele has served as a director of the Company since October 1993.
Mr. Thoele has been a consultant to Sisters of Mercy Health Systems since
February 1991. From 1986 to February 1991, he served as a director and the Chief
Operating Officer of Sisters of Mercy Health Systems. Mr. Thoele is currently
Chairman of the Catholic Hospital Association. Mr. Thoele is also a Director of
HBO & Company.

          There are no family relationships between any director or executive
officer and any other director or executive officer of the Company.

BOARD OF DIRECTORS

          The Board of Directors of the Company currently consists of five
persons. The Company's By-Laws provide that the Board of Directors shall consist
of not less than one person, the precise number to be determined from time to
time by the Board of Directors or shareholders of the Company. The directors are
elected annually by the shareholders of the Company and serve for a term of one
year, or until their earlier resignation, removal from office or death. The
executive officers of the Company are elected annually by the Board of Directors
and serve for a term of one year, or until their earlier resignation, removal
from office or death.

          The Company's Board of Directors has two standing committees--the
Audit and Finance Committee and the Stock Option and Compensation Committee. The
Audit and Finance Committee, which is comprised of Messrs. Lucas and Huff, has
been assigned the principal functions of: (i) recommending the independent
auditors; (ii) reviewing and approving the annual report of the independent
auditors; (iii) approving the annual financial statements; and (iv) reviewing
and approving summary reports of the auditor's findings and recommendations. The
Stock Option and Compensation Committee, which is comprised of Messrs. Huff and
Thoele, has been assigned the functions of administering the Company's 1992
Stock Option Plan, as amended and making recommendations concerning the
establishment of additional employee benefit plans and compensation for the
Company's executive officers.

SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE

          Section 16(a) of the Securities Exchange Act of 1934 requires the
Company's directors, executive officers and persons who own more than 10% of the
outstanding common stock of the Company, to file with the Securities and
Exchange Commission reports of changes in ownership of the common stock of the
Company held by such persons. Officers, directors and greater than 10%
shareholders are also required to furnish the Company with copies of all forms
they file under this regulation. To the Company's knowledge, based solely on a
review of the copies of such reports furnished to the Company and
representations that no other reports were required during the year ended
December 31, 1996, all Section 16(a) filing requirements applicable to its
officers, directors and greater than 10% shareholders were complied with except
Todd Mann, an executive officer of the Company, failed to file his initial
Statement of Beneficial Ownership of  Securities on Form 3 within ten days of
becoming an executive officer of the Company.


                                      41
<PAGE>

ITEM 11. EXECUTIVE COMPENSATION

          The following table provides certain summary information for the
fiscal years ended December 31, 1994, 1995 and 1996 concerning compensation paid
or accrued by the Company to or on behalf of the Company's Chief Executive
Officer and the other executive officers of the Company whose total annual
salary and bonus exceeded $100,000 during the year ended December 31, 1996 (the
"Named Executive Officers").

                           SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
                                                                                LONG-TERM
                                                                              COMPENSATION
                                                                               SECURITIES
                                                                               UNDERLYING
NAME AND PRINCIPAL POSITION              YEAR(1)       SALARY($)  $BONUS($)  OPTIONS/SAR'S(#)
--------------------------------------  ---------      --------  --------   -----------------
<S>                                     <C>           <C>        <C>        <C>
Larry G. Gerdes.......................   12/31/96     $ 210,115  $     --           --
President and Chief Executive.........   12/31/95       205,376        --           --
 Officer..............................   12/31/94       116,700        --           --

Julian L. Cohen (2)...................   12/31/96     $ 205,000        --           --
Chief Operating Officer...............   12/31/95       193,756        --         45,000
                                         12/31/94     $  39,600        --        100,000

G. Scott Dillon (3)...................   12/31/96     $ 191,932        --           --
Executive Vice President Outsourcing..   12/31/95        59,599        --         60,000
 Services.............................   12/31/94            --        --           --
David W. Murphy.......................   12/31/96     $ 120,000  $     --           --
Executive Vice President Finance,.....   12/31/95       100,130    22,675         40,000
 Chief Financial Officer,.............   12/31/94        28,385        --         20,000
 Treasurer and Secretary
</TABLE>
--------
(1)  The fiscal year ended December 31, 1994 was for a seven month period.
(2)  Mr. Cohen's employment with the Company was terminated in November 1996.
(3)  The 1996 compensation listed above includes $32,182 in commissions paid
     based on achieving certain 1996 sales objectives.

COMPENSATION OF DIRECTORS

         Directors of the Company who are compensated as officers of the Company
serve without compensation for their services as directors. Each director of the
Company who is not a compensated officer of the Company is paid a fee of $8,000
per annum. Each person who first becomes a non-employee director is granted, as
of the date such person becomes a director of the Company, an option to purchase
10,000 shares of Common Stock. Each non-employee director will be granted an
option to purchase 6,000 shares of the Common Stock, except the Chairman who
will be granted an option to purchase 9,000 shares, upon election or re-election
at the annual meeting of shareholders provided they have served on the board a
minimum of six months.

COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION

         The following persons served as members of the Stock Option and
Compensation Committee of the Board of Directors during the year ended December
31, 1996: Walter J. Huff, Jr. and Charles E. Thoele. None of the members of the
Stock Option and Compensation Committee has been an officer or employee of the
Company.

         On September 5, 1996, the Company raised $2.4 million in a private
placement of common stock and warrants to purchase common stock. A total of
522,000 shares of common stock were sold at a price of $4.44 per share and a
total of 522,000 warrants were sold at a price of $0.25 per warrant to 20
investors. Participating in this private placement were Walter S. Huff, Jr., a
director of the Company, who purchased 225,225 shares at $4.44 per share and
warrants to purchase an additional 225,225 shares at $.25 per warrant and
Charles E. Thoele, a director of the Company, who purchased 11,261 shares at
$4.44 per share and warrants to purchase an additional 11,261 shares at $.25 per
warrant. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations--Liquidity and Capital Resources."

                                      42


<PAGE>

STOCK OPTION PLAN

         The Company has adopted a 1992 Stock Option Plan, as amended (the
"Plan") for selected employees and directors who are not employed by the Company
("Non-Employee Directors"). The Plan is administered by the Stock Option and
Compensation Committee of the Board of Directors. The Plan was amended at a
special meeting of shareholders held on June 5, 1996, increasing the number of
shares reserved for issuance under the Plan by 400,000 shares such that the Plan
currently provides for the grant of incentive and non-qualified stock options to
purchase up to 2,000,000 shares of Common Stock.

         Under the terms of the Plan, the Stock Option and Compensation
Committee may determine the employees to whom options will be granted, the time
or times of exercise, the number of shares subject to an option and the terms
and conditions of each stock option agreement. The Stock Option and Compensation
Committee also determines whether an option is an incentive stock option or a
non-qualified stock option. The price per share of stock subject to an incentive
stock option must equal 100% of the fair market value thereof on the date of
grant. The price per share of stock subject to a non-qualified stock option is
to be determined by the Stock Option and Compensation Committee and may be less
than fair market value. The exercise period for an incentive stock option cannot
exceed ten years, while there is no limitation with respect to non-qualified
stock options. In addition, the Stock Option and Compensation Committee cannot
grant an incentive stock option to any person who owns at least 10% of the
outstanding Common Stock unless the price is 110% of fair market value and the
option exercise period does not exceed five years.

         The Plan also provides for non-discretionary or automatic grants of
options to Non-Employee Directors. See "Executive Compensation--Compensation of
Directors." The price of Common Stock subject to a Non-Employee Director option
is the fair market value on the date of grant, except that the price of Common
Stock subject to options granted on March 16, 1992 was the fair market value on
October 14, 1992, the date the Plan was approved by the shareholders of the
Company. Each Non-Employee Director option must conform to the provisions of the
Plan. Non-Employee Director options become exercisable six months from the date
of grant and expire ten years from the date of grant. Moreover, in the event a
Non-Employee Director terminates membership on the Board for any reason, an
option held by him may be exercised until the earlier of the expiration of the
option or 12 months from the date of termination.

         As of March 1, 1997, options to purchase a total of 1,095,500 shares of
Common Stock were outstanding at a weighted average exercise price of $2.95 per
share. In addition, as of March 1, 1997, options to purchase a total of  4,680
shares of Common Stock were outstanding under the former Transcend Services,
Inc. stock option plan at a weighted average exercise price of $.30 per share.
During fiscal 1996, no options were granted under the Plan to the Named
Executive Officers.

         During fiscal 1996, no options were granted under the Plan to the Named
Executive Officers.  The following table sets forth certain information
concerning the unexercised stock options held by the Named Executive Officers.

  AGGREGATED OPTION EXERCISES IN FISCAL 1996 AND FISCAL YEAR END OPTION VALUES

                                 VALUE OF UNEXERCISED OPTIONS AT FISCAL YEAR END
                                 -----------------------------------------------
<TABLE>
<CAPTION>
                                                                   NUMBER                     VALUE OF
                                                                OF SECURITIES               UNEXERCISED(1)
                                                                  UNDERLYING             IN-THE-MONEY OPTIONS
                                 SHARES                          EXERCISED                   AT FY-END($)
                                ACQUIRED      VALUE          OPTIONS AT FY-END               IN-THE-MONEY
NAME                           ON EXERCISE   REALIZED     EXERCISABLE/UNEXERCISABLE     EXERCISABLE/UNEXERCISABLE
----                           -----------   --------     -------------------------     -------------------------
<S>                            <C>           <C>          <C>                           <C>
Larry G. Gerdes............       100,000    $256,200          616,000 /   --            $    2,011,200 /   --
Julian L. Cohen (2)........        63,500     341,800            --  /     --                    --     /   --
G. Scott Dillon............         7,500      15,000          7,500 / 45,000            $   13,125 / $ 78,750
David W. Murphy............            --          --         20,000 / 40,000            $   56,875 / $103,125
</TABLE>
--------
(1) Dollar values calculated by determining the difference between the fair
    market value of the underlying securities at December 31, 1996 ($5.25 per
    share) and the aggregate exercise price of the options.

(2)  All unexercised options held by Mr. Cohen were canceled upon Mr. Cohen's
     departure from the Company in November, 1996.

EMPLOYEE RETIREMENT SAVINGS PLAN

  The Company has established a savings and retirement plan that qualifies as a
tax-deferred savings plan under Section 401(k) of the Internal Revenue Code (the
"401(k) Plan") for its salaried, clerical and hourly employees. Under the 401(k)
Plan, eligible employees may contribute up to $9,500 of their gross salary to
the 401(k) Plan in 1996. Each participating employee is fully vested in
contributions made by such employee. The Company presently matches 10% of the
amount contributed by

                                      43


<PAGE>

an employee up to 6% of the employee's salary, but the Company's policy
regarding matching contributions may be changed annually in the discretion of
the Board of Directors. All amounts contributed under the 401(k) Plan are
invested in one or more investment accounts administered by an independent plan
administrator.

EMPLOYEE STOCK PURCHASE PLAN

  The Company has adopted a 1990 Employee Stock Purchase Plan, as amended (the
"Stock Purchase Plan"). The purpose of the Stock Purchase Plan is to provide an
incentive for employees of the Company and its subsidiaries to acquire or
increase their proprietary interests in the Company through the purchase of
shares of Common Stock of the Company. The Stock Purchase Plan is administered
by the Board of Directors of the Company, which has the authority to interpret
the Stock Purchase Plan, to prescribe, amend and rescind rules and regulations
relating to it and to establish the terms of each offering of Common Stock under
the Stock Purchase Plan. All employees of the Company are eligible to
participate in the Stock Purchase Plan with certain limited exceptions.

  Participants may direct the deduction of a specified percentage, as set by the
Board of Directors, from their eligible compensation to be used to purchase
Common Stock under the Stock Purchase Plan. The terms of the Stock Purchase Plan
provide for two six month offering periods each calendar year in which eligible
employees may elect to participate. At the end of each offering period, the
Company uses the accumulated payroll deductions to purchase Common Stock for the
participant. The price of Common Stock purchased with such payroll deductions
during each offering period shall be the lesser of: (i) 85% of the mean between
the bid and asked prices of the Common Stock at the beginning of each offering;
or (ii) 85% of the mean between the bid and asked prices of the Common Stock on
the last day of such offering period.

  The Company will not grant to any participant any right to purchase Common
Stock under the Stock Purchase Plan if the exercise of such right would cause
such participant to own 5% or more of the combined voting power or value of all
classes of the Company's capital stock. In addition, an employee may not
participate if such participation would permit the employee to purchase stock
under all employee stock purchase plans of the Company and its subsidiaries to
accrue at a rate which exceeds $25,000 of the fair market value of the stock for
each calendar year in which an option to purchase stock under the plan is
outstanding at any time.

  An aggregate of 225,000 shares of Common Stock have been reserved for issuance
under the Stock Purchase Plan.

                                      44

<PAGE>



ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

  The following tables sets forth information regarding the beneficial
ownership of the Common Stock as of March 1, 1997, with respect to (i) each
person known by the Company to own beneficially more than 5% of the outstanding
shares of Common Stock, (ii) each of the Company's directors, (iii) each of the
Named Executive Officers, and (iv) all directors and executive officers as a
group. Unless otherwise indicated, each of the stockholders has sole voting and
investment power with respect to the shares beneficially owned.
<TABLE>
<CAPTION>


                                                    AMOUNT AND
                                                    NATURE OF
  NAME AND ADDRESS                                  BENEFICIAL     PERCENT OF
  OF BENEFICIAL OWNER                             OWNERSHIP/(1)/   CLASS/(1)/
----------------------                          -----------------  ---------------
<S>                                            <C>                 <C>
  Gerdes Huff Investments...............        3,500,001/(2)/     17.953%
  3353 Peachtree Road, N.E, Suite 1030
  Atlanta, Georgia 30326

  Donald L. Lucas.......................          532,145/(3)/      2.729%

  Larry G. Gerdes.......................       4,688,001/(4)/      24.047%
  3353 Peachtree Road, N.E, Suite 1000
  Atlanta, Georgia 30326

  George B. Caldwell....................        112,767/(5)/            *%

  Walter S. Huff, Jr....................      4,824,765/(6)/       24.748%
  3353 Peachtree Road, N.E, Suite 1000
  Atlanta, Georgia 30326

  Charles E. Thoele.....................         64,180/(7)/            *%

  Julian L. Cohen.......................         32,034/(8)/            *%

  G. Scott Dillon.......................          7,750/(9)/            *%

  David W. Murphy.......................        31,146/(10)/            *%

 All Directors and Officers as a group
  ( 8 persons)                               6,760,753/(11)/       34.679%
-------------------
</TABLE>

*   Represents less than 1%

/(1)/ "Beneficial Ownership" includes shares for which an individual, directly
or indirectly, has or shares voting or investment power or both and also
includes shares of Common Stock underlying options and warrants to purchase
Common Stock which are exercisable within sixty days of the date hereof.
Beneficial ownership as reported in the above table has been determined in
accordance with Rule 13d-3 of the Securities Exchange Act of 1934. The
percentages are based upon 19,495,202 shares outstanding as of March 1, 1997,
except for certain parties who hold presently exercisable options or warrants to
purchase Common Stock. The percentages for those parties who hold presently
exercisable options or warrants are based upon the sum of 19,495,202 shares plus
the number of shares subject to presently exercisable options or warrants held
by them, as indicated in the following notes. Unless otherwise indicated, each
person has sole voting and dispositive power with respect to all shares listed
opposite his name.
/(2)/ Such shares are owned of record by Gerdes Huff Investments, a general
partnership the sole general partners of which are Messrs. Gerdes and Huff. As a
result, each of Messrs. Gerdes and Huff are deemed the beneficial owner of all
of such shares.
/(3)/ Includes 410,664 held by the Donald L. Lucas and Lygia S. Lucas Trust
dated December 3, 1984, of which Mr. Donald L. Lucas is trustee; 35,000 shares
held by the Donald L. Lucas Profit Sharing Trust of which Mr. Lucas is Successor
Trustee; 21,481 shares held by the Donald L. Lucas Remuneration Account dated
July 7, 1993 and 65,000 shares which Mr. Lucas has the right to acquire pursuant
to presently exercisable stock options. Excludes certain shares and shares
underlying warrants with respect to which Mr. Lucas disclaims beneficial
ownership which were purchased by the Richard M. Lucas Cancer Foundation in the
Company's private placement dated September 5, 1996 and 71,500 shares which may
be acquired upon the conversion of an 8% Convertible Debenture also held by the
Richard M. Lucas Cancer Foundation, of which Mr. Lucas is the Chairman.
/(4)/ Includes 3,500,001 shares held by Gerdes Huff Investments, a general
partnership of which Mr. Gerdes is a general partner; 93,600 shares held by Mr.
Gerdes' spouse; 94,155 shares held by Mr. Gerdes as custodian for his minor
children; and 616,000 shares purchasable pursuant to presently exercisable stock
options.
/(5)/ Includes 22,522 shares subject to presently exercisable warrants to
purchase Common Stock and 16,000 shares which Mr. Caldwell has the right to
acquire pursuant to presently exercisable stock options.
/(6)/ Includes 3,500,001 shares held by Gerdes Huff Investments, a general
partnership of which Mr. Huff is a general partner; 62,650 shares held by Laumar
Corporation which is wholly owned by Mr. Huff; 100,000 shares held by Laumar
Investment Partnership which is wholly owned by Mr. Huff; 28,000 shares
purchasable pursuant to presently exercisable options; 225,225 shares subject to
presently execisable warrants to

                                      45

<PAGE>

      purchase Common Stock and 56,300 shares held by the Larry G. Gerdes Trust
      of which Mr. Huff is the trustee. Excludes 57,200 shares with respect to
      which Mr. Huff disclaims beneficial ownership and which may be acquired
      upon the conversiom of an 8% Convertible Debenture held by the Walter S.
      Huff, Jr. Charitable Foundation, of which Mr. Huff's adult children are
      trustees.
/(7)/ Includes 11,261 shares subject to presently exercisable warrants to
      purchase Common Stock and 28,000 shares purchasable pursuant to presently
      exercisable stock options.
/(8)/ Mr. Cohen's employment with the Company terminated in November, 1996.
/(9)/ Includes 250 shares held by Mr. Dillon as custodian for his minor
      children; 7,500 shares purchasable pursuant to presently exercisable
      options.
/(10)/Includes 27,500 shares purchasable pursuant to presently exercisable
      options.
/(11)/Includes 788,000 shares subject to presently exercisable stock options and
      259,008 shares subject to presently exercisable warrants.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

  In September 1994, the Company loaned the sum of $80,000 to Julian L. Cohen,
the former Chief Operating Officer of the Company, which was used by Mr. Cohen
to purchase his residence. The loan to Mr. Cohen was in the form of a promissory
note for the principal sum of $80,000, bearing interest at 7 3/4% per annum,
payable on each January 1, April 1, July 1 and October 1, commencing on January
1, 1995, with the principal due in one lump sum on September 30, 1999.  The note
was secured by Mr. Cohen's right to purchase shares of the Company's Common
Stock pursuant to the Company's 1992 Stock Option Plan, as amended, and the
shares of Common Stock underlying such rights.  On November 8, 1996, Mr.
Cohen repaid the $80,000 outstanding through the exercise of 33,500 options.
The Company waived the payment of interest on this Note.

  On September 5, 1996, the Company raised $2.4 million in a private placement
of Common Stock and warrants to purchase Common Stock. A total of 522,000 shares
of Common Stock were sold at a price of $4.44 per share and a total of 522,000
warrants were sold at a price of $0.25 per warrant to 20 investors. Certain
Directors of the Company and parties affiliated with Directors of the Company
purchased shares and warrants in this offering as follows: 22,522 shares and
warrants to purchase an additional 22,522 shares were purchased by Mr. George B.
Caldwell; 225,225 shares and warrants to purchase an additional 225,225 shares
were purchased by Mr. Walter S. Huff, Jr.; 11,261 shares and warrants to
purchase an additional 11,261 shares were purchased by Mr. Charles E. Thoele;
and 50,675 shares and warrants to purchase an additional 50,675 shares were
purchased by the Richard M. Lucas Cancer Foundation, of which Mr. Donald L.
Lucas is Chairman, and over which Mr. Lucas disclaims beneficial ownership. The
$4.44 price represents the ten day average of the closing price of the Company's
Common Stock prior to the board meeting approving the private placement. The
securities issued in the private placement were issued in reliance on certain
exemptions from registration under federal and state securities laws. The
warrants have a five-year term and are exercisable at a price of $4.44 per
share, are redeemable by the Company at any time with thirty days notice (during
which time the holder may exercise the warrants) at an exercise price of $4.44
and are non-transferrable. The shares of Common Stock underlying the warrants
and the Common Stock issued in the private placement carry piggy-back
registration rights, subject to certain limitations, in the event the Company
proposes to register the sale of any of its securities for its own account or
for the account of its shareholders.

  See "Item 11.  Executive Compensation--Compensation Committee Interlocks and
Insider Participation" which describes certain transactions between the Company
and Walter S. Huff, Jr., a director of the Company, between the Company and
Larry G. Gerdes, an executive officer and director of the Company and between
the Company and Charles E. Thoele, a director of the Company.

                                      46
<PAGE>

                                   PART IV

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.

  (a) The following documents are filed as a part of this Annual Report for
      Transcend Services, Inc.:

  (1) Financial Statements

     The Consolidated Financial Statements, the Notes to Consolidated Financial
     Statements and the Report of Independent Public Accountants listed below
     appear as Item 8.

     Report of Independent Public Accountants.

     Consolidated Balance Sheets as of December 31, 1995 and 1996

     Consolidated Statements of Operations for the years ended December 31,
     1994,1995 and 1996

     Consolidated Statements of Shareholder's Equity for the years ended
     December 31, 1994, 1995 and 1996

     Consolidated Statements of Cash Flows for the years ended December 31,
     1994, 1995 and 1996

     Notes to Consolidated Financial statements

     No financial statement schedules are required

  (b) Reports on Form 8-K.   No reports on Form 8-K have been filed by the
      Company during the fourth quarter of fiscal 1996.

  (c) Exhibits.
  --------

  The following exhibits are filed with or incorporated by reference into this
report. The exhibits which are denoted by an asterisk (*) were previously filed
as a part of, and are hereby incorporated by reference from, either (i) a
Registration Statement on Form S-1 under the Securities Act of 1933 for the
Company, Registration No. 33-32587, filed on December 14, 1989 (referred to as
"1989 S-1"); (ii) a Registration Statement on Form S-1 under the Securities Act
of 1933 for the Company, Registration No. 33-41361, filed on June 26, 1991
(referred to as "1991 S-1"); (iii) a Registration Statement on Form S-4 under
the Securities Act of 1933 for the Company, Registration No. 33-83344, filed on
December 2, 1993 (referred to as "S-4"); (iv) a Registration Statement on Form
S-3 under the Securities Act of 1933 for the Company, Registration No. 333-
19177, filed on January 2, 1997 (referred to as "S-3"); (v) a Registration
Statement on Form S-8 under the Securities Act of 1933 for the Company,
Registration No. 33-37685, filed on November 8, 1990 (referred to as "1990 S-
8"); (vi) a Registration Statement on Form S-8 under the Securities Act of 1933
for the Company, Registration No. 33-57072, filed on January 15, 1993 (referred
to as "1993 S-8"); (vii) a Registration Statement on Form S-8 under the
Securities Act of 1933 for the Company, Registration No. 333-16213, filed on
November 15, 1996 (referred to as "1996 S-8"); (viii) the Company's Current
Report on Form 8-K relating to an event which occurred on March 1, 1992
(referred to as "3/1/92 8-K"); (ix) the Company's Current Report on Form 8-K
relating to an event which occurred June 15, 1994 (referred to as "6/15/94 8-
K"); (x) the Company's Current Report on Form 8-K relating to an event which
occurred September 16, 1994 (referred to as "9/16/94 8-K"); (xi) the Company's
Annual Report on Form 10-K for the year ended May 31, 1990 (referred to as "1990
10-K"); (xii) the Company's Annual Report on Form 10-K for the year ended May
31, 1992 (referred to as "1992 10-K"); (xiii) the Company's Annual Report on
form 10-K for the year ended May 31, 1993 (referred to as "1993 10-K"); (xiv)
the Company's Quarterly Report on Form 10-Q for the quarter ended November 30,
1995 (referred to as "11/30/95 10-Q"); and (xv) the Company's Quarterly Report
on Form 10-Q for the quarter ended June 30, 1995 (referred to as "6/30/95 10-
Q"); and (xvi) Amendment No. 1 to the Company's Quarterly Report on Form 10-Q
for the quarter ended September 30, 1996 (referred to as "9/30/96 10-Q/A No. 1".

                                      47

<PAGE>

EXHIBIT
NO.      DESCRIPTION
---      -----------

*2.1  -  Acquisition of Industrial Plus Health Network, Inc. by Occu-Care, Inc.
      (3/31/92 8-K, Exhibit 2(a))

*2.2  - Stock Purchase Agreement between TriCare, Inc., and Dorothy C. Sullivan
      and Timothy Sullivan for the purchase and sale of all issued and
      outstanding capital stock of Sullivan Health & Rehabilitation Management,
      Inc. (6/15/94 8-K, Exhibit 2(a))

*2.3  - Asset Acquisition Agreement, executed on September 16, 1994 by and among
      Occu-Care, Inc. ("OCI"), a wholly owned subsidiary of TriCare, Inc.,
      Industrial PlusHealth Network, a wholly-owned subsidiary of OCI, together
      with AmHealth, Inc. (9/16/94 8-K, Exhibit 2(a))

*2.4  - Agreement and Plan of Merger dated as of May 13, 1994 by and among
      TriCare, Inc., First Western Health Corporation and Transcend Services,
      Inc., as amended (included as Appendix A to the Prospectus contained in
      Part I of the S-4)

*2.5  - Letter Agreement, dated December 30, 1994, between AmHealth, Inc. and
      Occu-Care, Inc. to exchange AmHealth Inc. convertible redeemable preferred
      stock for the existing junior promissory notes held by Occu-Care and
      issued by AmHealth (11/30/95 10-Q, Exhibit 2(a))

*3.1.1 - Certificate of Incorporation, as amended (1989 S-1, Exhibit 3(a))

*3.1.2 - Certificate of Incorporation (6/30/95 10-Q, Exhibit 3)

*3.2  -  Bylaws (as restated) (1993 10-K, Exhibit 3(a))

*4.1  -  1990 Employee Stock Purchase Plan (1990 S-8, Exhibit 4)

*4.2  -  1992 Stock Option Plan, as amended (1993 S-8, Exhibit 4(a))

*4.3   - 1992 Stock Option Plan, as Amended and Restated (1996 S-8, Exhibit 4.1)

*4.4  -  Subordinated Convertible Debenture Purchase Agreement (9/30/95 10-Q,
         Exhibit 4)

*4.5  -  1986 Incentive Stock Option Plan, as amended (1989 S-1, Exhibit 10(i))

*4.6   - Loan and Security Agreement, $5,000,000 Working Capital Line and
         $750,000 Equipment Line, provided by Silicon Valley Bank to Transcend
         Services, Inc. (9/30/96 10-Q/A No. 1, Exhibit 4.1)

*4.7   - Working Capital Note (9/30/96 10-Q/A No. 1, Exhibit 4.2)

*4.8   - Equipment Term Note (9/30/96 10-Q/A No. 1, Exhibit 4.3)

*4.9   - Warrant to Purchase Common Stock (9/30/96 10-Q/A No. 1, Exhibit 4.4)

*4.10 -  Silicon Valley Bank Antidilution Agreement (9/30/96 10-Q/A No. 1,
         Exhibit 4.5)

*4.11 -  Silicon Valley Registration Rights Agreement (9/30/96 10-Q/ No. 1,
         Exhibit 4.6)

*10.1  - Form of Non-qualified Stock Option Agreement (1989 S-1, Exhibit
         10(g))

*10.2  - Form of Incentive Stock Option Agreement (1989 S-1, Exhibit 10(j))

                                      48

<PAGE>

*10.3  - Form of Incentive Stock Option Agreement under 1992 Stock Option
         Plan, as Amended and Restated (1996 S-8, Exhibit 4.2)

*10.4  - Restated Rental and Management Agreement between First Western Health
         Corporation and FWHC Medical Group, Inc. dated January 17, 1990 (1989
         S-1, Exhibit 10(l))

*10.5  - Form of Covenants Not to Compete between Occu-Care and each of the
         other parties to the Acquisition Agreement (1990 10-K, Exhibit
         10(c))

*10.6  - Management Agreement between Veritas Healthcare Management and
         Veritas Medical Group, Inc. dated as of January 1, 1991 (1991 S-1,
         Exhibit (10(b))

*10.7  - Rental and Management Agreement between Occu-Care, Inc. and Occu-
         Care Medical Group, Inc. dated as of May 31, 1990, as amended (1991
         S-1, Exhibit 10(a))

*10.8  - Rental and Management Agreement between Occu-Care, Inc. and Del Amo
         Industrial Medical Clinic dated as of March 1, 1992 (1992 10-K, Exhibit
         10(a))

*10.9  - Form of indemnification agreement (1993 10-K, Exhibit 10(a))

*10.10 - Letter Agreement dated December 5, 1996 by and between the Company and
         VHA, Inc. (S-3, Exhibit 10.1)

*10.11-  Services Agreement dated December 5, 1996 by and between the Company
         and VHA, Inc. (S-3, Exhibit 10.2)

 11   -  Statement re: Computation of earnings per share


 21.1 -  Subsidiaries of the Registrant

 23   -  Consent of Arthur Andersen LLP

 27   -  Financial Data Schedule (for SEC use only)

                                      49

<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, thereunto duly authorized.


                                                    TRANSCEND SERVICES, INC.


Dated: March 27, 1996           By:/s/ Larry G. Gerdes
                                   ---------------------------
                                   Larry G. Gerdes
                                   President
                                   and Chief Executive Officer

  Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated:

      SIGNATURE                        TITLE                     DATE



/s/ Donald L. Lucas          Chairman of the Board            March 27, 1997
--------------------------
Donald L. Lucas


/s/ Larry G. Gerdes          President, Chief Executive       March 27, 1997
--------------------------   Officer and Director
Larry G. Gerdes              (Principal Executive Officer)


/s/ David W. Murphy          Executive Vice President         March 27, 1997
--------------------------   Finance, Chief Financial Officer,
David W. Murphy              Treasurer and Secretary
                             (Principal Financial Officer)


/s/ George B. Caldwell       Director                         March 27, 1997
--------------------------
George B. Caldwell


/s/ Walter S. Huff, Jr.      Director                         March 27, 1997
--------------------------
Walter S. Huff, Jr.



/s/ Charles E. Thoele        Director                         March 27, 1997
--------------------------
Charles E. Thoele


                                      50