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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
|- | ------------------------------------------------------------------------------------



For the fiscal year ended December 31, 2003



or



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



For the transition period from  to



Commission File Number 0-18217



TRANSCEND SERVICES, INC.

(Exact name of registrant as specified in its charter)



|                                               |  |                                  
|---------------------------------------------- |  | ---------------------------------
|Delaware                                       |  | 33-0378756                       
|(State or other jurisdiction of incorporation) |  | (IRS Employer Identification No.)



945 East Paces Ferry
Road, N.E., Suite 1475, Atlanta, Georgia 30326

(Address of principal executive offices and zip code)



(404) 364-8000

(Registrants telephone number, including area code)



Securities registered pursuant to Section 12(b) of the Act: None

Securities registered pursuant to Section 12(g) of the Act:

Common Stock, $.05 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. x



Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Securities Exchange Act of 1934) Yes ̈No x



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 by the Nasdaq SmallCap Market on June 30, 2003 was $15,849,990. For purposes of this response, officers, directors and holders of more than 5% of the Registrants common stock are considered the affiliates of the
Registrant at that date.



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



|                             |  |                                
|---------------------------- |  | -------------------------------
|Class                        |  | Outstanding at January 30, 2004
|Common Stock, $.05 par value |  | 7,318,565                      



DOCUMENTS
INCORPORATED BY REFERENCE



Portions of the
registrants proxy statement filed in connection with the 2004 Annual Meeting of Stockholders to be held on May 6, 2004, are incorporated by reference herein in response to Part III of this report.



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PART I



|ITEM 1. | BUSINESS
|------- | --------



OVERVIEW



Transcend
Services, Inc. (Transcend or the Company) provides medical transcription services to the healthcare industry. Transcription services encompass receiving, typing, formatting and distributing electronic copies of
physician-dictated medical documents.



Transcend creates text
files from voice files without regard to how the dictation was captured. Voice recordings can be captured on either our proprietary systems or on other popular third-party systems.



Our mission is to become the preeminent supplier of dictation and transcription services to the healthcare market. Our
state-of-the-art web-based voice and data distribution technology provides an efficient and secure platform for our home-based medical language specialists, who document patient care by converting physicians voice recordings into electronic
medical record documents. We have invested significant time and intellectual capital in designing and managing a production environment that ensures the timely, accurate and secure creation and distribution of electronic medical documents, which
form the foundation for the patient medical record. We believe this tested and proven infrastructure helps us differentiate ourselves from the vast majority of transcription companies.



Transcends proven production technology helps to ensure the timely, accurate and secure creation and distribution of
electronic medical documents. Based upon comprehensive, written annual surveys from our customers, we believe that our services can be differentiated from that of our competitors by fast, predictable turnaround times; by quality and accuracy; by
distribution methodology and flexibility; and perhaps most important, by the breadth and depth of our service offerings. We can create customized transcription services that fit any clients needs, from the large in-house department that needs
a new data center, to the department that desires a complete outsourcing solution, to project-based overflow work. In addition to a proven set of technologies that deliver superior service, the Company is actively testing voice recognition software,
which we regard as an emerging trend in the healthcare transcription industry. While we do not have any patents for our proprietary technology, we are in the process of preparing a patent application for our proprietary voice recognition process.



The market for Transcends medical transcription services
is sizable. According to a report on the transcription services industry prepared by the Medical Transcription Industry Alliance in January 2002, the total annual market potential for outsourced medical transcription services is estimated to be
approximately $6 billion. While competition is significant with over 1,000 transcription services companies nationally, management believes that Transcend is one of only a handful of companies that operates on a single, Internet-based technology and
uses US-based medical language specialists.



Our customers
include hospitals, hospital systems, multi-specialty clinics and physician group practices in the United States.



Government regulation, managed care and labor resource constraints are shaping new opportunities for Transcend and other healthcare service providers.
Breakthroughs in telecommunications technologies and the growing acceptance of the Internet are enabling home-based professionals to provide more and more services to meet the needs of healthcare. New applications, such as voice recognition and
digital imaging, are also emerging, allowing for increased productivity, capacity and quality. In addition, compliance requirements have increased the importance of the security and confidentiality of patient medical records at all levels of the
healthcare industry. Demand for documentation of clinician decisions has increased, raising demand for the types of transcription services offered by Transcend. Most recently, the Health Insurance Portability and Accountability Act
(HIPAA) has provided us with both a challenge to comply with its evolving security and confidentiality requirements and an opportunity to differentiate Transcend, in particular from foreign competitors and those unable to invest in the
time and technologies necessary to ensure HIPAA compliance. As a result of these factors and trends, specialized healthcare service companies, like Transcend, are leveraging technology to increase their value to healthcare providers.



INDUSTRY OVERVIEW



The healthcare industry continues to undergo rapid change. Government regulation and managed care have increased the focus
on quality of care, quality of data, billing compliance and patient privacy. Healthcare providers continue to come under increased scrutiny from regulators and third-party payers. Reimbursement pressures from managed-care growth have fueled industry
consolidation and the formation of various types of healthcare provider groups, from integrated delivery networks to managed service organizations. Documentation requirements have significantly increased, resulting in an increase in the need for
dictation and transcription of medical notes. As a result of breakthroughs in technology, telecommunications, the growing acceptance of the Internet,



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and new applications (such as digital imaging systems and voice recognition systems), healthcare providers are relying on new technologies and outsourcing to
help them stay competitive.



Advances in telecommunications,
Internet technologies, and voice recognition capabilities are emerging, thereby creating opportunities to apply these technological advances to outsourcing certain medical record functions, such as medical transcription. These technologies enable
the digital movement of voice, images and data that allows for the cost-effective, off-site completion of the medical transcription function. The ability to process transcription services off-site allows for faster turnaround times, increased
availability of scarce skilled professionals, improved quality and lower costs.



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). 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. The historical
financial statements of the former Transcend Services, Inc. became the financial statements of the Company and include the businesses of both companies as of the effective date of 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 and records coding. 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 March 16, 1998, Transcend sold the net assets of Transcend Case
Management, Inc., its wholly owned subsidiary, to TCM Services, Inc., a wholly owned subsidiary of CORE, Inc. (CORE), a publicly traded company. On December 23, 1998, the Company re-acquired TCM from CORE and filed an arbitration claim
against CORE after learning of COREs intent to discontinue the business. In February 2000, an arbitrator ruled that CORE breached its purchase contract with Transcend and ordered CORE to compensate Transcend for damages. The Company ceased
TCMs operations effective December 31, 1999.



On June 1,
1998, Transcend completed the acquisition of Health Care Information Systems, Inc. (HCIS). The acquisition was accounted for under the pooling of interests method of accounting. Transcend merged HCIS into a wholly owned subsidiary,
Cascade Health Information Software, Inc. (Cascade), the product name formerly used by HCIS, which is widely recognized in the industry.



On November 11, 1999, the Companys Board of Directors approved managements plan to restructure the business to focus on medical transcription
using the Companys Internet-based transcription technology. In November and December 1999, the Company sold its Utah and Northeast-based transcription operations and certain of its transcription contracts that did not operate using the
Companys Internet-based transcription technology. On October 13, 2000, the Company sold its CodeRemote business, which provided remote coding services, and its Co-Sourcing business, which provided on-site management of hospital medical records
operations, to Provider HealthNet Services, Inc.



On May 31,
2002, the Company sold certain assets and the operations of Cascade to QuadraMed Corporation (QuadraMed) for $911,000 in cash and the assumption of certain liabilities by QuadraMed, which resulted in a gain on the sale of assets of
$954,000. The strategic sale refocused the Company on its core recurring revenue transcription services business. As a result of the sale of Cascade, the Company now operates in one, and only one, reportable business segment as a provider of medical
transcription services to the healthcare industry.



BUSINESS STRATEGY



Transcends sole focus is providing medical
transcription services to the healthcare industry. Its strategy is to succeed in the marketplace by: (1) increasing its penetration in the market; (2) maintaining and enhancing customer satisfaction; (3) sustaining technological leadership; (4)
attracting and retaining talented medical language specialists (transcriptionists); (5) managing internal growth effectively; (6) increasing its visibility; and (7) helping the market to understand how its offerings are different and superior.



Increase Market Penetration



We believe that our tested and proven infrastructure will allow us to serve
substantially more customers without a significant increase in fixed cost. While continuing to focus on day-to-day customer satisfaction, we intend to add new accounts to our existing



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customer base so as to efficiently utilize the capacity of the Companys infrastructure and established customer-oriented support organization.



We have hired and organized an experienced sales team to focus
on the initial sale of medical transcription services to new accounts as well as additional sales to existing customers. We have begun marketing initiatives that will improve our ability to create visibility and generate sales leads. In addition,
our established account management organization will act as one of several lead generation sources for the Companys sales force.



Maintain and Enhance Customer Satisfaction



We believe that happy customers, who provide sales leads and references, are our best sales force. Accordingly, we have an ongoing program to monitor and
improve customer satisfaction. This program includes continuous monitoring of transcription production statistics relative to contracted standards, periodic transcription customer surveys and a dedicated customer support organization that maintains
regular, oftentimes daily, contact with transcription customers.



Sustain Technological Leadership



We intend to
utilize the most effective technologies available to improve the medical transcription process because we believe that the application of advanced technologies will reshape the way patient information is managed across the healthcare delivery system
in the future as well as provide margin expansion through improved business efficiencies. We have converted all of our transcription operations to an Internet-based platform, which provides significant advantages in recruiting, workflow management,
and production control. We will continue to invest in improving our infrastructure to yield faster turnaround times, better workflow management, and increased productivity by evaluating new technologies, such as voice recognition and natural
language processing. We have also made a concerted effort to ensure that our information, and that of our clients, remains confidential and secure.



Attract and Retain Professional Staff



One of our critical success factors is the recruitment and retention of the industrys best knowledge workers (medical language specialists,
application developers and service and sales professionals). We believe that there will be a shortage of qualified professionals in the future, most certainly with medical language specialists, who are already in short supply. The solution to this
shortage will be to attract and retain a core group of knowledge workers by offering excellent pay and benefits, stable and caring management and, in the case of medical language specialists, the opportunity to work from home. This core group of
knowledge workers may support less skilled production employees and may complete documents that have been translated using voice recognition software. We intend to continue to hire domestically and believe that we are one of a few large medical
transcription companies that provide entirely U. S.  based transcription services.



Manage Necessary Internal Growth



We intend to grow internally through a direct sales force focused on both new accounts and our existing customer base. This will involve adding sales and account management resources as necessary to concentrate on revenue growth. In
addition, we will selectively consider opportunities for contract management of medical transcription departments and acquisitions of medical transcription companies.



Increase Companys Visibility To The Target Market



Our strategy is to increase the distribution of our services and/or to increase our ability to offer services to clients
using other transcription platforms.



Tactics that will be used
by Transcend to build visibility, generate an understanding of the Companys differentiating features and attract leads include targeted public relations, sales support activities, advertising in industry trade publications, direct mailings,
attendance at key industry shows, exploiting its web site presence, building upon existing software, hardware and service vendor relationships to generate leads and/or introductions to prospects for transcription services, and utilizing customer
testimonials to generate new sales leads.



Increase Target
Markets Understanding of Transcend Differentiators



Transcend has designed a proven production technology that helps to ensure the timely, accurate and secure creation and distribution of electronic medical documents. Based upon comprehensive, written annual surveys from our customers, we
believe that our services can be differentiated from those of competitors by a number of factors. These factors include: fast, predictable turnaround



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times; consistently high accuracy and document quality; flexible distribution methodology that delivers documents securely to a variety of end-user sources
including HCIS systems, faxes, printers and a web-based console; and a breadth and depth of offerings unmatched in the industry. Transcend can create customized transcription services that fit any clients needs, from the large in-house
department that needs a new data center; to the department that desires a complete outsourcing solution; to project-based overflow work. Our offerings make use of a range of technologies, including an advanced typing platform, a secure and reliable
data center, and advanced integration and distribution technologies. In addition, the Company is actively testing voice recognition software, which we believe has particular merit for the healthcare transcription industry.



SERVICES



Medical Transcription Services. Powered by its web-enabled voice and data distribution technology, Transcends
home-based medical language specialists convert physicians voice recordings into electronic medical record documents. Physicians may dictate from several dictation products on the market (including handheld devices) or any phone (including
hospital- or clinic-based transcription stations, an office- or home-based land line, or even a cell phone). The information is securely captured in a digital format in the Companys central voice hub in Atlanta, Georgia. The digital voice
files are then compressed, encrypted and stored. The Companys home-based medical language specialists access these files over the Internet, play back the voice recordings using headsets and foot pedals, and transcribe the recorded voice to
create electronic documents. The completed electronic documents are then returned to the Atlanta hub over the Internet. The documents may then be accessed by remote quality assurance personnel, if necessary, and delivered electronically to the
healthcare provider. Typically, documents are produced and delivered within 24 hours of the physicians dictation. Documents requiring faster turnaround times, many as quickly as four hours for STAT requests, are priced at a premium. The
Companys transcription operations run around the clock, every day of the year.



Our transcription services can become the complete, outsourced transcription solution for a client (using either a full contract management model or a total outsourcing model). As an alternative, clients may choose to
use their own in-house transcriptionists and outsource only some percentage of their transcription needs to Transcend (via either overflow support or by allowing their staff to use our platform with our transcriptionists).



Network/Data Center Services. We have expertise in designing, building
and managing data centers specifically designed to support transcription services, and offer this expertise on a consulting or package basis as a service to our market.



CUSTOMERS



We currently deliver dictation and transcription services to 55 hospitals and clinics with recurring revenue under long-term contracts or other
arrangements. The average level of annual revenue generated by a transcription customer is approximately $300,000, but we had several customers that each contributed annual revenue over $1 million in 2003.



No single customer contributed revenue equal to or in excess of 10% of total
revenue in 2001 or 2002, but revenue attributable to one customer totaled $1,572,000, or 10.7% of total revenue in 2003.



SALES AND MARKETING



We currently employ five full-time sales professionals managed by a Vice President of Sales and Marketing to sell transcription services. Historically,
our sales leads were generated from personal contacts with senior hospital executives and from client referrals. Current marketing initiatives should expand our visibility in the industry and increase the pool of leads for the sales force.



Tactics we will use to build visibility and attract leads
include targeted public relations, sales support activities, advertising in industry trade publications, direct mailings, attending key industry meetings, exploiting our presence on the Internet, building upon existing software, hardware and service
vendor relationships to generate leads and/or introductions to prospects for transcription services, and utilizing customer testimonials to generate new sales leads.



COMPETITION



We experience competition from many local, regional and national businesses. The medical transcription services market, which is estimated at over $6
billion in annual expenditures, is highly fragmented with more than 1,000 companies, ranging from sole practitioners to large public companies, in the United States alone. In addition, the medical transcription industry in the United States
experiences overseas competition, primarily from India. While the costs for overseas transcription assistance is lower, quality and turnaround time is often unacceptable, and with the increasing scrutiny of the security of medical records, overseas
transcription is worrisome to many segments of the market, especially hospitals and health systems. Over the past several years, the medical transcription industry has been undergoing consolidation by MedQuist, Inc., Spheris and others.



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Medical transcription is either done in-house (by hospital or clinic personnel) or outsourced (to local,
regional or national vendors). Hospitals and clinics may choose to outsource because of: (1) the shortage of qualified medical transcriptionists; (2) the unique management challenges of managing a 24/7 operation that must deliver critical patient
care information quickly; or (3) the high cost of equipping in-house personnel with the hardware, software and support necessary for their jobs. Successful transcription companies make use of technological advances in Internet access, security,
software and hardware that allow remotely located, highly trained personnel to function as well as (or even better than) in-house employees. We believe that the principal historical competitive factors of price and quality (turnaround time and
accuracy) will expand to include other factors such as electronic security, hardware redundancy (to protect against data loss) and data integration. In addition, we believe that the ability to recruit, train, and most important, manage personnel
nationally and internationally, coupled with the use of Internet communications, will lead to further outsourcing, and that only those companies prepared to compete using resources outside the local market will prosper.



We believe that our top four domestic competitors are MedQuist, Inc.,
Spheris, HealthScribe, Inc. and CBay Systems, Ltd. Competition for transcription software, which is used by in-house transcription personnel, comes largely from SoftMed Systems, Inc. with their Chartscript product.



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. We have attempted to structure our operations to comply with these
regulations. We are 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 and software may impact us and require us to
restructure operations in order to comply with such regulations.



The Health Insurance Portability and Accountability Act of 1996 (HIPAA) contains provisions regarding standardization, privacy, security and administrative simplification in the healthcare industry. As a result of regulations
that have been proposed and enacted under HIPAA, the Company has made and will continue to make investments to support customer operations in areas such as:



| |  | Electronic transactions involving healthcare information;
| | - | ---------------------------------------------------------



| |  | Privacy of individually identifiable health information; and
| | - | ------------------------------------------------------------



| |  | Security of healthcare information and electronic signatures.
| | - | -------------------------------------------------------------



The regulations governing the electronic exchange of information established a standard format for the most common healthcare transactions, including
claims, remittance, eligibility and claims status. The regulations also establish national privacy standards for the protection of individually identifiable health information. A substantial part of our activities involve the receipt or delivery of
confidential health information concerning patients of our customers in connection with the provision of transcription services to participants in the healthcare industry. We intend to ensure our compliance with the regulations to the extent they
are applicable to us. The regulations may restrict the manner in which we transmit and use certain information.



The proposed security regulations establishing security and electronic HIPAA signature standards were recently finalized. The regulations will require
certain healthcare organizations to implement administrative safeguards, physical safeguards, technical security services and technical security mechanisms with respect to information that is electronically maintained or transmitted in order to
protect the confidentiality, integrity and availability of individually identifiable health information.



The Company has designated its Chief Information Officer as its HIPAA compliance officer and has implemented physical, technical and administrative
safeguards related to the access, use and/or disclosure of individually identifiable health information to help ensure the privacy and security of this information as required by HIPAA. Although it is not possible to anticipate the total effect of
these regulations, the Company has made and continues to make investments in systems to support customer operations that are regulated by HIPAA.



EMPLOYEES



As of December 31, 2003, we had 292 full-time and 81 part-time employees. These include 280 full-time and 80 part-time employees dedicated to the medical transcription business, and 12 full-time and 1 part-time
executive, accounting and administrative employees at our headquarters office in Atlanta, Georgia. We are not currently a party to any collective bargaining agreement, nor are our employees. We have not experienced any strikes or work stoppages, and
believe that our relations with our employees are good.



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|ITEM 2. | PROPERTIES.
|------- | -----------



The Company leases the space for its principal offices in Atlanta, Georgia under leases that expire in September 2004 and October 2007. The Company also
leases space in Beaverton, Oregon, which was utilized by its wholly owned subsidiary Cascade Health Information Software, Inc. (Cascade), until select assets and the operations of Cascade were sold to QuadraMed Corporation
(QuadraMed) on May 31, 2002. The Company has sublet the Beaverton, Oregon space to QuadraMed from June 1, 2002 through April 30, 2005 at which time the Company will reassume responsibility for the lease through February 2007.



|ITEM 3. | LEGAL PROCEEDINGS.
|------- | ------------------



On April 5, 2001, Our Lady of the Lakes Hospital, Inc. (OLOL) filed a lawsuit against the Company. The lawsuit, styled Our Lady of the
Lakes Hospital, Inc. v. Transcend Services, Inc. was filed in the 19th Judicial District Court, Parish of East, State of Louisiana, Civil Case Number 482775, Div. A. The lawsuit alleges, among other things, that the Company breached certain
contracts entered into between OLOL and the Company, including a staffing and management servicing contract, a transcription platform agreement and a marketing agreement. OLOL is seeking an unspecified amount of monetary damages. On May 30, 2001,
the Company filed a timely Answer that generally denied all liability, and the Company filed a counterclaim against OLOL primarily seeking fees owed by OLOL for services performed by the Company and interest on unpaid invoices. OLOL has subsequently
added Transcends insurance carriers as defendants to the lawsuit.



The Company intends to vigorously defend all claims made by OLOL. The lawsuit is in an early procedural stage, however, and therefore it is not possible at this time to determine the outcome of the actions or the effect, if any, that their
outcome may have on the Companys results of operations and financial condition. There can be no assurances that this litigation will not have a material adverse effect on the Companys results of operations and financial condition.



The Company has been threatened by another company related to
a dispute with that company regarding the level of fees payable under a cross-marketing agreement that provides for binding arbitration of disputes. The threatened binding arbitration process has not been initiated at this time and it is uncertain
when, if ever, the threatened binding arbitration process will be initiated. While the Company believes that it has meritorious defenses against the claims of the other party in the dispute, there can be no assurance that the results of this
threatened binding arbitration will not have material adverse effect on the Companys results of operations and financial condition.



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



No matters were submitted to a vote of the security holders during the quarter ended December 31, 2003.



PART II



|ITEM 5. | MARKET FOR REGISTRANTS COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
|------- | ---------------------------------------------------------------------



The Companys Common Stock is quoted on the Nasdaq SmallCap Market under the symbol TRCR. As of January 30,
2004 there were approximately 245 holders of record of the Companys Common Stock. The table below sets forth for the periods indicated the high and low bid prices per share of the Companys Common Stock as reported on the Nasdaq SmallCap
Market for the periods indicated. These quotations also reflect inter-dealer prices without retail mark-ups, mark-downs or commissions, and may not necessarily represent actual transactions.



|                                       |  |                                 |       |     |   |      
|-------------------------------------- |  | ------------------------------- | ----- | --- | - | -----
|                                       |  | Price Per Share of Common Stock
|                                       |  | High                            |       | Low
|Year Ended December 31, 2003           |  |                                 |       |     |   |      
|First Quarter ended March 31, 2003     |  | $                               | 2.280 |     | $ | 0.750
|Second Quarter ended June 30, 2003     |  | $                               | 3.500 |     | $ | 1.750
|Third Quarter ended September 30, 2003 |  | $                               | 3.300 |     | $ | 2.500
|Fourth Quarter ended December 31, 2003 |  | $                               | 4.600 |     | $ | 2.600
|Year Ended December 31, 2002           |  |                                 |       |     |   |      
|First Quarter ended March 31, 2002     |  | $                               | 1.700 |     | $ | 1.220
|Second Quarter ended June 30, 2002     |  | $                               | 1.660 |     | $ | 1.200
|Third Quarter ended September 30, 2002 |  | $                               | 1.650 |     | $ | 1.150
|Fourth Quarter ended December 31, 2002 |  | $                               | 1.350 |     | $ | 0.580



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The Companys policy is to retain earnings for the expansion and development of the Companys
business. The Company does not anticipate paying cash dividends on its Common Stock in the foreseeable future.



See Note 9 of Notes to Consolidated Financial Statements for information with respect to the Companys equity compensation plans.



|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 Miller Ray & Houser, independent public accountants, with respect to such consolidated financial statements as of December 31, 2003 and 2002 and for each of the three years in the
period ended December 31, 2003 is included in Item 8. This selected financial data should be read in conjunction with the consolidated financial statements, related notes and other financial information included and incorporated by reference herein.



|                                                              |  |      |        |   |      |   |        |      |  |   |        |   |      |   |        |  |   |       
|------------------------------------------------------------- |  | ---- | ------ | - | ---- | - | ------ | ---- |  | - | ------ | - | ---- | - | ------ |  | - | ------
|Selected Financial Data (in thousands,
except per share data) |  | 1999 |        |   | 2000 |   |        | 2001 |  |   | 2002   |   | 2003
|Results of Operations:(1) (2)(3)                              |  |      |        |   |      |   |        |      |  |   |        |   |      |   |        |  |   |       
|                                                              |  |      |        |   |     
|Revenue                                                       |  | $    | 47,281 |   |      | $ | 24,007 |      |  | $ | 11,817 |   |      | $ | 12,225 |  | $ | 14,663
|Income (loss) from operations                                 |  | $    | (7,375 | ) |      | $ | (363   | )    |  | $ | (214   | ) |      | $ | 42     |  | $ | 1,030 
|Income (loss) before discontinued operations                  |  | $    | (2,456 | ) |      | $ | (233   | )    |  | $ | (139   | ) |      | $ | 999    |  | $ | 1,020 
|Income (loss) before discontinued operations per common share |  | $    | (0.67  | ) |      | $ | (0.16  | )    |  | $ | (0.14  | ) |      | $ | 0.11   |  | $ | 0.14  
|Diluted weighted average shares of common stock(3)            |  |      | 4,386  |   |      |   | 4,341  |      |  |   | 4,404  |   |      |   | 4,547  |  |   | 6,117 
|                                                              |  |      |        |   |     
|Financial Position at Year End:                               |  |      |        |   |      |   |        |      |  |   |        |   |      |   |        |  |   |       
|Total assets                                                  |  | $    | 17,482 |   |      | $ | 5,679  |      |  | $ | 3,128  |   |      | $ | 3,215  |  | $ | 3,346 
|Total debt                                                    |  | $    | 6,903  |   |      | $ | 614    |      |  | $ |       |   |      | $ |       |  | $ | 200   
|Stockholders equity                                          |  | $    | 2,568  |   |      | $ | 2,176  |      |  | $ | 2,009  |   |      | $ | 2,421  |  | $ | 2,440 

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|(1) | The Company has completed several acquisitions and divestitures that could affect the comparability of the information reflected in the table. Revenue attributable
to business units that were sold or to customers that were not converted to the Companys T2K platform totaled $33,996,000 in 1999 and $10,341,000 in 2000.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(2) | Certain prior year results related to the operations of First Western Health Corporation, Veritas Health Management, Transcend Case Management and Cascade Health
Information Software, Inc. (Cascade) have been reclassified to loss from discontinued operations for comparative purposes. See also Note 2 of Notes to Consolidated Financial Statements.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(3) | Diluted weighted average shares of common stock have been restated to show the effects of the
1-for-5 reverse stock split effected on January 14, 2000.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------



|ITEM 7. | MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
|------- | -------------------------------------------------------------------------------------



This report contains forward-looking statements that involve a number of risks and uncertainties. Among the important
factors that could cause actual results to differ materially from those indicated by such forward-looking statements are competitive pressures, loss of significant customers, the mix of revenue, changes in pricing policies, delays in revenue
recognition, lower-than-expected demand for the Companys products and services, business conditions in the integrated health care delivery network market, general economic conditions, and the risk factors detailed from time to time in the
Companys periodic reports and registration statements filed with the Securities and Exchange Commission.



The Companys consolidated financial statements are prepared in conformity with accounting principles generally accepted in the United States of
America, which require management to make estimates and assumptions that affect the reported amounts and disclosures in the Companys financial statements and accompanying notes. Actual results could differ from those estimates. A summary of
the Companys significant accounting policies is contained in Note 1 of Notes to Consolidated Financial Statements. The Company believes that none of these accounting policies are extraordinarily complex or require an unusual degree of judgment
as these policies relate to the Companys operations and financial condition.



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.



8



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OVERVIEW



Transcend Services, Inc. (the Company) provides medical transcription services to the healthcare industry. Powered by its web-based voice and
data distribution technology, the Companys home-based medical language specialists document patient care by converting physicians voice recordings into electronic medical record documents. On May 31, 2002, the Company sold certain assets
and the operations of its wholly owned subsidiary, Cascade Health Information Software, Inc. (Cascade). Cascade previously provided software for the coding and abstracting of patient medical records and is presented as discontinued
operations in 2001 and 2002.



Year Ended December 31, 2003 Compared to Year
Ended December 31, 2002



Revenue increased $2,438,000, or
20%, from $12.2 million in 2002 to $14.7 million in 2003. This increase in revenue is primarily attributable to: (1) an increase of $684,000 in revenue from existing transcription customers; (2) revenue of $2,407,000 from new transcription
customers; and (3) a decrease of $653,000 in revenue from three customers who terminated their contracts with the Company during 2003.



Direct costs increased $1,129,000, or 13%, from $8.9 million in 2002 to $10.0 million in 2003. Direct costs consist of transcription compensation, which
is a totally variable expense, transcription recruiting, production management, customer service, support, implementation and depreciation and amortization related to the production operation, all of which are semi-variable expenses. Transcription
compensation, which comprises 69% of the total direct costs, increased $967,000, or 16%, to handle the increased level of revenue referred to above. In addition, recruiting, production management customer service and support, all of which are
semi-variable production infrastructure expenses, increased $196,000, or 9%, to handle actual and planned transcription service revenue growth. Implementation expense decreased by $150,000 as the Company reduced its reliance upon third-party
implementation specialists. Depreciation and amortization expense increased $116,000, or 22%, related to the increased level of capital expenditures for production operations in 2003 and the amount and timing of such capital expenditures in prior
years.



Gross profit increased $1,309,000, or 40%, from $3.3
million in 2002 to $4.6 million in 2003. Gross profit as a percentage of revenue increased from 27% in 2002 to 32% in 2003 due to the revenue growth rate exceeding the growth rate of direct costs, both of which were discussed above. Further, the
improvement in gross profit is due to the employment of labor-saving tools and techniques by the transcriptionists to enhance their productivity and the control of production infrastructure expenses discussed above.



Marketing and sales expenses increased $325,000, or 61%, from $529,000 in
2002 to $854,000 in 2003. These expenses also increased as a percentage of revenue from 4% in 2002 to 6% in 2003. The Company doubled the size of its sales force in 2003, which resulted in higher levels of salaries and travel expenses and an
increased level of sales commissions related to the increased level of revenue discussed above. In addition, marketing expenses increased as a result of the development and production of sales collateral material by a third party.



Research and development expenses increased $111,000, or 33%, from $332,000
in 2002 to $443,000 in 2003, but remained the same as a percentage of revenue at 3% for 2002 and 2003. This increase is primarily due to a reassignment of technology resources from other areas to work on technology development projects. Slightly
offsetting this increase is capitalized internal software development costs of $17,000 related to the development of an order-based information module for the transcription typing platform to facilitate the preparation of radiology, pathology and
other order-based reports. The Company believes that the current size of its research and development staff is sufficient to accomplish its planned research and development activities for the foreseeable future.



General and administrative expenses decreased $115,000, or 5%, from $2.4
million in 2002 to $2.3 million in 2003 as the Company had overall conservative spending during the year.



Net interest expense increased from zero in 2002 to $16,000 in 2003 due primarily to the amortization of the line of credit facility fee paid to the
Companys Chief Executive Officer and one of its Directors as Guarantors of the repayment of borrowings, if any, under the Companys line of credit.



The gain of sale of assets of $6,000 is an earn-out payment pursuant to the sale of the Co-Sourcing and CodeRemote business units in 2000.



The Company reported no income tax expense in either 2002 or 2003 since it
has available net operating loss carry-forwards of approximately $19 million as of December 31, 2003.



During the first half of 2003, the Company issued 2,903,422 shares of common stock in the stockholder-approved preferred stock conversion on June 25, 2003
and in lieu of dividends at the preferred stock dividend payment dates of February 15 and May 15, 2003 after which latter date preferred stock dividends were no longer required. Accordingly, dividends on preferred stock decreased



9



---

from $478,000 in 2002 to $180,000 in 2003. In addition, weighted average common shares outstanding increased significantly from 4.5 million shares in 2002 to
5.9 million and 6.1 million shares on a basic and diluted basis, respectively, in 2003.



Year Ended December 31, 2002 Compared to Year Ended December 31, 2001



Revenue increased $408,000, or 3%, from $11.8 million in 2001 to $12.2 million in 2002. This increase in revenue is primarily attributable to: (1) an increase in revenue from existing transcription customers of
$959,000; (2) revenue of $873,000 from new transcription customers; and (3) a decrease in revenue from two customers who terminated their contracts with the Company in late 2001 and mid-2002 that contributed revenue of approximately $1.4 million in
2001.



Direct costs increased $37,000, or less than 1%. Direct
costs consist of transcription compensation, which is a totally variable expense, transcription recruiting, production management, customer service, support, implementation and depreciation and amortization related to the production operation, all
of which are semi-variable expenses. Recruiting, production management customer service, support and implementation, all of which are semi-variable production infrastructure expenses, increased $256,000 to handle actual and planned transcription
service revenue growth. Depreciation and amortization expense decreased $110,000 related to the decline in capital expenditures required for production operations over the last few years. Transcription compensation decreased a relatively
insignificant $109,000, or less than 2% of the total transcription compensation included in direct costs, which comprises about two-thirds of total direct costs.



Gross profit increased $371,000, or 13%, from $2.9 million in 2001 to $3.3 million in 2002. Gross profit as a percentage of
revenue increased from 25% in 2001 to 27% in 2002. The increase in gross profit margin is primarily due to relatively higher margins on revenue from new customers when compared to the margins on revenue from customers in 2001. In addition, the
production management, technical service group and customer service operations effectively controlled their departmental expenses in relation to the 3% increase in revenue mentioned above.



Marketing and sales expenses increased $151,000, or 40%, from $378,000 in
2001 to $529,000 in 2002. These expenses also increased as a percentage of revenue from 3% in 2001 to 4% in 2002. The Company increased the size of its sales force in 2002 to improve sales during 2002 resulting in increased salaries and commissions.
In addition, marketing costs increased to provide more market exposure and to explore different sales strategies.



Research and development expenses increased $8,000, or 2%, from $324,000 in 2001 to $332,000 in 2002, but remained the same as a percentage of revenue at
3% for 2001 and 2002. The Company believes that the current size of its research and development staff is sufficient to accomplish its planned research and development activities for the foreseeable future.



General and administrative expenses decreased $44,000, or 2%, from $2.5
million in 2001 to $2.4 million in 2002 as the Company had overall conservative spending during the year.



Net interest expense decreased from $18,000 in 2001 to zero in 2002 due to: (1) the reduction of periodic short-term borrowings under the Companys
line of credit during the first half of 2002 using a portion of the cash received on the sale of certain assets and the operations of Cascade on May 31, 2002, (2) the interest income earned on the investment of the net proceeds from the sale of
certain assets and the operations of Cascade in overnight money market funds, (3) the nationwide reduction in the prime interest rate during 2002; and (4) the below-prime borrowing rate on the Companys line of credit made possible by the
personal guarantees of the Companys Chief Executive Officer and one of its Directors.



The gain on sale of assets of $957,000 in 2002 consists primarily of a gain of $954,000 from the sale of certain assets and the operations of Cascade on May 31, 2002. The remaining gain of $3,000 is an earn-out
payment pursuant to the sale of the Co-Sourcing and CodeRemote business units in 2000. The gain on sale of assets of $553,000 in 2001 represents an earn-out payment related to the sale of the Companys Utah and Northeast-based medical
transcription services operations and certain other contracts for transcription services in December 1999.



The loss on sale of short-term investment of $576,000 in 2001 is the realized loss on the sale of unregistered common stock that was received in a legal
settlement during 2000, but bore resale restrictions until its sale in 2001.



The Company reported an income tax benefit of $116,000 in 2001 due to the elimination of deferred income tax liabilities of $121,000 established in prior years most of which related to a workers compensation insurance
claim settlement by a now discontinued operation that are no longer required, offset slightly by state income taxes of $5,000. The Company had available net operating loss carry-forwards of approximately $19.5 million as of December 31, 2002.



10



---

In November 1997, the Company issued 212,800 shares of Series A Convertible Preferred Stock with a
dividend of 9%. The net income (loss) attributable to common stockholders includes the effect of preferred stock dividends of $478,000 and $479,000 in 2002 and 2001, respectively.



OFF-BALANCE SHEET ARRANGEMENTS



Other than operating lease obligations discussed below, the Company does not have any off-balance sheet arrangements.



LIQUIDITY AND CAPITAL RESOURCES



The Companys current financial condition has been significantly
influenced by four factors: (1) the proceeds of $911,000 from its sale of certain assets and the operations of Cascade during the second quarter of 2002; (2) profitable and positive cash flow operations for five consecutive quarters up to and
including the fourth quarter of 2003; (3) the redemption of a portion of its preferred stock for $600,000 cash on July 1, 2003; and (4) the conversion of the remaining shares of preferred stock into common stock on June 25, 2003, thereby eliminating
quarterly cash dividend payments of approximately $120,000 after May 15, 2003.



As of December 31, 2003, the Company had cash and cash equivalents of $558,000, short-term debt of $200,000 related to the redemption of the preferred stock into common stock and full availability of its $1.5 million
line of credit, which expires on March 31, 2004.



Net cash
provided by operating activities totaled $1,140,000 in 2003 due primarily to profitable operations and non-cash depreciation and amortization expenses.



Net cash used in investing activities of the Company were capital expenditures of $568,000, primarily for computer hardware and software upgrades and
enhancements.



Net cash used in financing activities of the
Company during the first nine months of 2003 related to (1) the payment of $600,000 in cash to redeem a portion of the Companys preferred stock; (2) the payments of quarterly preferred stock dividends of $110,000 prior to the conversion of the
Companys preferred stock into common stock on June 25, 2003; and (3) expenses totaling approximately $86,000 related to the stockholder-approved, redemption and conversion of the Companys preferred stock. As a result of the
stockholder-approved redemption and conversion of the Companys preferred stock, the quarterly preferred stock cash dividend payments referred to above were $70,000 lower than normal since certain preferred shareholders elected to receive
43,422 shares of common stock in lieu of preferred stock cash dividends at the February 15 and May 15, 2003 preferred stock dividend payment dates.



To simplify its capital structure and to eliminate the adverse cash and net income effects of the preferred stock dividends, the Companys
stockholders approved an amendment to redeem a portion of its preferred stock and convert the remaining preferred stock into common stock at its annual meeting of stockholders on May 6, 2003 (the Preferred Stock Strategy). As a result,
the Company became obligated to expend $800,000 in cash to redeem a portion of the preferred stock. The Company paid $600,000 of this total cash expenditure on July 1, 2003 and $100,000 subsequent to year-end on January 1, 2004 upon maturity of a
short-term promissory note; the remaining $100,000 is due on April 1, 2004. The Preferred Stock Strategy also resulted in an increase in the Companys outstanding common stock of 2,860,000 shares. As of December 31, 2003, there were 7,316,565
shares of common stock outstanding and no shares of preferred stock outstanding.



Aside from cash available under its $1.5 million line of credit referred to above, during the fourth quarter of each year in both 2004 and 2005, the Company has potential cash resources of an undetermined amount of
earn-out payments, if any, payable by Provider HealthNet Services, Inc. (PHNS) based on a fixed percentage of certain defined future revenue recognized by PHNS from the Co-Sourcing and CodeRemote businesses sold to PHNS by Transcend in
October 2000.



The Company is a defendant in the OLOL lawsuit
and has been threatened regarding a separate dispute that is subject to binding arbitration. See Note 5 to the Consolidated Financial Statements included with this report and Item 3. Legal Proceedings. It is possible that the outcome of
the OLOL matter will be known in 2004, but it is impossible to predict the outcome at this time. There is no timetable, if ever, for the threatened action regarding the dispute. However, if the outcome of the OLOL lawsuit is unfavorable to
Transcend, the Company would most likely appeal the verdict or decision. Nonetheless, the OLOL lawsuit and the results of the threatened binding arbitration could have a material adverse effect on the Companys results of operations and
financial condition in the future.



11



---

The Company has the following contractual obligations as of December 31, 2003:



|                            |  |                        |       |                 |   |            |  |            |     |                  |   |     |  |   |  
|--------------------------- |  | ---------------------- | ----- | --------------- | - | ---------- |  | ---------- | --- | ---------------- | - | --- |  | - | -
|(in 000s)                  |  | Payments due by period
|Contractual Obligation      |  | Total                  |       | Less than1 year |   | 1  3years |  | 3  5years |     | More than5 years
|Long-term debt obligations  |  | $                      | 0     |                 | $ | 0          |  | $          | 0   |                  | $ | 0   |  | $ | 0
|Capital lease obligations   |  |                        | 0     |                 |   | 0          |  |            | 0   |                  |   | 0   |  |   | 0
|Operating lease obligations |  |                        | 1,005 |                 |   | 250        |  |            | 553 |                  |   | 202 |  |   | 0
|Purchase obligations        |  |                        | 0     |                 |   | 0          |  |            | 0   |                  |   | 0   |  |   | 0
|Other long-term liabilities |  |                        | 0     |                 |   | 0          |  |            | 0   |                  |   | 0   |  |   | 0
|                            |  |                        |       |                 |   |            |  |            |     |                  |   |     |  |   |  
|Total                       |  | $                      | 1,005 |                 | $ | 250        |  | $          | 553 |                  | $ | 202 |  | $ | 0
|                            |  |                        |       |                 |   |            |  |            |     |                  |   |     |  |   |  



Absent a material
adverse outcome from the lawsuit and threatened binding arbitration discussed above, the Company anticipates that cash on hand, together with internally generated funds, cash available under its line of credit and potential cash from the PHNS
earn-out agreement, if any, should be sufficient to finance continuing operations, make capital investments in the normal and ordinary course of its business and pay the short-term debt related to the Preferred Stock Strategy when due during 2004
and for the foreseeable future.



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 or lower expenses, or both, in amounts that offset inflationary cost increases.



|ITEM 7A. | QUANTATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
|-------- | -------------------------------------------------------



The Company has no material exposure to market risk from derivatives or other financial instruments as of December 31, 2003.



|ITEM 8. | FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
|------- | -------------------------------------------



The following financial statements are filed with this report:



Report of Independent Public Accountants



Consolidated Balance Sheets as of December 31, 2003 and 2002



Consolidated Statements of Operations for the years ended December 31, 2003, 2002 and 2001



Consolidated Statements of Stockholders Equity for the years ended December 31, 2003, 2002 and 2001



Consolidated Statements of Cash Flows for the years ended December 31, 2003,
2002 and 2001



Notes to Consolidated Financial Statements



12



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REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS



To the Board of Directors and Stockholders of Transcend Services, Inc.:



We have audited the accompanying consolidated balance sheets of Transcend Services, Inc. (a Delaware corporation) and subsidiary as of
December 31, 2003 and 2002 and the related consolidated statements of operations, stockholders equity, and cash flows for each of the three years in the period ended December 31, 2003. These financial statements are the responsibility of the
Companys management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.



We conducted our audits in accordance with auditing standards generally accepted in the United States of America. 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 subsidiary as of December 31, 2003 and 2002 and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2003 in conformity
with accounting principles generally accepted in the United States of America.



|                                 
|---------------------------------
|                                 
|/s/ Miller Ray & Houser LLP      
|Atlanta, Georgia January 23, 2004



13



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TRANSCEND SERVICES, INC.



CONSOLIDATED BALANCE SHEETS



|                                                                                                                                                                                                                        |  |              |             |   |      |   |             |  
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------ | ----------- | - | ---- | - | ----------- | -
|                                                                                                                                                                                                                        |  | December 31, |            
|                                                                                                                                                                                                                        |  | 2003         |             |   | 2002 |  
|ASSETS                                                                                                                                                                                                                  |  |              |             |   |      |   |             |  
|                                                                                                                                                                                                                        |  |             
|Current assets:                                                                                                                                                                                                         |  |              |             |   |      |   |             |  
|Cash and cash equivalents                                                                                                                                                                                               |  | $            | 558,000     |   |      | $ | 782,000     |  
|Accounts receivable, net of allowances for doubtful accounts of $39,000 and $50,000 at December 31, 2003 and 2002,
respectively                                                                                         |  |              | 1,306,000   |   |      |   | 947,000     |  
|Prepaid expenses and other current assets                                                                                                                                                                               |  |              | 216,000     |   |      |   | 101,000     |  
|                                                                                                                                                                                                                        |  |              |             |   |      |   |             |  
|Total current assets                                                                                                                                                                                                    |  |              | 2,080,000   |   |      |   | 1,830,000   |  
|                                                                                                                                                                                                                        |  |              |             |   |      |   |             |  
|Property and equipment:                                                                                                                                                                                                 |  |              |             |   |      |   |             |  
|Computer equipment                                                                                                                                                                                                      |  |              | 1,971,000   |   |      |   | 1,534,000   |  
|Software                                                                                                                                                                                                                |  |              | 1,826,000   |   |      |   | 1,702,000   |  
|Furniture and fixtures                                                                                                                                                                                                  |  |              | 170,000     |   |      |   | 162,000     |  
|                                                                                                                                                                                                                        |  |              |             |   |      |   |             |  
|Total property and equipment                                                                                                                                                                                            |  |              | 3,967,000   |   |      |   | 3,398,000   |  
|Accumulated depreciation                                                                                                                                                                                                |  |              | (2,749,000  | ) |      |   | (2,082,000  | )
|                                                                                                                                                                                                                        |  |              |             |   |      |   |             |  
|Property and equipment, net                                                                                                                                                                                             |  |              | 1,218,000   |   |      |   | 1,316,000   |  
|                                                                                                                                                                                                                        |  |              |             |   |      |   |             |  
|Other assets                                                                                                                                                                                                            |  |              | 48,000      |   |      |   | 69,000      |  
|                                                                                                                                                                                                                        |  |              |             |   |      |   |             |  
|Total assets                                                                                                                                                                                                            |  | $            | 3,346,000   |   |      | $ | 3,215,000   |  
|                                                                                                                                                                                                                        |  |              |             |   |      |   |             |  
|LIABILITIES AND STOCKHOLDERS EQUITY                                                                                                                                                                                    |  |              |             |   |      |   |             |  
|                                                                                                                                                                                                                        |  |             
|Current liabilities:                                                                                                                                                                                                    |  |              |             |   |      |   |             |  
|Promissory notes payable                                                                                                                                                                                                |  | $            | 200,000     |   |      | $ |            |  
|Accounts payable                                                                                                                                                                                                        |  |              | 109,000     |   |      |   | 154,000     |  
|Accrued compensation and benefits                                                                                                                                                                                       |  |              | 486,000     |   |      |   | 397,000     |  
|Other accrued liabilities                                                                                                                                                                                               |  |              | 111,000     |   |      |   | 243,000     |  
|                                                                                                                                                                                                                        |  |              |             |   |      |   |             |  
|Total current liabilities                                                                                                                                                                                               |  |              | 906,000     |   |      |   | 794,000     |  
|                                                                                                                                                                                                                        |  |              |             |   |      |   |             |  
|Commitments and contingencies (Note 5)                                                                                                                                                                                  |  |              |             |   |      |   |             |  
|Stockholders equity:                                                                                                                                                                                                   |  |              |             |   |      |   |             |  
|Preferred stock, $.01 par value; 2,000,000 and 21,000,000 shares authorized at December 31, 2003 and December 31, 2002,
respectively:                                                                                   |  |              |             |   |      |   |             |  
|Series A Convertible Preferred Stock, 0 and 212,800 shares issued and outstanding at December 31, 2003 and 2002,
respectively                                                                                         |  |              |            |   |      |   | 2,000       |  
|Series B Convertible Preferred Stock, 0 and 60,000 shares issued and outstanding at December 31, 2003 and 2002,
respectively                                                                                          |  |              |            |   |      |   | 1,000       |  
|Common stock, $.05 par value; 15,000,000 and 6,000,000 shares authorized at December 31, 2003 and 2002, respectively; 7,317,000 and 4,413,000
shares issued and outstanding at December 31, 2003 and 2002, respectively |  |              | 364,000     |   |      |   | 220,000     |  
|Additional paid-in capital                                                                                                                                                                                              |  |              | 27,058,000  |   |      |   | 28,020,000  |  
|Accumulated deficit                                                                                                                                                                                                     |  |              | (24,982,000 | ) |      |   | (25,822,000 | )
|                                                                                                                                                                                                                        |  |              |             |   |      |   |             |  
|Total stockholders equity                                                                                                                                                                                              |  |              | 2,440,000   |   |      |   | 2,421,000   |  
|                                                                                                                                                                                                                        |  |              |             |   |      |   |             |  
|Total liabilities and stockholders equity                                                                                                                                                                              |  | $            | 3,346,000   |   |      | $ | 3,215,000   |  
|                                                                                                                                                                                                                        |  |              |             |   |      |   |             |  



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



14



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TRANSCEND SERVICES, INC.



CONSOLIDATED STATEMENTS OF OPERATIONS



|                                                                  |  |                          |            |   |      |   |            |      |  |   |            |  
|----------------------------------------------------------------- |  | ------------------------ | ---------- | - | ---- | - | ---------- | ---- |  | - | ---------- | -
|                                                                  |  | YEARS ENDED DECEMBER 31, |           
|                                                                  |  | 2003                     |            |   | 2002 |   |            | 2001 | 
|Revenue                                                           |  | $                        | 14,663,000 |   |      | $ | 12,225,000 |      |  | $ | 11,817,000 |  
|Direct costs                                                      |  |                          | 10,044,000 |   |      |   | 8,915,000  |      |  |   | 8,878,000  |  
|                                                                  |  |                          |            |   |      |   |            |      |  |   |            |  
|Gross profit                                                      |  |                          | 4,619,000  |   |      |   | 3,310,000  |      |  |   | 2,939,000  |  
|                                                                  |  |                          |            |   |      |   |            |      |  |   |            |  
|Operating expenses:                                               |  |                          |            |   |      |   |            |      |  |   |            |  
|Marketing and sales                                               |  |                          | 854,000    |   |      |   | 529,000    |      |  |   | 378,000    |  
|Research and development                                          |  |                          | 443,000    |   |      |   | 332,000    |      |  |   | 324,000    |  
|General and administrative                                        |  |                          | 2,292,000  |   |      |   | 2,407,000  |      |  |   | 2,451,000  |  
|                                                                  |  |                          |            |   |      |   |            |      |  |   |            |  
|Total operating expenses                                          |  |                          | 3,589,000  |   |      |   | 3,268,000  |      |  |   | 3,153,000  |  
|                                                                  |  |                          |            |   |      |   |            |      |  |   |            |  
|Income (loss) from operations                                     |  |                          | 1,030,000  |   |      |   | 42,000     |      |  |   | (214,000   | )
|                                                                  |  |                          |            |   |      |   |            |      |  |   |            |  
|Other (expense) income:                                           |  |                          |            |   |      |   |            |      |  |   |            |  
|Interest expense, net                                             |  |                          | (16,000    | ) |      |   |           |      |  |   | (18,000    | )
|Gains on sales of assets                                          |  |                          | 6,000      |   |      |   | 957,000    |      |  |   | 553,000    |  
|Loss on sale of short-term investment                             |  |                          |           |   |      |   |           |      |  |   | (576,000   | )
|                                                                  |  |                          |            |   |      |   |            |      |  |   |            |  
|Total other (expense) income                                      |  |                          | (10,000    | ) |      |   | 957,000    |      |  |   | (41,000    | )
|                                                                  |  |                          |            |   |      |   |            |      |  |   |            |  
|Income (loss) before income taxes and discontinued operations     |  |                          | 1,020,000  |   |      |   | 999,000    |      |  |   | (255,000   | )
|Income tax benefit                                                |  |                          |           |   |      |   |           |      |  |   | 116,000    |  
|                                                                  |  |                          |            |   |      |   |            |      |  |   |            |  
|Income (loss) before discontinued operations                      |  |                          | 1,020,000  |   |      |   | 999,000    |      |  |   | (139,000   | )
|Loss from discontinued operations                                 |  |                          |           |   |      |   | (109,000   | )    |  |   | (449,000   | )
|                                                                  |  |                          |            |   |      |   |            |      |  |   |            |  
|Net income (loss)                                                 |  |                          | 1,020,000  |   |      |   | 890,000    |      |  |   | (588,000   | )
|Dividends on preferred stock                                      |  |                          | (180,000   | ) |      |   | (478,000   | )    |  |   | (479,000   | )
|                                                                  |  |                          |            |   |      |   |            |      |  |   |            |  
|Net income (loss) attributable to common stockholders             |  | $                        | 840,000    |   |      | $ | 412,000    |      |  | $ | (1,067,000 | )
|                                                                  |  |                          |            |   |      |   |            |      |  |   |            |  
|Basic earnings (loss) per share:                                  |  |                          |            |   |      |   |            |      |  |   |            |  
|From continuing operations                                        |  | $                        | 0.14       |   |      | $ | 0.12       |      |  | $ | (0.14      | )
|From discontinued operations                                      |  |                          | 0.00       |   |      |   | (0.02      | )    |  |   | (0.10      | )
|                                                                  |  |                          |            |   |      |   |            |      |  |   |            |  
|Net earnings (loss) per share attributable to common stockholders |  | $                        | 0.14       |   |      | $ | 0.09       |      |  | $ | (0.24      | )
|                                                                  |  |                          |            |   |      |   |            |      |  |   |            |  
|Weighted average common shares outstanding                        |  |                          | 5,935,000  |   |      |   | 4,513,000  |      |  |   | 4,404,000  |  
|                                                                  |  |                          |            |   |      |   |            |      |  |   |            |  
|Diluted earnings (loss) per share:                                |  |                          |            |   |      |   |            |      |  |   |            |  
|From continuing operations                                        |  | $                        | 0.14       |   |      | $ | 0.11       |      |  | $ | (0.14      | )
|From discontinued operations                                      |  |                          | 0.00       |   |      |   | (0.02      | )    |  |   | (0.10      | )
|                                                                  |  |                          |            |   |      |   |            |      |  |   |            |  
|Net earnings (loss) per share attributable to common stockholders |  | $                        | 0.14       |   |      | $ | 0.09       |      |  | $ | (0.24      | )
|                                                                  |  |                          |            |   |      |   |            |      |  |   |            |  
|Weighted average common shares outstanding                        |  |                          | 6,117,000  |   |      |   | 4,547,000  |      |  |   | 4,404,000  |  
|                                                                  |  |                          |            |   |      |   |            |      |  |   |            |  



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



15



---

TRANSCEND SERVICES, INC.



CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY



|                                                                                      |  |                |        |   |              |   |        |                |  |   |                            |   |  |                         |          |   |                                          |   |             |                     |  |   |                      |   |  |                    |          |   |  |   |             |   |  |   |            |   |  |   |            |  
|------------------------------------------------------------------------------------- |  | -------------- | ------ | - | ------------ | - | ------ | -------------- |  | - | -------------------------- | - |  | ----------------------- | -------- | - | ---------------------------------------- | - | ----------- | ------------------- |  | - | -------------------- | - |  | ------------------ | -------- | - |  | - | ----------- | - |  | - | ---------- | - |  | - | ---------- | -
|                                                                                      |  | PREFERREDSTOCK |        |   | COMMON STOCK |   |        | TREASURY STOCK |  |   | ADDITIONAL PAID-IN CAPITAL |   |  | SUBSCRIPTION RECEIVABLE |          |   | UNREALIZED LOSS ON SHORT-TERM INVESTMENT |   |             | ACCUMULATED DEFICIT |  |   | STOCKHOLDERS EQUITY |   |  | COMPREHENSIVE LOSS |         
|                                                                                      |  | SERIES A       |        |   | SERIES B     |   |        |                |  |   |                            |   |  |                        
|Balance, December 31, 2000                                                            |  | $              | 2,000  |   |              | $ | 1,000  |                |  | $ | 224,000                    |   |  | $                       | (620,000 | ) |                                          | $ | 28,602,000  |                     |  | $ |                     |   |  | $                  | (866,000 | ) |  | $ | (25,167,000 | ) |  | $ | 2,176,000  |   |  |   |            |  
|Comprehensive loss:                                                                   |  |                |        |   |              |   |        |                |  |   |                            |   |  |                         |          |   |                                          |   |             |                     |  |   |                      |   |  |                    |          |   |  |   |             |   |  |   |            |   |  |   |            |  
|Net loss attributable to common Stockholders                                          |  |                |       |   |              |   |       |                |  |   |                           |   |  |                         |         |   |                                          |   |            |                     |  |   |                     |   |  |                    |         |   |  |   | (1,067,000  | ) |  |   | (1,067,000 | ) |  | $ | (1,067,000 | )
|Reverse valuation reserve on short-term investment                                    |  |                |       |   |              |   |       |                |  |   |                           |   |  |                         |         |   |                                          |   |            |                     |  |   |                     |   |  |                    | 866,000  |   |  |   |            |   |  |   | 866,000    |   |  |   | 866,000    |  
|                                                                                      |  |                |        |   |              |   |        |                |  |   |                            |   |  |                         |          |   |                                          |   |             |                     |  |   |                      |   |  |                    |          |   |  |   |             |   |  |   |            |   |  |   |            |  
|Comprehensive loss                                                                    |  |                |       |   |              |   |       |                |  |   |                           |   |  |                         |         |   |                                          |   |            |                     |  |   |                     |   |  |                    |         |   |  |   |            |   |  |   |           |   |  | $ | (201,000   | )
|                                                                                      |  |                |        |   |              |   |        |                |  |   |                            |   |  |                         |          |   |                                          |   |             |                     |  |   |                      |   |  |                    |          |   |  |   |             |   |  |   |            |   |  |   |            |  
|Issuance of 100,000 shares of Common Stock in private Placement                       |  |                |       |   |              |   |       |                |  |   | 5,000                      |   |  |                         |         |   |                                          |   | 121,000     |                     |  |   | (126,000             | ) |  |                    |         |   |  |   |            |   |  |   |           |   |  |   |            |  
|Issuance of 40,000 shares of Common Stock from exercise of options and other issuance |  |                |       |   |              |   |       |                |  |   | 1,000                      |   |  |                         |         |   |                                          |   | 33,000      |                     |  |   |                     |   |  |                    |         |   |  |   |            |   |  |   | 34,000     |   |  |   |            |  
|Retirement of Treasury Stock                                                          |  |                |       |   |              |   |       |                |  |   | (5,000                     | ) |  |                         | 620,000  |   |                                          |   | (615,000    | )                   |  |   |                     |   |  |                    |         |   |  |   |            |   |  |   |           |   |  |   |            |  
|                                                                                      |  |                |        |   |              |   |        |                |  |   |                            |   |  |                         |          |   |                                          |   |             |                     |  |   |                      |   |  |                    |          |   |  |   |             |   |  |   |            |   |  |   |            |  
|Balance, December 31, 2001                                                            |  |                | 2,000  |   |              |   | 1,000  |                |  |   | 225,000                    |   |  |                         |         |   |                                          |   | 28,141,000  |                     |  |   | (126,000             | ) |  |                    |         |   |  |   | (26,234,000 | ) |  |   | 2,009,000  |   |  |   |            |  
|Net income attributable to common stockholders                                        |  |                |       |   |              |   |       |                |  |   |                           |   |  |                         |         |   |                                          |   |            |                     |  |   |                     |   |  |                    |         |   |  |   | 412,000     |   |  |   | 412,000    |   |  |   |            |  
|Issuance of Common Stock in private placement                                         |  |                |       |   |              |   |       |                |  |   | (5,000                     | ) |  |                         |         |   |                                          |   | (121,000    | )                   |  |   | 126,000              |   |  |                    |         |   |  |   |            |   |  |   |           |   |  |   |            |  
|                                                                                      |  |                |        |   |              |   |        |                |  |   |                            |   |  |                         |          |   |                                          |   |             |                     |  |   |                      |   |  |                    |          |   |  |   |             |   |  |   |            |   |  |   |            |  
|Balance, December 31, 2002                                                            |  |                | 2,000  |   |              |   | 1,000  |                |  |   | 220,000                    |   |  |                         |         |   |                                          |   | 28,020,000  |                     |  |   |                     |   |  |                    |         |   |  |   | (25,822,000 | ) |  |   | 2,421,000  |   |  |   |            |  
|Net income attributable to common stockholders                                        |  |                |       |   |              |   |       |                |  |   |                           |   |  |                         |         |   |                                          |   |            |                     |  |   |                     |   |  |                    |         |   |  |   | 840,000     |   |  |   | 840,000    |   |  |   |            |  
|Conversion and redemption of Preferred Stock                                          |  |                | (2,000 | ) |              |   | (1,000 | )              |  |   | 144,000                    |   |  |                         |         |   |                                          |   | (962,000    | )                   |  |   |                     |   |  |                    |         |   |  |   |            |   |  |   | (821,000   | ) |  |   |            |  
|                                                                                      |  |                |        |   |              |   |        |                |  |   |                            |   |  |                         |          |   |                                          |   |             |                     |  |   |                      |   |  |                    |          |   |  |   |             |   |  |   |            |   |  |   |            |  
|Balance, December 31, 2003                                                            |  | $              |       |   |              | $ |       |                |  | $ | 364,000                    |   |  | $                       |         |   |                                          |   | $27,058,000 |                     |  | $ |                     |   |  | $                  |         |   |  | $ | (24,982,000 | ) |  | $ | 2,440,000  |   |  |   |            |  
|                                                                                      |  |                |        |   |              |   |        |                |  |   |                            |   |  |                         |          |   |                                          |   |             |                     |  |   |                      |   |  |                    |          |   |  |   |             |   |  |   |            |   |  |   |            |  



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



16



---

TRANSCEND SERVICES, INC.



CONSOLIDATED STATEMENTS OF CASH FLOWS



|                                                                                               |  |                          |           |   |      |   |          |      |  |   |            |  
|---------------------------------------------------------------------------------------------- |  | ------------------------ | --------- | - | ---- | - | -------- | ---- |  | - | ---------- | -
|                                                                                               |  | YEARS ENDED DECEMBER 31, |          
|                                                                                               |  | 2003                     |           |   | 2002 |   |          | 2001 | 
|CASH FLOWS FROM OPERATING ACTIVITIES:                                                          |  |                          |           |   |      |   |          |      |  |   |            |  
|Net income (loss) attributable to common shareholders                                          |  | $                        | 840,000   |   |      | $ | 412,000  |      |  | $ | (1,067,000 | )
|                                                                                               |  |                          |           |   |      |   |          |      |  |   |            |  
|Adjustments to reconcile net income (loss) to net cash provided by operating activities:       |  |                          |           |   |      |   |          |      |  |   |            |  
|Depreciation and amortization                                                                  |  |                          | 667,000   |   |      |   | 652,000  |      |  |   | 820,000    |  
|Loss related to discontinued operations                                                        |  |                          |          |   |      |   | 109,000  |      |  |   | 449,000    |  
|Loss on sale of short-term investment                                                          |  |                          |          |   |      |   |         |      |  |   | 576,000    |  
|Gains on sales of assets                                                                       |  |                          | (6,000    | ) |      |   | (957,000 | )    |  |   | (553,000   | )
|Preferred Stock dividends                                                                      |  |                          | 180,000   |   |      |   | 478,000  |      |  |   | 479,000    |  
|Changes in assets and liabilities:                                                             |  |                          |           |   |      |   |          |      |  |   |            |  
|Accounts receivable, net                                                                       |  |                          | (359,000  | ) |      |   | 69,000   |      |  |   | 602,000    |  
|Prepaid expenses and other current assets                                                      |  |                          | (115,000  | ) |      |   | 15,000   |      |  |   | 24,000     |  
|Other assets                                                                                   |  |                          | 21,000    |   |      |   | (23,000  | )    |  |   | 359,000    |  
|Accounts payable                                                                               |  |                          | (45,000   | ) |      |   | (20,000  | )    |  |   | (885,000   | )
|Accrued liabilities                                                                            |  |                          | (43,000   | ) |      |   | (62,000  | )    |  |   | (1,050,000 | )
|                                                                                               |  |                          |           |   |      |   |          |      |  |   |            |  
|Total adjustments                                                                              |  |                          | 300,000   |   |      |   | 261,000  |      |  |   | 821,000    |  
|                                                                                               |  |                          |           |   |      |   |          |      |  |   |            |  
|Net cash provided by (used in) continuing operations                                           |  |                          | 1,140,000 |   |      |   | 673,000  |      |  |   | (246,000   | )
|Net cash provided by (used in) discontinued operations                                         |  |                          |          |   |      |   | (197,000 | )    |  |   | 543,000    |  
|                                                                                               |  |                          |           |   |      |   |          |      |  |   |            |  
|Net cash provided by operating activities                                                      |  |                          | 1,140,000 |   |      |   | 476,000  |      |  |   | 297,000    |  
|                                                                                               |  |                          |           |   |      |   |          |      |  |   |            |  
|CASH FLOWS FROM INVESTING ACTIVITIES:                                                          |  |                          |           |   |      |   |          |      |  |   |            |  
|Capital expenditures                                                                           |  |                          | (568,000  | ) |      |   | (431,000 | )    |  |   | (653,000   | )
|Proceeds from disposition of assets                                                            |  |                          |          |   |      |   | 911,000  |      |  |   | 553,000    |  
|Proceeds from the sale of short-term investment                                                |  |                          |          |   |      |   |         |      |  |   | 1,160,000  |  
|                                                                                               |  |                          |           |   |      |   |          |      |  |   |            |  
|Net cash provided by (used in) investing activities                                            |  |                          | (568,000  | ) |      |   | 480,000  |      |  |   | 1,060,000  |  
|                                                                                               |  |                          |           |   |      |   |          |      |  |   |            |  
|CASH FLOWS FROM FINANCING ACTIVITIES:                                                          |  |                          |           |   |      |   |          |      |  |   |            |  
|Redemption of Preferred Stock                                                                  |  |                          | (600,000  | ) |      |   |         |      |  |   |           |  
|Preferred Stock dividends                                                                      |  |                          | (110,000  | ) |      |   | (478,000 | )    |  |   | (479,000   | )
|Preferred Stock redemption/conversion expenses                                                 |  |                          | (86,000   | ) |      |   |         |      |  |   |           |  
|Repayments (borrowings) under line of credit agreement                                         |  |                          |          |   |      |   |         |      |  |   | (614,000   | )
|Proceeds from stock options and other issuances                                                |  |                          |          |   |      |   |         |      |  |   | 34,000     |  
|                                                                                               |  |                          |           |   |      |   |          |      |  |   |            |  
|Net cash used in financing activities                                                          |  |                          | (796,000  | ) |      |   | (478,000 | )    |  |   | (1,059,000 | )
|                                                                                               |  |                          |           |   |      |   |          |      |  |   |            |  
|Net change in cash and cash equivalents                                                        |  |                          | (224,000  | ) |      |   | 478,000  |      |  |   | 298,000    |  
|Cash and cash equivalents, at beginning of year                                                |  |                          | 782,000   |   |      |   | 304,000  |      |  |   | 6,000      |  
|                                                                                               |  |                          |           |   |      |   |          |      |  |   |            |  
|Cash and cash equivalents, at end of year                                                      |  | $                        | 558,000   |   |      | $ | 782,000  |      |  | $ | 304,000    |  
|                                                                                               |  |                          |           |   |      |   |          |      |  |   |            |  
|Supplemental cash flow information:                                                            |  |                          |           |   |      |   |          |      |  |   |            |  
|Cash paid for interest expense                                                                 |  | $                        | 19,000    |   |      | $ | 2,000    |      |  | $ | 60,000     |  
|                                                                                               |  |                          |           |   |      |   |          |      |  |   |            |  
|Noncash investing and financing activities:                                                    |  |                          |           |   |      |   |          |      |  |   |            |  
|Issuance of promissory notes payable in conjunction with the redemption of Preferred Stock     |  | $                        | 200,000   |   |      | $ |         |      |  | $ |           |  
|                                                                                               |  |                          |           |   |      |   |          |      |  |   |            |  
|Issuance of Common Stock in lieu of Preferred Stock cash dividends                             |  | $                        | 70,000    |   |      | $ |         |      |  | $ |           |  
|                                                                                               |  |                          |           |   |      |   |          |      |  |   |            |  
|(Cancellation) receipt of secured promissory notes receivable for the issuance of Common Stock |  | $                        |          |   |      | $ | (126,000 | )    |  | $ | 126,000    |  
|                                                                                               |  |                          |           |   |      |   |          |      |  |   |            |  



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



17



---

TRANSCEND SERVICES, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2003, 2002 AND 2001



1. NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES



NATURE OF BUSINESS



Transcend Services, Inc. (the Company) provides medical transcription services to the healthcare industry. Powered by its web-based voice and data distribution technology, the Companys home-based medical language
specialists document patient care by converting physicians voice recordings into electronic medical record documents.



BASIS OF PRESENTATION



The consolidated financial statements include the accounts of the Company and its wholly owned subsidiary, Cascade Health Information Software, Inc.
(Cascade) prior to the sale of certain assets and the operations of Cascade on May 31, 2002 at which time Cascade was presented as discontinued operations (see Note 2). All intercompany accounts and transactions have been eliminated in
consolidation.



ACCOUNTING ESTIMATES



The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts and disclosures in the Companys financial statements and accompanying notes. Actual results
could differ from those estimates.



CASH AND CASH EQUIVALENTS



All highly liquid investments purchased with an original
maturity of three months or less are classified as cash equivalents.



SHORT-TERM INVESTMENT



The Company follows
Financial Accounting Standards Board (FASB) Statement of Financial Accounting Standards (SFAS) No. 115, Accounting for Certain Investments in Debt and Equity Securities. SFAS No. 115 mandates that a determination be made of
the appropriate classification for debt and equity securities with readily determinable fair value at the time of purchase and a reevaluation of such designation as of each balance sheet date. The Company considered its short-term investment that
was sold during 2001, which consisted of unregistered common stock of a publicly traded company acquired in a legal settlement effective March 31, 2000, as available for sale. A valuation reserve of $866,000 was established for the
difference between the cost basis of this short-term investment of approximately $1,736,000 and its fair market value of $870,000 as of December 31, 2000. On April 2, 2001, the Company sold this short-term investment for approximately $1,160,000,
net of commission expense of $10,000, resulting in a realized loss of approximately $576,000, which is presented as the loss on sale of short-term investment in the accompanying consolidated statement of operations for the year ended December 31,
2001. The valuation reserve of $866,000 that was established for this short-term investment as of December 31, 2000 was reversed at the time of the sale resulting in a net increase in stockholders equity of approximately $290,000 during 2001
due to this sale.



ACCOUNTS RECEIVABLE



Accounts receivable are recorded net of an allowance for doubtful accounts
established to provide for losses on uncollectible accounts based on managements estimates and historical collection. The provisions for doubtful accounts were $3,000, $15,000 and $0 in 2003, 2002 and 2001, respectively. Charges for bad debts
were $14,000, $26,000 and $466,000 in 2003, 2002 and 2001, respectively.



REVENUE AND COST RECOGNITION



Service revenue
related to Cascade prior to the sale of Cascade includes system implementation, software support and software maintenance fees. Cascades implementation fee revenue was recognized on the basis of hours worked by each implementation person



18



---

times the contracted hourly billing rate applicable to each such implementation person. Software support and maintenance revenue was typically billed in
advance on either a quarterly or annual basis, but was recognized as revenue monthly on a straight-line basis over the applicable quarterly or annual service period. Software license fee revenue was recognized in accordance with Statement of
Position (SOP) 97-2, Software Revenue Recognition,SOP 98-9, Software Revenue Recognition with Respect to Certain Transactions and Staff Accounting Bulletin No. 101, Revenue Recognition in Financial Statements.Accordingly, the Company recognized software license fee revenue when: (1) a software license agreement existed; (2) delivery and installation had occurred; (3) the fee was fixed or determinable; and (4) collectibility was probable.
Transcription service fee revenue is recognized as the related transcription work is performed on the basis of the number of lines transcribed times the contracted billing rate per line transcribed. Implementation fees related to transcription
services are recognized on the basis of hours worked by each implementation person times the contracted hourly billing rate applicable to each such implementation person. All service-related costs were expensed as incurred for Cascade and are
expensed as incurred for the continuing operations.



PROPERTY AND EQUIPMENT



Property and equipment is stated at cost, less
accumulated depreciation. Charges for depreciation of capital assets are computed using the straight-line method over their estimated useful lives, which range from three to six years, and are included in direct costs and general and administrative
expenses in the accompanying consolidated statements of operations.



Effective April 1, 2002, the Company changed the estimated useful life of its proprietary T2K transcription system from four to six years to reflect the success of the Companys on-going software maintenance and enhancement efforts,
which are expensed as incurred, in extending the useful life of the system. This change reduced amortization expense by approximately $17,000 per month, or $204,000 (approximately $0.03 per share) in 2003 and $153,000 (approximately $0.03 per share)
in 2002. In addition, during the first quarter of 2002, the Company wrote off fully depreciated computer equipment of $1,783,000 and furniture and fixtures of $162,000 that were no longer in productive use.



All costs in the software development process that are classified as research
and development are expensed as incurred until technological feasibility has been established. Once technological feasibility has been established, such costs are considered for capitalization. The Companys policy is to amortize these costs
using the straight-line method over the remaining estimated economic life of the product, not to exceed five years. No software development costs were capitalized for the continuing operations in 2002 or 2001, but $17,000 was capitalized in 2003.



OTHER ASSETS



Other assets consist primarily of deposits for rented facilities.



GOODWILL AND OTHER INTANGIBLE ASSETS



The Company accounts for goodwill and other intangible assets in accordance
with the provisions of SFAS No. 142, Goodwill and Other Intangible Assets.Under the provisions of this Statement goodwill and intangible assets that have indefinite useful lives are tested at least annually for impairment rather than be
amortized like intangible assets with finite useful lives, which are amortized over their useful lives. The Company has no goodwill or intangible assets subject to the provisions of SFAS No. 142 as of December 31, 2003 and 2002.



IMPAIRMENT



The Company accounts for long-lived assets under the provisions of SFAS No. 121, Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to be Disposed Of. This Statement requires that long-lived assets and certain identifiable intangibles be reviewed for impairment whenever events or changes in circumstances indicate that the carrying
amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to future undiscounted net cash flows expected to be generated by the asset. If such assets are
considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value of the assets. Assets to be disposed of are reported at the lower of the carrying amount or fair
value less cost to sell. In managements opinion, the long-lived assets are appropriately valued in the accompanying balance sheets.



FAIR VALUE OF DEBT



In accordance with SFAS No. 107, Disclosures About Fair Value of Financial Instruments, the fair value of short-term debt, which totaled
$200,000 as of December 31, 2003, is estimated to approximate its carrying value. The fair value of long-term debt is



19



---

estimated based on approximate market interest rates for similar issues. The Company had no short-term debt at December 31, 2002 and no long-term debt at
December 31, 2003 and 2002.



STOCK BASED COMPENSATION



In accordance with the provisions of Accounting Principles Board Opinion No.
25, Accounting for Stock Issued to Employees, the Company measures stock-based compensation expense as the excess of the market price on date of grant over the amount of the grant. Since the Company grants all stock-based compensation at the market
price on the date of grant, no compensation expense is recognized. As permitted, the Company has elected to adopt only the disclosure provisions of SFAS No. 123, Accounting for Stock-based Compensation (see Note 9).



INCOME TAXES



The Company accounts for its income taxes in accordance with Statement of Financial Accounting Standards (SFAS)
No. 109. Deferred tax assets and liabilities, if any, are recognized for the expected tax consequences of temporary differences between the tax basis of assets and liabilities and their reported amounts and for operating loss and tax credit
carry-forwards.



NET INCOME (LOSS) PER SHARE



The Company follows SFAS No. 128, Earnings per Share. That
statement requires the disclosure of basic net income (loss) per share and diluted net income (loss) per share. Basic net income (loss) per share is computed by dividing net income (loss) available to common shareholders by the weighted-average
number of common shares outstanding during the period and does not include any other potentially dilutive securities. Diluted net income (loss) per share gives effect to all potentially dilutive securities. The Companys stock options are
potentially dilutive securities. The diluted net income per share was reported for the years ended December 31, 2003 and 2002. All potentially dilutive securities were antidilutive and therefore are not included in diluted net loss per share
calculations in 2001.



COMPREHENSIVE LOSS



The Company accounts for comprehensive loss under the provisions of SFAS No.
130, Reporting Comprehensive Income. This statement establishes standards for reporting and display of comprehensive loss and its components in a full set of general purpose financial statements. The Company has chosen to disclose
comprehensive loss, which consists of a reversal of a valuation reserve on a short-term investment, in the consolidated statements of stockholders equity.



CREDIT RISK



The Companys accounts receivable potentially subject the Company to credit risk, as collateral is generally not required. The Companys risk of
loss is limited due to the ability to terminate access on delinquent accounts. The carrying amount of the Companys receivables approximates their fair values. The Company monitors the financial condition of the institutions in which it has
depository accounts and believes the risk of loss is minimal.



RECENT
ACCOUNTING PRONOUNCEMENTS



The Financial Accounting
Standards Board (FASB) issued Statement of Financial Accounting Standard No. 149 (SFAS 149), regarding An Amendment of Statement 133 on Derivative Instruments and Hedging Activities in April 2003 and SFAS 150
regarding Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity in May 2003 and revised SFAS 132 regarding Employers Disclosures about Pensions and Other Postretirement Benefits
 an amendment of FASB Statements No. 87, 88 and 106 in December 2003 (collectively, the Statements). The provisions of the Statements, which are currently not applicable to the Company, became, or will become, effective in
whole or in part at various times in 2003 and thereafter. The Statements will be considered and adopted, where and when applicable, by the Company at the appropriate future point in time. None of the Statements had an effect on the results of
operations or financial position of the Company reported in the accompanying consolidated financial statements.



2. DISCONTINUED OPERATIONS



On May 31, 2002, the Company sold certain assets and the operations of Cascade Health Information Software, Inc. (Cascade), a wholly owned
subsidiary of the Company, to QuadraMed Corporation for $911,000 in cash and the assumption of certain liabilities, which resulted in a gain on the sale of



20



---

assets of $954,000. All information presented in the accompanying consolidated financial statements has been restated to classify Cascade as discontinued
operations. As a result of the sale of Cascade, the Company now operates in one, and only one, reportable business segment as a provider of medical transcription services. See Note 12. The operating results for Cascade were as follows:



|         |  |                                |          |   |      |   |           |  
|-------- |  | ------------------------------ | -------- | - | ---- | - | --------- | -
|         |  | For the Year EndedDecember 31, |         
|         |  | 2002*                          |          |   | 2001 |  
|Revenue  |  | $                              | 641,000  |   |      | $ | 1,968,000 |  
|Net loss |  | $                              | (109,000 | ) |      | $ | (449,000  | )



|* | Represents Cascades results for the five months ended May 31, 2002 (the date of sale).
|- | ---------------------------------------------------------------------------------------



3. NON-RECURRING ITEM



The Company incurred a loss of $576,000 in 2001 on the sale of common stock of another company that was received by the Company in a legal settlement
during 2000, but bore resale restrictions until its sale in 2001. See also Note 2 regarding Discontinued Operations and Note 11 regarding the gains on sales of assets.



4. BORROWING ARRANGEMENTS



On March 25, 2002, the Company signed a one-year promissory note due March 31, 2003 that established a $1.5 million line of credit (the LOC)
with Bank of America, N.A. (B of A). Borrowings under this LOC bear interest at B of As prime rate less one-half percent (3.5% at December 31, 2003). On March 21, 2003, the Company extended the maturity date of the LOC to March 31,
2004. Repayment of borrowings, if any, under the LOC are personally guaranteed by the Companys Chief Executive Officer and one of its Directors (the Guarantors). On July 23, 2003 the independent members of the board of directors
authorized the payment of an annual facility fee to the Guarantors in an amount equal to 1% of the LOC facility (or $15,000 in aggregate). In addition, quarterly usage fees are payable to the Guarantors at the rate of 2% per annum on average daily
borrowings under the LOC during the quarter. No such usage fees were payable to the Guarantors during 2003. There was no balance outstanding under the LOC as of December 31, 2003 and December 31, 2002. The entire $1.5 million LOC is available for
borrowing at December 31, 2003. The Company expects to renew the LOC agreement upon expiration of the extended promissory note.



5. COMMITMENTS AND CONTINGENCIES



Lease Commitments



Future minimum annual rental obligations under non-cancelable operating leases as of December 31, 2003 are as follows:



|                                         |  |   |          
|---------------------------------------- |  | - | ---------
|2004 (net of sublease income of $54,000) |  | $ | 250,000  
|2005 (net of sublease income of $18,000) |  |   | 265,000  
|2006                                     |  |   | 288,000  
|2007                                     |  |   | 190,000  
|2008                                     |  |   | 12,000   
|                                         |  |   |          
|Total rental obligation                  |  | $ | 1,005,000
|                                         |  |   |          



Rental expense was
$226,000, $248,000 and $301,000 for the years ended December 31, 2003, 2002 and 2001, respectively.



Litigation



On April 5,
2001, Our Lady of the Lakes Hospital, Inc. (OLOL) filed a lawsuit against the Company. The lawsuit, styled Our Lady of the Lakes Hospital, Inc. v. Transcend Services, Inc. was filed in the 19th Judicial District Court, Parish
of East, State of Louisiana, Civil Case Number 482775, Div. A. The lawsuit alleges, among other things, that the Company breached certain contracts entered into between OLOL and the Company, including a staffing and management servicing contract, a
transcription platform agreement and a marketing agreement. OLOL is seeking an unspecified amount of monetary damages. On May 30, 2001, the Company filed a timely Answer that generally denied all liability, and the Company filed a counterclaim
against OLOL primarily seeking fees owed by OLOL for services performed by the Company and interest on unpaid invoices. OLOL has subsequently added Transcends insurance carriers as defendants to the lawsuit.



The Company intends to vigorously defend all claims made by OLOL. The lawsuit
is in an early procedural stage, however, and therefore it is not possible at this time to determine the outcome of the actions or the effect, if any, that their outcome may have on the



21



---

Companys results of operations and financial condition. There can be no assurances that this litigation will not have a material adverse effect on the
Companys results of operations and financial condition.



In May 2003, a company threatened Transcend with a demand for binding arbitration related to a dispute between that company and Transcend regarding the level of fees payable under a cross-marketing agreement that provides for binding
arbitration of disputes. The threatened binding arbitration process has not been initiated at this time and it is uncertain when, if ever, the threatened binding arbitration process will be initiated. While Transcend believes that it has meritorious
defenses against the claims of the other party in the dispute, there can be no assurance that the results of this threatened binding arbitration will not have a material adverse effect on Transcends results of operations and financial
condition.



6. 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. There have been no Company matching contributions for 2003, 2002 and 2001.



7. TRANSACTIONS WITH RELATED PARTIES



On
December 28, 2001, the Company sold 100,000 shares of its unregistered common stock (the Stock) on a contingent basis to certain of the Companys officers at market value of $126,000 as determined by the closing price reported on
the Nasdaq SmallCap Market on that date. The issuance of the Stock was made in reliance on the exemption from registration provided in Section 4(2) of the Securities Act of 1933 as a transaction by an issuer not involving a public offering. As
consideration for the sale, the officers issued interest bearing, secured promissory notes in the aggregate amount of $126,000 payable to the Company on January 15, 2003 (the Notes). The Notes were secured by the Stock. The sale was
contingent upon the Companys stock trading at or above $4.00 per share for ten consecutive days during 2002. Since the Companys stock did not trade at or above the required price in 2002, the officers surrendered the Stock to the Company
for cancellation and retirement and the Notes were cancelled on December 30, 2002.



In 2003, the Companys Chief Executive Officer and one of its Directors received $15,000 in aggregate for personally guaranteeing the repayment of borrowings, if any, under the Companys line of credit. See
Note 4.



The Companys Chief Executive Officer and two of
its Directors received an aggregate of 836,687 shares of the 2,903,422 shares of common stock issued in the stockholder-approved conversion of the Companys preferred stock and in lieu of cash at the preferred stock dividend payment dates of
February 15 and May 15, 2003. See Note 8.



8. STOCKHOLDERS EQUITY



On June 25, 2003, The stockholders of the Company
approved an amendment to the Companys Certificate of Incorporation that authorized the Company to increase the number of authorized shares of common stock, par value $0.05, from 6,000,000 shares to 15,000,000 shares and to decrease the number
of authorized shares of preferred stock, par value $0.01, from 21,000,000 shares to 2,000,000 shares.



The Company issued 2,860,000 shares of its unregistered common stock to the holders of its Series A and B Convertible Preferred Stock in a
stockholder-approved transaction to convert most of its outstanding preferred stock to common stock at $2.00 per share on June 25, 2003. The Company redeemed the remaining outstanding shares of its preferred stock on July 1, 2003 in a
stockholder-approved transaction for $600,000 in cash and two short-term promissory notes payable of $100,000 each. In addition, the Company issued 31,050 and 12,372 shares of its unregistered common stock at $1.50 and $2.00 per share, respectively,
to certain holders of its Series A Convertible Preferred Stock who elected to receive their quarterly preferred stock dividends in common stock in lieu of cash at the preferred stock dividend payment dates of February 15 and May 15, 2003. The
2,903,422 shares of common stock that were issued in the preferred stock conversion and in lieu of preferred stock dividends were registered for potential resale by certain shareholders of the Company in a registration statement that was declared
effective by the Securities and Exchange Commission on October 1, 2003. The Company did not and will not receive any proceeds from the sale of the registered shares by the selling shareholders.



The Company had 7,316,565 shares of common stock and no shares of preferred
stock outstanding as of December 31, 2003.



22



---

9. STOCK OPTIONS



The Company has established stock option plans for its key employees, Directors and key consultants, two of which plans have been approved by its
stockholders and a third plan was adopted by the Companys Board of Directors on December 9, 2003, subject to the approval of the stockholders at their next annual meeting (the Plans). The Plans provide for the issuance of incentive
stock options and non-statutory options, and the third plan also provides for the grant of restricted stock awards, none of which awards have been granted as of December 31, 2003. Under the Plans, options are granted for the purchase of the
Companys common stock at the approximate fair value, as defined in the option agreement, on the date of grant.



The following is a summary of stock option transactions:



|                          |  |                  |   |  |                        |  |                               |     
|------------------------- |  | ---------------- | - |  | ---------------------- |  | ----------------------------- | ----
|                          |  | NUMBER OFOPTIONS |   |  | AVERAGE PRICEPER SHARE |  | WEIGHTEDAVERAGEPRICE PERSHARE
|Outstanding at 12/31/2000 |  | 355,000          |   |  | $1.34 to $27.50        |  | $                             | 3.55
|Granted                   |  | 162,000          |   |  | $1.10 to $2.50         |  | $                             | 1.63
|Forfeited                 |  | (99,000          | ) |  | $1.34 to $27.50        |  | $                             | 4.65
|Exercised                 |  | (10,000          | ) |  | $1.72                  |  | $                             | 1.72
|                          |  |                  |   |  |                        |  |                               |     
|Outstanding at 12/31/2001 |  | 408,000          |   |  | $1.10 to $18.13        |  | $                             | 2.56
|Granted                   |  | 86,000           |   |  | $0.74 to $1.25         |  | $                             | 0.86
|Forfeited                 |  | (60,000          | ) |  | $1.23 to $15.6250      |  | $                             | 3.23
|Exercised                 |  |                 |   |  |                       |  | $                             |    
|                          |  |                  |   |  |                        |  |                               |     
|Outstanding at 12/31/2002 |  | 434,000          |   |  | $0.74 to $18.13        |  | $                             | 2.13
|Granted                   |  | 362,000          |   |  | $1.45 to $4.15         |  | $                             | 3.22
|Forfeited                 |  | (29,000          | ) |  | $0.74 to $18.13        |  | $                             | 8.02
|Exercised                 |  |                 |   |  |                       |  | $                             |    
|                          |  |                  |   |  |                        |  |                               |     
|Outstanding at 12/31/2003 |  | 767,000          |   |  | $0.74 to $6.88         |  | $                             | 2.46
|                          |  |                  |   |  |                        |  |                               |     
|Exercisable at 12/31/2003 |  | 288,000          |   |  | $0.74 to $6.88         |  | $                             | 1.95
|                          |  |                  |   |  |                        |  |                               |     



|                                                              |  |                                                                                              |  |                                                                              |      |                                                                                                                                           |        
|------------------------------------------------------------- |  | -------------------------------------------------------------------------------------------- |  | ---------------------------------------------------------------------------- | ---- | ----------------------------------------------------------------------------------------------------------------------------------------- | -------
|                                                              |  | Number of securities to beissued upon exercise ofoutstanding
options,warrants and rights (a) |  | Weighted-averageexercise price ofoutstanding options,warrants and
rights (b) |      | Number of securitiesremaining availablefor future issuanceunder equitycompensation
plans(excluding securitiesreflected in column (a)) (c)
|Equity compensation plans approved by security holders        |  | 667,000                                                                                      |  | $                                                                            | 2.20 |                                                                                                                                           | 56,000 
|Equity compensation plans not approved by security holders(1) |  | 100,000                                                                                      |  | $                                                                            | 4.15 |                                                                                                                                           | 250,000
|                                                              |  |                                                                                              |  |                                                                              |      |                                                                                                                                           |        
|Total                                                         |  | 767,000                                                                                      |  | $                                                                            | 2.46 |                                                                                                                                           | 306,000
|                                                              |  |                                                                                              |  |                                                                              |      |                                                                                                                                           |        



|(1) | The Companys 2003 Stock Incentive Plan was approved by the Companys Board of
Directors on December 9, 2003, subject to the approval of the Companys stockholders at its next annual meeting.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



The Company has elected to account for its stock-based compensation plans under Accounting Principles Board 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 2003, 2002 and 2001 to employees and Directors of the Company
using the Black-Scholes option-pricing model and the following weighted average assumptions:



|                        |  |            |   |  |            |   |  |            |  
|----------------------- |  | ---------- | - |  | ---------- | - |  | ---------- | -
|                        |  | 2003       |   |  | 2002       |   |  | 2001       |  
|Risk-free interest rate |  | 2.55       | % |  | 2.65       | % |  | 4.25       | %
|Expected dividend yield |  |           |   |  |           |   |  |           |  
|Expected life           |  | Four years |   |  | Four years |   |  | Four years |  
|Expected volatility     |  | 55         | % |  | 64         | % |  | 63         | %





23



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The total fair value of the options granted during the years ended December 31, 2003, 2002 and 2001 was
computed to be approximately $537,000, $34,000 and $128,000, 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 income (loss) for the years ended December 31, 2003, 2002 and 2001 would have been as follows:



|                                                                                   |  |      |         |      |   |         |  |             |  
|---------------------------------------------------------------------------------- |  | ---- | ------- | ---- | - | ------- |  | ----------- | -
|                                                                                   |  | 2003 |         | 2002 |   | 2001    | 
|Net income (loss) attributable to common stockholders:                             |  |      |         |      |   |         |  |             |  
|As reported                                                                        |  | $    | 840,000 |      | $ | 412,000 |  | ($1,067,000 | )
|Pro forma                                                                          |  | $    | 744,000 |      | $ | 319,000 |  | ($1,184,000 | )
|Basic and diluted net income (loss) per share attributable to common stockholders: |  |      |         |      |   |         |  |             |  
|As reported                                                                        |  | $    | 0.14    |      | $ | 0.09    |  | ($0.24      | )
|Pro forma                                                                          |  | $    | 0.12    |      | $ | 0.07    |  | ($0.27      | )



The following table
sets forth the exercise price range, number of shares, weighted average exercise price, and remaining contractual lives by groups of similar prices and grant dates:



|                               |  |                               |  |                                 |  |                              |      |                               |         |                              |   |     
|------------------------------ |  | ----------------------------- |  | ------------------------------- |  | ---------------------------- | ---- | ----------------------------- | ------- | ---------------------------- | - | ----
|                               |  | Options Outstanding           |  | Options Exercisable            
|Actual Range of Exercise Price |  | OutstandingatDecember 31,2003 |  | AverageRemainingContractualLife |  | WeightedAverageExercisePrice |      | ExercisableatDecember 31,2003 |         | WeightedAverageExercisePrice
|$0.74 - $1.09                  |  | 70,000                        |  | 9.0 years                       |  | $                            | 0.79 |                               | 20,000  |                              | $ | 0.79
|$1.10 - $1.50                  |  | 159,000                       |  | 7.6 years                       |  | $                            | 1.29 |                               | 89,000  |                              | $ | 1.29
|$1.51 - $2.00                  |  | 121,000                       |  | 6.4 years                       |  | $                            | 1.75 |                               | 102,000 |                              | $ | 1.73
|$2.01 - $3.00                  |  | 203,000                       |  | 9.1 years                       |  | $                            | 2.61 |                               | 46,000  |                              | $ | 2.68
|$3.01 - $5.00                  |  | 206,000                       |  | 9.5 years                       |  | $                            | 4.06 |                               | 23,000  |                              | $ | 3.54
|$5.01 - $6.88                  |  | 8,000                         |  | 5.2 years                       |  | $                            | 6.40 |                               | 8,000   |                              | $ | 6.40
|                               |  |                               |  |                                 |  |                              |      |                               |         |                              |   |     
|$0.74 - $6.88                  |  | 767,000                       |  | 8.4 years                       |  | $                            | 2.46 |                               | 288,000 |                              | $ | 1.95
|                               |  |                               |  |                                 |  |                              |      |                               |         |                              |   |     



10. INCOME TAXES



Since the Companys taxable income for the year ended December 31, 2003
was offset by available net operating loss carry-forwards and the Company generated a net loss for income tax purposes in the year ended December 31, 2001, no income tax provision has been recorded in 2003, 2002 and 2001. The Company reported an
income tax benefit of $116,000 in 2001 due to the elimination of deferred income tax liabilities of $121,000 established in prior years that are no longer required, offset slightly by state income taxes of $5,000.



The tax effects of temporary differences, if any, 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, if any, as of December 31, 2003 and 2002, were as follows:



|                                   |  |                    |            |   |      |   |            |  
|---------------------------------- |  | ------------------ | ---------- | - | ---- | - | ---------- | -
|                                   |  | As of December 31, |           
|                                   |  | 2003               |            |   | 2002 |  
|Deferred tax assets:               |  |                    |            |   |      |   |            |  
|Net operating loss carry-forwards  |  | $                  | 7,410,000  |   |      | $ | 7,605,000  |  
|Cash-basis deferral                |  |                    | 0          |   |      |   | 20,000     |  
|Valuation allowance                |  |                    | (7,410,000 | ) |      |   | (7,625,000 | )
|                                   |  |                    |            |   |      |   |            |  
|Net deferred tax asset (liability) |  | $                  | 0          |   |      | $ | 0          |  
|                                   |  |                    |            |   |      |   |            |  



At December 31, 2003,
the Company had net operating loss carry-forwards of approximately $19,000,000 that may be used to reduce future income taxes. If not utilized these carry-forwards will begin to expire in 2009. The Company has established a valuation allowance of
$7,410,000 and $7,625,000 at December 31, 2003 and 2002, respectively, due to the uncertainty regarding the realizability of certain deferred tax assets, including its net operating loss carry-forwards.



|                                  |  |      |    |  |      |    |  |      |   
|--------------------------------- |  | ---- | -- |  | ---- | -- |  | ---- | --
|Reconciliation of Tax Rates:      |  | 2003 |    |  | 2002 |    |  | 2001 |   
|Federal                           |  | 34   | %  |  | 34   | %  |  | 34   | % 
|State                             |  | 5    | %  |  | 5    | %  |  | 5    | % 
|Net operating loss carry-forwards |  | 0    | %  |  | 0    | %  |  | 0    | % 
|Valuation allowance               |  | (39  | %) |  | (39  | %) |  | (55  | %)
|                                  |  |      |    |  |      |    |  |      |   
|Effective tax rate                |  | 0    | %  |  | 0    | %  |  | (16  | %)
|                                  |  |      |    |  |      |    |  |      |   



24



---

11. DIVESTITURES



The Company received a one-time earn-out payment of $553,000 in December 2001 related to the sale of certain medical transcription services operations and
certain contracts in December 1999. This earn-out payment is presented as a gain on sale of assets in the accompanying consolidated statements of operations.



The Company received earn-out payments of $6,000 in 2003 and $9,000 in 2002 of which $6,000 applied to 2001, all related to the sale of its Co-Sourcing
and CodeRemote business units (the Businesses) to Provider HealthNet Services, Inc. (PHNS) pursuant to an Asset Purchase Agreement (the Agreement) with PHNS on October 13, 2000 under which the Company received
$4.7 million in cash during 2000 with the potential to receive additional consideration payable over the subsequent five years. The amount of future consideration, if any, will be based on a fixed percentage of certain defined future revenue
recognized by PHNS from the Businesses.



See Note 2 regarding
Discontinued Operations.



12. MAJOR CUSTOMER



No single customer contributed revenue equal to or in excess of 10% of total
revenue in 2001 or 2002, but revenue attributable to one customer totaled $1,572,000, or 10.7% of total revenue in 2003.



13. SEGMENT INFORMATION



Subsequent to the sale of certain assets and the operations of Cascade Health Information Software, Inc. (Cascade) on May 31, 2002, the
Company operates in one, and only one, reportable segment. All information presented in the accompanying consolidated financial statements has been restated to classify Cascade as discontinued operations. The continuing operations of the Company, as
presented in the accompanying consolidated financial statements, were devoted exclusively to one reportable segment (medical transcription) in 2003, 2002 and 2001.



14. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)



|                                                                           |  |               |           |   |               |   |              |  |   |               |   |  |   |          
|-------------------------------------------------------------------------- |  | ------------- | --------- | - | ------------- | - | ------------ |  | - | ------------- | - |  | - | ---------
|                                                                           |  | First Quarter |           |   | SecondQuarter |   | ThirdQuarter |  |   | FourthQuarter
|2003                                                                       |  |               |           |   |               |   |              |  |   |               |   |  |   |          
|Revenue                                                                    |  | $             | 3,481,000 |   |               | $ | 3,393,000    |  | $ | 3,754,000     |   |  | $ | 4,035,000
|Gross profit                                                               |  | $             | 1,110,000 |   |               | $ | 1,072,000    |  | $ | 1,197,000     |   |  | $ | 1,240,000
|Net income attributable to common shareholders(1)                          |  | $             | 80,000    |   |               | $ | 130,000      |  | $ | 280,000       |   |  | $ | 350,000  
|Diluted net income per share attributable to common stockholders(1)        |  | $             | 0.02      |   |               | $ | 0.03         |  | $ | 0.04          |   |  | $ | 0.05     
|2002                                                                       |  |               |           |   |               |   |              |  |   |               |   |  |   |          
|Revenue                                                                    |  | $             | 2,913,000 |   |               | $ | 2,989,000    |  | $ | 2,988,000     |   |  | $ | 3,335,000
|Gross profit                                                               |  | $             | 783,000   |   |               | $ | 714,000      |  | $ | 738,000       |   |  | $ | 1,075,000
|Net income (loss) attributable to common shareholders(1)                   |  | $             | (229,000  | ) |               | $ | 704,000      |  | $ | (224,000      | ) |  | $ | 161,000  
|Diluted net income (loss) per share attributable to common stockholders(1) |  | $             | (0.05     | ) |               | $ | 0.16         |  | $ | (0.05         | ) |  | $ | 0.04     



|(1) | The following unusual items are included in the determination of net income (loss)
attributable to common stockholders: (a) gain (loss) on sales of assets of $962,000 in the second quarter of 2002, $(6,000) in the third quarter of 2002, and $(2,000) in the fourth quarter of 2002, related to the Cascade sale on May 31, 2002 (see
Note 2); and (b) gain on sale of assets of $3,000 and $6,000 in the fourth quarters of 2002 and 2003, respectively, related to the sales of Co-Sourcing and Code Remote business units during October 2000 (see Note 11).
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



There has been no occurrence requiring response to this item.



|ITEM 9A. | CONTROLS AND PROCEDURES
|-------- | -----------------------



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



Internal control over financial reporting consists of control processes designed to provide assurance regarding the reliability of financial reporting and the preparation of the Companys financial statements in
accordance with GAAP. To the extent that components of the Companys internal control over financial reporting are included in the Companys disclosure controls, they are included in the scope of the evaluation by the Companys
principal executive officer and principal financial officer referenced above.



25



---

There were no significant changes in the Companys internal control over financial reporting during the
Companys last fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Companys internal control over financial reporting.



PART III



|ITEM 10. | DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
|-------- | --------------------------------------------------



The disclosures required herein are incorporated by reference from the Companys proxy statement to be filed in connection with the 2004 Annual
Meeting of Stockholders to be held May 6, 2004.



|ITEM 11. | EXECUTIVE COMPENSATION
|-------- | ----------------------



The disclosures required herein are incorporated by reference from the Companys proxy statement to be filed in connection with the 2004 Annual
Meeting of Stockholders to be held May 6, 2004.



|ITEM 12. | SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
|-------- | --------------------------------------------------------------



The disclosures required herein are incorporated by reference from the Companys proxy statement to be filed in connection with the 2004 Annual
Meeting of Stockholders to be held May 6, 2004.



|ITEM 13. | CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
|-------- | ----------------------------------------------



The disclosures required herein are incorporated by reference from the Companys proxy statement to be filed in connection with the 2004 Annual
Meeting of Stockholders to be held May 6, 2004.



|ITEM 14. | PRINCIPAL ACCOUNTING FEES AND SERVICES
|-------- | --------------------------------------



The disclosures required herein are incorporated by reference from the Companys proxy statement to be filed in connection with the 2004 Annual
Meeting of Stockholders to be held May 6, 2004.



PART IV



|ITEM 15. | 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 Reports of Independent Public Accountants listed below are included in Item 8.



Report of Independent Public Accountants



Consolidated Balance Sheets as of December 31, 2003 and 2002



Consolidated Statements of Operations for the years ended December 31, 2003, 2002 and 2001



Consolidated Statements of Stockholders Equity for the years ended December 31, 2003, 2002 and 2001



Consolidated Statements of Cash Flows for the years ended December 31, 2003,
2002 and 2001



Notes to Consolidated Financial Statements



Financial Statement Schedules are not required



(b) Reports on Form 8-K



The following report on Form 8-K was furnished to the Securities and Exchange
Commission during the three months ended December 31, 2003: Form 8-K, dated October 16, 2003, a press release announcing the Companys unaudited operating results for the three and nine months ended September 30, 2003 and its unaudited
financial condition as of September 30, 2003.



26



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(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-3 under the Securities Act of 1933 for the Company, Registration No. 333-19177, filed on January 2, 1997 (referred to as S-3); (ii) 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); (iii) 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); (iv) 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); (v) the Companys Annual Report on form 10-K for the year ended May 31, 1993 (referred to as 1993 10-K); (vi) the Companys Quarterly Report on Form 10-Q for the quarter
ended June 30, 1995 (referred to as 6/30/95 10-Q); (vii) 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); (viii) the
Companys Annual Report on Form 10-K for the year ended December 31, 1998 (referred to as 12/31/98 10-K); (ix) the Companys Current Report on Form 8-K relating to an event which occurred April 28, 1998 (referred to as
4/28/98 8-K); (x) the Companys Current Report on Form 8-K/A relating to an event which occurred December 23, 1998 (referred to as 12/23/98 8-K/A); (xi) the Companys Quarterly Report on Form 10-Q for the quarter
ended March 31, 1997 (referred to as 3/31/97 10-Q); (xii) the Companys Current Report on Form 8-K filed December 27, 1999 (referred to as 12/27/99 8-K); (xiii) the Companys Current Report on Form 8-K filed October
30, 2000 (referred to as 10/30/00 8-K); (xiv) the Companys Annual Report on Form 10-K for the year ended December 31, 2000 (referred to as 2000 10-K); (xv) the Companys Annual Report on Form 10-K for the year
ended December 31, 2001 (referred to as 2001 10-K); (xvi) a Registration Statement on Form S-3 under the Securities Act of 1933 for the Company, Registration No. 333-106446, filed on June 25, 2003 (referred to as 2003 S-3).



|            |  |   |  |                                                                                                                                                                                      
|----------- |  | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|EXHIBIT NO. |  |   |  | DESCRIPTION                                                                                                                                                                          
|            |  |  
|*2.1        |  |  |  | Merger Agreement dated April 16, 1997 for acquisition of DocuMedX (3/31/97 10-Q, Exhibit 2.6)                                                                                        
|            |  |  
|*2.2        |  |  |  | Purchase and Sale agreement dated March 16, 1998 with CORE, INC. for the sale of the net assets of Transcend Case Management, Inc. (12/31/98 10-K)                                   
|            |  |  
|*2.3        |  |  |  | Merger and Reorganization Agreement dated April 28, 1998 for acquisition of Health Care Information Systems, Inc. (4/28/98 8-K, Exhibit 2(a))                                        
|            |  |  
|*2.4        |  |  |  | Assignment and Assumption agreement dated December 23, 1998 with TCM Services, Inc. (12/23/98 8-K/A, Exhibit 2(a))                                                                   
|            |  |  
|*2.5        |  |  |  | Asset Purchase Agreement dated December 9, 1999 with Medquist Transcriptions, Ltd. for the sale of net assets and contracts of Transcend Services, Inc. (12/27/99 8-K, Exhibit
2(a)) 
|            |  |  
|*2.6        |  |  |  | Asset Purchase Agreement dated December 16, 1999 with Medquist Transcriptions, Ltd. for the sale of net assets and contracts of Transcend Services, Inc. (12/27/99 8-K, Exhibit
2(d))
|            |  |  
|*2.7        |  |  |  | Asset Purchase Agreement dated October 13, 2000 with Provider HealthNet Services, Inc. (10/30/00 8-K, Exhibit 2.7)                                                                   
|            |  |  
|*3.1        |  |  |  | Certificate of Incorporation (2003 S-3, Exhibit 4.1)                                                                                                                                 
|            |  |  
|*3.2        |  |  |  | Restated Bylaws (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)                                                                                                              
|            |  |  
|*4.9        |  |  |  | Warrant to Purchase Common Stock Granted to Silicon Valley Bank (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)                                                                                                      



27



---

|            |  |   |  |                                                                                                                                                                            
|----------- |  | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|EXHIBIT NO. |  |   |  | DESCRIPTION                                                                                                                                                                
|            |  |  
|*4.15       |  |  |  | 2001 Stock Option Plan (2001 10-K)                                                                                                                                         
|            |  |  
|*10.3       |  |  |  | Form of Incentive Stock Option Agreement under 1992 Stock Option Plan, as Amended and Restated (1996 S-8, Exhibit 4.2)                                                     
|            |  |  
|*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)                                                                     
|            |  |  
|14.1        |  |  |  | Transcend Services, Inc. Code of Business Conduct and Ethics Policy                                                                                                        
|            |  |  
|21.1        |  |  |  | Subsidiaries of the Registrant                                                                                                                                             
|            |  |  
|23.1        |  |  |  | Consent of Miller Ray & Houser LLP                                                                                                                                         
|            |  |  
|**31.1      |  |  |  | Certification of Chief Executive Officer of the Registrant Pursuant to Rule 13a-14(a) and Rule 15d-14(a), promulgated under the Securities Exchange Act of 1934, as amended
|            |  |  
|**31.2      |  |  |  | Certification of Chief Financial Officer of the Registrant Pursuant to Rule 13a-14(a) and Rule 15d-14(a), promulgated under the Securities Exchange Act of 1934, as amended
|            |  |  
|**32.1      |  |  |  | Certification of Chief Executive Officer of the Registrant Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002                                                       
|            |  |  
|**32.2      |  |  |  | Certification of Chief Financial Officer of the Registrant Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002                                                       



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



28



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SIGNATURES



Pursuant to the requirements of Section 13 or 15(d) 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 Service, Inc.By:

/s/ Larry G. GerdesLarry G. GerdesChief Executive Officer(Principal Executive Officer)




Dated: February 12, 2004



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/ Larry G. Gerdes     |  | Director and Chief Executive Officer    |  | February 12, 2004
|                        |  |                                         |  |                  
|Larry G. Gerdes         |  | (Principal Executive Officer)           |  |                  
|                        |  |                                        
|/s/ Joseph G. Bleser    |  | Chief Financial Officer                 |  | February 12, 2004
|                        |  |                                         |  |                  
|Joseph G. Bleser        |  | (Principal Financial Officer)           |  |                  
|                        |  |                                        
|/s/ Jeanne N. Bateman   |  | Controller and Chief Accounting Officer |  | February 12, 2004
|                        |  |                                         |  |                  
|Jeanne N. Bateman       |  | (Principal Accounting Officer)          |  |                  
|                        |  |                                        
|/s/ Joseph P. Clayton   |  | Director                                |  | February 12, 2004
|                        |  |                                         |  |                  
|Joseph P. Clayton       |  |                                         |  |                  
|                        |  |                                        
|/s/ James D. Edwards    |  | Director                                |  | February 12, 2004
|                        |  |                                         |  |                  
|James D. Edwards        |  |                                         |  |                  
|                        |  |                                        
|/s/ Walter S. Huff, Jr. |  | Director                                |  | February 12, 2004
|                        |  |                                         |  |                  
|Walter S. Huff, Jr.     |  |                                         |  |                  
|                        |  |                                        
|/s/ Charles E. Thoele   |  | Director                                |  | February 12, 2004
|                        |  |                                         |  |                  
|Charles E. Thoele       |  |                                         |  |                  



29