<PAGE>   1
================================================================================

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

                                   FORM 10-QSB

              {X} QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE
                         SECURITIES EXCHANGE ACT OF 1934

                For the Quarterly Period Ended September 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)


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

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


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

                                 NOT APPLICABLE
              (Former name, former address and former fiscal year,
                         if changed since last report)

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 { }

The number of shares outstanding of the registrant's common stock as of
September 30, 1998 was 4,196,154.

Transitional Small Business Disclosure Format (check one): Yes { } No {x}

================================================================================
<PAGE>   2
                        DIGITAL TRANSMISSION SYSTEMS INC.
                                   FORM 10-QSB

                    FOR THE QUARTER ENDED SEPTEMBER 30, 1998

                                      INDEX

<TABLE>
<CAPTION>
                                                                                 PAGE
PART I.        FINANCIAL INFORMATION                                            NUMBER
                                                                                ------
<S>            <C>                                                              <C>
Item 1.        Financial Statements:

               Condensed Consolidated Balance Sheets at September 30,
               1998 (Unaudited) and June 30, 1998                                  3

               Condensed Consolidated Statements of Operations for the
               Three Months ended September 30, 1998 and 1997 (Unaudited)          4

               Condensed Consolidated Statements of Cash Flows for the
               Three Months Ended September 30, 1998 and 1997 (Unaudited)          5

               Notes to Interim Condensed Consolidated Financial
               Statements (Unaudited)                                              6

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

PART II.       OTHER INFORMATION

Items 1 - 5.   Not applicable

Item 6.        Exhibits and Reports on Form 8-K                                   11

               Signatures                                                         12

Exhibit 27.0   Financial Data Schedule  (SEC use only)                            13
</TABLE>






                                     Page 2
<PAGE>   3
                       DIGITAL TRANSMISSION SYSTEMS, INC.
                      CONSOLIDATED CONDENSED BALANCE SHEETS
                        (in thousands, except share data)

<TABLE>
<CAPTION>
                                                                        September 30,
                                                                            1998        June 30, 1998
                                                                         (Unaudited)
                                                                        -------------   -------------
<S>                                                                     <C>             <C>
                                     ASSETS

Current assets:

Cash and cash equivalents                                                 $    181         $     91
Trade accounts receivable, net of allowances for
  returns and doubtful accounts of $757 and $733 at
  September 30 and June 30, 1998, respectively                               1,574            2,283
Inventories                                                                  2,153            2,469
Prepaid expenses                                                                80              105

                                                                          --------         --------
   Total current assets                                                      3,988            4,948
                                                                          --------         --------

Property and equipment, net of accumulated
  depreciation and amortization                                                803              886
Intangible assets, net                                                         955            1,045
Other assets                                                                   310              329
                                                                          --------         --------
   Total assets                                                           $  6,056         $  7,208
                                                                          ========         ========

                     LIABILITIES AND SHAREHOLDERS' DEFICIT

Current liabilities:
Line of credit                                                            $  1,031         $  1,329
Accounts payable and accrued liabilities                                     4,911            4,581
Accrued payroll and benefits                                                   124              248
Convertible debentures                                                       4,000            4,000
Warranty reserve                                                               613              618
                                                                          --------         --------
   Total current liabilities                                                10,679           10,776
                                                                          --------         --------
Shareholders' deficit:
Preferred stock; 3,000,000 shares authorized; -0- issued                        --               --

Common stock -- $.01 par value; 15,000,000 shares authorized;
   4,191,460 issued and outstanding at September 30 and
   June 30, 1998, respectively                                                  42               42
Additional paid-in capital                                                  11,462           11,462
Deferred compensation                                                          (40)             (56)
Notes receivable from stock sales                                              (63)             (63)
Accumulated deficit                                                        (16,030)         (14,953)
                                                                          --------         --------
   Total shareholders' deficit                                              (4,626)          (3,568)
Commitments and contingencies
                                                                          --------         --------
   Total liabilities and shareholders' deficit                            $  6,056         $  7,208
                                                                          ========         ========
</TABLE>


See accompanying notes to condensed consolidated financial statements.




                                     Page 3
<PAGE>   4
                       DIGITAL TRANSMISSION SYSTEMS, INC.
                 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
                      (in thousands, except per share data)


<TABLE>
<CAPTION>
                                                           THREE MONTHS ENDED SEPTEMBER 30
                                                           -------------------------------
                                                                 1998            1997
                                                              Unaudited       Unaudited
                                                              ---------       ---------
<S>                                                           <C>             <C>
Net sales                                                      $ 1,519         $ 2,203
Cost of sales                                                    1,073           1,789

                                                               -------         -------
   Gross profit                                                    446             414
                                                               -------         -------

Selling, general and administrative                                835           1,331

Product development                                                503             519

                                                               -------         -------
   Total operating expenses                                      1,338           1,850
                                                               -------         -------

   Operating loss                                                 (892)         (1,436)

Interest expense, net                                             (185)            (55)

                                                               -------         -------
Loss before income tax expense                                  (1,077)         (1,491)

Income tax benefit (expense)                                        --              --

                                                               -------         -------
Net loss                                                       $(1,077)        $(1,491)
                                                               =======         =======

Net loss per share - basic and diluted                         $ (0.26)        $ (0.36)
                                                               =======         =======


Weighted average shares outstanding - basic and diluted          4,160           4,127
                                                               =======         =======
</TABLE>

See accompanying notes to condensed consolidated financial statements.




                                     Page 4
<PAGE>   5
                       DIGITAL TRANSMISSION SYSTEMS, INC.
                 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
                                 (in thousands)

<TABLE>
<CAPTION>
                                                                         THREE MONTHS ENDED SEPTEMBER 30
                                                                         -------------------------------
                                                                              1998              1997
                                                                           Unaudited         Unaudited
                                                                         -------------     -------------
<S>                                                                      <C>               <C>
Cash flows from operating activities:
  Net loss                                                                  $(1,077)          $(1,491)
  Adjustments to reconcile net loss
   to net cash used in (provided by) operating activities:
     Depreciation and amortization                                              220               353
     Amortization of deferred compensation expense                               16                16
  Changes in assets and liabilities:
     Trade and other accounts receivable                                        709             1,439
     Inventories                                                                316              (633)
     Prepaid expenses and other assets                                           44               (68)
     Accounts payable and other accrued expenses                                212            (1,682)
     Warranty accrual                                                            (5)               54

                                                                            -------           -------
Net cash provided by (used in) operating activities                             435            (2,012)
                                                                            -------           -------

Cash flows from investing activities:
  Purchases of property and equipment                                           (22)             (160)
  Additions to capitalized product development costs                            (25)             (145)

                                                                            -------           -------
Net cash used in investing activities                                           (47)             (305)
                                                                            -------           -------

Cash flows from financing activities:
  Net payments under line of credit agreement                                  (298)           (1,035)
  Proceeds from sale of convertible debentures                                   --             4,000
  Proceeds from exercise of stock options                                        --                15

                                                                            -------           -------
Net cash (used in) provided by financing activities                            (298)            2,980
                                                                            -------           -------

Net increase in cash and cash equivalents                                        90               663
Cash and cash equivalents at beginning of period                                 91               712

                                                                            -------           -------
Cash and cash equivalents at end of period                                  $   181           $ 1,375
                                                                            =======           =======

Supplemental disclosure of cash paid for income taxes and interest
    Cash paid for income taxes                                                   --                --
                                                                            -------           -------
    Cash paid for interest                                                  $    43           $    39
                                                                            -------           -------
</TABLE>

See accompanying notes to condensed consolidated financial statements.




                                     Page 5
<PAGE>   6
                       DIGITAL TRANSMISSION SYSTEMS, INC.
          NOTES TO CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
                         SEPTEMBER 30, 1998 (UNAUDITED)

1. DESCRIPTION OF THE BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES.

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'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 accompanying condensed consolidated 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. The Company has
incurred significant losses in recent periods and is in violation of its debt
covenants. The Company has a net capital deficit of $4,626,000 as of September
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 condensed consolidated 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.
The Company was not in compliance with the covenants of its line of credit and
convertible debenture agreements at September 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.

The accompanying unaudited condensed consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for interim
financial information and with the instructions to Form 10-QSB. Accordingly,
they do not include all of the information and footnotes required by generally
accepted accounting principles for complete financial statements. The financial
information included herein is unaudited; however, the information reflects all
adjustments (consisting solely of normal recurring adjustments) that are, in the
opinion of management, necessary for a fair presentation of the financial
position, results of operations and cash flows for the interim periods.
Operating results for the three months ended September 30, 1998 are not
necessarily indicative of the results that may be expected for the year ended
June 30, 1999. For further information, refer to the financial statements and
footnotes thereto included in the Company's Form 10-KSB for the year ended June
30, 1998.

There have been no changes to the accounting policies of the Company during the
periods presented. For a description of these policies, see Note 1 of the Notes
to Financial Statements in the Company's Annual Report on Form 10-KSB.


2. INCOME (LOSS) PER COMMON 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. The Company has restated its
earnings (loss) per share for all periods presented to conform to the provisions
of SFAS 128.


                                     Page 6
<PAGE>   7
3. 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 condensed consolidated financial
statements as of September 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 September
30, 1998.

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












                                     Page 7
<PAGE>   8
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
        OF OPERATIONS

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 Mobilnet, 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.

RESULTS OF OPERATIONS

THREE MONTHS ENDED SEPTEMBER 30, 1998 AND SEPTEMBER 30, 1997

The following table sets forth certain financial data derived from the Company's
statement of operations for the three months ended September 30, 1998 and
September 30, 1997.

<TABLE>
<CAPTION>
                                              THREE MONTHS ENDED      THREE MONTHS ENDED
                                              SEPTEMBER 30, 1998      SEPTEMBER 30, 1997
                                              ------------------      ------------------
                                                           % OF                    % OF
                                                 $         SALES         $         SALES
                                              --------     -----      --------     -----
  <S>                                         <C>          <C>        <C>          <C>
  Net sales                                   $ 1,519       100       $ 2,203       100
  Gross profit                                    446        29           414        19
  Product development                             503        33           519        24
  Selling, general and administrative             835        55         1,331        60
  Net income (loss)                            (1,077)      (71)       (1,491)      (68)
</TABLE>








                                     Page 8
<PAGE>   9
NET SALES. Net sales decreased by 31%, to $1,519,000 for the three months ended
September 30, 1998 from $2,203,000 for the three months ended September 30,
1997. The sales mix, and the corresponding percentage of total sales of the
Company's products, is set forth in the chart below:


<TABLE>
<CAPTION>
                                                      PERCENTAGE OF
                                                           TOTAL
                          THREE MONTHS ENDED        THREE MONTHS ENDED
                             SEPTEMBER 30,             SEPTEMBER 30,
                          ------------------        ------------------
                           1998       1997           1998        1997
                          ------     ------         ------      ------
  <S>                     <C>        <C>            <C>         <C>
  Flex T1/E1                969        867             64          39
  SKYPLEX                   527      1,281             35          58
  DIV modem                  --          1             --           1
  Other products             23         54              1           2
                          -----      -----            ---         ---
         Totals           1,519      2,203            100         100
                          =====      =====            ===         ===
</TABLE>


For the three months ended September 30, 1998, revenues from the Company's
FlexT1/E1 product line increased 12% from $867,000 for the three months ended
September 30, 1997 to $969,000 for the three months ended September 30, 1998.
Contributing to this increase were sales of the Company's new product,
microFlex, which accounted for approximately $349,000 of revenue for the three
month period ended September 30, 1998. Revenues from sales of the Company's
SKYPLEX product decreased 59% to $527,000 for the three months ended September
30, 1998 from $1,281,000 for the three months ended September 30, 1997
reflecting an overall decrease in sales to markets in Asia and Latin America and
continued product quality problems associated with the Company's international
radio products.

The Company does not anticipate a strong revenue upswing in the second quarter
of fiscal 1999. The Company expects sales for the 2nd quarter of fiscal 1999 to
be less than sales for the 2nd quarter of fiscal 1998 and the Company expects
sales for fiscal 1999 to be less than 1998.

GROSS PROFIT. Cost of sales consists of component costs, compensation costs and
the overhead costs related to the production and shipping of the Company's
products, along with the support and warranty expense associated with such
products. Gross profit increased 8% to $446,000 for the three month period ended
September 30, 1998 from $414,000 for the three month period ended September 30,
1997. As a percentage of sales, gross profit increased to 29% for the three
months ended September 30, 1998 from 19% for the three months ended September
30, 1997. This increase is a result of the 12% increase in sales of the
Company's higher margin products in the FlexT1/E1 product line experienced
during the first quarter of fiscal 1999. Additionally, sales of the Company's
SKYPLEX product, a lower margin product, represented approximately 58% of the
Company's total sales for the three month period ended September 30, 1997 as
compared to a reduced level of 35% for the same period ended September 30, 1998.
Further contributing to the overall increase in gross profit for the three month
period ended September 30, 1998 is a reduction in the Company's overhead costs
as a result of specific cost reduction plans that were instituted by management
during late fourth quarter of fiscal 1998 and the first quarter of fiscal 1999.

PRODUCT DEVELOPMENT. Product development expense consists of personnel costs,
consulting, prototyping, supplies and depreciation expenses. Product development
expenses decreased 3%, to $503,000 for the three months ended September 30, 1998
from $519,000 for the three months ended September 30, 1997. The decrease in
product development expense for the three month period ended September 30, 1998
is primarily due to reduced spending on new development projects. Approximately
$25,000 of development costs related to new projects were capitalized for the
three month period ended September 30, 1998 as compared to $145,000 for the
three month period ended September 30, 1997. As a percentage of sales, product
development costs were 33% for the three months ended September 30, 1998 and 24%
for the three months ended September 30, 1997.


                                     Page 9
<PAGE>   10
SELLING, GENERAL AND ADMINISTRATIVE. Selling expense consists primarily of
compensation costs for sales and marketing personnel, travel, consulting, trade
show and advertising expenses. General and administrative expense consists
primarily of occupancy costs and compensation expenses for administrative and
finance personnel, as well as accounting, legal and consulting fees. Selling,
general and administrative expense decreased by 37%, to $835,000 for the three
months ended September 30, 1998 from $1,331,000 for the three months ended
September 30, 1997. Total selling, general and administrative costs were 55% of
total sales for the three months ended September 30, 1998 as compared to 60% of
sales for the three months ended September 30, 1997. The overall decrease in
selling, general and administrative expenses is primarily due to the Company's
reduction in personnel compensation and other administrative costs due to
several cost reduction plans instituted by management during the fourth quarter
of fiscal 1998 and the first quarter of fiscal 1999. As of September 30, 1998
the Company had approximately 37 full-time employees reflecting a decrease in
overall headcount of 22, from 59 full-time employees as of September 30, 1997.
Selling expense decreased by 51%, to $349,000 for the three months ended
September 30, 1998 from $711,000 for the three months ended September 30, 1997.
This decrease was due to lower sales personnel compensation costs and sales
commission costs associated with the decreased sales level for the three months
ended September 30, 1998 as compared to the three months ended September 30,
1997. Marketing expenditures decreased by 38% from $258,000 to $161,000 due to
reduced advertising efforts and a reduction in tradeshow participation during
the three month period ended September 30, 1998. General and administrative
expenses decreased by 10%, to $325,000 for the three months ended September 30,
1998 from $362,000 for the three months ended September 30, 1997. This decrease
is primarily a result of the overall decrease in headcount at September 30, 1998
as compared to September 30, 1997.

NET LOSS. The net loss decreased to $1,077,000 for the three months ended
September 30, 1998 from $1,491,000 for the three months ended September 30,
1997. This decrease was the result of the increase in revenues from the
Company's high margin FlexT1/E1 product line, an overall increase in product
margin of 17% and the decrease in selling, general and administrative expenses
as a result of an overall reduction in operating expenses. The Company will
incur a loss in the second quarter of fiscal 1999 and a loss is anticipated for
fiscal 1999.


LIQUIDITY AND CAPITAL RESOURCES

The accompanying condensed consolidated 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. The Company has
incurred significant losses in recent periods and is in violation of its debt
covenants. The Company has a net capital deficit of $4,626,000 as of September
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 condensed consolidated 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.
The Company was not in compliance with the covenants of its line of credit and
convertible debenture agreements at September 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. The Company's securities are currently traded on
the OTC Bulletin Board.

On April 10, 1997, the Company established a bank line of credit agreement with
Silicon Valley Bank which makes available $2,500,000 in borrowings with
availability based on the Company's accounts receivable. The loan 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
September 30, 1998). In September 1998, the Company agreed to a UCC filing
whereby all assets of the Company become collateral under the Agreement. 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


                                    Page 10
<PAGE>   11
subsequent to that date 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 September 30, 1998. The Company is attempting to obtain
waivers of certain financial covenants so that the Company's ability to borrow
additional funds under the Agreement is not hindered.

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 with a contractural due date of September 25, 2002. The
Debenture Purchase 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 changes to $8.00 per share if
the Company's common stock is 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 September 30, 1998 and has been delisted as of October 14, 1998. Accordingly,
the debentures have been listed as a current liability in the accompanying
condensed consolidated financial statements.

At September 30, 1998, the Company had approximately $181,000 in cash and cash
equivalents. For the three months ended September 30, 1998, $435,000 was
provided by operating activities as compared to cash used by operating
activities of $2,012,000 for the same period the previous year. The net loss for
the three month period ended September 30, 1998 of $1,077,000 includes non-cash
depreciation and amortization charges of $236,000. Cash was provided for
operations primarily through a decrease in accounts receivable of $709,000, a
decrease in inventory of $316,000 and an increase in accounts payable and
accrued expenses of $212,000.

The Company purchased $22,000 and $160,000 of property, plant and equipment
during the three months ended September 30, 1998 and 1997, respectively. In
addition, the Company capitalized certain product development expenses paid to
outside contractors. During the three months ended September 30, 1998, the
Company capitalized $25,000 of such costs as compared to capitalized costs of
$145,000 for the three months ended September 30, 1997.

Net cash used in financing activities for the three month period ended September
30, 1998 was $298,000 reflecting net payments under the Company's line of credit
facility.


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 the
summer months. The Company's business plan is to continue the diversification of
its product offerings, further develop its distribution channels and further
expand its customer base. The Company believes that the implementation of this
plan and the expected decrease of sales to MCI will decrease the seasonality of
its sales. The Company operates with a moderate level of backlog for each
product line due to advance purchase commitments and production lead times.


                                    Page 11
<PAGE>   12
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. The Company does operate older PC's in its manufacturing and
engineering organizations, but they are not used in time or date critical
operations.

The Company's products are designed to be Year 2000 compliant.

The Company has a number of material relationships with third parties and is
aware of the risks involved and is currently analyzing the potential impact on
future operations. 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.


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.


                                    Page 12
<PAGE>   13
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 13
<PAGE>   14
                           PART II. OTHER INFORMATION


ITEMS 1, 2, 4 AND 5 ARE NOT APPLICABLE.

ITEM 3(A) - DEFAULT UPON SENIOR SECURITIES

The Company was in default of certain financial covenants with respect to its
senior indebtedness to Silicon Valley Bank and Tandem Capital as of September
30, 1998. The Company is specifically in default of minimum tangible net worth
covenants and required NASDAQ listing covenants as of September 30, 1998.
Accordingly, all such senior indebtedness has been listed as a current liability
in the accompanying condensed consolidated financial statements. Total amounts
due under each agreement at September 30, 1998 were $4,158,333 and $1,030,000
payable to Tandem Capital and Silicon Valley Bank, respectively. The
indebtedness includes recognition of liability for all unpaid and accrued
interest amounts payable under the aforementioned agreements as of September 30,
1998.

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

(A)      EXHIBITS

<TABLE>
<CAPTION>
         Exhibit
         Number            Description of Exhibits
         ------            -----------------------
         <S>               <C>
          27.0             Financial Data Schedule (for SEC use only)
</TABLE>


(B)      REPORTS ON FORM 8-K

The registrant did not file any reports on Form 8-K during the three months
ended September 30, 1998.








                                    Page 14
<PAGE>   15
                                   SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.


                                    Digital Transmission Systems, Inc.



Date: November 13, 1998             By: /s/ Andres C. Salazar
                                       ----------------------
                                        Andres C. Salazar, President and
                                       Chief Executive Officer


Date: November 13, 1998             By: /s/ Clive N. W. Marsh
                                       ----------------------
                                       Clive N. W. Marsh, Controller
                                      (Principal Accounting Officer)












                                    Page 15