<PAGE>   1
                                  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, 1998

              { } 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)


<TABLE>
<S>                                                          <C>
           Delaware                                             58-2037949
  (State or other jurisdiction                               (I.R.S. Employer
of incorporation or organization)                            Identification No.)
</TABLE>


           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:

<TABLE>
<CAPTION>
                                                      NAME OF EACH EXCHANGE ON
     TITLE OF EACH CLASS                                  WHICH REGISTERED
     -------------------                           --------------------------------------- 
     <S>                                           <C>
        Common Stock                               Philadelphia and Boston Stock Exchanges
          Warrants                                 Philadelphia and Boston Stock Exchanges
</TABLE>


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 response 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. { }


<PAGE>   2


Total revenues for the registrant for the fiscal year ended June 30, 1998 were:
$15,579,000.

At October 12, 1998, there were 4,196,154 shares of common stock outstanding.
The aggregate market value of the common stock held by non-affiliates (based
upon the closing price quoted on the NASDAQ National Market System at October
12, 1998 was approximately $2,229,207. Effective October 14, 1998 the Company's 
securities are no longer listed on NASDAQ.

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 on
or before December 17, 1998 (the "1998 Proxy Statement").


<PAGE>   3


                                     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
   wireless service providers, including those offering cellular telephone
   services and Personal Communications Services ("PCS") and domestic and
   international resellers who sell to and service end users with telecom
   equipment. Customers include Nextel, 360(Degree) Communications, AirTouch,
   GTE Wireless, Digitel in Brazil and Skywater in China.

   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. 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, wireless service providers, including cellular,
   Specialized Mobile Radio ("SMR") and PCS service companies, are targeted as
   prospective customers directly by the Company's sales force. DTS utilizes
   telecommunications equipment resellers in the United States and other
   countries to market to private network customers. The Company has agreements
   with over sixty resellers resident in over forty two countries 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 Wireless 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.

   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 exceeded $2.1 billion in 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.

   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 



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   payload 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
   family of access devices - FlexT1(R), FlexE1(TM), FlexAir(TM), microFlex(TM)
   and SKYPLEX(R). In fiscal 1998 the Company introduced microFlex, a DS-1 cross
   connect switch which addresses the need for high speed line concentration in
   wireless carrier networks and in wireline applications. 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 FlexT1 and FlexEl(TM) 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. A companion product to the FlexT1/E1 family is microFlex(TM), a
   cross connect switch or "DACS" (Digital Access Cross Connect Switch). The
   microFlex offers non-blocking DS0 cross connect capability for up to sixteen
   T1's or E1's in a one RU (1.75 in.) high package. This product has
   applications in hubbing or grooming environments involving many aggregate
   lines such as those found when concentration of voice lines from several
   cellsites are necessary before transport to the central switching center.

   The Company's wireless network access products (SKYPLEX and FlexAir)
   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 SKYPLEX and FlexAir systems allow for rapid service deployment
   since FCC or equivalent agency license approval is not required for the use
   of spread spectrum frequencies. SKYPLEX and FlexAir 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 and 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 a sales force and support staff to further penetrate
   the growing domestic and international Cellular and PCS markets. The
   Company's network access products have numerous wireless applications and
   offer what the Company believes is a unique integrated solution to the


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   wireless carriers' need to monitor and control transmission facilities to
   hundreds of remote cell sites.

   Develop and Expand on Flexible and Modular Platforms. The Company continues
   to expand upon its modular Flex and microFlex 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 42 countries via a network of over
   60 resellers/dealers/distributors. Over the past two years, the Company has
   expanded its international sales channels by signing 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.

   microFlex Product

   During fiscal 1998 the Company introduced microFlex which in conjunction with
   FlexT1/E1 allows more efficient use of high speed lines which a wireless
   carrier utilizes to connect voice and other traffic between cellsites and its
   switching center. In particular, microFlex offers cross connect functionality
   between segments of one high speed line (T1 or E1) with another in a total
   set of up to sixteen high speed lines.

   FlexT1 and FlexE1 Product Family

   The FlexTl family of products 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.


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   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.

   SKYPLEX Products
  
   The SKYPLEX product family consist of various models of microwave radio
   products used primarily for point to point digital data transmission. These
   products employ spread spectrum technology whose use does not require an
   engineering study nor a license from any government spectrum regulatory
   agency. SKYPLEX I can provide the user the ability to transmit at digital
   rates of 64Kbps, 128Kbps, 256Kbps, 384Kbps and 512Kbps. SKYPLEX II features
   the capability of transmitting at the higher speeds of 1.544Mbps (T1) or
   2.048Mbps (E1). Perhaps the greatest advantage that spread spectrum radios
   have over traditional narrow-band microwave products is that they are faster
   to deploy in the field, offer a range of up to thirty miles with directional
   antennas, and often are less expensive

   The Company offers its complete set of products to wireless and wireline
   service providers 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. A OEM contract was signed with Lucent Technologies in fiscal
   1998 for supplying that equipment provider with Flex modules to be integrated
   in Lucent minicell base stations. Additionally, the Company has recently
   expanded its list of customers to include major wireless service providers
   such as Nextel, 360(degree) Communications, GTE Wireless, DigiPH, Aliant
   Cellular and U.S. West Wireless. In fiscal 1998 DTS accepted an order for six
   thousand Flex units from Nextel with value of $5.4 million to be deployed
   nationwide in that carrier's network. In addition, in fiscal 1998 Lucent
   Technologies and the Company announced an OEM contract for FlexT1 equipment
   to be integrated into Lucent PCS minicells. The contract is expected to net
   the Company $9M in sales over three years.



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



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   MANUFACTURING

   DTS currently outsources most subassembly kitting, board assembly and testing
   to high quality suppliers which are ISO 9002 certified.

   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 continues to
   strive for quality in the design and the manufacturing of products in order
   to attain a competitive advantage. 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 (1.544 Mbps) digital
   modem technology. In order to quickly implement the Company's network access
   product plans, the Company intends to continue 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 microFlex products include:

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

   -  T1/E1 alarm reporting and trunk conditioning

   -  High-speed digital timing insertion

   -  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

   -  10Base5 and 10BaseT Ethernet Media Access Control

   -  Microprocessor-based product design


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   -  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.


   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 patent or patent
   applications mentioned above, most of the designs are secured only by a claim
   of trade secret rights.

   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 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 processed 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


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   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," "microFlex," 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 Company and Fujitsu have reached
   an agreement whereby the DTS trademarks can be used with few restrictions.

   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.


   RESEARCH AND DEVELOPMENT COSTS

   During fiscal years 1998, 1997, and 1996, the Company's expenditures in
   product development were $3.0 million, $3.9 million, and $2.7 million,
   respectively. The decrease in spending from 1997 to 1998 is primarily due to
   the completion of the Company's Flex product line during fiscal 1998 thereby
   reducing required development expenditures. During fiscal 1997, approximately
   $1.4 million in costs were capitalized related to the development of the Flex
   product line and the SKYPLEX spread spectrum radio product line. During
   fiscal 1998, the Company capitalized approximately $584,000 primarily for the
   continued development of the Company's SKYPLEX spread spectrum radio product
   line. It was determined that the future recoverability of the capitalized
   costs of certain features developed for the aforementioned radio was not
   assured and that the value of the asset was impaired. As a result,
   approximately $414,000 and $554,000 of the asset was written off during the
   years ended June 30, 1998 and 1997, respectively, and appropriately charged
   to Cost of Sales in the accompanying financial statement data.




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   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. A 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.

   YEAR 2000 (Y2K) IMPACT ON COMPANY'S INFORMATION TECHNOLOGY

   The Company operates an Enterprise Resource Planning ("ERP") software system
   which has modules supporting order entry, planning, inventory management,
   operations, and general ledger functions. The vendor of this information
   system has sent the Company a letter indicating the ERP system is Y2K
   complaint. The hardware platform vendor, through its web presence, also
   indicates that the system is Y2K compliant.

   Most of the desktop computing systems used at the Company were manufactured
   after 1995. They use operating system and document preparation software from
   Microsoft Corporation. These systems are generally compliant with the year
   2000 requirements and any non-compliant functions are not expected to
   adversely impact the Company's operations.

   The Company does operate older PC's in its manufacturing and engineering
   organizations, but they are not used in time or date critical operations.
   Accordingly, the Company does not anticipate spending significant additional
   amounts on Year 2000.

   The Company's products are designed to be Year 2000 compliant as they utilize
   two digit date fields as opposed to four digit fields. The Company is,
   however, aware of the risk that third parties, including vendors and
   customers of the Company, will not adequately address the Year 2000 problem
   and the resultant potential adverse impact on the Company.

   Notwithstanding the above, there can be no assurance that the Company's
   internal systems or products will operate beyond 1999 or that major business
   disruptions will not occur in mission critical systems and processes.

   EMPLOYEES

   As of June 30, 1998, the Company had approximately 64 full-time employees, of
   whom approximately 18 are technical personnel engaged in developing the
   Company's products, approximately 22 are marketing and sales personnel,
   approximately 15 are quality assurance, customer service and operations
   personnel and approximately 9 are involved in administration and finance. On
   July 10, 1998 and on August 14, 1998, the Company performed a reduction in
   staff due to the reduced revenue level of the fourth fiscal quarter of 1998
   and the low revenue anticipated in the first quarter of fiscal 1999. After
   these reductions the employee headcount was 37 of which 12 are technical
   personnel, 12 are in sales and marketing, 4 in administration and finance and
   9 are in operations. 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 a public 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.




                                     Page 9
<PAGE>   12


   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 with a three year extension signed in May 1998. The
   extension also allows for an additional 4,000 square foot adjoining space to
   be available to the Company at the same rate. 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

       In August 1998, a vendor of the Company filed suit against the Company
   alleging nonpayment of account. Total demands for judgment are $550,826 in
   unpaid invoices, plus pre-judgment and post-judgment interest on principal
   amounts outstanding and court costs. The Company is disputing the validity
   and accuracy of the billed amounts, and believes that its obligation to the
   plaintiff is $200,000, which has been accrued in the financial statements as
   of June 30, 1998.

   The Company believes that it has meritorious defenses in the plaintiff's
   claims and intends to continue a vigorous defense in this matter. However, no
   assurance can be given as to the ultimate outcome with respect to such
   lawsuit and the amount, if any, which may be paid in excess of the accrual
   recorded at June 30, 1998.

         The Company is also involved in various claims and legal actions
   arising in the ordinary course of business. In the opinion of management, the
   ultimate disposition of these matters, including the litigation discussed in
   the previous paragraph, will not have a material adverse effect on the
   Company's financial position, results of operations, or liquidity. 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 10
<PAGE>   13




                                     PART II

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

   Effective October 14, 1998, the Company was delisted from NASDAQ.

   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 (the "Separation Date"), when each Unit was separated
   into one share of Common Stock and one Warrant. The Common Stock and Warrants
   have been listed on the NASDAQ SmallCap Market, the Company's principal
   market, under the symbols DTSX and DTSXW, respectively, and have been listed
   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, 1996           $ 9.375      $ 8
June 30, 1996                                                $14.75       $ 9
September 30, 1996                                           $15.50       $14
December 31, 1996                                            $16.25       $14.125
Commencing January 1, 1997 and ending February 14, 1997      $18          $13.875
</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 traded on the NASDAQ Market and the Philadelphia and Boston
   exchanges. Effective October 14, 1998, the Company's securities are no longer
   listed on NASDAQ. 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, 1997      $13          $10.75
June 30, 1997                                               $12.50       $10.25
September 30, 1997                                          $11.25       $ 9
December 31, 1997                                           $ 9.438      $ 3.50
March 31, 1998                                              $ 6.875      $ 4
June 30, 1998                                               $ 6.875      $ 2.875
</TABLE>




                                    Page 11
<PAGE>   14


       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, 1997      $5         $2.875
June 30, 1997                                               $4.25      $2.375
September 30, 1997                                          $3.25      $2.50
December 31, 1997                                           $2         $1.50
March 31, 1998                                              $1         $0.50
June 30, 1998                                               $0.50      $0.20
</TABLE>


       The closing sale price of the Company's Common Stock as reported by the
   NASDAQ Stock Market on June 30, 1998 was $2.875. The closing sale price of
   the Company's Warrants as reported by the NASDAQ Stock Market on June 30,
   1998 was $.375.

       The total number of shareholders of record of the Company's common shares
   as of September 30, 1998, 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 12
<PAGE>   15





   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

   In fiscal 1998 the Company completed its first full year in realizing all its
   revenues from new markets and completely eliminate any dependency on MCI, the
   Company's previously dominant customer. Net sales for the 1998 fiscal year
   increased nearly eight percent to a historical high of $15.5 million compared
   to $14.5 million for the 1997 fiscal year. However, the Company posted a loss
   of $8.38 million for fiscal 1998, a substantial increase from the $4.2
   million loss recorded in fiscal 1997. The operational contribution to the net
   loss was due to the heavy investment the Company made during the year in its
   transition to new markets by expanding its new domestic and international
   sales channels and the expenses related to the development and introduction
   of new products. This shift to new products and customers has negatively
   impacted the gross profit margin and net earnings of the Company.

   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

   Net sales to MCI totaled $7.1 million (64% of total sales) in fiscal 1996,
   $4.4 million (31% of total sales) in fiscal 1997 and none in fiscal 1998.
   However, sales of non-MCI products which include FlexT1/E1 network access
   products and the SKYPLEX spread spectrum radio products, have continued at a
   high growth level, recording $15.4 million in sales in fiscal 1998 - a 55%
   increase, compared to $10.1 million in fiscal 1997. The FlexT1/E1 products
   are sold primarily to major USA based wireless service providers while
   SKYPLEX products find many applications for unlicensed microwave network
   connections in Latin American and Asia Pacific markets.

   International sales increased from $3.7 million in fiscal 1996 to $5.4
   million in fiscal 1998, a 46% increase. As a percentage of the Company's
   sales, international accounted for 35% in fiscal 1997 compared to 24% in
   fiscal 1997. The Company has now achieved sales in over 42 countries through
   agreements with over 60 reseller partners. The Company is currently seeking
   strategic alternatives such as potential acquisitions or divestitures with
   respect to its international business unit.




                                    Page 13
<PAGE>   16


   COMPARISON OF YEARS ENDED JUNE 30, 1998 AND JUNE 30, 1997

   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, 1998              JUNE 30, 1997
                                           -------------              -------------
                                                      % of                      % of
                                             $        Sales             $       Sales
                                          -------     -----          -------    -----
<S>                                       <C>         <C>            <C>        <C>
Net sales                                 $15,579      100           $14,484     100
Gross profit                                1,858       12             4,639      32
Product development                         2,367       15             2,458      17
Selling, general and administrative         7,018       45             6,331      44
Net income (loss)                          (8,380)     (54)           (4,190)    (29)
</TABLE>


    Net Sales. Net sales increased by 8%, to $15,579,000 for the year ended June
30, 1998, from $14,484,000 for the year ended June 30, 1997. 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,
                            ------------------      ---------------
                            1998          1997      1998       1997
                            ----          ----      ----       ----
<S>                        <C>          <C>         <C>      <C>
MCI network control             --      $ 4,394       --       30
Other network control           --          940       --        6
FlexT1 / E1                $ 9,960        4,861       64       34
SKYPLEX                      5,224        3,342       34       23
DIV modem                       10          556                 4
Other products                 385          391        2        3
                           -------      -------     ----     ---- 
     Totals                $15,579      $14,484      100      100
                           =======      =======     ====     ====
</TABLE>


   During the year ended June 30, 1998, two customers accounted for greater than
   10% each of the Company's sales. Nextel represented 35% of total sales and
   Walker (a reseller/integrator of telecommunications products) accounted for
   approximately 13% of the Company's sales. Revenues from the Company's
   FlexT1/E1 product line increased over 100% from $4,861,000 in the year ended
   June 30, 1997 to $9,960,000 in the year ended June 30, 1998 and revenues from
   SKYPLEX grew by 56% from $3,342,000 in the year ended June 30, 1997 to
   $5,224,000 in the year ended June 30, 1998. A new product, microFlex -
   introduced in fiscal 1998, realized $214,000 in sales and is being sold into
   the same markets as FlexT1/E1. Total international sales increased by
   approximately 42% from $3,766,000 in the year ended June 30, 1997 to
   $5,333,000 in the year ended June 30, 1998.


   Net Sales for the 4th quarter of fiscal 1998 decreased to $2.9 million from
   the third quarter total of $6.1 million. This decrease was due primarily to
   the fulfillment of a large order for FlexT1 products from Nextel in
   approximately seven months of the fiscal year, most of the shipments
   occurring in the 3rd quarter. Some shipments, anticipated by the Company to
   occur in the 4th quarter, were postponed by customers into fiscal 1999.
   Simultaneously, international shipments also experienced a decrease,
   contributing somewhat to the overall decline in sales from the 3rd quarter to
   the 4th quarter. The Company does not anticipate a strong revenue upswing in
   the first quarter of fiscal 1999 since, historically, the Company has
   experienced low levels of telecom equipment sales in the summer months. The
   Company expects sales for 1st quarter 1999 to be less than sales for the
   first quarter of 1998 and the Company expects sales for fiscal 1999 to be
   less than 1998. The Company will incur a loss in the first quarter of 1999
   and a loss is anticipated for fiscal 1999.


   Gross Profit. Gross profit decreased by 60% to $1,858,000 for the year ended
   June 30, 1998 from $4,639,000 for the year ended June 30, 1997. As a
   percentage of sales, gross profit decreased from 



                                    Page 14
<PAGE>   17

32% for the year ended June 30, 1997 to 12% for the year ended June 30, 1998.
This decrease is due to the increase in product and service costs of newer
products, particularly the SKYPLEX radio products, and a one-time charge of
$414,000 to write off certain capitalized product development for products that
will not be realized in future years, additional reserves to record potential
inventory obsolescence and to recognize additional warranty costs and a shift in
product mix from higher margin network control products to the newer products in
the Flex and SKYPLEX product lines. The product and service cost increase and
warranty accrual increases was caused in part by a vendor of the Company that
had difficulty meeting Company and customer specifications for certain products.

PRODUCT DEVELOPMENT. Product development expenses decreased slightly from
$2,458,000 for the year ended June 30, 1997 to $2,367,000 for the year ended
June 30, 1998. Beginning at the end of the fiscal year ended June 30, 1997 and
continuing through most of the year ended June 30, 1998, the Company was
involved in the development of a new product line, the microFlex network access
product. Approximately $583,000 of development costs related to new products
were capitalized during the fiscal 1998 year, as compared to $1,432,000 during
the year ended June 30, 1997. During the fourth quarter of the year ended June
30, 1998, management determined that, given the anticipated direction of the
Company's product line, certain product features that had been developed for
SKYPLEX and capitalized as product development costs would not be implemented in
the foreseeable future. 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. Accordingly, the Company wrote off $414,000 of these
capitalized costs during the year ended June 30, 1998, as compared to write-offs
of $555,000 in capitalized product costs during the year ended June 30, 1997. As
a percentage of sales, total product development costs decreased from 17% in the
year ended June 30, 1997 to 15% in the year ended June 30, 1998.


SELLING, GENERAL AND ADMINISTRATIVE. Selling, general and administrative
expenses increased by 12%, from $6,331,000 for the year ended June 30, 1997 to
$7,018,000 for the year ended June 30, 1998. Selling expenses increased by less
than 1% from $4,820,000 in the year ended June 30, 1997 to $4,854,000 in the
year ended June 30, 1998. The increase resulted from the growth in revenue in
the U.S. as well as from increased sales activity outside the U.S. Selling
expenses as a percentage of net sales decreased from 33% for the year ended June
30, 1997 to 31% for the year ended June 30, 1998 primarily due to the increased
sales activity. General and administrative expenses increased from $1,511,000 in
the year ended June 30, 1997 to $2,164,000 in the year ended June 30, 1998 due
primarily to one 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 10% in the year ended June 30, 1997 to 14% in the year
ended June 30, 1998.


NET INCOME / (LOSS). The net loss increased from $4,190,000 for the year ended
June 30, 1997 to a loss of $8,380,000 for the year ended June 30, 1998. This
increase resulted primarily from higher general and administrative expenses,
higher product and service costs of newer products, increases in inventory
obsolescence and warranty reserves, a write off of the deferred tax asset and
the shift in product mix to lower margin products.




                                    Page 15
<PAGE>   18


   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>


    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
FlexT1 / 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.


                                    Page 16
<PAGE>   19


   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.


   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 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.



                                    Page 17
<PAGE>   20

   CREATION OF SOUTHTECH, A WHOLLY OWNED SUBSIDIARY

   In July 1998 DTS incorporated a wholly owned subsidiary - SouthTech - whose
   business purpose is the administration of the Company's international
   business. The SKYPLEX and DIV product lines and associated intellectual
   property together with certain assets and liabilities pertaining to those
   product lines will be reported under the subsidiary. A separate balance sheet
   and profit and loss statement will track the operational progress of that
   subsidiary.

   LIQUIDITY AND CAPITAL RESOURCES

   The accompanying financial statements have been prepared on a going concern
   basis, which contemplates the realization of assets and the satisfaction of
   liabilities in the normal course of business. As shown in the financial
   statements during the years ended June 30, 1998 and 1997, the Company
   incurred losses of $8,380,000 and $4,190,000, respectively, is in violation
   of its debt covenants, and has a net capital deficit of $3,566,000 as of June
   30, 1998. These factors, among others, raise substantial doubt about the
   Company's ability to continue as a going concern for a reasonable period of
   time.

   The financial statements do not include any adjustments relating to the
   recoverability and classification of assets and liabilities that might be
   necessary should the Company be unable to continue as a going concern. As
   described in notes 5 and 6 in the accompanying financial statements, the
   Company was not in compliance with the covenants of its line of credit and
   convertible debenture agreements at June 30, 1998. The Company's continuation
   as a going concern is dependent upon its ability to generate sufficient cash
   flow to meet its obligations on a timely basis, to comply with the terms of
   its financing agreements, to obtain additional financing or refinancing as
   may be required, and ultimately to attain profitability. The Company is
   actively pursuing additional equity financing through discussions with
   potential investors, and is also pursuing potential merger or acquisition
   candidates and seeking to divest a division.

   On October 14, 1998, NASDAQ delisted the Company because the Company did not
   meet its listing requirements.

   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 agreement was
   amended on March 18, 1998 to increase the maximum eligible borrowing to the
   lesser of $4,000,000 or 80% eligible receivables plus 30% of eligible
   inventory, as defined, through the maturity date of April 10, 2000. 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, 1998). The weighted average interest rate for
   the year ended June 30, 1998 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, 1997. 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 agreement term is two years with an automatic renewal each year unless
   written notice of termination is given by one of the parties. Further, a net
   worth covenant was amended subsequent March 18, 1998 requiring the Company to
   have a net worth of $1,000,000. The Company issued 60,000 two year warrants
   to Silicon Valley Bank at a strike price of $5.25 each as consideration for
   the amended agreement. The Agreement imposes certain covenants as defined in
   the Agreement with which the Company was not in compliance as of June 30,
   1998. The Company is in the process of attempting to obtain waivers of
   certain financial covenants so that the Company's ability to borrow
   additional funds under the Agreement is not hindered. In September 1998, the
   Company agreed to a UCC filing whereby the assets of the Company became
   collateral under the Agreement.


   During fiscal 1998, the Company issued $4 million of 11.5% subordinated
   debentures to Tandem Capital of Nashville, Tennessee. The debentures were
   issued on September 25, 1997 and are due on September 25, 2002. The Debenture
   Purchase Agreement (the "Debenture Agreement") contains numerous rights,
   privileges, and conditions in favor of the lender, only certain of which have
   been included herein. 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 conversion price changed
   to $8.00 per share because the Company's common stock was trading for less
   than that amount on September 25, 1998. 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 (a) there is a change in control,
   as defined in the Debenture Agreement, (b) the Company's common stock is
   delisted from NASDAQ, or (c) the Company's common stock ceases to be publicly
   traded at the sum of the principal amount of the debentures tendered for
   redemption, plus any accrued and/or unpaid interest outstanding related to
   the debentures, plus 15% interest on outstanding principal and interest
   amounts due, plus any expense or costs owed to the lender as set forth in the
   Debenture Agreement. The Company was not in compliance with the debt
   covenants nor the NASDAQ listing criteria as of June 30, 1998 and has been
   delisted as of October 14, 1998 (see Note 5 to the Financial Statements).
   Accordingly, the debentures have been listed as a current liability in the
   accompanying financial statements.

   Due to low cash reserves, the Company requested a sixty day delay in the
   quarterly interest payment due to Tandem Capital on September 1, 1998. Tandem
   Capital has agreed to the delay without declaration of an event of default
   provided that the Company pay the overdue interest on November 1, 1998 and
   from then on, pay the debenture interest on a monthly basis. In addition,
   Tandem Capital has requested that the Company accede to UCC filings on its
   assets junior only to Silicon Valley Bank. The Company has agreed to those
   conditions.

   At June 30, 1998, the Company had approximately $91,000 in cash and cash
   equivalents. For the year ended June 30, 1998, the Company used $2,786,000 of
   cash in operating activities reflecting a net loss of $8,380,000, an increase
   in inventory balances of $29,000 and a reduction in accrued payroll and
   benefits at June 30, 1998 of $343,000. Cash was provided for operations
   primarily through an increase in accounts payable and accrued liabilities of
   $1,565,000 and a decrease in accounts receivable of $1,940,000. 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 $658,000 of property and equipment during the year
   ended June 30, 1998. Purchases were made primarily for equipment used to
   design and test products currently under development.

   During 1998, the Company capitalized $583,000 of product development
   expenditures relating to products expected to be made commercially available
   during the next fiscal year. These amounts were primarily for development of
   the Company's SKYPLEX spread spectrum radio product.

   Net Cash provided by financing activities for the year ended June 30, 1998
   was $3,406,000 reflecting proceeds of $4,000,000 from the sale of convertible
   debentures during the year offset by net payments under the Company's line of
   credit of $629,000.



                                    Page 18
<PAGE>   21
   SEASONALITY

   The Company's sales have been subject to quarterly fluctuations mainly due to
   the purchasing cycle of the Company's major customers. Other fluctuations
   occur due to increased buildout of the telecommunications infrastructure
   during certain months of the year. The Company's business plan 



                                    Page 19
<PAGE>   22
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 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.

YEAR 2000 (Y2K) IMPACT ON COMPANY'S INFORMATION TECHNOLOGY

The Company operates an Enterprise Resource Planning ("ERP") software system
which has modules supporting order entry, planning, inventory management,
operations, and general ledger functions. The vendor of this information
system has sent the Company a letter indicating the ERP system is Y2K
complaint. The hardware platform vendor, through its web presence, also
indicates that the system is Y2K compliant.

Most of the desktop computing systems used at the Company were manufactured
after 1995. They use operating system and document preparation software from
Microsoft Corporation. These systems are generally compliant with the year
2000 requirements and any non-compliant functions are not expected to
adversely impact the Company's operations.

The Company does operate older PC's in its manufacturing and engineering
organizations, but they are not used in time or date critical operations.
Accordingly, the Company does not anticipate spending significant additional
amounts on Year 2000.

The Company's products are designed to be Year 2000 compliant as they utilize
two digit date fields as opposed to four digit fields. The Company is,
however, aware of the risk that third parties, including vendors and
customers of the Company, will not adequately address the Year 2000 problem
and the resultant potential adverse impact on the Company.

Notwithstanding the above, there can be no assurance that the Company's
internal systems or products will operate beyond 1999 or that major business
disruptions will not occur in mission critical systems and processes.

LEGAL PROCEEDINGS

In August 1998, a vendor of the Company filed suit against the Company alleging
nonpayment of account.  Total demands for judgment are $550,826 in unpaid
invoices, plus pre-judgment and post-judgment interest on principal amounts
outstanding and court costs.  The Company is disputing the validity and accuracy
of the billed amounts, and believes that its obligation to the plaintiff is
$200,000, which has been accrued in the financial statements as of June 30,
1998.

The Company believes that it has meritorious defenses in the plaintiff's claim 
and intends to continue a vigorous defense in this matter.  However, no 
assurance can be given as to the ultimate outcome with respect to such lawsuit 
and the amount, if any, which may be paid in excess of the accrual recorded at 
June 30, 1998.

The Company is also involved in various claims and legal actions arising in the 
ordinary course of business.  In the opinion of management, the ultimate 
disposition of these matters, including the litigation discussed in the 
previous paragraph, will not have a material adverse effect on the Company's 
financial position, results of operations, or liquidity.

NEW ACCOUNTING PRONOUNCEMENTS

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 interim and annual periods beginning after
December 15, 1997. Reclassification of financial statements for earlier periods
provided for comparative purposes is required. The Company did not have any
other comprehensive income items during the applicable periods and, thus, the
adoption of the provisions of SFAS 130 did not have an impact on the Company's
reporting.

In June 1997, the Financial Accounting Standards Board issued SFAS 131,
Disclosures about Segments of an Enterprise and Related Information. SFAS 131
establishes standards for the way that public business enterprises report
information about operating segments in annual financial statements and requires
that those enterprises report selected financial information about operating
segments in interim financial reports. It also establishes standards for related
disclosures about products and services, geographic areas and major customers.
SFAS 131 is effective for fiscal years beginning after December 15, 1997, and
therefore the Company will adopt the new requirements in the annual report as of
June 30, 1999.

In October 1997, the Accounting Standards Executive Committee issued Statement 
of Position 97-2, Software Revenue Recognition ("SOP 97-2").  SOP 97-2 is 
effective for financial statements for fiscal years beginning after December 
15, 1997.  The Company does not expect that adoption of SOP 97-2 will 
significantly affect its results of operations because the Company does not 
believe that SOP 97-2 applies to most sales.  However, if the Company's 
products become subject to the provisions of SOP 97-2, the adoption of SOP 97-2 
could significantly negatively affect its results of operations.

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 or before November 27, 1998 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 or before November 27, 1998 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 or before November 27, 1998 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 or before November 27, 1998 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, 1998.









                                    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.



 October 16, 1998                      /s/  Andres C Salazar                   .
 ----------------                      -----------------------------------------
                                       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 13, 1998
-----------------------------------------------   Director (Principal Executive Officer)
   Andres C. Salazar                         



   /s/   Clive Marsh                          . Controller                                   October 13, 1998
-----------------------------------------------   (Principal Financial and Accounting Officer)
   Clive Marsh                                 




   /s/   Frank LaHaye                         . Director                                     October 13, 1998
-----------------------------------------------
   Frank LaHaye



   /s/   Gene Miller                          . Director                                     October 13, 1998
-----------------------------------------------
   Gene Miller



   /s/   Robert D. Francis                    . Director                                     October  13, 1998
-----------------------------------------------
   Robert D. Francis



   /s/   Edwin Kantor                         . Director                                     October 13, 1998
-----------------------------------------------
   Edwin Kantor
</TABLE>






                                    Page 25
<PAGE>   28
                         Index to Financial Statements


Balance Sheets as of June 30, 1998 and 1997

Statements of Operations for the years ended June 30, 1998 and 1997

Statements of Cash Flows for the years ended June 30, 1998 and 1997

Statements of Shareholders' (Deficit) Equity for the years ended June 30, 1998
   and 1997

Notes to Financial Statements

Independent Auditors' Report - KPMG Peat Marwick LLP



                                      F-1
<PAGE>   29


                       DIGITAL TRANSMISSION SYSTEMS, INC.

                                 Balance Sheets

                             June 30, 1998 and 1997

                        (in thousands, except share data)


<TABLE>
<CAPTION>
                                   ASSETS (NOTE 6)                           1998            1997
                                                                            --------       -------

<S>                                                                         <C>            <C>
Current assets:
    Cash and cash equivalents                                               $     91           712
    Trade accounts receivable, net of allowances for
       returns and doubtful accounts of $733 and
       $226 at June 30, 1998 and 1997, respectively                            2,283         4,223
    Inventories (note 3)                                                       2,469         2,440
    Prepaid expenses and other current assets                                    105           309
                                                                            --------       -------
                  Total current assets                                         4,948         7,684

Property and equipment, net of accumulated depreciation
    and amortization (note 4)                                                    886         1,186
Deferred tax benefit (note 7)                                                     --           285
Intangible assets (note 2)                                                     1,045         1,137
Other assets                                                                     329            19
                                                                            --------       -------

                  Total assets                                              $  7,208        10,311
                                                                            ========       =======

<CAPTION>
                    LIABILITIES AND SHAREHOLDERS' (DEFICIT) EQUITY
<S>                                                                         <C>            <C>
Current liabilities:
    Line of credit (note 6)                                                 $  1,329         1,958
    Accounts payable and accrued liabilities                                   4,581         3,016
    Accrued payroll and benefits                                                 248           591
    Warranty accrual                                                             618           203
    Convertible debentures (note 5)                                            4,000            --
                                                                                           
                                                                            --------       -------
                  Total current liabilities                                   10,776         5,768
                                                                            --------       -------

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; 4,191,460 and 4,121,143 shares issued
       and outstanding at June 30, 1998 and 1997, respectively                    42            41
    Additional paid-in capital                                                11,462        11,232
    Deferred compensation                                                        (56)         (124)
    Notes receivable from stock sales                                            (63)          (33)
    Accumulated deficit                                                      (14,953)       (6,573)
                                                                                           
                                                                            --------       -------
                  Total shareholders' (deficit) equity                        (3,568)        4,543
                                                                            --------       -------

Commitments and contingencies (notes 5, 6, 8, 10 and 11)
                                                                            --------       -------

                  Total liabilities and shareholders' (deficit) equity      $  7,208        10,311
                                                                            ========       =======
</TABLE>


See accompanying notes to financial statements.





                                      F-2
<PAGE>   30


                       DIGITAL TRANSMISSION SYSTEMS, INC.

                            Statements of Operations

                       Years ended June 30, 1998 and 1997

                        (in thousands, except share data)


<TABLE>
<CAPTION>
                                                                   1998          1997
                                                                 --------       -------

<S>                                                              <C>            <C>  
Net sales (note 9)                                               $ 15,579        14,484
Cost of sales, including $414 and $554 in write-offs of
    capitalized product development costs in 1998 and 1997,
    respectively                                                   13,721         9,845
                                                                 --------       -------
                  Gross profit                                      1,858         4,639
                                                                 --------       -------

Selling, general, and administrative                                7,018         6,331
Product development (note 10(c))                                    2,367         2,458
                                                                 --------       -------
                  Total operating expenses                          9,385         8,789
                                                                 --------       -------

                  Operating loss                                   (7,527)       (4,150)

Interest expense, net of interest income                             (576)          (39)
Other income (expense)                                                  8            (1)
                                                                 --------       -------
                  Total other income (expense)                       (568)          (40)
                                                                 --------       -------

                  Loss before income tax expense                   (8,095)       (4,190)

Income tax benefit (expense) - (note 7)                              (285)           --
                                                                 --------       -------

                  Net loss                                       $ (8,380)       (4,190)
                                                                 ========       =======

Basic loss per share                                             $  (2.01)        (1.05)
                                                                 ========       =======

Diluted loss per share                                           $  (2.01)        (1.05)
                                                                 ========       =======

Weighted-average common and common equivalent shares
    outstanding                                                     4,160         3,999
                                                                 ========       =======
</TABLE>


See accompanying notes to financial statements.





                                      F-3
<PAGE>   31



                       DIGITAL TRANSMISSION SYSTEMS, INC.

                            Statements of Cash Flows

                       Years ended June 30, 1998 and 1997

                                 (in thousands)


<TABLE>
<CAPTION>
                                                                             1998         1997
                                                                           -------       ------
<S>                                                                        <C>           <C>    
Cash flows from operating activities:
    Net loss                                                               $(8,380)      (4,190)
    Adjustments to reconcile net loss to net
       cash used in operating activities:
         Depreciation and amortization                                       1,219          814
         Write-off of capitalized product development costs                    414          554
         Amortization of deferred compensation expense                          68           64
         Deferred tax expense                                                  285           --
         Change in assets and liabilities:
            Trade accounts receivable                                        1,940         (567)
            Inventories                                                        (29)         (99)
            Prepaid expenses and other current assets                          204          (33)
            Accounts payable and accrued liabilities                         1,565        1,055
            Accrued payroll and benefits                                      (343)         275
            Warranty reserve                                                   415          101
            Other                                                             (144)           7
                                                                           -------       ------
                 Net cash used in operating activities                      (2,786)      (2,019)
                                                                           -------       ------

Cash flows from investing activities:
    Purchases of property and equipment                                       (658)      (1,446)
    Additions to capitalized product development costs                        (583)      (1,432)
                                                                           -------       ------
                 Net cash used in investing activities                      (1,241)      (2,878)
                                                                           -------       ------

Cash flows from financing activities:
    Net borrowings (payments) under line of
       credit agreements                                                      (629)       1,958
    Proceeds from maturities of held-to-maturity
       investment securities                                                    --        3,001
    Proceeds from sale of convertible debentures                             4,000           --
    Proceeds from exercise of stock options                                     35           57
    Proceeds from issuances of common stock                                     --            7
                                                                           -------       ------
                 Net cash provided by financing activities                   3,406        5,023
                                                                           -------       ------

                 Net (decrease) increase in cash and cash equivalents         (621)         126

Cash and cash equivalents at beginning of year                                 712          586
                                                                           -------       ------

Cash and cash equivalents at end of year                                   $    91          712
                                                                           =======       ======

Supplemental disclosure of cash paid for income taxes and interest:
       Cash paid for income taxes                                          $    --           --
                                                                           =======       ======

       Cash paid for interest                                              $   517           56
                                                                           =======       ======
</TABLE>


See accompanying notes to financial statements.





                                      F-4
<PAGE>   32


                       DIGITAL TRANSMISSION SYSTEMS, INC.

                  Statements of Shareholders' (Deficit) Equity

                       Years ended June 30, 1998 and 1997

                                 (in thousands)


<TABLE>
<CAPTION>
                                        COMMON STOCK                                                    
                                     ------------------                              NOTES                       TOTAL
                                       NUMBER            ADDITIONAL                RECEIVABLE                 SHAREHOLDERS'
                                     OF SHARES            PAID-IN     DEFERRED     FROM STOCK    ACCUMULATED   (DEFICIT)
                                       ISSUED    AMOUNT   CAPITAL   COMPENSATION     SALES         DEFICIT      EQUITY
                                       ------    ------   -------    -----------     -----         -------      ------
<S>                                  <C>         <C>     <C>        <C>            <C>           <C>          <C>
Balance at June 30, 1996               3,921      $39      11,137        (188)         --          (2,383)       8,605
Exercise of stock options                200        2          88          --         (33)             --           57
Compensation expense                      --       --          --          64          --              --           64
Shares issued under purchase plan         --       --           7          --          --              --            7
Net loss                                  --       --          --          --          --          (4,190)      (4,190)
                                       -----      ---      ------        ----         ---         -------       ------
Balance at June 30, 1997               4,121       41      11,232        (124)        (33)         (6,573)       4,543

Exercise of stock options                 70        1          64          --         (30)             --           35
Compensation expense                      --       --          --          68          --              --           68
Issuance of warrants to purchase
    common shares (note 8e)               --       --         166          --          --              --          166
Net loss                                  --       --          --          --          --          (8,380)      (8,380)
                                       -----      ---      ------        ----         ---         -------       ------

Balance at June 30, 1998               4,191      $42      11,462         (56)        (63)        (14,953)      (3,568)
                                       =====      ===      ======        ====         ===         =======       ======
</TABLE>


See accompanying notes to financial statements.




                                      F-5
<PAGE>   33




                       DIGITAL TRANSMISSION SYSTEMS, INC.

                          Notes to Financial Statements

                             June 30, 1998 and 1997


(1)    SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

       (a)   DESCRIPTION OF BUSINESS

             Digital Transmission Systems, Inc. (the "Company") 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)   GOING CONCERN MATTERS AND BASIS OF PRESENTATION

             The accompanying financial statements have been prepared on a going
             concern basis, which contemplates the realization of assets and
             the satisfaction of liabilities in the normal course of business.
             As shown in the financial statements during the years ended June
             30, 1998 and 1997, the Company incurred losses of $8,380,000 and
             $4,190,000, respectively, is in violation of its debt covenants,
             and has a net capital deficit of $3,566,000 as of June 30, 1998.
             These factors, among others, raise substantial doubt about the
             Company's ability to continue as a going concern for a reasonable
             period of time.

             The financial statements do not include any adjustments relating to
             the recoverability and classification of assets and liabilities
             that might be necessary should the Company be unable to continue as
             a going concern. As described in notes 5 and 6 in the accompanying
             financial statements, the Company was not in compliance with the
             covenants of its line of credit and convertible debenture
             agreements at June 30, 1998. The Company's continuation as a going
             concern is dependent upon its ability to generate sufficient cash
             flow to meet its obligations on a timely basis, to comply with the
             terms of its financing agreements, to obtain additional financing
             or refinancing as may be required, and ultimately to attain
             profitability. The Company is actively pursuing additional equity
             financing through discussions with potential investors, and is also
             pursuing potential merger or acquisition candidates and seeking to
             divest a division.
  
       (c)   CASH AND CASH EQUIVALENTS

             Cash and cash equivalents include cash on deposit in banks and
             money market accounts. 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.

       (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.

             Management of the Company has established a valuation allowance for
             inventory obsolescence based on a review of the composition,
             quantity, and expected future sales levels of inventory on hand.
             The amount of inventory obsolescence ultimately incurred could
             differ materially in the near term from the allowance recorded in
             these financial statements.

       (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:

<TABLE>
                  <S>                                           <C>    
                  Computer and Test Equipment                   3 years
                  Software                                      1 years
                  Furniture and Fixtures                        3 years
                  Leasehold Improvements                        3 years
</TABLE>

      (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, 1998 and 1997, approximately $414,000
           and $554,000, respectively, in write-offs were recognized due to
           impairment of net realizable value.




                                      F-6
<PAGE>   34


                       DIGITAL TRANSMISSION SYSTEMS, INC.

                          Notes to Financial Statements

                             June 30, 1998 and 1997


             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

             Long-lived assets are accounted for under the provisions of
             Statement of Financial Accounting Standards No. 121 ("SFAS"),
             Accounting for the Impairment of Long-Lived Assets and for
             Long-Lived Assets to Be Disposed Of ("SFAS 121"), which 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. The Company recorded no adjustments
             related to SFAS 121 during the years ended June 30, 1998 or 1997.

       (h)   FINANCIAL INSTRUMENTS

             Financial instruments which potentially subject the Company to
             concentrations of credit risk are primarily cash, cash equivalents,
             and accounts receivable. The Company's cash equivalents are in
             money market accounts. Other than the significant customers
             disclosed in Note 9, the Company believes no significant
             concentration of credit risk exists with respect to these financial
             instruments.

             Accounts receivable arise from Company sales off its products
             primarily to long-distance carriers, wireless service providers,
             and resellers/integrators in the telecommunications industry, both
             domestically and internationally. 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.



                                      F-7
<PAGE>   35


                       DIGITAL TRANSMISSION SYSTEMS, INC.

                          Notes to Financial Statements

                             June 30, 1998 and 1997


             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 two 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.

       (k)   INCOME TAXES

             Income taxes are accounted for under the asset 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.




                                      F-8
<PAGE>   36


                       DIGITAL TRANSMISSION SYSTEMS, INC.

                          Notes to Financial Statements

                             June 30, 1998 and 1997


       (l)   STOCK OPTION PLAN

             SFAS No. 123, Accounting for Stock-Based Compensation, 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, Accounting for Stock
             Issued to Employees, under which compensation expense would be
             recorded on the date of grant only if the current market price of
             the underlying stock exceeded the exercise price, while providing
             pro forma net income and pro forma earnings per share disclosures
             for employee stock option grants made in fiscal 1996 and subsequent
             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)   EARNINGS (LOSS) PER SHARE

             The Company has presented earnings (loss) per share in accordance
             with the provisions of SFAS No. 128, Earnings Per Share ("SFAS
             128"), which requires companies that have publicly held common
             stock or potential common stock to present both basic and diluted
             earnings (loss) per share (EPS) on the face of the income
             statement. Basic EPS is calculated as income (loss) available to
             common shareholders divided by the weighted-average number of
             common shares outstanding during the period. Diluted EPS is
             calculated as income (loss) available to common shareholders
             divided by the weighted-average number of common shares outstanding
             during the period plus any dilutive potential common shares, such
             as convertible debt or stock options. To the extent that the
             Company reports a loss, these dilutive potential common shares are
             not included in the diluted EPS calculation as they would have an
             anti-dilutive effect. The Company has restated its earnings (loss)
             per share for all periods presented to conform to the provisions of
             SFAS 128.

       (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 1997 financial statements have been
             reclassified to conform to classifications adopted in 1998.





                                      F-9
<PAGE>   37


                       DIGITAL TRANSMISSION SYSTEMS, INC.

                          Notes to Financial Statements

                             June 30, 1998 and 1997


(2)    INTANGIBLE ASSETS

       Intangible assets consist of the following as of June 30, 1998 and 1997
(in thousands):

<TABLE>
<CAPTION>
                                                              1998       1997
                                                              ----       ----
            <S>                                              <C>         <C>  
            Capitalized product development costs            $1,254      1,085
            Intangible asset related to the acquisition
                of SKYPLEX rights                               200        200
                                                             ------      -----
                                                              1,454      1,285
            Less accumulated amortization                       409        148
                                                             ------      -----
                                                             $1,045      1,137
                                                             ======      =====
</TABLE>


      Amortization expense recorded for the years ended June 30, 1998 and 1997
      was approximately $261,000 and $109,000, respectively.

(3)    INVENTORIES

      Inventories consist of the following at June 30, 1998 and 1997 (in
thousands):

<TABLE>
<CAPTION>
                                                              1998       1997
                                                              ----       ----
            <S>                                              <C>          <C>  
            Raw materials                                    $ 2,149      1,853
            Work in process                                      458         --
            Finished goods                                     1,189        953
            Inventory reserve                                 (1,327)      (366)
                                                             -------      -----
                                                             $ 2,469      2,440
                                                             =======      =====
</TABLE>




(4)    PROPERTY AND EQUIPMENT

       Property and equipment consist of the following at June 30, 1998 and 1997
(in thousands):

<TABLE>
<CAPTION>
                                                              1998       1997
                                                              ----       ----
            <S>                                              <C>         <C>  
            Computer and test equipment                      $2,906      2,324
            Software                                            339        286
            Furniture and fixtures                              159        159
            Leasehold improvements                              228        205
                                                             ------      -----
                                                              3,632      2,974
            Less accumulated depreciation and amortization    2,746      1,788
                                                             ------      -----
                                                             $  886      1,186
                                                             ======      =====
</TABLE>




                                      F-10
<PAGE>   38


                       DIGITAL TRANSMISSION SYSTEMS, INC.

                          Notes to Financial Statements

                             June 30, 1998 and 1997


(5)    CONVERTIBLE DEBENTURES

       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 were
       convertible at any time by the lender into common stock of the Company at
       a conversion price of $10.25 per share but the conversion price was
       changed to $8.00 per share because the Company's common stock was trading
       for less than that amount on September 25, 1998. 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 (a) there is a
       change in control, as defined in the Debenture Agreement, (b) the
       Company's common stock is delisted from NASDAQ, or (c) the Company's
       common stock ceases to be publicly traded at the sum of the principal
       amount of the debentures tendered for redemption, plus any accrued, plus
       unpaid interest outstanding related to the debentures, plus 15% interest
       on outstanding principal and interest amounts due, plus any expenses and
       costs owed to the lender as set forth in the Debenture Agreement. The
       Debenture Agreement imposes certain covenants as defined in the Debenture
       Agreement. The Company was not in compliance with the debt covenants as
       of June 30, 1998. Effective October 14, 1998, the Company was delisted
       from NASDAQ. Accordingly, the debentures have been classified as a
       current liability in these financial statements.

(6)    LINE OF CREDIT AGREEMENT

       In April 1997, the Company executed a line of credit agreement with a
       financial institution whereby it could borrow the lesser of $2,500,000 or
       80% of eligible receivables, as defined in the Loan and Security
       Agreement (the "Agreement"). In March 1998, the Agreement was amended to
       increase the maximum eligible borrowing to the lesser of $4,000,000 or
       80% of eligible receivables plus 30% of eligible inventory, as defined,
       through the maturity date of April 10, 2000. In September 1998, the
       Company agreed to a UCC Filing whereby all assets of the Company become
       collateral under the Agreement. Amounts outstanding under the Agreement
       were $1,329,352 and $1,958,172 at June 30, 1998 and 1997, respectively.
       Borrowings accrue interest at the prime rate plus 2.25% (10.75% at June
       30, 1998 and 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, 1998. Accordingly,
       the outstanding balance under the Agreement has been classified as a
       current liability in these financial statements.




                                      F-11
<PAGE>   39


                       DIGITAL TRANSMISSION SYSTEMS, INC.

                          Notes to Financial Statements

                             June 30, 1998 and 1997


(7)    INCOME TAXES

       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>
                                                               1998       1997
                                                               ----       ----
            <S>                                              <C>         <C>
            Computed "expected" income tax benefit
                at Federal statutory rate of 34%             $(2,752)    (1,425)
            State income taxes, net of Federal benefit          (321)      (165)
            Increase in valuation allowance                    3,435      1,638
            Other, net                                           (77)       (48)
                                                             -------     ------ 
                                                             $   285         --
                                                             =======     ====== 
</TABLE>


       The income tax effects of the temporary differences that give rise to
       significant portions of the Company's deferred tax assets at June 30,
       1998 and 1997 are presented below (in thousands):

<TABLE>
<CAPTION>
                                                              1998          1997
                                                              ----          ----
            <S>                                             <C>             <C>
            Deferred tax assets:
                Allowance for doubtful accounts             $   278            86
                Inventory valuation allowance                   504           139
                Accrued warranty reserve                        235            69
                Accrued expenses not reduced 
                  for tax purposes                               14            30
                Property and equipment depreciation             141            47
                Net operating loss carryforwards              5,331         2,982
                Product and development tax credit
                  carryforwards                                 441           441
                                                            -------         ----- 
                       Gross deferred tax asset               6,944         3,794

            Less valuation allowance                          6,944         3,509
                                                            -------         ----- 
                  Net deferred tax assets                   $    --           285
                                                            =======         =====
</TABLE>



                                      F-12
<PAGE>   40


                       DIGITAL TRANSMISSION SYSTEMS, INC.

                          Notes to Financial Statements

                             June 30, 1998 and 1997



       The valuation allowance for deferred tax assets as of June 30, 1998 and
       1997 was $6,944,000 and $3,509,000, respectively. The net change in the
       total valuation allowance for the years ended June 30, 1998 and 1997 was
       an increase of approximately $3,435,000 and $1,638,000, 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 $15,000,000 prior to the expiration of the net operating
       loss carryforwards beginning in 2005. Taxable loss for the years ended
       June 30, 1998 and 1997 was approximately $(5,956,000) and $(3,680,000),
       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 has established a 100% net
       valuation allowance.

       At June 30, 1998, the Company has net operating loss carryforwards for
       federal income tax purposes of approximately $14,000,000 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.

       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.




                                      F-13
<PAGE>   41


                       DIGITAL TRANSMISSION SYSTEMS, INC.

                          Notes to Financial Statements

                             June 30, 1998 and 1997



(8)    SHAREHOLDERS' EQUITY

       (a)   INITIAL PUBLIC OFFERING

             On March 4, 1996, the Company completed a public stock offering
             (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 as of June 30, 1996 for the purpose of
             the statement of stockholders' (deficit) equity.

       (b)   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.

       (c)   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, and some of these agreements were extended beyond
             one year. No lock-up agreements remain in effect as of June 30,
             1998.

       (d)   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.

       (e)   WARRANTS

             The 1,220,700 warrants included in the units sold in the Offering
             were separated on February 18, 1997 as discussed in (d) above.
             These warrants entitle the holder to purchase one share of common
             stock at an exercise price of $9, and expire March 4, 2001. All
             1,220,700 warrants remain outstanding and exercisable as of June
             30, 1998.



                                      F-14
<PAGE>   42


                       DIGITAL TRANSMISSION SYSTEMS, INC.

                          Notes to Financial Statements

                             June 30, 1998 and 1997



             In connection with the March 1998 amendment to the line of credit
             agreement, the Company issued five-year warrants to the financial
             institution which permit them to purchase 60,000 shares of the
             Company's common stock at $5.50 per share. Using the Black-Scholes
             option pricing model, the Company has calculated the fair market
             value of the warrants granted to be approximately $166,000 as of
             the date of grant. This amount was recorded as additional paid-in
             capital and debt issuance costs, which will be amortized as
             interest expense over the remaining term of the Agreement. Total
             amortization expense of $20,000 was recorded to interest expense
             during the year ended June 30, 1998. All 60,000 warrants remain
             outstanding and exercisable as of June 30, 1998.

       (f)   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.

             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, 1998, there were no options available for grant
             under the 1992 Plan, and there were 47,872 options available for
             grant under the 1996 Plan.




                                      F-15
<PAGE>   43


                       DIGITAL TRANSMISSION SYSTEMS, INC.

                          Notes to Financial Statements

                             June 30, 1998 and 1997



             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, 1998, 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 at the conclusion of each fiscal year. As of June 30,
             1998, 51,388 of these options were outstanding of which 47,388 were
             exercisable.

             The per share weighted-average fair value of all stock options
             granted during the years ended June 30, 1998 and 1997 was $2.48
             and $4.48 on the date of grant using the Black-Scholes
             option-pricing model with the following weighted-average
             assumptions: 1998 -- expected dividend yield 0%, expected
             volatility 50%, risk-free interest rate of 5.8%, and an expected
             life of 4 years; 1997 -- expected dividend yield 0%, expected
             volatility 45%, risk-free interest rate of 5.8%, and an expected
             life of 4 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,
                                                                                 ---------------------
                                                                                   1998         1997
                                                                                   ----         ----
               <S>                                        <C>                    <C>           <C>
               Net loss attributable to common
                  shareholders                            As reported            $(8,380)      (4,190)
                                                          Pro forma              $(8,850)      (4,447)

               Net loss per common share and
                  common share equivalent                 As reported            $ (2.01)       (1.05)
                                                          Pro forma              $ (2.13)       (1.11)
</TABLE>

           Pro forma net loss reflects only options granted during the years
           ended June 30, 1996 through 1998. 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.




                                      F-16
<PAGE>   44


                       DIGITAL TRANSMISSION SYSTEMS, INC.

                          Notes to Financial Statements

                             June 30, 1998 and 1997



             The following summarizes stock option activity, excluding
             underwriter options, for the years ended June 30, 1998 and 1997:

<TABLE>
<CAPTION>
                                                                       NUMBER            EXERCISE
                                                                      OF SHARES       PRICE PER SHARE
                                                                      ---------       ---------------
                <S>                                                   <C>            <C> 
                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
                                                                       =======       ==================

                   Granted                                             288,722         4.25   - 10.50          
                   Exercised                                            70,317          .067  -  4.73
                   Canceled or expired                                 242,511          .067  - 12.25
                                                                       -------       ------------------
                Outstanding at June 30, 1998                           698,115          .0085 - 11.490 
                                                                       =======       ==================
</TABLE>

             At June 30, 1998, the weighted-average remaining contractual life
             of outstanding options, excluding underwriter options, was 7.8
             years. At June 30, 1998 and 1997, the number of options exercisable
             was 281,267 and 221,466, respectively, and the weighted-average
             exercise price of those options was $3.16 and $1.22, respectively.

             During fiscal 1988, the Company lowered the exercise price of 
             272,015 options to $4.15, from exercise prices previously ranging
             from $4.25 to $12.875. These revised exercise prices were used to 
             calculate the weighted-average exercise price of outstanding
             options at June 30, 1998. The impact of the stock option repricing
             was not material to the June 30, 1998 statement of operations. 

       (g)   NOTES RECEIVABLE FROM STOCK SALES

             Notes receivable from stock sales result from the exercise of stock
             options for full recourse promissory notes during the years ended
             June 30, 1998 and 1997.

       (h)   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 $68,000
             and $64,000 was recorded in the Statement of Operations during the
             years ended June 30, 1998 and 1997, respectively, for the options
             that vested during these years.




                                      F-17
<PAGE>   45


                       DIGITAL TRANSMISSION SYSTEMS, INC.

                          Notes to Financial Statements

                             June 30, 1998 and 1997



       (i)   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 no shares to employees in 1998, and 782 shares to
             employees in 1997.

(9)    CONCENTRATION OF SALES AND CREDIT RISKS

       For the years ended June 30, 1998 and 1997, 48% and 45%, respectively, of
       the Company's revenues were derived from two customers. Additionally, the
       Company's accounts receivable from these two customers represented 49%
       and 44% of total accounts receivable at June 30, 1998 and 1997,
       respectively.

       For the years ended June 30, 1998 and 1997, international sales were
       approximately 34% and 26%, respectively, of total sales of the Company.
       International sales and gross profit were as follows (in thousands):

<TABLE>
<CAPTION>
                                                              1998       1997
                                                              ----       ----
            <S>                                              <C>         <C>  
            Sales                                            $5,333      3,766
            Gross profit                                        402      1,120
</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>
                                1999                                               $216
                                2000                                                205
                                2001                                                183
                                                                                   ----
                                                                                   $604
                                                                                   ====
</TABLE>



                                      F-18
<PAGE>   46


                       DIGITAL TRANSMISSION SYSTEMS, INC.

                          Notes to Financial Statements

                             June 30, 1998 and 1997



             Rental expense under all lease agreements for the years ended June
             30, 1998 and 1997 was approximately $406,000 and $415,000,
             respectively.

       (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 approximately $32,000 and $24,000 for the years ended
             June 30, 1998 and 1997, respectively. The Company elected to make
             no discretionary contributions to the Plan during the years ended
             June 30, 1998 and 1997.

       (c)   PRODUCT DEVELOPMENT AGREEMENTS

             During the years ended June 30, 1998 and 1997, the Company had
             agreements with certain outside subcontractors for the development
             of new product technology. The agreements defined milestones which,
             upon completion, called for the payment of agreed-upon fees.
             Portions of these payments were capitalized as product development
             costs, as discussed in note 1. There were no firm commitments
             remaining in effect as of June 30, 1998.

       (d)   LEGAL MATTERS

             IN August 1998, a vendor of the Company filed suit against the
             Company alleging nonpayment of account. Total demands for judgment
             are $550,826 in unpaid invoices, plus pre-judgment and
             post-judgment interest on principal amounts outstanding and court
             costs. The Company is disputing the validity and accuracy of the
             billed amounts, and believes that its obligation to the plaintiff
             is $200,000, which has been accrued in the financial statements as
             of June 30, 1998.

             The Company believes that it has meritorious defenses in the
             plaintiff's claims and intends to continue a vigorous defense in
             this matter. However, no assurance can be given as to the ultimate
             outcome with respect to such lawsuit and the amount, if any, which
             may be paid in excess of the accrual recorded at June 30, 1998.

             The Company is also involved in various claims and legal actions
             arising in the ordinary course of business. In the opinion of
             management, the ultimate disposition of these matters, including
             the litigation discussed in the previous paragraph, will not have a
             material adverse effect on the Company's financial position,
             results of operations, or liquidity.



                                      F-19
<PAGE>   47
                       DIGITAL TRANSMISSION SYSTEMS, INC.

                          Notes to Financial Statements

                             June 30, 1998 and 1997



(11)   SUBSEQUENT EVENTS

       On August 10, 1998, the Board of Directors approved a reissuance of
       employee options whereby all optionholders under the 1992 and 1996 Plans
       could forfeit their outstanding, options and receive instead new options
       at an exercise price of $.75, the fair market value of the Company's
       stock on the approval date. The reissued options vest quarterly over
       three years, but none can be exercised prior to February 10, 1999.
       305,894 options were approved for reissue under the terms of this
       arrangement.



                                      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, 1998 and 1997, and the related statements of operations,
shareholders' (deficit) 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, 1998 and 1997, and the results of its operations and its
cash flows for the years then ended in conformity with generally accepted
accounting principles.

The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in notes 1(b), 5 and 6 to
the financial statements, the Company has suffered recurring losses from
operations, is in violation of its debt covenants, and has a net capital
deficiency that raises substantial doubt about its ability to continue as a
going concern. Management's plans in regard to these matters are also described
in note 11. The financial statements do not include any adjustments that might
result from the outcome of this uncertainty.




Atlanta, Georgia
October 8, 1998, except as to paragraph 2 of note 5 
which is as of October 14, 1998




                                      F-21
<PAGE>   49






                                INDEX TO EXHIBITS



<TABLE>
<CAPTION>
     EXHIBIT
     NUMBER                      DESCRIPTION
     <S>          <C>         <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>         <C>
    **10.22 (1)   -           Form of Digital Transmission Systems, Inc. Employee Stock Purchase Plan

      10.23       -           Form of Amendment to the Company's 401 (K) Savings Plan

   ***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 ).

      **    Incorporated by reference to the corresponding exhibit of the
            Registrant's Form 10-KSB filed 9/30/96.

      ***   Incorporated by reference to the corresponding exhibit of the
            Registrant's Form 10-KSB filed 10/14/97.

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




                                       E-2