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

                                 FORM 10-KSB


              [X] ANNUAL REPORT UNDER SECTION 13 OR 15(D) OF THE
                       SECURITIES EXCHANGE ACT OF 1934


                    For the Fiscal Year Ended June 30, 1997


            [ ] TRANSITION REPORT UNDER SECTION 13 OR 15(D) OF THE
                       SECURITIES EXCHANGE ACT OF 1934

                For the Transition Period From _____ to _____

                             -------------------

                        Commission File Number 1-14198


                      DIGITAL TRANSMISSION SYSTEMS, INC.
      (Exact name of small business issuer as specified in its charter)

         DELAWARE                                         58-2037949
(State or other jurisdiction of                         (I.R.S. Employer
incorporation or organization)                          Identification No.)


          3000 NORTHWOODS PARKWAY, BUILDING 330, NORCROSS, GA  30071
             (Address of principal executive office)        (Zip Code)


                                (770) 798-1300
               (Issuer's telephone number, including area code)

SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:


                                          NAME OF EACH EXCHANGE ON
        TITLE OF EACH CLASS                    WHICH REGISTERED
        -------------------         ---------------------------------------
           Common Stock             Philadelphia and Boston Stock Exchanges
             Warrants               Philadelphia and Boston Stock Exchanges


SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:

                          Common Stock and Warrants
                               (Title of Class)

Check whether the issuer (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
proceeding 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 [ ]

Check if disclosure of delinquent filers in reponse to Item 405 of Regulation
S-B is not contained in this form, and no disclosure will be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-KSB or any amendment to
this Form 10-KSB. [ ] 

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Total revenues for the registrant for the fiscal year ended June 30, 1997 were:
$14,484,000.

At September 24, 1997, there were 4,132,180 shares of common stock
outstanding.  The aggregate market value of the common stock held by
non-affiliates (based upon the closing price of common stock quoted on the
NASDAQ National Market System at September 24, 1997) was approximately
$21,465,594.

Transitional Small Business Disclosure Format (check one):  Yes [ ] No[X]


DOCUMENTS INCORPORATED BY REFERENCE

        Part III of this Annual Report on Form 10-KSB incorporates by reference
information (to the extent specific sections are referred to herein) from the
Company's Proxy Statement for its Annual Meeting of Shareholders to be held
October 30, 1997 (the "1997 Proxy Statement").

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                                     PART I

ITEM 1. BUSINESS

GENERAL


  Digital Transmission Systems, Inc., a Delaware corporation ("DTS" or the
"Company"), designs, manufactures, and markets a broad range of products for the
telecommunications industry. The Company's primary customers are domestic and
international long distance carriers and wireless service providers, including
those offering cellular telephone services and Personal Communications Services
("PCS"). Customers include Nextel, PrimeCo Personal Communications L.P.,
360(Degree) Communications, AirTouch, Sprint, MCI, Tele2000 in Peru and
TeleBahia in Brazil.

  The Company's products, consisting of proprietary software and hardware
modules, facilitate the control, monitoring and efficient transmission of
high-speed digital information through public or private telecommunications
networks. The Company's network access products enable telecommunications
service providers to give their customers economical, high-quality access to
public and private networks and various telecommunications services. These
services include voice and high-speed data transmission, the Internet and video
and desktop conferencing. The Company's network control products enable service
providers to detect degradation on their networks so that appropriate action may
be taken in advance of service interruption. Important product requirements in
these market segments include high feature density, modularity, quality
performance and compactness. The Company's products meet these requirements and
are suitable for both wireline and wireless service environments.

  DTS markets its products through a direct sales force and several reseller
channels. Domestically, inter-exchange carriers and wireless service providers,
including cellular, Specialized Mobile Radio ("SMR") and PCS service providers,
are serviced directly by the Company's sales force. DTS utilizes
telecommunications equipment resellers in the United States and Canada to sell
to private network customers. Within the last eighteen months, the Company has
signed thirty-four reseller agreements in Latin America, Asia Pacific, Europe
and the Middle East.


BACKGROUND

  The telecommunications industry is undergoing rapid and fundamental changes.
Enhanced communication services such as those offering multimedia applications,
the Internet, video and desktop conferencing, facsimile transmission, compressed
voice communications and data communications between computers necessitate the
increased use of high-speed digital, rather than analog, transmissions. The
increased demand for digital transmission capacity has led to significant
network infrastructure growth and efforts to improve the efficiency of current
telecommunications systems. For all participants in the telecommunications
industry, including long distance carriers, telephone operating companies and
wireless service providers, the need for efficient transmission of high-speed
digitized signals, lower operating costs, seamless connectivity and the
assurance of quality service between networks is of vital importance. Continued
growth in traditional wireline and alternative services will increase the need
for products like those offered by the Company which are designed to address
these requirements. The Company believes the following trends are contributing
and will continue to contribute to the growth in demand for its products:


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  Growth in Wireline Services. The Company believes the markets for traditional
  wireline service will continue to grow and estimates that the market for
  packet data services alone will exceed $2.1 billion by 1998. Internet access
  is expanding and the Company believes the trend of increased telecommuting is
  likely to continue, because of declining costs of telecommunications equipment
  and services, employer cost-cutting and desires to improve employee
  productivity, availability and convenience of improved technology and
  environmental concerns. The increasing number of public telecommunications
  services has created the need for high-speed connection devices which give
  service providers the ability to economically expand their networks to provide
  new service offerings without drastic changes in technology and the associated
  infrastructure costs. The ability to quickly connect existing customers to
  these new services without changing access technologies usually means lower
  costs to end users and simplification of network construction for the service
  provider.

  Growth in Cellular Services. According to industry sources, the wireless
  market is currently estimated to include over 52 million cellular customers in
  the United States and is expected to grow to over 60 million customers by the
  year 2001. Service revenues from the cellular industry for 1996 were $23.6
  billion in the United States, and are expected to grow worldwide to $600
  billion by 2010. The growth of the cellular industry, along with the
  deployment of new wireless packet data offerings such as Cellular Digital
  Packet Data ("CDPD"), has created the need for highly integrated,
  multi-functional, high-speed network access products to speed deployment of
  cellular services, ease the maintainability of networks, lower cell site costs
  and simplify the day-to-day operation of the associated network.

  Deployment of PCS. The Company believes that significant infrastructure
  investments will be made over the next few years as PCS licensees build new
  communications networks. In March 1996, over $8.2 billion was bid for the
  licenses to provide broadband PCS service (similar to currently available
  cellular service) in several consumer markets around the nation. Additional
  PCS licenses are scheduled to be auctioned within the next year. The
  establishment of a PCS network involves the construction of a significant
  infrastructure which must be reliably connected to existing wireline and
  cellular services. Each of these networks will require efficient equipment to
  control and monitor the flow of digital information without significant
  dependency on the local telephone company for links between cell sites or
  major switching centers.

  Proliferation of Competitive Access Providers. Deregulation of the
  telecommunications industry has resulted in an increase in competitive
  alternatives for local access to network services. These Competitive Access
  Providers ("CAPs"), such as cable TV companies, utilities and long distance
  telephone service providers, have targeted major metropolitan markets in the
  United States to offer local telephone and network services and are courting
  large corporate customers who have traditionally been serviced by the local
  Regional Bell Operating Companies ("RBOCs"). These CAPs have unique connection
  requirements for access to the public network which are creating opportunities
  for wireless digital transport equipment providers. Bridging two buildings
  separated by 100 yards or two locations 30 miles apart with wireless transport
  equipment allows companies to avoid the expense of leased lines from the local
  RBOC. The market for equipment which connects the various networks is one that
  the Company believes will continue to grow through the late 1990s.

  Growth of International Markets. Many countries throughout the world lag
  behind the United States in telecommunications infrastructure development. As
  customers in such countries begin to demand new or enhanced communications
  services, service providers will seek the ability to upgrade telecommunication
  networks quickly without sacrificing service quality. Service providers in
  developing countries are faced with the need to promptly connect high-speed
  digital lines to public networks, provide telecommunications to rural areas
  and provide extensions for thin route cellular services. This creates an
  opportunity for a wireless digital transport device with payload


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  speeds of 64Kbps up to several megabits/second that can create an instant
  digital connection without requiring the existence of a sophisticated
  telecommunications infrastructure.

  All of these trends have created and will continue to create the need for
cost-effective, quality high-speed network control and network access products,
such as those offered by the Company, that permit carriers to economically build
and operate networks to address the service requirements of their customers.


  THE DTS SOLUTION

  DTS has developed an integrated, systems-based, high-speed network control and
access solution for wireless and wireline networks that consists of the
software-based FlexSentry(TM) Network Management System (NMS) the FlexSentry
Network Control Unit and the family of access devices - FlexT1(C), FlexE1(TM),
FlexAir(TM) and SKYPLEX(TM). [The FlexSentry NMS was previously marketed as the
Communications Network Control System.] The Company believes that its products
can be combined to offer whole product solutions that provide significant
differentiation from competitive offerings in the marketplace with respect to
size, price, feature density and reliability.

  The FlexSentry NMS is a software-based management system with graphical user
interface that, together with the Company's Network Control product, gives
telecommunications service providers tools to control, monitor, maintain and
rapidly deploy network services. These systems allow immediate activation of new
network sites, yielding associated subscriber revenues quickly. In addition, the
integrated systems solution provides proactive maintenance, assuring minimal
network downtime and lost revenue.

  The FlexT1 and FlexEl network access products provide integrated access to
public network services for both domestic ("T1") and international ("El")
markets. The FlexT1 and FlexEl are provided in a compact physical package, are
expandable and allow an end user to access many of the business services
available from the public network. These products also enable the sharing of
telecommunication facilities among the different services, such as voice, video,
the Internet and facsimile, thus reducing the number of access lines the user
must lease and potentially reducing overall telecommunications expenses.

  The Company's wireless network access products (FlexAir and SKYPLEX) eliminate
the dependency of wireless carriers and PCS providers upon Regional Bell
Operating Companies ("RBOCs") or Departments of Postal, Telegraph & Telephone
("PTTs") for leased access lines to connect their cell sites by providing a
wireless digital transport alternative using spread spectrum radio technology.
Additionally, in the United States and many developing countries, the FlexAir
and SKYPLEX systems allow for rapid service deployment since FCC or equivalent
agency license approval is not required for the use of spread spectrum
frequencies. FlexAir and SKYPLEX are delivered in compact packages which
optimize the use of limited space at telecommunications sites.


  COMPANY STRATEGY

  The Company's goal is to become a leading worldwide supplier of network
control systems and associated access products for both public and private
high-speed telecommunications networks. In order to realize these goals the
Company plans to:

  Concentrate on the Domestic and International Expanding Cellular and PCS
Markets. The Company has recently increased the size of its sales force and
support staff to further penetrate the


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  growing domestic and international Cellular and PCS markets. The Company's
  network access products have numerous wireless applications, and together with
  the proprietary FlexSentry NMS offer what the Company believes is a unique
  integrated solution to the wireless carriers' need to monitor and control
  transmission facilities to hundreds - or thousands - of remote cell sites.

  Develop and Expand on Flexible and Modular Platforms. The Company continues to
  expand upon its modular Flex line of network access products and plans to add
  various modules for feature enhancements, facilitating continued utilization
  of Flex products as new applications are developed.

  Enhance the Company's International Presence. DTS has successfully employed
the following strategies to expand internationally: acquisitions,
distributorships, agents, export control and support:

  - In December 1995, the Company acquired SKYPLEX, a product line with an
existing distribution network in Latin America through which the Flex line of
products can also be sold.
  - DTS products are sold into more than 40 countries via a network of 60
resellers/dealers/distributors. In the past eighteen months the Company has
expanded its international sales channels by signing 34 sales agreements with
resellers in Latin America, Asia Pacific, Eastern Europe and the Middle East. 
  - Agents, or independent companies representing multiple, but non-competing
product lines were identified in four key regions. These agents were provided
with product training, technical support, collateral/marketing materials, and
products targeted at local market requirements. 
  - Multi-lingual sales administration and technical assistance comprise the
export control at the Norcross, Georgia facility. Any agent, reseller, dealer or
distributor can contact these personnel for support.

  The Company was certified in December 1994 as an ISO 9001 supplier, thus
establishing its quality assurance credentials for the international arena.


PRODUCTS AND TECHNOLOGY

  The Company's products facilitate network access, bandwidth management,
network control and delivery of high-speed digital telecommunications services.
The Company's products include T1 network control Units, the family of network
access products and the associated network management systems. Some of the
Company's T1-based products are designed to be controlled with FlexSentry, a
UNIX-based system capable of controlling and managing up to 3,000 T1 circuits.
DTS has been a major supplier for T1 network control systems to MCI and T1
network control systems to Sprint. These systems, which provide important
network functions such as performance monitoring, test access, timing insertion
and signaling, have been deployed to both customers.

  As one of its first products, the Company pioneered the 2001 Data In Voice
("DIV") modem to transmit digitized information at T1 rates over an analog link.
This product uses Quadrature Amplitude Modulation ("QAM"), automatic
equalization and forward error correction algorithms to provide T1 transport
over analog microwave or cable facilities. The 2001 DIV modem is easy to install
and has shown a reliable record of performance in over 1,000 installations.

T1 Network Control Products

  The 4010 and 4030 Network Control Units are T1-based products that provide
performance monitoring, frame format and line coding conversion and access to
Customer Premises Equipment ("CPE") like the FlexT1. These functions are
provided in a 12.5 inch chassis for 28 T1 circuits and


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  and the unit is typically deployed at the service provider's central office.
  The main difference between the two products is that the 4030 is designed to
  operate with MCI's proprietary management systems while the 4010 is designed
  to work with the Company's FlexSentry.

  The 4010 and 4030 products are each comprised of three different modules:
 
  - T1 Line Monitoring and Control Module - Provides conversion features,
performance monitoring and FDL access to CPE equipment. Each shelf can contain
28 of these modules.

  - Shelf Control Unit - Provides the interface to the Communication Network
Control System. There is one control unit per shelf.

  - Shelf Power Supply - Provides power to the shelf. There are two power
supplies per shelf, providing full redundant operation.


FlexSentry NMS

  Global control of 4010 Network Control Units is provided by the FlexSentry, a
UNIX-based, graphically driven management system that can control up to 3,000 Tl
circuits per user system. FlexSentry NMS provides alarm information, archiving
of circuit history and provisioning of T1 equipment, including FlexT1 network
access devices. The system uses a Client-Server architecture in which servers,
running on a primary workstation provide basic functions such as alarm
collection and performance data gathering. Clients running on either the primary
or secondary workstations provide the operator interfaces.

  The primary objective of this system is to detect and report network problems
in the most timely manner possible. The FlexSentry NMS will retrieve performance
and alarm information from the 4010 NCU as well as from the remote CPE, like the
FlexTl or other competitive network access equipment.

  The FlexSentry is designed to aid the operator in determining the exact
location and nature of problems by providing the appropriate software "tools."
The system uses mouse-driven, graphics-based displays which are organized to
allow the operator to identify the source of circuit problems quickly. Displays
are projected on the operator's screen in "windows" and multiple windows can be
present on the screen at the same time. Finally, the system allows the operator
to log the performance of the circuits in the network automatically, thereby
providing the operators with a mechanism to implement a preventive maintenance
system.

  The FlexSentry provides the following operations and features:

-        Automatic reporting and time stamping of alarm conditions 
-        Operator alert upon alarm initiation 
-        Graphics-oriented and text-oriented performance displays
-        Archiving of performance information
-        Circuit routing database 
-        Schematic display of network elements and remote setup capability
-        Password-controlled operator access 
-        Logging of operator- and network-initiated events.



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FlexT1 and FlexE1 Product Family

  The FlexTl family of products, introduced in fiscal year 1995, provides
integrated access to public network telecommunications services. The FlexTl
consists of single and multi-slot enclosures that are customized with various
card sets to satisfy a wide range of network access applications. The FlexE1
provides much of the same functionality currently available in the FlexT1 for
countries using the E1 (international) standard. Customer equipment needs
include N x 56/64 Kbps and full T1 interfaces for data, voice and video
applications.

FLEXT1/E1 SYSTEM ARCHITECTURE

  The FlexT1/E1 bandwidth management features are derived from an advanced
architecture with two independent Time Division Multiplexed ("TDM") busses
available to each card position within a FlexT1/E1 enclosure. This architecture
allows users to pay only for the functions and features needed for a particular
application. Bandwidth managers connect directly to the service provider's
network and user traffic is interfaced through card sets that connect directly
to voice, data and video terminals. All card sets within the product family can
be upgraded with software as new features become available.

  The Company offers its complete set of products to wireless service providers
and long distance carriers through a direct sales force. Network access products
and the DIV modems are sold directly to utilities and railways. The family of
network access products is sold to corporate end users through a network of
domestic and international resellers. A secondary channel to telecommunications
service providers exists through selected OEM arrangements. The Company has had
long-standing supplier relationships with MCI and Sprint and has recently
expanded its list of customers to include three major wireless service providers
(PrimeCo Personal Communications, L.P., Nextel, and 360 degree Communications).


COMPETITION

  The market for telecommunications products is highly competitive and subject
to rapid technological change, regulatory developments and emerging industry
standards. The Company believes that the principal competitive factors in its
markets are: support for multiple types of carrier services, conformance of
products to multiple public carrier standards, reliability and safety, the
development and rapid introduction of new product features, price, performance,
and quality of customer support.

  The Company's principal competition to date has come from major
telecommunications equipment suppliers active in certain market segments. In the
network access market, competitors include but are not limited to Tautron (a
division of General Signal Corporation) and Hekemian (a division of Axel Johnson
Corporation). In the network control marketplace, Kentrox Industries (a
subsidiary of ADC Telecommunications Inc.), Premisys Corporation, Digital Link
Corporation, Adtran. Inc. and Newbridge Networks, Inc. are competitors. Western
Multiplex, P-COM, Inc., California Microwave Inc. and Cylink compete with DTS in
the wireless transport business.

  The Company expects increased competition from existing competitors as they
develop products with functionality similar to that of the Company's products.
In addition, the Company expects to compete with other new entrants to the
telecommunications access equipment marketplace, including those targeting
bandwidth on demand services and broadband integrated access products. To the
extent that current or potential competitors can expand their current offerings
to include 


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monitoring and maintaining network facilities in an integrated
product, the Company's business and operating results could be materially
adversely affected.


MANUFACTURING

  DTS currently outsources subassembly kitting, board assembly and testing to
high quality suppliers which are ISO 9002 certified and were space program
suppliers to NASA and other United States governmental agencies.

  Subassemblies and finished circuit boards are brought to DTS headquarters for
final assembly, system integration, testing and product burn-in. Defective
subassemblies are returned to the contract manufacturers for root cause analysis
and process problem resolution. System test development is jointly done by the
Company's engineering and quality assurance personnel. Most DTS product board
assemblies contain surface mount technology ("SMT") components so that only
minor touch-up is possible by DTS manufacturing personnel.

  High quality is demanded by all DTS' customers. The Company believes that
quality in the design and the manufacturing of products is a competitive
advantage that it enjoys. The failure rate of network control products shipped
by the Company to three major customers and under warranty is below 1% in a base
of over 60,000 Units. This demonstrates the extent to which the quality control
department and associated manufacturing processes have succeeded in satisfying
stringent product quality requirements. All key procedures in the Company have
been documented and Company policy requires that employees follow these
procedures. It is the Company's belief that this policy promotes consistency in
the delivery of value to the customer. This effort led to ISO 9001 certification
for the Company in December, 1994 and six successful follow-up compliance
surveillance audits. The Company believes that ISO 9001 certification has become
important for international trade, since overseas customers can feel assured
that quality-based processes have been followed.


PRODUCT DEVELOPMENT

The market value of the Company's diversified network access and control systems
is based upon its core technologies in customer terminal interfaces for voice
and high-speed data applications, Tl networking and microwave radio
applications. Additionally, the Company has valuable experience in public,
private and cellular T1 networking standards and control systems. The Company's
product development efforts are currently concentrated in the Tl network access,
transport and control areas. In addition, core hardware and software
technologies have been developed by the Company's product development staff in
subTl areas such as high-speed (1.5 Mbps) digital modem technology. In order to
quickly implement the Company's network access product plans, the Company
intends to develop or acquire additional technologies in radio frequency
interfaces and E1 international access and transport.

The Company's resident core technologies resulting from the developments of the
Flex, SKYPLEX and FlexSentry products include:

-        T1 / E1 multiplexing of voice and high speed data signals 

-        T1 / E1 alarm reporting and trunk conditioning 

-        High-speed digital timing insertion


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-        Network performance monitoring and testing 

-        Network management software with graphical user interfaces

-        TI ESF data link message transport 

-        SNMP protocol processing 

-        TCP/IP protocol message handling 

-        1OBase5 and 1OBaseT Ethernet Media Access Control 

-        Microprocessor-based product design

-        Signal processing algorithms such as modulation, automatic equalization
         and forward error correction

-        Real time processing of control and data signals 

-        Spread spectrum signal design 

-        Design of programmable logic device 

-        Basic rate ISDN transport signal design and control

  The Company's product development efforts have also resulted in the
development of a number of relevant technologies for products targeted toward
the wireless infrastructure and CAP market segments. These technologies include
hardware and software modules for high-speed digital modems, high data rate QAM
modulation algorithms, error correcting coding, automatic equalization methods
utilizing digital signal processing, VLSI devices, RF filtering for microwave
products, point-to-point and multipoint networking protocols, X.25 interfaces,
voice compression, voice telephony interfaces and T1 digital cross connects.

  The technologies listed above are being used by the Company's product
development group to design wireless products and enhancements for the FlexT1/El
platform. Additional technologies will be developed or acquired for the
Company's wireless product lines. Local, domestic and international outsourced
design suppliers have been identified for assisting in the development of spread
spectrum, RF signal and antenna modules. The Company plans to incorporate access
technologies (e.g., multiplexing) as well as management (e.g., SNMP protocols)
into the FlexAir product line.


INTELLECTUAL PROPERTY

  The Company's proprietary technology is protected by one patent granted and
two patents pending which relate to channel bank design and ISDN signal coding.
Core technologies described in the "Product Development" section are
incorporated in the Company's products through proprietary hardware and software
modules which embed original algorithmic and device circuitry. Although some of
these original designs are protected by the patents or patent applications
mentioned above, most of the designs are secured only by a claim of trade secret
rights. Two software modules used in several of the Company's products have been
licensed from outside suppliers. Although the loss of these licenses might
adversely affect the Company's performance if it were unable to license
replacement technology, the Company believes that such replacement technology is
readily available from other suppliers on favorable terms.

  The patent positions of high technology firms, including those of the Company,
are uncertain and involve complex legal and factual questions for which
important legal principles are largely 


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unresolved. In addition, the coverage claimed in a patent application can be
significantly reduced before a patent is issued. Consequently, even though
patent applications covering the technology used by the Company are being
prosecuted with the United States and certain foreign patent offices, there can
be no assurance that any of such patent applications will result in the issuance
of patents or, if any patents are issued, that they will provide significant
proprietary protection and will not be circumvented or invalidated. Since patent
applications in the United States are maintained in secrecy until patents issue
or foreign counterparts, if any, publish, and since publication of discoveries
in scientific or patent literature often lags behind actual discoveries, the
Company cannot be certain that it was the first creator of inventions covered by
pending patent applications or that it was the first to file patent applications
for such inventions. Moreover, the Company might have to participate in one or
more interference proceedings declared by the United States Patent and Trademark
Office to determine priority of invention, which could result in substantial
cost to the Company, whether or not the result of such proceedings was favorable
to the Company. There can be no assurance that any patents which may be issued
based upon the Company's patent application would be held valid and enforceable
by a court or that any given competitor's technology or product would be found
to infringe upon such patents. Litigation, which could result in substantial
cost to the Company, might be necessary to attempt to enforce the Company's
rights under the patents owned by the Company or to determine the scope and
validity of other parties' proprietary rights.

  If the outcome of any such litigation were to be adverse, the Company's
business could be materially and adversely affected. The Company is unable to
predict how courts would resolve any future issues relating to the validity and
scope of the patents licensed by the Company, or any patents that may be issued
to the Company in the future.

  A number of companies have developed technologies, filed patent applications
or received patents on various technologies that may be related to the Company's
technology. Many of these entities are larger and have significantly greater
resources than the Company. Some of the technologies, applications or patents of
these entities may conflict with the Company's technologies, patents or patent
applications. Such conflict could limit the scope of the patents that the
Company has or may be able to obtain or could result in denial of the Company's
patent applications. In addition, if patents that cover the technologies used by
the Company are issued to other companies, there can be no assurance that the
Company would be able to license these patents at a reasonable cost or be able
to develop or obtain alternative non-infringing technology.

  The Company acquired the trademark of "SKYPLEX," and currently owns the
trademarks of "FlexT1," "FlexE1," and "FlexAir.' It has also filed federal
trademark applications for FlexSentry, FlexCell, FlexE1 and FlexAir
internationally, and these applications were published for opposition in the
Trademark Office after examination. The applications for FlexCell, FlexE1 and
FlexAir were formally opposed by Fujitsu Network Transmission Systems, Inc.
Fujitsu has alleged that the trademark registrations should be denied because of
their prior rights filed on a trademark application for FlexR, for certain
access controllers. The opposition proceeding is in an early stage, and the
Company intends to contest the allegations of the trademark opposition and to
assert the company's right to register the three trademarks in the federal
Patent and Trademark Office and internationally.

  The Company also relies upon trade secret protection for its confidential and
proprietary information. There can be no assurance that competitors or potential
competitors of the Company will not independently develop substantially
equivalent proprietary information and techniques or otherwise gain access to
the Company's trade secrets or disclose such technology, or that the Company can
meaningfully protect its trade secrets. Failure to obtain needed patents or
licenses or proprietary information held by others could have a material adverse
effect on the Company.


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RESEARCH AND DEVELOPMENT COSTS

  During fiscal years 1997, 1996, and 1995, the Company's expenditures in
product development were $3.9 million, $2.7 million and $1.9 million,
respectively. The increase in spending from 1996 to 1997 is due to the continued
product development of the Company's Flex product line and the initial
development of the Company's SKYPLEX spread spectrum radio product. Total
research and development spending for fiscal 1997 includes $1.4 million of costs
that were capitalized relating to the development of the SKYPLEX radio. It was
determined that the future recoverability of the cost of certain features
developed for the radio was not assured and that the value of the asset was
impaired. As a result, $555,000 of the asset was written off during the year.


GOVERNMENT REGULATION

  The FCC has regulated the design of telecommunications equipment for use in
the United States by restricting radio frequency signal emissions and by
licensing frequency usage. Compliance with electronic product safety regulations
is also required for every new product design. It is possible that a government
agency such as the FCC could issue regulations which would require the
modification of DTS equipment in order to comply with the new regulations. This
change in FCC rules may impact sales of DTS products should it occur.
International standards for electronic product design in the areas of safety and
signal emissions are different in many cases from those issued by United States
government agencies. Sales of telecommunications equipment in a foreign country
are often restricted by equipment design standards and regulations adopted by a
centralized governmental agency similar to the FCC. The Company has to date
experienced no material difficulties in complying with the various laws and
regulations affecting its business.



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EMPLOYEES

  As of June 30, 1997, the Company had approximately 62 full-time employees, of
whom approximately 21 are technical personnel engaged in developing the
Company's products, approximately 20 are marketing and sales personnel,
approximately 13 are quality assurance, customer service and operations
personnel and approximately 8 are involved in administration and finance.
Substantially all of the Company's employees are full-time. The Company's
employees are not unionized and the Company believes that its employee relations
are good.


BACKGROUND OF THE COMPANY

  A predecessor by merger to the Company was incorporated in Delaware in 1984.
The Company was originally incorporated in Delaware in 1992 as Netra Inc. and
changed its name to Digital Transmission Systems, Inc. in 1995 in conjunction
with the merger with its wholly-owned subsidiary Digital Transmission Systems,
Inc., a California corporation. On March 4, 1996, the Company completed the
Offering of 1,220,700 Units each consisting of one share of Common Stock and one
warrant to purchase one share of Common Stock at a price of 120% of the unit
offering price of $7.50. On February 18, 1997, trading of the Units was split
into separate trading of the underlying Common Stock and Warrants.


ITEM 2. PROPERTIES

  The Company's operations are located in an approximately 20,000 square foot
facility in a technology park in Norcross (in the greater Atlanta, Georgia
area). In May of 1993, the Company entered into a six year lease for its current
facility. The base annual triple-net rate for this space is $7.02 per square
foot, including amortization of buildout costs of approximately $150,000, and
escalates by 4% per year. The Company believes its facilities are suitable and
adequate for its purposes.



ITEM 3. LEGAL PROCEEDINGS

  The Company is not a party to any material legal proceedings. From time to
time, the Company is involved in various routine legal proceedings incidental to
the conduct of its business.


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

       None.




                                    Page 11
<PAGE>   14




                                     PART II

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

  On March 4, 1996, the Company completed a public offering of 1,220,700 Units
("Units"), each consisting of one share of Common Stock ("Common Stock") and one
Warrant ("Warrant") to purchase one share of Common Stock at an exercise price
per share equal to 120% of the initial public offering price of the Units. The
shares of Common Stock and Warrants were not detachable or separately
transferable, and could only have been traded as part of a Unit until February
18, 1997, when each Unit was separated into one share of Common Stock and one
Warrant (the "Separation Date"). The Common Stock and Warrants have been
approved for quotation on the NASDAQ SmallCap Market, the Company's principal
market, under the symbols DTSX and DTSXW, respectively, and have been approved
for listing on the Philadelphia Stock Exchange and the Boston Stock Exchange
under the symbols DTS and DTS.W, respectively. The Units previously traded on
the NASDAQ Market and the Philadelphia and Boston exchanges. The price per Unit
reflected in the table below represents the range of low and high closing sale
prices for the Company's Units as reported by the NASDAQ Stock Market for the
quarters indicated:

<TABLE>
<CAPTION>

         Quarter Ended                                         High Price          Low Price
-------------------------------------------------------------------------------------------------
<S>                                                            <C>                 <C>
   Commencing March 4, 1996 and ending  March 30                   $ 9 3/8            $8
   June 30, 1996                                                   $14 3/4            $9
   September 30, 1996                                              $15 1/2            $14
   December 31, 1996                                               $16 1/4            $14 1/8
   Commencing January 1, 1997 and ending  February 14, 1997        $18                $13 7/8
</TABLE>


  On February 18, 1997 the Common Stock and Warrants underlying the Units began
trading separately and the Units ceased to trade. Both the Common Stock and
Warrants currently trade on the NASDAQ Market and the Philadelphia and Boston
exchanges. The price per share of the Company's Common Stock in the table below
represents the range of low and high closing sale prices as reported by the
NASDAQ Stock Market for the quarters indicated:

<TABLE>
<CAPTION>

         Quarter Ended                                         High Price          Low Price
---------------------------------------------------------------------------------------------------
<S>                                                            <C>                 <C>
   Commencing February 18, 1997 and ending  March 31               $13                $10 3/4
   June 30, 1997                                                   $12 1/2            $10 1/4
</TABLE>


       The price per share of the Company's Warrants in the table below
   represents the range of low and high closing sale prices as reported by the
   NASDAQ Stock Market for the quarters indicated:

<TABLE>
<CAPTION>
         Quarter Ended                                         High Price          Low Price
----------------------------------------------------------------------------------------------------
<S>                                                            <C>                 <C>
   Commencing February 18, 1997 and ending  March 31               $5                 $2 7/8
   June 30, 1997                                                   $4 1/4             $2 3/8
</TABLE>

  The closing sale price of the Company's Common Stock as reported by the NASDAQ
Stock Market on September 30, 1997 was $9. The closing sale price of the
Company's Warrants as reported by the NASDAQ Stock Market on September 30, 1997
was $2 3/8.

                                    Page 12
<PAGE>   15

  The Company has 2,700,000 shares of Common Stock which are outstanding but
were not registered as part of the Company's public offering. The Company has
approximately 42 shareholders of this Common Stock.

  The total number of shareholders of record of the Company's common shares as
of September 30, 1997, was approximately 42. Because many shares are held by
brokers and other institutions on behalf of shareholders, the Company is unable
to estimate the total number of shareholders represented by these record
holders.

  The Company has never paid cash dividends on its Common Stock. The Company
currently intends to retain any earnings for use in the business and does not
anticipate paying any cash dividends in the foreseeable future.










                                    Page 13
<PAGE>   16






ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.


       The following discussion of the results of operations and financial
                    condition should be read in conjunction
       with the Company's audited financial statements and notes thereto.

OVERVIEW

  During the fiscal year ended June 30, 1997, sales to MCI accounted for 30% of
total revenue, as compared to 63% in fiscal year 1996 and 84% in fiscal year
1995. These sales have consisted primarily of the version of the Company's
network control products that was developed specifically for MCI. The Company
expects that future sales of this MCI proprietary product will be minimal and
that the growth will continue for its FlexT1, FlexEl, FlexAir and SKYPLEX
product lines. The Company's strategy is to leverage its technology to develop
these newer products and to continue its customer diversification to enable it
to achieve higher sales and net income over time. However, this shift in
products and customers has and may be expected to continue to negatively impact
the gross profit margin of the Company. The Company is currently experiencing
high initial costs of production on initial, lower volume production runs of its
new products. As the Company builds volume in these products, it is expected
that the gross profit margins will increase.

  Industry trends which may also affect the Company's operating results include
the rate of demand for cellular and PCS services, the market acceptance of high
speed wireline service from telecommunications service providers, and the level
of investment in telecommunications infrastructure by developing countries over
the next few years.




COMPARISON OF YEARS ENDED JUNE 30, 1997 AND JUNE 30, 1996

The following table sets forth certain financial data derived from the Company's
Statements of Operations (dollars in thousands):

<TABLE>
<CAPTION>
                                                    YEAR ENDED                      YEAR ENDED
                                                  JUNE 30, 1997                    JUNE 30, 1996
                                                --------------------            --------------------
                                                               % OF                            % OF
                                                   $           SALES               $           SALES
                                                -------        -----            -------        -----
<S>                                             <C>            <C>              <C>            <C>
Net Sales                                       $14,484         100             $11,228         100
Gross Profit                                      4,639          32               4,272          38
Product development                               2,458          17               2,495          22
Selling, general and administrative               6,331          44               4,206          37
Net income (loss)                                (4,190)        (29)             (2,383)        (21)
 
</TABLE>



                                    Page 14
<PAGE>   17



  NET SALES. Net sales increased by 29%, to $14,484,000 for the year ended June
30, 1997, from $11,228,000 for the year ended June 30, 1996. The sales mix, and
the resulting percentage of total sales, is shown in the table below (dollars in
thousands):

<TABLE>
<CAPTION>
                
                                                               PERCENTAGE OF
                                                                   TOTAL
                                     FISCAL YEAR                FISCAL YEAR
                                    ENDED JUNE 30,             ENDED JUNE 30,  
                               -----------------------   -----------------------
                                                       
                                 1997           1996       1997           1996 
                               -------        --------   --------       --------
<S>                            <C>            <C>        <C>            <C>  
MCI network control            $ 4,394         $ 7,113         30             63
Other network control              940             592          6              5
Flex T1/E1                       4,861           1,905         34             17
SKYPLEX                          3,342           1,111         23             10
DIV modem                          556             381          4              4
Other products                     391             126          3              1
                               -------        --------   --------       --------
           Totals              $14,484         $11,228        100            100
                               =======        ========   ========       ========
</TABLE>

During the year ended June 30, 1997, two customers accounted for greater than
10% each of the Company's sales. MCI represented 30% of total sales and Walker
(a reseller/integrator of telecommunications products) accounted for
approximately 15% of the Company's sales. Revenues from the Company's FlexT1/E1
product line increased over 155% from $1,905,000 in the year ended June 30, 1996
to $4,861,000 in the year ended June 30, 1997 and revenues from SKYPLEX grew by
201% from $1,111,000 in the year ended June 30, 1996 to $3,342,000 in the year
ended June 30, 1997. Total international sales increased by approximately 214%
from $1,200,000 in the year ended June 30, 1996 to $3,766,000 in the year ended
June 30, 1997.


GROSS PROFIT. Gross profit increased by 9%, to $4,639,000 for the year ended
June 30, 1997 from $4,272,000 for the year ended June 30, 1996. This increase is
due to the increase in total revenue of $3,256,000 for the year ended June 30,
1997 over the year ended June 30, 1996. As a percentage of sales, gross profit
decreased from 38% in the year ended June 30, 1996 to 32% in the year ended June
30, 1997. Cost of goods sold for the year ended June 30, 1997 includes a charge
to write off certain capitalized product development for products that will not
be realized in future years. The amount of capitalized product development costs
written off during the year ended June 30, 1997 was $555,000. In addition, the
decrease in margins also reflects a shift in product mix from higher margin
network control products to the newer products in the Flex and SKYPLEX product
lines. The Company is currently experiencing high initial costs of production on
initial, lower volume production runs of its new products. As the Company builds
volume in these products, it is expected that the gross profit margins will
increase.


PRODUCT DEVELOPMENT. Product development expenses decreased slightly from
$2,495,000 for the year ended June 30, 1996 to $2,458,000 for the year ended
June 30, 1997. Beginning at the end of the fiscal year ended June 30, 1996 and
continuing through most of the year ended June 30, 1997, the Company was
involved in initial development of a new product line, the SKYPLEX spread
spectrum radio product. Certain development costs related to the SKYPLEX product
were capitalized. During the year ended June 30, 1997, the Company capitalized
$1,432,000 of these 



                                    Page 15
<PAGE>   18

costs as compared to $207,000 during the year ended June 30, 1996. During the
fourth quarter of the year ended June 30, 1997, management determined that,
given the anticipated direction of the Company's product line, certain product
features that had been developed for SKYPLEX would not be implemented for some
time. Consequently, it was determined that the future recoverability of the cost
of those features was not assured and that the value of the asset was impaired.
As a result, the Company has written off $555,000 of costs that had been
capitalized during the year. As a percentage of sales, total product development
costs decreased from 22% in the year ended June 30, 1996 to 17% in the year
ended June 30, 1997.


SELLING, GENERAL AND ADMINISTRATIVE. Selling, general and administrative
expenses increased by 51% from $4,206,000 for the year ended June 30, 1996 to
$6,331,000 for the year ended June 30, 1997. Selling expenses increased by 50%
from $3,213,000 in the year ended June 30, 1996 to $4,820,000 in the year ended
June 30, 1997. The increase resulted from expanded sales activity in the U.S. as
well as from expansion of sales activity outside the U.S. Selling expenses as a
percentage of net sales increased from 29% for the year ended June 30, 1996 to
33% for the year ended June 30, 1997 primarily due to the higher average
commission rates paid for new product lines compared to the rates paid on MCI
revenue. General and administrative expenses increased from $993,000 in the year
ended June 30, 1996 to $1,511,000 in the year ended June 30, 1997 due primarily
to increases in administrative and infrastructure costs needed to support the
operations of the business with expanded product lines and distribution
channels. As a percentage of net sales, general and administrative expenses
increased from 9% in the year ended June 30, 1996 to 10% in the year ended June
30, 1997.


NET INCOME / (LOSS). The net loss increased from $2,383,000 for the year ended
June 30, 1996 to a loss of $4,190,000 for the year ended June 30, 1997. This
increase resulted primarily from the shift in product mix to lower margin
products, as well as increased spending in sales and marketing and general and
administrative expenses.



COMPARISON OF YEARS ENDED JUNE 30, 1996 AND JUNE 30, 1995

The following table sets forth certain financial data derived from the Company's
Statements of Operations (dollars in thousands):

<TABLE>
<CAPTION>
                                            YEAR ENDED                     YEAR ENDED       
                                           JUNE 30, 1996                 JUNE 30, 1995      
                                         ------------------            -----------------    
                                           1996     1995                  1996    1995      
                                         ------------------            -----------------    
                                                     % OF                          % OF     
                                            $       SALES                 $        SALES    
                                         -------  ---------            --------  -------    
<S>                                      <C>      <C>                  <C>       <C>        
Net sales                                $11,228     100               $10,228      100     
Gross profit                               4,272      38                 5,410       53     
Product development                        2,495      22                 1,926       19     
Selling, general and administrative        4,206      37                 3,082       30     
Net income (loss)                         (2,383)    (21)                  407        4     
</TABLE>





                                    Page 16
<PAGE>   19
  NET SALES. Net sales increased by 10%, to $11,228,000 for the year ended June
30, 1996, from $10,228,000 for the year ended June 30, 1995. The sales mix, and
the resulting percentage of total sales, is shown in the table below (dollars in
thousands):

<TABLE>
<CAPTION>
                                                                   PERCENTAGE OF
                                                                       TOTAL
                                      FISCAL YEAR                   FISCAL YEAR
                                     ENDED JUNE 30,                ENDED JUNE 30,
                                   ------------------            ------------------
                                     1996       1995               1996       1995
                                   -------    -------            ------     -------
<S>                                <C>        <C>                <C>         <C>
MCI network control                $ 7,113    $ 8,620                 63         84
Other network control                  592        281                  5          3
Flex T1/E1                           1,905        456                 17          4
SKYPLEX                              1,111          0                 10          0
DIV modem                              381        694                  4          7
Other products                         126        177                  1          2
                                   -------    -------             ------     ------  
     Totals                        $11,228    $10,228                100        100  
                                   =======    =======             ======     ======  
</TABLE>


No customer, other than MCI, accounted for more than 10% of sales during
either of these fiscal years. Revenues from the Company's FlexT1/E1 product line
increased over 300% from $456,000 to $1,905,000 and revenues from SKYPLEX, in
it's first year of sales, were $1,110,000. Total international sales increased
by approximately 150% from $483,000 in the year ended June 30, 1995 to
$1,200,000 in the year ended June 30, 1996.

GROSS PROFIT. Gross profit decreased by 21%, to $4,272,000 for the year ended
June 30, 1996 from $5,410,000 for the year ended June 30, 1995. This decrease is
primarily due to the shift in product mix from higher margin network control
products to the newer products in the Flex product line which currently have
lower margins due to smaller production runs resulting in higher materials costs
which are typically related to products in early stages of production. As a
percentage of sales, gross profit decreased from 53% in the year ended June 30,
1995 to 38% in the year ended June 30, 1996.

PRODUCT DEVELOPMENT. Product development expenses increased from $1,926,000
for the year ended June 30, 1995 to $2,495,000 for the year ended June 30, 1996.
This increase represents increased spending on engineering for new products
which was funded, in part, by the proceeds of a public stock offering in March,
1996. As a percentage of sales, total product development costs increased from
19% in the year ended June 30, 1995 to 22% in the year ended June 30, 1996.

SELLING, GENERAL AND ADMINISTRATIVE. Selling, general and administrative
expenses increased by 36% from $3,082,000 for the year ended June 30, 1995 to
$4,206,000 for the year ended June 30, 1996. Selling expenses increased by 39%
from $2,317,000 in the year ended June 30, 1995 to $3,213,000 in the year ended
June 30, 1996. The increase resulted from expanded sales activity in the U.S. as
well as from expansion of sales activity outside the U.S. Selling expenses as a
percentage of net sales increased from 23% for the year ended June 30, 1995 to
29% for the year ended June 30, 1996. General and administrative expenses
increased from $765,000 in the year ended June 30, 1995 to $993,000 in the year
ended June 30, 1996 due primarily to increases in legal and accounting costs to
support business growth and the Company's position as a publicly traded entity.
As a percentage of net sales, general and administrative expenses increased from
7% in the year ended June 30, 1995 to 9% in the year ended June 30, 1996.


                                    Page 17
<PAGE>   20

NET INCOME / (LOSS). Net income decreased from $407,000 for the year ended June
30, 1995 to a loss of $2,383,000 for the year ended June 30, 1996. This decrease
resulted primarily from the shift in product mix to lower margin products, as
well as increased spending in product development and sales and marketing.



LIQUIDITY AND CAPITAL RESOURCES

On March 4, 1996 the Company completed an initial public offering (the
"Offering") of Units consisting of one share of the Company's Common Stock and
one Warrant to purchase one share of Common Stock at a price of 120% of the
initial unit offering price. Through this Offering, the Company raised
approximately $6,931,000 net of expenses. Of the net proceeds, $200,000 was used
to pay accrued dividends on the Series C Preferred Stock. On February 18, 1997
the Common Stock and Warrants underlying the Units began trading separately and
the Units ceased to trade.

On April 10, 1997, the Company established a bank line of credit agreement with
Silicon Valley Bank which makes available $2,500,000 in borrowings with
availability based on the Company's accounts receivable. The loan is secured by
the Company's assets and bears interest at the rate of prime plus 2.25% (10.75%
at June 30, 1997). The weighted average interest rate for the year ended June
30, 1997 was 9.45% compared to the weighted average interest rate of 9.25% on
the Company's borrowing facility for the year ended June 30, 1996. The loan
requires a monthly monitoring fee of $1,000 and a commitment fee of 0.125% due
monthly on the unused portion of the facility. The line of credit agreement term
is one year with an automatic renewal each year unless written notice of
termination is given by one of the parties. As of June 30, 1997, the Company was
in violation of certain covenants established by this credit facility regarding
the Company's tangible net worth. With the investment from Tandem Capital on
September 25, 1997, the Company was within the terms of this covenant.

At June 30, 1997, the Company had approximately $712,000 in cash and cash
equivalents. For the year ended June 30, 1997, the Company used $2,019,000 of
cash in operating activities, reflecting a net loss of $4,190,000, an increase
in accounts receivable of $567,000 and an increase in inventory of $99,000. Cash
was provided for operations through an increase in accounts payable and accrued
liabilities of $1,330,000. Working capital balances continue to grow as the
Company expands its product line and adds new customers both domestically and
internationally. Due to the shift in the Company's revenues from MCI to
resellers and certain international customers, it is anticipated that the days
sales outstanding will increase based on the terms of condition of certain of
these sales.

The Company purchased $1,446,000 of property and equipment during the year ended
June 30, 1997. Purchases were made primarily for equipment used to design and
test the Company's new SKYPLEX product line.

During 1997, the Company capitalized $1,432,000 of product development
expenditures relating to products expected to be made commercially available
before June 30, 1998. These amounts were primarily for development of the
Company's SKYPLEX spread spectrum radio product.


During the year ended June 30, 1997, the Company increased its borrowings and
sold investment securities to cover approximately $4,897,000 of cash used in
operating and investing activities. Borrowings under the Company's working
capital line of credit increased by $1,958,000 during the year ended June 30,
1997. In addition, the Company sold $3,001,000 of investment securities during
the year ended June 30, 1997.



                                    Page 18
<PAGE>   21

At June 30, 1997, the Company's net current assets position was approximately
$1,916,000. The Company has no significant purchase commitments other than those
incurred in the normal course of business and commitments under facilities and
operating leases.

On September 25, 1997, the Company issued $4 million of 11.5% subordinated
debentures due September 25, 2002. The Debenture Purchase Agreement contains
numerous rights, privileges, conditions, etc., in favor of the lender, only
certain of which have been included herein. Accordingly, the Debenture Purchase
Agreement should be read in conjunction with this summary note. The debentures
are convertible at any time by the lender into common stock of the Company at a
conversion price of $10.25 per share, subject to adjustment in certain events.
The debentures are redeemable by the Company after September 1999 provided that
(a) the Company pays the lender additional interest such that the lender would
receive an effective compounded 20% interest rate from inception of the loan or
(b) the 20-day average bid price for the Company's stock exceeds $15.00 per
share.

The debentures may be required to be redeemed by the Company at the option of
the lender at any time prior to maturity if there is a change in control, as
defined in the debenture agreement, at the repayment prices set forth in the
debenture agreement, subject to adjustment, together with accrued interest. The
debenture agreement specifies certain covenants with which the Company must
comply.

The Company believes its available funds and its line of credit will satisfy the
Company's projected working capital requirements over the next 12 months.


SEASONALITY

The Company's sales have been subject to quarterly fluctuations mainly due to
the purchasing cycle of the Company's large customer, MCI. Other fluctuations
occur due to increased buildout of the telecommunications infrastructure during
the summer months. The Company's business plan is to continue the
diversification of its product offerings, further develop its distribution
channels and further expand its customer base. The Company believes that the
implementation of this plan and the expected decrease of sales to MCI will
decrease the seasonality of its sales. The Company operates with a moderate
level of backlog for each product line due to advance purchase commitments and
production lead times.


NEW ACCOUNTING PRONOUNCEMENTS

In February 1997, the Financial Accounting Standards Board issued SFAS 128,
Earnings per Share. SFAS 128 specifies modifications to the calculation of
earnings per share from those currently utilized by the Company. Under SFAS 128,
"basic" earnings per share will be calculated based upon the weighted average
number of common shares actually outstanding, and "diluted" earnings per share
will be calculated based upon the weighted average number of common shares and
dilutive potential common shares. The Company intends that it will be adopted
when required. The Company believes that the adoption of SFAS 128 will have no
effect on the Company's financial position or cash flows.

In February 1997, the Financial Accounting Standards Board issued SFAS 129,
Disclosure of Information about Capital Structure. SFAS 129 requires companies
to disclose descriptive information about securities that is not necessarily
related to the computation of earnings per share. 



                                    Page 19
<PAGE>   22

It also requires disclosure of information about the liquidation preference of
preferred stock and redeemable stock. SFAS 129 is effective for financial
statements for periods ending after December 15, 1997. The Company does not
expect that SFAS 129 will require significant revision of prior disclosures.

In June 1997, the Financial Accounting Standards Board issued SFAS 130,
Reporting Comprehensive Income. SFAS requires companies to display, with the
same prominence as other financial statements, the components of other
comprehensive income. SFAS 130 requires that an enterprise classify items of
other comprehensive income by their nature in a financial statement and display
the accumulated balance of other comprehensive income separately from retained
earnings and additional paid-in capital in the equity section of the balance
sheet. SFAS 130 is effective for fiscal years beginning after December 15, 1997.
Reclassification of financial statements for earlier periods provided for
comparative purposes is required. The Company's financial statements will
include the disclosure of other comprehensive income in accordance with the
provisions of SFAS 130 beginning in the first quarter of fiscal year ending June
30, 1999.

In June 1997, the Financial Accounting Standards Board issued SFAS 131,
Disclosures about Segments of an Enterprise and Related Information. SFAS 131
requires that an enterprise disclose certain information about operating
segments. SFAS 131 is effective for financial statements for periods beginning
after December 15, 1997. The Company will evaluate the need for such disclosures
at that time.


IMPORTANT CONSIDERATIONS RELATED TO FORWARD-LOOKING STATEMENTS

It should be noted that this discussion contains forward-looking statements
which are subject to substantial known and unknown risks and uncertainties.
There are a number of factors which could cause actual results to differ
materially from those anticipated in statements made herein. Such factors
include, but are not limited to, changes in general economic conditions, the
growth rate of the market for the Company's products and services, the effect of
competitive products and pricing, and the irregular pattern of revenues, as well
as a number of other risk factors which could affect the future performance of
the Company.


                                    Page 20
<PAGE>   23






ITEM 7.   FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.



             Please see pages F-1 through F-21.






                                    Page 21
<PAGE>   24






ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.


  On July 11, 1996, the Company dismissed its independent public accountants,
Price Waterhouse LLP. Prior to July 11, 1996, Price Waterhouse LLP was engaged
as the principal accountant to audit the Company's financial statements. The
reports by Price Waterhouse LLP on the Company's financial statements for the
fiscal years ended June 30, 1995, June 30, 1994, and subsequent interim periods
did not contain any adverse opinion or disclaimer of opinion, nor were they
qualified or modified as to uncertainty, audit scope or accounting principles.
The dismissal of the former accountants was recommended by the Company's Audit
Committee and approved by the Company's Board of Directors.

  During the Company's fiscal years ended June 30, 1995 and June 30, 1994, and
during the subsequent interim fiscal periods through the date of dismissal,
there were no disagreements with Price Waterhouse LLP on any matter of
accounting principles or practices, financial statement disclosure, or auditing
scope or procedure, which disagreements, if not resolved to the satisfaction of
Price Waterhouse LLP, would have caused it to make reference to the subject
matter of the disagreement in their reports. Also, there were no reportable
events of the nature described in Rule 304(a)(1)(v) during the Company's fiscal
years ended June 30, 1995 and June 30, 1994, or during the subsequent interim
fiscal periods following the Company's fiscal year ended June 30, 1995 through
the date of dismissal.

  On July 11, 1996, the Company announced the appointment of KPMG Peat Marwick
LLP as independent public accountants to audit the Company's financial
statements as of and for the year ended June 30, 1996.




                                    Page 22
<PAGE>   25





                                    PART III



ITEM 9. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.

  The information required by this will be included in the Company's Proxy
Statement for the Annual Meeting of Shareholders expected to be filed with the
Commission on October 10, 1997 under the captions "Election of Directors" and
"Executive Officers" and is incorporated by reference herein.



ITEM 10. EXECUTIVE COMPENSATION.

  The information required by this item will be included in the Company's Proxy
Statement for the Annual Meeting of Shareholders expected to be filed with the
Commission on October 10, 1997 under the caption "Executive Compensation" and is
incorporated by reference herein.



ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.

  The information required by this item will be included in the Company's Proxy
Statement for the Annual Meeting of Shareholders expected to be filed with the
Commission on October 10, 1997 under the caption "Security Ownership of Certain
Beneficial Owners and Management" and is incorporated by reference herein.


ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.

  The information required by this item will be included in the Company's Proxy
Statement for the Annual Meeting of Shareholders expected to be filed with the
Commission on October 10, 1997 under the caption "Related Transactions" and is
incorporated by reference herein.





                                    Page 23
<PAGE>   26



ITEM 13. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.


(a) Exhibits:

      The Exhibits are listed in the Index to Exhibits on page E - 1.


(b) Reports on Form 8-K. The Company filed no reports on Form 8-K during the
    quarter ended June 30, 1997.







                                    Page 24
<PAGE>   27




                                   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.

                                          DIGITAL TRANSMISSION SYSTEMS, INC.



                                          /s/  Andres C Salazar                
                                          -------------------------------------
Date: October 8, 1997                     By:  Andres C. Salazar,
                                          President and Chief Executive Officer


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


<TABLE>

<S>                                   <C>                                             <C>
/s/Andres C. Salazar                       Chief Executive Officer,                   October 8, 1997
----------------------------.         Director (Principal Executive Officer)
Andres C. Salazar



/s/Roger Maloch.                           Vice-President-Finance and Secretary       October 8, 1997
----------------------------.         (Principal Financial and Accounting Officer)
Roger Maloch                        



/s/Frank LaHaye                                       Director                        October 8, 1997
----------------------------.
Frank LaHaye



/s/Gene Miller                                        Director                        October 8, 1997    
----------------------------.
Gene Miller



/s/Robert D. Francis                                  Director                        October 8, 1997   
----------------------------.
Robert D. Francis



/s/Edwin Kantor                                       Director                        October 8, 1997     
----------------------------.                        
Edwin Kantor
</TABLE>




                                   Page 25
<PAGE>   28
                          Index to Financial Statements


Balance Sheets as of June 30, 1997 and 1996

Statements of Operations for the years ended June 30, 1997 and 1996

Statements of Cash Flows for the years ended June 30, 1997 and 1996

Statements of Shareholders' Equity for the years ended June 30, 1997 and 1996

Notes to Financial Statements

Independent Auditors' Report - KPMG Peat Marwick LLP


                                      F-1
<PAGE>   29



                       DIGITAL TRANSMISSION SYSTEMS, INC.


                                 Balance Sheets

                             June 30, 1997 and 1996

                        (in thousands, except share data)


<TABLE>
<CAPTION>
                                     Assets (note 6)                                           1997           1996
                                                                                               ----           ----
<S>                                                                                          <C>           <C>   
Current assets:
    Cash and cash equivalents                                                                $    712           586
    Investment securities                                                                           -         3,001
    Trade accounts receivable, net of allowances for
      returns and doubtful accounts of $226 and
      $50 in 1997 and 1996, respectively                                                        4,223         3,595
    Other receivables                                                                              14            75
    Inventories (note 4)                                                                        2,440         2,341
    Prepaid expenses                                                                              295           262
    Deferred tax benefit (note 7)                                                                   -           250
                                                                                             --------      --------
           Total current assets                                                                 7,684        10,110

Property and equipment, net of accumulated depreciation
    and amortization (note 5)                                                                   1,186           445
Deferred tax benefit (note 7)                                                                     285            35
Intangible assets (note 3)                                                                      1,137           368
Other assets                                                                                       19            26
                                                                                             --------      --------

           Total assets                                                                      $ 10,311        10,984
                                                                                             ========      ========

                          Liabilities and Shareholders' Equity

Current liabilities:
    Line of credit (note 6)                                                                  $  1,958             -
    Accounts payable and accrued liabilities                                                    3,016         1,961
    Accrued payroll and benefits                                                                  591           316
    Warranty accrual                                                                              203           102
                                                                                             --------      --------
           Total liabilities                                                                    5,768         2,379
                                                                                             --------      --------

Shareholders' equity (note 8):
    Preferred stock - 3,000,000 shares authorized; -0- shares
      issued and outstanding                                                                       -              -
    Common stock - $.01 par value; 15,000,000 shares
      authorized; 4,121,143 and 3,920,700 shares issued
      and outstanding at June 30, 1997 and 1996, respectively                                      41            39
    Additional paid-in capital                                                                 11,232        11,137
    Deferred compensation                                                                        (124)         (188)
    Notes receivable from stock sales                                                             (33)            -
    Accumulated deficit                                                                        (6,573)       (2,383)
                                                                                             --------      --------
           Total shareholders' equity                                                           4,543         8,605

Commitments and contingencies (notes 8, 9, 10, and 11)

           Total liabilities and shareholders' equity                                        $ 10,311        10,984
                                                                                             ========      ========
</TABLE>

See accompanying notes to financial statements.



                                      F-2
<PAGE>   30


                       DIGITAL TRANSMISSION SYSTEMS, INC.

                            Statements of Operations

                       Years ended June 30, 1997 and 1996

                        (in thousands, except share data)

<TABLE>
                                                                                              1997           1996
                                                                                              ----           ----
 <S>                                                                                      <C>              <C>   
Net sales (note 9)                                                                        $    14,484        11,228
Cost of sales, including $555 in write-offs of capitalized
  product development costs                                                                     9,845         6,956
                                                                                          -----------      --------
           Gross profit                                                                         4,639         4,272
                                                                                          -----------      --------

Selling, general, and administrative                                                            6,331         4,206
Product development (note 10(c))                                                                2,458         2,495
                                                                                          -----------      --------
           Total operating expenses                                                             8,789         6,701
                                                                                          -----------      --------

           Operating loss                                                                      (4,150)       (2,429)

Other (expense) income                                                                            (40)           46
                                                                                          -----------      --------
           Loss before income tax expense                                                      (4,190)       (2,383)

Income tax benefit (expense)                                                                        -             -
                                                                                          -----------      --------

           Net loss                                                                            (4,190)       (2,383)

Accretion of redemption value and dividends accrued
    on redeemable preferred stock                                                                   -           225
                                                                                          -----------      --------

Net loss attributable to common shareholders                                              $    (4,190)       (2,608)
                                                                                          ===========      ========

Net loss per common share and common share equivalent                                     $     (1.05)         (.81)
                                                                                          ===========      ========

Weighted average common and equivalent shares outstanding                                       3,999         3,228
                                                                                          ===========      ========
</TABLE>

See accompanying notes to financial statements.

                                      F-3
<PAGE>   31


                       DIGITAL TRANSMISSION SYSTEMS, INC.

                            Statements of Cash Flows

                       Years ended June 30, 1997 and 1996

                                 (in thousands)


<TABLE>
<CAPTION>
                                                                                            1997           1996
                                                                                            ----           ---- 
<S>                                                                                        <C>             <C>    
Cash flows from operating activities:
    Net loss                                                                                $(4,190)      (2,383)
    Adjustments to reconcile net loss to net
      cash used in operating activities:
        Depreciation and amortization                                                           814          532
        Write-off of capitalized product development costs                                      554           -
        Amortization of deferred compensation expense                                            64           81
        Change in assets and liabilities:
          Trade accounts receivable                                                            (567)      (1,647)
          Inventories                                                                           (99)        (948)
          Prepaid expenses                                                                      (33)         (94)
          Accounts payable and accrued liabilities                                            1,055        1,210
          Accrued payroll and benefits                                                          275          153
          Warranty reserve                                                                      101           27
          Other                                                                                   7           (8)
                                                                                            -------      -------
                Net cash used in operating activities                                        (2,019)      (3,077)
                                                                                            -------      -------

Cash flows from investing activities:
    Purchases of property and equipment                                                      (1,446)        (585)
    Additions to capitalized product development costs                                       (1,432)        (207)
    Purchase of business                                                                         -          (200)
    Purchases of held-to-maturity investment securities                                          -        (3,001)
                                                                                            -------      -------
                Net cash used in investing activities                                        (2,878)      (3,993)
                                                                                            -------      -------

Cash flows from financing activities:
    Net borrowings (payments) under line of
      credit agreements                                                                       1,958         (450)
    Proceeds from maturities of held-to-maturity
      investment securities                                                                   3,001           -
    Preferred dividends paid                                                                     -          (200)
    Proceeds from exercise of stock options                                                      57           18
    Proceeds from issuances of common stock, net of
      $2,155,000 in offering costs in 1996                                                        7        6,931
                                                                                            -------      -------
                Net cash provided by financing activities                                   $ 5,023        6,299
                                                                                            -------      -------

Net increase (decrease) in cash and cash equivalents                                            126         (771)

Cash and cash equivalents at beginning of year                                                  586        1,357
                                                                                            -------      -------

Cash and cash equivalents at end of year                                                    $   712          586
                                                                                            =======      =======
</TABLE>

                                                                 (Continued)

                                      F-4
<PAGE>   32


                       DIGITAL TRANSMISSION SYSTEMS, INC.

                            Statements of Cash Flows

                                 (in thousands)



<TABLE>
<S>                                                                                     <C>              <C>
Supplemental disclosure of cash paid for income taxes and interest:
      Cash paid for income taxes                                                        $        --            3
                                                                                             ======      =======

      Cash paid for interest                                                            $        56           59
                                                                                             ======      =======

</TABLE>



See accompanying notes to financial statements.


                                      F-5

<PAGE>   33

                       DIGITAL TRANSMISSION SYSTEMS, INC.


                       Statements of Shareholders' Equity

                       Years ended June 30, 1997 and 1996

                                 (in thousands)


<TABLE>
<CAPTION>

                                                            Common stock                                                  
                                                     ------------------------                                           Notes
                                                      Number                          Additional                      receivable  
                                                     of shares                         paid-in           Deferred     from stock    
                                                      issued           Amount          capital        compensation       sales 
                                                      ------           ------          -------        ------------    -----------  
<S>                                                   <C>              <C>             <C>            <C>             <C>          
Balance at June 30, 1995                                  772          $    8              299             -               -       
Exercise of stock options                                  46               -               18             -               -      
Shares granted under stock incentive plan                   -               -              269          (269)              -      
Compensation expense                                        -               -                -            81               -      
Dividends accrued on Series C preferred stock               -               -              (58)            -               -      
Accretion of redemption value of Series A                                                                                         
    and Series B preferred stock                            -               -             (167)            -               -      
Conversion of Series A, Series B, and Series C                                                                                     
    preferred stock to common stock                     1,813              18            3,534             -               -      
Units issued in public offering, net of                                                                                            
    $2,155,000 of expenses                              1,221              12            6,919             -               -      
Payment of accrued dividends on Series C                                                                                           
    preferred stock                                        69               1              323             -               -      
Net loss                                                    -               -                -             -               -      
                                                      -------          ------          -------         -----            ----     
Balance at June 30, 1996                                3,921              39           11,137          (188)              -      
                                                                                                                                   
Exercise of stock options                                 200               2               88             -             (33)    
Compensation expense                                        -               -                -            64               -      
Shares issued under purchase plans                          -               -                7             -               -      
Net loss                                                    -               -                -             -               -      
                                                      -------          ------          -------         -----            ----     
                                                                                                                                   
Balance at June 30, 1997                                4,121          $   41           11,232          (124)            (33)    
                                                      =======          ======          =======         =====            ====     
</TABLE>

<TABLE>
<CAPTION>
                                                             Retained                                    
                                                             earnings            Total                  
                                                            (accumulated)     shareholders'            
                                                              deficit)          equity                  
                                                           ------------      -------------          
<S>                                                        <C>                <C>                   
Balance at June 30, 1995                                          -               307                   
Exercise of stock options                                         -                18                   
Shares granted under stock incentive plan                         -                 -                    
Compensation expense                                              -                81                    
Dividends accrued on Series C preferred stock                     -               (58)                  
Accretion of redemption value of Series A                                                               
    and Series B preferred stock                                  -              (167)                  
Conversion of Series A, Series B, and Series C                                                          
    preferred stock to common stock                               -             3,552                   
Units issued in public offering, net of                                                                 
    $2,155,000 of expenses                                        -             6,931                   
Payment of accrued dividends on Series C                                                                
    preferred stock                                               -               324                   
Net loss                                                     (2,383)           (2,383)                  
                                                             ------            ------                   
Balance at June 30, 1996                                     (2,383)            8,605                   
                                                                                                        
Exercise of stock options                                         -                57                   
Compensation expense                                              -                64                   
Shares issued under purchase plans                                -                 7                   
Net loss                                                     (4,190)           (4,190)                  
                                                             ------            ------                   
                                                                                                        
Balance at June 30, 1997                                     (6,573)            4,543                   
                                                             ======            ======                   


</TABLE>

See accompanying notes to financial statements.


                                      F-6


<PAGE>   34





                       DIGITAL TRANSMISSION SYSTEMS, INC.

                          Notes to Financial Statements

                             June 30, 1996 and 1995


(1)    Summary of Significant Accounting Policies

      (a)  Description of Business

           Digital Transmission Systems, Inc. (the "Company"), formerly NETRA
           Inc. (see note 2), designs, manufactures, markets, and services a
           broad range of products for the telecommunications industry. The
           Company's primary customers are long distance carriers and wireless
           service providers. The Company sells its products both in the U.S.,
           as well as key international markets, including Latin America, the
           Asia/Pacific region and Eastern Europe. The Company's products,
           consisting of proprietary software and hardware modules, facilitate
           the control, monitoring, and efficient transmission of high-speed
           digital information in telecommunications networks. The Company
           subcontracts the kitting and assembly of its products to various
           manufacturers.

      (b)  Cash and Cash Equivalents

           Cash and cash equivalents include cash on deposit in banks, money
           market accounts, and commercial paper instruments. All cash and cash
           equivalents are carried at cost which approximates market. For
           purposes of the statements of cash flows, the Company considers all
           highly liquid investments with original maturities of three months
           or less to be cash equivalents.

      (c)  Investment Securities

           The Company classifies its debt and equity securities in one of
           three categories: trading, available-for-sale, or held-to-maturity.
           Trading securities are bought and held principally for the purpose
           of selling them in the near term. Held-to-maturity securities are
           those securities in which the Company has the ability and intent to
           hold the security until maturity. All other securities not included
           in trading or held-to-maturity are classified as available-for-sale.

           Investments at June 30, 1996 consist of U.S. Government agency
           mortgage-backed debt securities, which were classified as
           held-to-maturity securities and recorded at amortized cost.
           Accordingly, temporary unrealized gains and losses on
           held-to-maturity securities were not recognized.

      (d)  Inventories

           Inventories are stated at the lower of cost or market. Cost is
           determined using average cost which approximates the first-in, first-
           out (FIFO) method.

      (e)  Property and Equipment

           Property and equipment are stated at cost less accumulated
           depreciation and amortization. Depreciation is calculated on the
           straight-line method over the estimated useful lives of the assets as
           follows:

                  Computer and Test Equipment              3 years
                  Software                                 1 years
                  Furniture and Fixtures                   3 years
                  Leasehold Improvements                   3 years


                                      F-7
<PAGE>   35


                       DIGITAL TRANSMISSION SYSTEMS, INC.

                          Notes to Financial Statements


      (f)  Intangible Assets and Research and Development Expenditures

           Capitalized product development costs, goodwill, and other intangible
           assets are being amortized on a straight-line basis over a three-year
           period. The Company evaluates the recoverability of these intangible
           assets at each period end using the undiscounted estimated future
           cash flows expected to be derived from such assets. If such
           evaluation indicates a potential impairment, the Company measures it
           based on projected discounted future operating cash flows using a
           discount rate reflecting the Company's average cost of funds. The
           assessment of the recoverability of these intangible assets will be
           impacted if estimated future operating cash flows are not achieved.
           During the years ended June 30, 1997 and 1996, $555,000 and $-0-,
           respectively, in write-offs were recognized due to impairment of net
           realizable value.

           Research and development costs related to new product development
           that has not reached product design phase are expensed as incurred.
           The Company capitalizes product development costs for outside
           contractors from the time that product design has been completed for
           the product to the time that the product is ready for production. The
           determination of completion of the product design phase and the
           ongoing assessment of recoverability of capitalized product
           development costs require considerable judgment by management with
           respect to certain external factors, including, but not limited to,
           anticipated future revenues, estimated economic life, and changes in
           technologies.

      (g)  Impairment of Long-Lived Assets and Long-Lived Assets to Be Disposed
           Of

           The Company adopted the provisions of SFAS No. 121, Accounting for
           the Impairment of Long-Lived Assets and for Long-Lived Assets to Be
           Disposed Of ("SFAS 121"), on July 1, 1996. SFAS 121 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 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 costs
           to sell. Adoption of SFAS 121 did not have a material impact on the
           Company's financial position or results of operations.

      (h)  Financial Instruments

           The Company's financial instruments consisted of cash and cash
           equivalents; investments; accounts receivable; line of credit;
           accounts payable and accrued expenses; and accrued payroll and
           benefits. The carrying values of these financial instruments,
           excluding investments and line of credit, approximate fair value
           because of the short maturity of those instruments. The carrying
           value of the Company's investments at June 30, 1996 was $3,000,910,
           as compared to the fair value of $3,055,000. The carrying value of
           the Company's line of credit approximates fair value based on the
           variable rate nature of the instrument.


                                      F-8
<PAGE>   36


                       DIGITAL TRANSMISSION SYSTEMS, INC.

                          Notes to Financial Statements


           Financial instruments which potentially subject the Company to
           concentrations of credit risk are primarily cash and equivalents,
           investments, and accounts receivable. The Company's cash equivalents
           are in money market accounts, and the Company's investments are in
           U.S. Government agency mortgage-backed debt securities. The Company
           believes no significant concentration of credit risk exists with
           respect to these financial instruments.

           The Company sells its products primarily to long-distance carriers,
           wireless service providers, and resellers/integrators in the
           telecommunications industry. Generally, the Company requires no
           collateral on trade receivables, but believes that any credit risks
           are substantially mitigated by its credit evaluation process, as well
           as letters of credit and credit insurance procured for certain
           international sales. The Company maintains allowances for potential
           credit losses, but historically has not experienced significant
           losses related to groups of customers in any particular geographic
           area.

      (i)  Revenue Recognition

           Revenue from the sale of equipment is recognized at the time of
           shipment. The Company estimates and records provisions for sales
           returns, discounts, and allowances in the period the sale is
           reported, based on its experience and other relevant factors.

           Certain of the Company's contractual arrangements allow for limited
           right of return. Management of the Company has provided an allowance
           for expected sales returns, discounts, and allowances related to
           these customers based on the historical return rates and expected
           future returns of sales to these customers. The amounts of sales
           discounts, returns, and allowances ultimately incurred could differ
           materially in the near term from the allowances recorded in these
           financial statements.

      (j)  Warranty Accrual

           The Company warrants its products against defects in design,
           materials, and workmanship for periods ranging from one to five
           years. A provision for estimated future costs relating to warranty
           expense is recorded when the products are shipped based on historical
           claims and projected future experience.

           Certain of the Company's product lines have been recently introduced
           to market and therefore limited historical data has been available on
           which to base estimates of future returns for warranty repairs.
           Management of the Company has provided for warranty expense related
           to these new products based on the historical return rates and repair
           costs of established products lines, as well as recent and expected
           return rates and repair costs of these new products. The amount of
           warranty expense ultimately incurred could differ materially in the
           near term from the accrual recorded in these financial statements.

    
                                      F-9
<PAGE>   37


                       DIGITAL TRANSMISSION SYSTEMS, INC.

                          Notes to Financial Statements


      (k)  Income Taxes

           Income taxes are accounted for under the assets and liability method.
           Deferred tax assets and liabilities are recognized for the future tax
           consequences attributable to differences between the financial
           statement carrying amounts of existing assets and liabilities and
           their respective tax bases and operating loss and tax credit
           carryforwards. Deferred tax assets and liabilities are measured using
           enacted tax rates expected to apply to taxable income in the years in
           which those temporary differences are expected to be recovered or
           settled. The effect on deferred tax assets and liabilities of a
           change in tax rates is recognized in income in the period that
           includes the enactment date.

      (l)  Stock Option Plan

           Prior to July 1, 1996, the Company accounted for its stock option
           plan in accordance with the provisions of Accounting Principles Board
           ("APB") Opinion No. 25, Accounting for Stock Issued to Employees, and
           related interpretations. As such, compensation expense would be
           recorded on the date of grant only if the current market price of the
           underlying stock exceeded the exercise price. Only July 1, 1996, the
           Company adopted SFAS No. 123, Accounting for Stock-Based
           Compensation, which permits entities to recognize as expense over the
           vesting period the fair value of all stock-based awards on the date
           of grant. Alternatively, SFAS No. 123 also allows entities to
           continue to apply the provisions of APB Opinion No. 25 and provide
           pro forma net income and pro forma earnings per share disclosures for
           employee stock option grants made in fiscal 1996 and future years as
           if the fair-value-based method defined in SFAS No. 123 had been
           applied. The Company has elected to continue to apply the provisions
           of APB Opinion No. 25 and provide the pro forma disclosure provisions
           of SFAS No. 123.

      (m)  Loss Per Share

           Net loss per common share has been computed using the
           weighted-average number of outstanding shares of common stock and
           common stock equivalents (when dilutive) during 1997 and 1996. The
           weighted-average number of shares for 1996 includes common stock and
           common stock equivalents issued within one year prior to the filing
           of the initial public offering for all periods presented without
           regard to whether the inclusion of the securities was dilutive. Net
           loss per share computed on a fully diluted basis is not significantly
           different than the weighted-average number of shares computed using
           the primary method described above.

           The pro forma loss per share for 1996 gives effect to the conversion
           of 1,813,289 shares of redeemable convertible preferred stock into an
           equal number of shares of common stock in conjunction with the
           Company's public stock offering as if such conversion had occurred at
           the beginning of 1996. Additionally, the pro forma earnings per share
           gives effect to the approximately 69,383 shares of common stock which
           were exchanged in partial consideration of accrued dividends (see
           note 8).




                                      F-10
<PAGE>   38


                       DIGITAL TRANSMISSION SYSTEMS, INC.

                          Notes to Financial Statements


      (n)  Use of Estimates

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

      (o)  Reclassifications

           Certain amounts in the 1996 financial statements have been
           reclassified to conform to classifications adopted in 1997.

(2)    Changes in Corporate Structure

       DTS Acquisition Corporation (DTS AC) was incorporated on August 14, 1990
       for the purpose of acquiring all stock of DTS, Inc. The acquisition was
       consummated on August 20, 1990 and DTS AC commenced operations on that
       date.

       NETRA Inc. ("NETRA"), a Delaware corporation, was formed on October 28,
       1992 to effect the purchase of Able Telecommunications, Inc. ("Able"). On
       February 5, 1993, Able stockholders contributed all outstanding shares of
       Able to NETRA in a tax-free reorganization pursuant to Section 351 of the
       Internal Revenue Code of 1986. Able Series A Preferred, Series B
       Preferred, and common stockholders received one share of the respective
       NETRA shares for each share of Able.

       Simultaneously with the NETRA/Able merger described above, DTS AC merged
       with and into NETRA, leaving NETRA as the surviving entity, in a tax-free
       reorganization. Following the merger of DTS AC into NETRA, DTS AC's
       wholly owned subsidiary, DTS, Inc., was merged with and into Able leaving
       Able as the surviving entity. Able subsequently changed its name to DTS,
       Inc. At the consummation of the transaction, NETRA was the parent company
       with one wholly owned subsidiary, DTS, Inc. DTS, Inc.'s operations
       include those of the former DTS, Inc. and Able Telecommunications, Inc.
       During fiscal year 1994, the Company consolidated the operations of Able
       from its California location to its Georgia facility. On November 11,
       1995, the Board of Directors of NETRA and DTS, Inc. voted to formally
       merge Digital Transmission Systems, Inc. into NETRA; on December 13,
       1995, the name of NETRA was changed to Digital Transmission Systems, Inc.
       As the NETRA consolidated financial statements prior to and for the year
       ended June 30, 1995 included DTS, Inc. as a wholly-owned subsidiary, this
       merger will have no effect on the financial statements included herein.

       The DTS, Inc./Able combination described above was accounted for using
       the purchase method of accounting for financial reporting purposes, with
       Able deemed to be the purchased entity. In accordance with the purchase
       method of accounting, the excess of the purchase price over specifically
       identifiable tangible and intangible net assets of Able was recorded as
       goodwill. The results of operations of DTS, Inc. and Able have been
       included in the Company's financial statements from the dates of their
       respective acquisitions.



                                      F-11
<PAGE>   39


                       DIGITAL TRANSMISSION SYSTEMS, INC.

                          Notes to Financial Statements


(3)    Intangible Assets

       Intangible assets consist of the following as of June 30, 1997 and 1996
       (in thousands):

<TABLE>
<CAPTION>
                                                                                        1997        1996
                                                                                        ----       -----
           <S>                                                                       <C>           <C>
           Capitalized product development costs                                     $    1,085       207
           Intangible asset related to the acquisition
               of SKYPLEX rights                                                            200       200
                                                                                     ----------     -----
                                                                                          1,285       407
           Less accumulated amortization                                                    148        39
                                                                                     ----------     -----
                                                                                     $    1,137       368
                                                                                     ==========     =====
</TABLE>

       Amortization expense recorded for the years ended June 30, 1997 and 1996
       was approximately $109,000 and $57,000, respectively.

(4)    Inventories

       Inventories consist of the following at June 30, 1997 and 1996 (in
thousands):

<TABLE>
<CAPTION>
                                                                                          1997       1996
                                                                                          ----       ----
           <S>                                                                       <C>           <C>
           Raw materials                                                             $    1,853      2,119
           Work in process                                                                   -         204
           Finished goods                                                                   953        376
           Inventory reserve                                                               (366)      (358)
                                                                                     ----------    -------
                                                                                     $    2,440      2,341
                                                                                     ==========    =======

</TABLE>

(5)    Property and Equipment

       Property and equipment consist of the following at June 30, 1997 and 1996
(in thousands):


<TABLE>
<CAPTION>
                                                                                        1997         1996
                                                                                        ----         ----
           <S>                                                                       <C>           <C>  
           Computer and test equipment                                               $    2,324      1,099
           Software                                                                         286        230
           Furniture and fixtures                                                           159         82
           Leasehold improvements                                                           205        117
                                                                                     ----------    -------
                                                                                          2,974      1,528
           Less accumulated depreciation and amortization                                 1,788      1,083
                                                                                     ----------    -------
                                                                                     $    1,186        445
                                                                                     ==========    =======

</TABLE>




                                      F-12
<PAGE>   40


                       DIGITAL TRANSMISSION SYSTEMS, INC.

                          Notes to Financial Statements


(6)    Lines of Credit

       In April 1997, the Company executed a line of credit agreement with a
       financial institution whereby it may borrow the lesser of $2,500,000 or
       80% of eligible receivables, as defined in the Loan and Security
       Agreement (the "Agreement"), through the maturity date of April 10, 1998.
       Amounts outstanding under the Agreement were $1,958,172 at June 30, 1997.
       Borrowings accrue interest at the prime rate plus 2.25% (10.75% at June
       30, 1997) and are secured by accounts receivable, inventory, and certain
       other assets as defined in the Agreement. A commitment fee of .125% of
       the unused portion of the line of credit and a $1,000 collateral fee are
       payable monthly under the terms of the Agreement.

       The Agreement imposes certain covenants as defined in the Agreement with
       which the Company was not in compliance as of June 30, 1997.

       DTS, Inc. had a line of credit agreement with a financial institution
       whereby it could borrow up to $1,200,000. Amounts outstanding under this
       agreement were $-0- at June 30, 1996, and the agreement was not renewed
       on its maturity date of October 31, 1996. Borrowings accrued interest at
       the prime rate plus 1% (9.25% at June 30, 1996) and were secured by
       accounts receivable and inventories. The line was additionally secured by
       an assignment of $600,000 of the company's investment securities. A
       commitment fee of .25% was charged on the unused portion of the line of
       credit.

(7)    Income Taxes

       Because of operating losses, the Company has not provided any income tax
       expense for the years ended June 30, 1997 and 1996. A reconciliation of
       the expected income tax benefit (at the statutory federal income tax rate
       of 34%) to the actual income taxes reported in the statement of
       operations is as follows (in thousands):

<TABLE>
<CAPTION>
                                                                         1997        1996
                                                                         ----        ----
          <S>                                                         <C>           <C>
           Computed "expected" income tax benefit
               at Federal statutory rate of 34%                       $  (1,425)      (810)
           State income taxes, net of Federal benefit                      (165)       (94)
           Increase in valuation allowance                                1,638        782
           Other, net                                                       (48)       122
                                                                        -------     ------
                                                                        
                                                                      $       -          - 
                                                                        =======     ====== 


</TABLE>

                                      F-13
<PAGE>   41


                       DIGITAL TRANSMISSION SYSTEMS, INC.

                          Notes to Financial Statements


       The income tax effects of the temporary differences that give rise to
       significant portions of the Company's deferred tax assets at June 30,
       1997 and 1996 are presented below (in thousands):
<TABLE>
<CAPTION>

                                                                            1997        1996
                                                                            ----        ----
           <S>                                                           <C>           <C>
           Deferred tax assets:
               Allowance for doubtful accounts                           $       86         19
               Inventory valuation allowance                                    139        136
               Accrued expenses not reduced for tax purposes                     99         39
               Property and equipment depreciation                               47         35
               Net operating loss carryforwards                               2,982      1,486
               Product and development tax credit
                 carryforwards                                                  441        441
                                                                         ----------    -------
                      Gross deferred tax asset                                3,794      2,156

           Less valuation allowance                                           3,509      1,871
                                                                         ----------    -------

                 Net deferred tax assets                                 $      285        285
                                                                         ==========    =======
</TABLE>

       The valuation allowance for deferred tax assets as of June 30, 1997 and
       1996 was $3,509,000 and $1,871,000, respectively. The net change in the
       total valuation allowance for the years ended June 30, 1997 and 1996 was
       an increase of approximately $1,638,000 and $782,000, respectively. In
       assessing the realizability of deferred tax assets, management considers
       whether it is more likely than not that some portion or all of the
       deferred tax assets will not be realized. The ultimate realization of
       deferred tax assets is dependent upon the generation of future taxable
       income during the periods in which those temporary differences become
       deductible. Management considers the scheduled reversal of deferred tax
       liabilities, projected future taxable income, and tax planning strategies
       in making this assessment. In order to fully realize the deferred tax
       asset, the Company will need to generate future taxable income of
       approximately $8,000,000 prior to the expiration of the net operating
       loss carryforwards beginning in 2005. Taxable loss for the years ended
       June 30, 1997 and 1996 was approximately ($3,680,000) and ($2,200,000),
       respectively. Based upon the level of historical taxable income and
       projections for future taxable income over the periods in which the
       deferred tax assets are deductible, management believes it is more likely
       than not the Company will realize the benefits of these deductible
       differences, net of the existing valuation allowances at June 30, 1997.
       The amount of the deferred tax asset considered realizable, however,
       could be reduced in the near term if estimates of future taxable income
       during the carryforward period are reduced.

       At June 30, 1997, the Company has net operating loss carryforwards for
       federal income tax purposes of approximately $8,000,000 which are
       available to offset future federal taxable income, if any, through 2005.
       In addition, the Company has product development tax credit carryforwards
       of approximately $441,000 which are available to reduce future federal
       regular income taxes, if any, and have expiration dates beginning in
       2005.


                                      F-14
<PAGE>   42


                       DIGITAL TRANSMISSION SYSTEMS, INC.

                          Notes to Financial Statements


       The amount of net operating loss and research and experimentation credit
       carryforwards may be limited due to an ownership change, as defined in
       the Internal Revenue Service regulations. In the event of an ownership
       change, the amount of taxable income of a loss corporation for any
       postchange year which may be offset by prechange losses shall not exceed
       the Internal Revenue Code Section 382 limitation for such year.
       Generally, an ownership change occurs if a 5% stockholder or any equity
       structure shift increases the percentage of the stock of the loss
       corporation owned by more than 50 percentage points over the lowest
       percentage of stock of the loss corporation owned by such stockholders at
       any time during a three-year look-back testing period. The annual Section
       382 limitation is equal to the value of the old loss corporation (before
       the ownership change) multiplied by the Federal long-term, tax-exempt
       rate.

(8)    Shareholders' Equity

       Amendment to the Certificate of Incorporation

       Effective March 4, 1996, the date of the Company's public stock offering
       (the "Offering"), the Company's Board of Directors amended the
       certificate of incorporation of Digital Transmission Systems, Inc. to
       declare a 3.35-to-1 reverse stock split on all common and redeemable
       convertible preferred shares authorized; change the par value on both the
       common stock and the redeemable convertible preferred stock from their
       original par value of $.00001 and $.0001, respectively, to $.0l; and
       reduce the number of authorized shares of common stock from 20,000,000 to
       15,000,000. The amendment also authorized 3,000,000 shares of $.01 par
       preferred stock. All shares and per share amounts have been retroactively
       restated to reflect the reverse stock split and the change in par value
       and authorized number of shares of common stock.

       Conversion of Series A, Series B, and
       Series C Redeemable Convertible Preferred Stock

       Concurrent with the Offering, the Company converted the 358,563, 90,850,
       and 1,363,876 outstanding shares of Series A, Series B, and Series C
       Redeemable Convertible Preferred Stock, respectively, to shares of $.01
       par value Common Stock on a 1:1 basis. At the time of the conversion,
       $523,400 was accrued in dividends on the redeemable convertible preferred
       stock. The Company paid $200,000 in cash and issued 69,383 shares of
       common stock as payment for the remainder. The owners of this common
       stock have retained certain demand registration rights. As of June 30,
       1997 and 1996, the Company has no redeemable convertible preferred stock
       authorized, issued, or outstanding.

       Shareholder Lock-Up Agreements

       Certain holders of the 2,700,000 shares of common stock outstanding prior
       to the Offering entered into agreements that they would not sell any
       common stock owned by them without the prior written consent of the
       underwriter for a period of one year from the date of the Offering. Some
       of these agreements have been extended beyond June 30, 1997.


                                      F-15
<PAGE>   43


                       DIGITAL TRANSMISSION SYSTEMS, INC.

                          Notes to Financial Statements


       Initial Public Offering

       On March 4, 1996, the Company completed the Offering of 1,220,700 units
       each consisting of one share of common stock and one warrant to purchase
       one share of common stock at an exercise price per share of $9. Through
       this Offering, the Company raised approximately $6,931,000 net of
       expenses.

       The 1,220,700 shares of common stock included in the units were shown as
       outstanding shares for the purposes of the balance sheet and statement of
       stockholders' equity as of and for the year ended June 30, 1996.

       Separation of Units

       The shares of common stock and warrants included in the 1,220,700 units
       sold in the Offering were not separately detachable or separately
       transferable, and could only be traded as units, until 365 days from the
       date of the Offering or such earlier date as the underwriter could
       determine (the "Separation Date"). On February 18, 1997, the units
       separated so that the common stock and warrants underlying the units
       began trading separately and the units ceased to trade.

       Warrants

       As of June 30, 1997, 1,220,700 warrants were issued and outstanding which
       entitle the holder to purchase one share of common stock at an exercise
       price of $9, and expire March 4, 2001. The Company has issued no warrants
       other than these, which were included in the units sold in the Offering.

       Stock Options

       Effective October 1992, the Board of Directors adopted the 1992 Stock
       Incentive Plan (the "1992 Plan") which provides for the grant of stock
       options for up to 840,946 shares of common stock. The 1992 Plan also
       permits the Board of Directors to grant stock appreciation rights, stock
       bonuses, and restricted stock awards in accordance with the provisions of
       the Plan. The Plan remains in effect until October 2002 unless sooner
       terminated by the Board of Directors.

       Effective January 1996, the Board of Directors adopted the 1996 Stock
       Incentive Plan (the "1996 Plan") which provides for the grant of stock
       options for up to 200,000 shares of common stock. In October 1996, the
       Board of Directors voted to increase the number of shares of common stock
       authorized under the 1996 Plan from 200,000 shares to 440,000 shares. The
       1996 Plan also permits the Board of Directors to grant stock appreciation
       rights, stock bonuses, and restricted stock awards in accordance with the
       provisions of the Plan. The Plan remains in effect until January 2006
       unless sooner terminated by the Board of Directors.


                                      F-16
<PAGE>   44


                       DIGITAL TRANSMISSION SYSTEMS, INC.

                          Notes to Financial Statements


       Options granted under the 1992 and 1996 Plans may be incentive stock
       options or nonqualified stock options, as determined by the Board of
       Directors at the time of grant. Incentive stock options are granted at a
       price not less than the fair market value of the stock on the grant date,
       and nonqualified options are granted at a price to be determined by the
       Board of Directors provided that such exercise price is not less than 85%
       of the fair market value of the stock on the grant date. Option vesting
       terms are established by the Board of Directors at the time of grant, and
       presently range from three to five years. The expiration date of options
       granted under the 1992 and 1996 Plans are determined at the time of grant
       and may not exceed ten years from the date of the grant.

       As of June 30, 1997, there were no options available for grant under the
       1992 Plan, and there were 131,752 options available for grant under the
       1996 Plan.

       On March 4, 1996, pursuant to the Underwriter's Agreement, the Company
       issued options to the underwriter to purchase 107,000 units (consisting
       of one share of common stock and one warrant to purchase one share of
       common stock at an exercise price of $14.85). The options have an
       exercise price per unit of $12.375 and expire March 4, 2001. The options
       were assigned a fair value of $-0- when issued due to the stated exercise
       prices which greatly exceeded the market value at the grant date. As of
       June 30, 1997, 107,000 options were outstanding and exercisable.

       The Company also issues options to members of the Board of Directors as
       compensation for board representation and attendance. Options are issued
       at the fair market value at the date of grant and vest immediately upon
       issue as of the date of each board meeting attended. As of June 30, 1997,
       35,388 of these options were outstanding of which 27,388 were
       exercisable.

       The per share weighted-average fair value of all stock options granted
       during the years ended June 30, 1997 and 1996 was $4.48 and $1.83 on the
       date of grant using the Black-Scholes option-pricing model with the
       following weighted-average assumptions: 1997 - expected dividend yield
       0%, expected volatility 45%, risk-free interest rate of 5.8%, and an
       expected life of 4 years; 1996 - expected dividend yield 0%, expected
       volatility 45%, risk-free interest rate of 5.8%, and an expected life of
       4 to 5 years.

       The Company applies APB Opinion No. 25 in accounting for its Plans and,
       accordingly, no compensation cost has been recognized for its stock
       options issued at fair value in the financial statements. Had the Company
       determined compensation cost based on the fair value at the grant date
       for its stock options under SFAS No. 123, the Company's net loss would
       have been adjusted by the pro forma amounts indicated below (in
       thousands, except share data):

<TABLE>
<CAPTION>

                                                                                         June 30,
                                                                                         --------
                                                                                     1997        1996
                                                                                     ----        ----

           <S>                                            <C>                    <C>             <C>    
           Net loss attributable to common
               shareholders                               As reported            $   (4,190)     (2,608)
                                                          Pro forma              $   (4,447)     (2,598)

           Net loss per common share and
               common share equivalent                    As reported            $    (1.05)       (.81)
                                                          Pro forma              $    (1.11)       (.80)

</TABLE>

                                      F-17
<PAGE>   45


                       DIGITAL TRANSMISSION SYSTEMS, INC.

                          Notes to Financial Statements


       Pro forma net loss reflects only options granted during the years ended
       June 30, 1997 and 1996. Therefore, the full impact of calculating
       compensation cost for stock options under SFAS 123 is not reflected in
       the pro forma loss amounts presented above because compensation cost is
       reflected over the options' vesting periods ranging from one to five
       years, and compensation cost for options granted prior to July 1, 1995 is
       not considered.

       The following summarizes stock option activity, excluding underwriter
       options, for the years ended June 30, 1997 and 1996:

<TABLE>
<CAPTION>
                                                                       Number               Exercise
                                                                      of shares          price per share
                                                                      ---------          ---------------

           <S>                                                       <C>          <C>         
           Outstanding at June 30, 1995                                542,201        .0084    -  1.6750

               Granted                                                 313,335        .8710    - 10.5000
               Exercised                                                45,327        .0084    -  1.1725
               Canceled or expired                                      87,066        .0670    -  1.1725
                                                                     ---------    ----------------------

           Outstanding at June 30, 1996                                723,143    $   .0084    - 10.5000
                                                                                  ======================

               Granted                                                 230,000      10.2500    - 12.8750
               Exercised                                               199,661        .0085    -  4.1875
               Canceled or expired                                      31,261        .0670    -  4.7300
                                                                     ---------    ----------------------

           Outstanding at June 30, 1997                                722,221    $   .0085    - 12.8750
                                                                     =========    ======================
</TABLE>

       At June 30, 1997, the weighted-average remaining contractual life of
       outstanding options, excluding underwriter options, was 7.8 years. At
       June 30, 1997 and 1996, the number of options exercisable was 221,466 and
       309,821, respectively, and the weighted-average exercise price of those
       options was $1.22 and $.33, respectively.

       Notes Receivable from Stock Sales

       Notes receivable from stock sales result from the exercise of stock
       options for notes during the year ended June 30, 1997. The notes are full
       recourse promissory notes bearing interest at 8% per annum. All accrued
       interest and the entire principal amount of each note is payable on
       November 7, 1997.

       Stock Compensation Expense

       Unearned compensation expense of $269,000 was recorded as a reduction of
       shareholders' equity for the fiscal year ended June 30, 1996 for 62,089
       options issued at an exercise price less than fair market value.
       Compensation expense of approximately $64,000 and $81,000 was recorded in
       the Statement of Operations during the years ended June 30, 1997 and
       1996, respectively, for the options that vested during these years.



                                      F-18
<PAGE>   46


                       DIGITAL TRANSMISSION SYSTEMS, INC.

                          Notes to Financial Statements


       Employee Stock Purchase Plan

       Effective November 7, 1996, the Board of Directors adopted the 1996
       Employee Stock Purchase Plan (the "Plan"), under which, the Company is
       authorized to issue up to 150,000 shares of common stock to its full-time
       employees. Substantially all of the Company's employees are eligible to
       participate. Under the terms of the Plan, employees can choose each year
       to have up to 10% of their annual base earnings withheld to purchase the
       Company's common stock. The purchase price of the stock is 85% of the
       lower of its beginning-of-year or end-of-year market price. Under the
       plan, the Company sold 782 shares to employees in 1997.

       Under FASB Statement 123, compensation cost is recognized for the fair
       value of the employees' purchase rights, which was estimated using the
       Black-Scholes model with the following assumptions for 1997: dividend
       yield of 0%; an expected life of one year; expected volatility of 45%;
       and risk-free interest rate of 5.8%. The weighted-average fair value of
       those purchase rights granted during the year ended June 30, 1997 was
       approximately $2,500.

(9)    Concentration of Sales and Credit Risks

       For the years ended June 30, 1997 and 1996, 45% and 66%, respectively, of
       the Company's revenues were derived from two customers. Additionally, the
       Company's accounts receivable from these customers represented 44% and
       60% of total accounts receivable at June 30, 1997 and 1996, respectively.

       For the years ended June 30, 1997 and 1996, international sales were 
       approximately 26% and 10%, respectively, of total sales of the Company.
       International sales and gross profit were as follows (in thousands):

<TABLE>
<CAPTION>
                                                                               1997       1996
           <S>                                                              <C>           <C>
           Sales                                                            $  3,766      1,200
           Gross profit                                                        1,120        254
</TABLE> 

(10)   Commitments and Contingencies

      (a)  Leases

           The Company leases a building and certain equipment under
           noncancelable operating lease agreements which expire at various
           times through 2001 and provide for minimum annual rentals as follows:

<TABLE>
<CAPTION>
                               Year ending
                                June 30,                 (in thousands)
                                --------                 --------------

                               <S>                       <C>     
                                1998                      $    197
                                1999                           159
                                2000                            15
                                2001                             3
                                                          --------

                                                          $    374
                                                          ========
</TABLE>

           Rental expense under all lease agreements for the years ended June
30, 1997 and 1996 was approximately $415,000 and $450,000, respectively.



                                      F-19

<PAGE>   47



                                      F-20

                       DIGITAL TRANSMISSION SYSTEMS, INC.

                          Notes to Financial Statements


      (b)  401(k) Plan

           The Company sponsors the Digital Transmission Systems, Inc. 401(k)
           Savings Plan (the "Plan") for the benefit of eligible employees and
           their beneficiaries. Employees may elect to contribute from 1% to 20%
           of their gross compensation to the Plan. The Plan was amended during
           the year ended June 30, 1997 to provide for a Company match of 25% of
           employee contributions up to 6% of their eligible compensation. The
           Company can also make an additional annual discretionary contribution
           that is allocated to employees based upon relative levels of
           compensation. The Company recorded matching expense of $23,505 and
           $-0- for the years ended June 30, 1997 and 1996, respectively. The
           Company elected to make no discretionary contributions to the Plan
           during the years ended June 30, 1997 and 1996.

      (c)  Product Development Agreements

           The Company has agreements with certain outside subcontractors for
           the development of new product technology. The agreements define
           milestones which, upon completion, call for the payment of
           agreed-upon fees. Portions of these payments are capitalized as
           product development cost, as discussed in note 1. There were no firm
           commitments remaining in effect as of June 30, 1997.

(11)   Subsequent Events

       On September 25, 1997, the Company issued $4 million of 11.5%
       subordinated debentures due September 25, 2002. The Debenture Purchase
       Agreement (the "Debenture Agreement") contains numerous rights,
       privileges, conditions, etc., in favor of the lender, only certain of
       which have been included herein. Accordingly, the Debenture Agreement
       should be read in conjunction with this summary note. The debentures are
       convertible at any time by the lender into common stock of the Company at
       a conversion price of $10.25 per share, subject to adjustment in certain
       events. The debentures are redeemable by the Company after September 1999
       provided that (a) the Company pays the lender additional interest such
       that the lender would receive an effective compounded 20% interest rate
       from inception of the loan or (b) the 20-day average bid price for the
       Company's stock exceeds $15.00 per share.

       The debentures may be required to be redeemed by the Company at the
       option of the lender at any time prior to maturity if there is a change
       in control, as defined in the Debenture Agreement, at the repayment
       prices set forth in the Debenture Agreement, subject to adjustment,
       together with accrued interest. The Debenture Agreement specifies certain
       covenants with which the Company must comply.


                                     F-20

<PAGE>   48

















                         REPORT OF INDEPENDENT AUDITORS


The Board of Directors and Shareholders of
Digital Transmission Systems, Inc.


We have audited the accompanying balance sheets of Digital Transmission Systems,
Inc. as of June 30, 1997 and 1996, and the related statements of operations,
shareholders' equity, and cash flows for the years then ended. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.

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

In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Digital Transmission Systems,
Inc. as of June 30, 1997 and 1996, and the results of its operations and its
cash flows for the years then ended in conformity with generally accepted
accounting principles.




                                                 /s/  KPMG PEAT MARWICK LLP


Atlanta, Georgia
July 17, 1997, except as to note 11,
    which is as of September 25, 1997



                                      F-21
<PAGE>   49
                                INDEX TO EXHIBITS



<TABLE>
<CAPTION>

     EXHIBIT
     NUMBER                    DESCRIPTION
     <S>                       <C>                                                                                               
     *3.1          -           Form of Amended and Restated Certificate of Incorporation of the Company.
     *3.2          -           Form of Amended and Restated Bylaws of the Company.
     *4.1          -           See Article 4 of the Company's Amended and Restated Certificate of Incorporation -- located within 
                                 Exhibit 3.1.
     *4.2          -           See Article 3 of the Company's Amended and Restated Bylaws located within Exhibit 3.2.
     *10.1         -           Loan Agreement, dated October 10, 1995, by and between the Company and SunTrust Bank.
     *10.2         -           Lease Agreement, dated September 14, 1994, by and between the Company and Advanta Leasing Corp.
     *10.3         -           The Company's 401 (K) Savings Plan.
     *10.4         -           Lease Agreement, dated January 28, 1991, by and between the Company and Colonial Pacific Leasing 
                                 Corporation.
     *10.5         -           Lease Agreement, dated January 4, 1994, by and between the Company and Amplicon, Inc.
     *10.6         -           Form of Reseller Agreement.
     *10.7 (1)     -           Proprietary Information, Noncompetition and Inventions Agreement, dated August 20, 1990, by and 
                                 between the Company and Thomas C. Mock
     *10.8         -           Form of Confidentiality and Invention Assignment Agreement.
     *10.9 (1)     -           Proprietary Information, Noncompetition and Invention Agreement, dated August 20, 1990, by and 
                                 between the Company and James W. Chamberlin
     *10.10        -           Acquisition Agreement, dated December 1, 1995, by and between the Company and Technology Ventures 
                                 International, Inc.
     *10.11        -           Lease Agreement, dated March 19, 1993, by and between New England Mutual Life Insurance Company and
                                 the Company.
     *10.12        -           Manufacturing Agreement, dated May 8, 1995, by and between the Company and Comptronix Corporation.
     *10.13 (1)    -           FY95 Employee Profit Sharing Plan.
     *10.14 (1)    -           FY96 Management Bonus Plan.
     *10.15 (1)    -           1992 Stock Incentive Plan.
     *10.16 (1)    -           FY96 Sales Commission Plan for Bobby Boykin.
     *10.17        -           Equipment Lease, dated December 17, 1991, by and between the Company and General Electric Capital 
                                 Corporation.
     *10.18 (1)    -           Form of  Employment  Agreement to be entered  into by and between the Company and each of Mr.  
                                 Salazar,  Mr.  Boykin and Mr. Nelson.
     *10.19 (1)    -           1996 Incentive Compensation Plan.
     *10.20        -           Form of Consent of Series C Preferred Stockholders.
     *10.21        -           Agreement, dated January 7, 1994, by and between the Company and Wiltron Company.
</TABLE>



                                    E-1
<PAGE>   50

<TABLE>
     <S>                       <C>   
      10.22 (1)    -           Form of Digital Transmission Systems, Inc. Employee Stock Purchase Plan
                               (previously filed with Form 10-KSB for the fiscal year ended June 30,
                               1996 and incorporated herein by reference)
      10.23        -           Form of Amendment to the Company's 401 (K) Savings Plan (previously
                               filed with Form 10-KSB for the fiscal year ended June 30, 1996 and
                               incorporated herein by reference)
      10.24        -           Form of Debenture Agreement between Sirrom Capital d/b/a Tandem Capital and the Company
      11.1         -           Statement of computation of per share earnings (loss)
     *23.1         -           Consent of Price Waterhouse LLP
     *23.2         -           Consent  of  Sutherland,  Asbill & Brennan  (included  in the  opinion  filed as  Exhibit  No.  5.1
                                 to the  Registration Statement.)
      27           -           Financial Data Schedule (for SEC use only)
</TABLE>


     * Incorporated by reference to the corresponding exhibit of the
       Registrant's registration statement on Form SB-2 (File Number 1-14198 ).

     (1)    Constitutes a management contract or compensatory plan or
            arrangement required to be filed.











                                      E-2