<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 December 31, 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 December
31, 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 DECEMBER 31, 1998

                                      INDEX


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

                Condensed Consolidated Balance Sheets at December 31, 1998
                  (Unaudited) and June 30, 1998                                        3

                Condensed Consolidated Statements of Operations for the Three
                  Months ended December 31, 1998 and 1997 (Unaudited)                  4

                Condensed Consolidated Statements of Operations for the Six
                  Months ended December 31, 1998 and 1997 (Unaudited)                  5

                Condensed Consolidated Statements of Cash Flows for the Six
                  Months Ended December 31, 1998 and 1997 (Unaudited)                  6

                Notes to Interim Condensed Consolidated  Financial Statements
                  (Unaudited)                                                          7

Item 2.         Management's Discussion and Analysis of
                Financial Condition and Results of Operations                          9

PART II.        OTHER INFORMATION

Items 1, 2, 4 & 5     Not applicable                                                  17

Item 3a               Default upon Senior Securities                                  17

Item 6.               Exhibits and Reports on Form 8-K                                17

                      Signatures                                                      18


Exhibit 27.0    Financial Data Schedule  (SEC use only)                               19
</TABLE>



                                     Page 2
<PAGE>   3



                       DIGITAL TRANSMISSION SYSTEMS, INC.
                      CONSOLIDATED CONDENSED BALANCE SHEETS
                        (in thousands, except share data)
<TABLE>
<CAPTION>
                                                                            December 31,
                                                                                1998      June 30, 1998
                                                                            (Unaudited)
                                                                            ------------- -------------
                                              ASSETS
<S>                                                                         <C>           <C>     
Current assets:
Cash and cash equivalents                                                    $     55       $     91
Trade accounts receivable, net of allowances for
  returns and doubtful accounts of $757 at
  December 31 and June 30, 1998, respectively                                   1,518          2,283
Inventories                                                                     1,780          2,469
Prepaid expenses                                                                  202            105

                                                                             --------       --------
   Total current assets                                                         3,555          4,948
                                                                             --------       --------

Property and equipment, net of accumulated
  depreciation and amortization                                                   731            886
Intangible assets, net                                                            902          1,045
Other assets                                                                      280            329
                                                                             --------       --------
   Total assets                                                              $  5,468       $  7,208
                                                                             ========       ========

                           LIABILITIES AND SHAREHOLDERS' DEFICIT

Current liabilities:
Line of credit                                                               $  1,083       $  1,329
Accounts payable and accrued liabilities                                        5,150          4,581
Accrued payroll and benefits                                                      154            248
Convertible debentures                                                          4,000          4,000
Warranty reserve                                                                  605            618

                                                                             --------       --------
   Total current liabilities                                                   10,992         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 December 31 and
   June 30, 1998, respectively                                                     42             42
Additional paid-in capital                                                     11,462         11,462
Deferred compensation                                                             (24)           (56)
Notes receivable from stock sales                                                 (63)           (63)
Accumulated deficit                                                           (16,941)       (14,953)
                                                                             --------       --------
   Total shareholders' deficit                                                 (5,524)        (3,568)
Commitments and contingencies
                                                                             --------       --------
   Total liabilities and shareholders' deficit                               $  5,468       $  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 DECEMBER 31
                                                         ------------------------------
                                                              1998           1997
                                                            Unaudited     Unaudited
                                                            ---------     ---------


<S>                                                         <C>           <C>    
Net sales                                                    $ 1,405       $ 4,373
Cost of sales                                                  1,000         3,099

                                                             -------       -------
   Gross profit                                                  405         1,274
                                                             -------       -------

Selling, general and administrative                              748         1,591

Product development                                              419           497


                                                             -------       -------
   Total operating expenses                                    1,167         2,088
                                                             -------       -------

   Operating loss                                               (762)         (814)

Interest expense, net                                           (149)         (152)

                                                             -------       -------
Loss before income tax expense                                  (911)         (966)

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


                                                             -------       -------
Net loss                                                     ($  911)      ($  966)
                                                             =======       =======

Net loss per share - basic and diluted                       $ (0.22)      $ (0.23)
                                                             =======       =======


Weighted average shares outstanding - basic and diluted        4,178         4,135
                                                             =======       =======
</TABLE>

See accompanying notes to condensed consolidated financial statements.




                                     Page 4
<PAGE>   5

                       DIGITAL TRANSMISSION SYSTEMS, INC.
                 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
                      (in thousands, except per share data)

<TABLE>
<CAPTION>
                                                         SIX MONTHS ENDED DECEMBER 31
                                                         ----------------------------
                                                               1998         1997
                                                            Unaudited     Unaudited
                                                            ---------     ---------


<S>                                                         <C>           <C>    
Net sales                                                    $ 2,924       $ 6,576
Cost of sales                                                  2,073         4,888

                                                             -------       -------
   Gross profit                                                  851         1,688
                                                             -------       -------

Selling, general and administrative                            1,583         2,922
                                                                             
Product development                                              922         1,016

                                                             -------       -------
   Total operating expenses                                    2,505         3,938
                                                             -------       -------

   Operating loss                                             (1,654)       (2,205)

Interest expense, net                                           (334)         (207)
                                                             -------       -------
Loss before income tax expense                                (1,988)       (2,457)

Income tax benefit (expense)                                      --            --

                                                             =======       =======
Net loss                                                     ($1,988)      ($2,457)
                                                             =======       =======

Net loss per share - basic and diluted                       $ (0.48)      $ (0.59)
                                                             =======       =======


Weighted average shares outstanding - basic and diluted        4,178         4,131
                                                             =======       =======
</TABLE>

See accompanying notes to condensed consolidated financial statements.



                                     Page 5
<PAGE>   6
                       DIGITAL TRANSMISSION SYSTEMS, INC.
                 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
                                 (in thousands)
<TABLE>
<CAPTION>
                                                                     SIX MONTHS ENDED DECEMBER 31
                                                                     ----------------------------
                                                                          1998          1997
                                                                       Unaudited      Unaudited
                                                                       ---------      ---------
<S>                                                                     <C>           <C>     
Cash flows from operating activities:
  Net loss                                                              ($1,988)      ($2,457)
  Adjustments to reconcile net loss
   to net cash used in (provided by) operating
    activities:
     Depreciation and amortization                                          438           721
     Amortization of deferred compensation expense                           32            36
  Changes in assets and liabilities:
     Trade and other accounts receivable                                    765        (1,388)
     Inventories                                                            689        (1,018)
     Prepaid expenses and other assets                                      (48)         (138)
     Accounts payable and other accrued expenses                            475           465
     Warranty accrual                                                       (13)           60

                                                                        -------       -------
Net cash provided by (used in) operating activities                         350        (3,719)
                                                                        -------       -------

Cash flows from investing activities:
  Purchases of property and equipment                                       (46)         (415)
  Additions to capitalized product development costs                        (94)         (294)          

                                                                        -------       -------
Net cash used in investing activities                                      (140)         (709)
                                                                        -------       -------

Cash flows from financing activities:
  Net borrowings under line of credit agreement                            (246)          168
  Proceeds from sale of convertible debentures                               --         4,000
  Proceeds from exercise of stock options                                    --            16

                                                                        -------       -------
Net cash (used in) provided by financing activities                        (246)        4,184
                                                                        -------       -------

Net increase in cash and cash equivalents                                   (36)         (244)
Cash and cash equivalents at beginning of period                             91           712

                                                                        -------       -------
Cash and cash equivalents at end of period                              $    55       $   468
                                                                        =======       =======

Supplemental disclosure of cash paid for income taxes and interest
    Cash paid for income taxes                                               --            --
                                                                        -------       -------
    Cash paid for interest                                              $    83       $   154
                                                                        -------       -------
</TABLE>

See accompanying notes to condensed consolidated financial statements.



                                     Page 6
<PAGE>   7


                       DIGITAL TRANSMISSION SYSTEMS, INC.
          NOTES TO CONDENSED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
                          DECEMBER 31, 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 $5,524,000 as of December
31, 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 December 31, 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. Furthermore, the Company is in the process of selling its
wholly-owned international subsidiary, SouthTech, Inc. and expects to recognize
a gain on the transaction once finalized.

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 six months ended December 31, 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 7
<PAGE>   8






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 $428,492 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 billed and unpaid invoices are no more
than $200,000, which has been accrued in the condensed consolidated financial
statements as of December 31, 1998.

The Company has asserted a counterclaim, believes that it has meritorious
defenses to 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 December 31, 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 8
<PAGE>   9




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 DECEMBER 31, 1998 AND DECEMBER 31, 1997

The following table sets forth certain financial data derived from the Company's
statement of operations for the three months ended December 31, 1998 and
December 31, 1997.


<TABLE>
<CAPTION>
                                          THREE MONTHS ENDED      THREE MONTHS ENDED
                                          DECEMBER 31, 1998       DECEMBER 31, 1997
                                          ------------------      ------------------

                                            $       % OF SALES      $      % OF SALES
                                          -------------------------------------------

<S>                                       <C>       <C>           <C>      <C>
Net Sales                                 1,405        100        4,373        100
Gross Profit                                405         29        1,274         29
Product development                         419         30          497         11
Selling, general and administrative         748         53        1,591         36
Net income (loss)                          (911)       (65)        (966)       (22)
</TABLE>




                                     Page 9
<PAGE>   10

NET SALES. Net sales decreased by 68%, to $1,405,000 for the three months ended
December 31, 1998 from $4,373,000 for the three months ended December 31, 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
                       DECEMBER 31,          DECEMBER 31,
                       ------------          ------------

                     1998        1997       1998     1997
                    ----------------------------------------

<S>                 <C>         <C>         <C>      <C>     
Flex T1/E1          $  843      $2,717       60       62
SKYPLEX                489       1,533       35       35
Other products          73         123        5        3
                    ------      ------      ---      ---
Totals              $1,405      $4,373      100      100
                    ======      ======      ===      ===
</TABLE>




For the three months ended December 31, 1998, revenues from the Company's
FlexT1/E1 product line decreased 69% from $2,717,000 for the three months ended
December 31, 1997 to $843,000 for the three months ended December 31, 1998. The
decrease is attributable to a reduction in shipments to customers due to working
capital restraints. Revenues from sales of the Company's SKYPLEX product
decreased 68% to $489,000 for the three months ended December 31, 1998 from
$1,533,000 for the three months ended December 31, 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 expects sales for the 3rd quarter of fiscal 1999 to be less than
sales for the 3rd 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 decreased 68% from $1,274,000 for the three month period
ended December 31, 1997 to $405,000 for the three month period ended December
31, 1998 primarily due to the accompanying decrease in sales noted for the same
period. As a percentage of sales, gross profit remained consistent at 29% of
sales for both the three months ended December 31, 1998 and December 31, 1997.

PRODUCT DEVELOPMENT. Product development expense consists of personnel costs,
consulting, supplies and prototyping expenses. Product development expenses
decreased 16%, to $419,000 for the three months ended December 31, 1998 from
$497,000 for the three months ended December 31, 1997. The decrease in product
development expense for the three month period ended December 31, 1998 is
primarily due to reduced spending on new development projects. Approximately
$60,000 of development costs related to new projects were capitalized for the
three month period ended December 31, 1998 as compared to $149,000 for the three
month period ended December 31, 1997. As a percentage of sales, product
development costs were 30% for the three months ended December 31, 1998 and 11%
for the three months ended December 31, 1997.

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 53%, to $748,000 for the three
months ended December 31, 1998 from $1,591,000 for the three months ended
December 31, 1997. Total selling, general and administrative costs were 53% of
total sales for the three months ended December 31, 1998 as compared to 36% of
sales for the three months ended December 31, 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




                                    Page 10
<PAGE>   11

fiscal 1998 and the first quarter of fiscal 1999. As of December 31, 1998 the
Company had approximately 38 full-time employees reflecting a decrease in
overall headcount of 21, from 59 full-time employees as of December 31, 1997.
Selling expense decreased by 66%, to $285,000 for the three months ended
December 31, 1998 from $847,000 for the three months ended December 31, 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 December 31, 1998 as compared to the three months ended December 31, 1997.
Marketing expenditures decreased by 65% from $293,000 to $104,000 due to reduced
advertising efforts and a reduction in tradeshow participation during the three
month period ended December 31, 1998. General and administrative expenses
decreased by 21%, to $358,000 for the three months ended December 31, 1998 from
$451,000 for the three months ended December 31, 1997. This decrease is
primarily a result of the overall decrease in headcount at December 31, 1998 as
compared to December 31, 1997.

NET LOSS. The net loss decreased to $911,000 for the three months ended December
31, 1998, from $966,000 for the three months ended December 31, 1997. This
decrease was primarily the result of the decrease in selling, general and
administrative expenses as a result of an overall reduction in operating
expenses. Furthermore, the Company expects to incur a loss for the 12 months
ended June 30, 1999.

SIX MONTHS ENDED DECEMBER 31, 1998 AND DECEMBER 31, 1997

The following table sets forth certain financial data derived from the Company's
statement of operations for the six months ended December 31, 1998 and December
31, 1997.


<TABLE>
<CAPTION>
                                           SIX MONTHS ENDED        SIX MONTHS ENDED
                                           DECEMBER 31, 1998       DECEMBER 31, 1997
                                           -----------------       -----------------

                                            $      % OF SALES       $      % OF SALES
                                         --------------------------------------------

<S>                                      <C>       <C>           <C>       <C>
Net Sales                                 2,924        100        6,576        100
Gross Profit                                851         29        1,688         26
Product development                         922         32        1,016         15
Selling, general and administrative       1,583         54        2,922         44
Net income (loss)                        (1,988)       (68)      (2,457)       (37)
</TABLE>




NET SALES. Net sales decreased by 55%, to $2,924,000 for the six months ended
December 31, 1998 from $6,576,000 for the six months ended December 31, 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          
                      SIX MONTHS ENDED            SIX MONTHS ENDED    
                        DECEMBER 31,                DECEMBER 31,      
                        ------------                ------------      
                                                                 
                     1998        1997          1998             1997   
                    ------------------------------------------------
                                                                       
<S>             <C>             <C>      <C>                    <C>   
Flex T1/E1          $1,812      $3,585           62              54    
SKYPLEX              1,016       2,814           35              43    
Other products          96         177            3               3    
                    ------      ------          ---             ---    
                                                                       
Totals              $2,924      $6,576          100             100    
                    ======      ======          ===             ===    
</TABLE>
                                                               



                                    Page 11
<PAGE>   12

For the six months ended December 31, 1998, revenues from the Company's
FlexT1/E1 product line decreased 49% from $3,585,000 for the six months ended
December 31, 1997 to $1,812,000 for the six months ended December 31, 1998. The
decrease is primarily attributable to reduced shipments to customers due to
working capital constraints. Revenues from sales of the Company's SKYPLEX
product decreased 64% to $1,016,000 for the six months ended December 31, 1998
from $2,814,000 for the six months ended December 31, 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 expects sales for the 3rd quarter of fiscal 1999 to be less than
sales for the 3rd quarter of fiscal 1998 and the Company expects sales for
fiscal 1999 to be less than 1998. Additionally, the Company expects sales for
the 9 month period ended March 31, 1999 to be less than sales for the nine month
period ended March 31, 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 decreased 50% from $1,688,000 for the six month period
ended December 31, 1997 to $851,000 for the six month period ended December 31,
1998 primarily due to the accompanying decrease in sales noted for the same
period. As a percentage of sales, gross profit increased from 26% of sales for
the six months ended December 31, 1997 to 29% of sales for the six months ended
December 31, 1998. The increase is primarily attributable to 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, supplies and prototyping expenses. Product development expenses
decreased 9%, to $922,000 for the six months ended December 31, 1998 from
$1,016,000 for the six months ended December 31, 1997. The decrease in product
development expense for the six month period ended December 31, 1998 is
primarily due to reduced spending on new development projects. Approximately
$94,000 of development costs related to new projects were capitalized for the
six month period ended December 31, 1998 as compared to $294,000 for the six
month period ended December 31, 1997. As a percentage of sales, product
development costs were 32% for the six months ended December 31, 1998 and 15%
for the six months ended December 31, 1997.

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 46%, to $1,583,000 for the six
months ended December 31, 1998 from $2,922,000 for the six months ended December
31, 1997. Total selling, general and administrative costs were 54% of total
sales for the six months ended December 31, 1998 as compared to 44% of sales for
the six months ended December 31, 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 December 31, 1998 the Company
had approximately 38 full-time employees reflecting a decrease in overall
headcount of 21, from 59 full-time employees as of December 31, 1997. Selling
expense decreased by 59%, to $634,000 for the six months ended December 31, 1998
from $1,558,000 for the six months ended December 31, 1997. This decrease was
due to lower sales personnel compensation costs and sales commission costs
associated with the decreased sales level for the six months ended December 31,
1998 as compared to the six months ended December 31, 1997. Marketing
expenditures decreased by 52% from $551,000 to $265,000 due to reduced
advertising efforts and a reduction in tradeshow participation during the six
month period ended December 31, 1998. General and administrative expenses
decreased by 16%, to $684,000 for the six months ended December 31, 1998 from
$813,000 for the six months ended December 31, 1997. This decrease is primarily
a result of the overall decrease in headcount at December 31, 1998 as compared
to December 31, 1997.

NET LOSS. The net loss decreased to $1,988,000 for the six months ended December
31, 1998, from $2,457,000 for the six months ended December 31, 1997. This
decrease was primarily the result of the decrease in selling, general and
administrative expenses as a result of an overall reduction in operating
expenses.



                                    Page 12
<PAGE>   13


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 $5,524,000 as of December
31, 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 December 31, 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 pursuing additional equity financing through discussions with
potential investors, is pursuing potential merger or acquisition candidates. 
Furthermore, the Company is in the process of selling its wholly-owned
international subsidiary, SouthTech, Inc. and expects to recognize a gain on
the transaction once finalized.

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. The delisting action has hampered the Company's efforts
to raise capital through a private placement of its stock with qualified
investors. However, in order to preserve its cash, the Company has been able to
use its common stock in settling debts with employees and affiliates. The amount
of common stock thus used through December 31, 1998 totals 410,000 shares which
settled $120,000 owed by the Company.

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% (9.50% at
December 31, 1998). A net worth covenant was amended on March 16, 1998 requiring
the Company to have a net worth of $1,000,000. 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. 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
December 31, 1998. The Company is attempting to obtain waivers of certain
financial covenants or an amendment to the current line of credit agreement so
that the Company's ability to borrow additional funds under the Agreement is not
hindered. Further, the Company has committed to issue additional warrants to
Silicon Valley Bank as consideration for the amended 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 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. Due to
continued noncompliance with debt 



                                    Page 13
<PAGE>   14

covenants and the NASDAQ listing criteria, the Company was delisted as of
October 14, 1998. Accordingly, the debentures have been listed as a current
liability in the accompanying condensed consolidated financial statements.

On January 31, 1999, approximately 1.7 million shares of the Company's
outstanding common stock were acquired by MicroTel International, Inc. via a
transaction independent of the Company. The stock was acquired in a private
transaction with Peregrine Ventures, formerly the Company's largest single
shareholder. One million restricted shares of MicroTel common stock were
exchanged for the 1.7 million shares previously held by Peregrine Ventures.

At December 31, 1998, the Company had approximately $55,000 in cash and cash
equivalents. For the six months ended December 31, 1998, $350,000 was provided
by operating activities as compared to cash used by operating activities of
$3,719,000 for the same period the previous year. The net loss for the six month
period ended December 31, 1998 of $1,988,000 includes non-cash depreciation and
amortization charges of $470,000. Cash was provided for operations primarily
through a decrease in accounts receivable of $765,000, a decrease in inventory
of $689,000 and an increase in accounts payable and accrued expenses of
$462,000.

The Company purchased $46,000 and $415,000 of property, plant and equipment
during the six months ended December 31, 1998 and 1997, respectively. In
addition, the Company capitalized certain product development expenses paid to
outside contractors. During the six months ended December 31, 1998, the Company
capitalized $94,000 of such costs as compared to capitalized costs of $294,000
for the six months ended December 31, 1997.

Net cash used in financing activities for the six month period ended December
31, 1998 was $246,000 reflecting net payments under the Company's line of credit
facility.

CREATION OF SOUTHTECH, A WHOLLY OWNED SUBSIDIARY

In fiscal 1998 the DTS Board of Directors directed the creation of a wholly
owned subsidiary - SouthTech, Inc., a Georgia corporation - to which certain
assets and liabilities will pertain and whose business purpose is the
administration and growth of the Company's international business. The SKYPLEX
and DIV product lines and associated intellectual property together with the
payables and receivables pertaining to the sales realized from those product
lines form part of the assets and liabilities transferred. Cash resources of the
Company have been used for the purposes of developing SKYPLEX I, a microwave
radio product utilizing spread spectrum technology, and developing sales
distribution channels in Latin America, Asia Pacific and the Mid-East global
sectors. The Company is in the process of selling its wholly-owned international
subsidiary, SouthTech, Inc. and expects to recognize a gain on the transaction
once finalized.


ELECTION OF BOARD MEMBERS & SHAREHOLDER MEETING - APRIL 8, 1999

On December 31, 1998, Frank LaHaye and Gene Miller, two DTS Board members
representing Peregrine Ventures, a venture capital firm and the Company's
largest single shareholder, tendered their resignations effective the same day.
The Board of Directors accepted their resignations and will thereby propose two
candidates for election to the DTS Board of Directors at the Shareholder Meeting
scheduled for Thursday, April 8, 1999 at the Company headquarters.

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 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.



                                    Page 14
<PAGE>   15

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 and have been 
adequately tested as to conformance with Year 2000 date processing. All 
products tested passed the conformance test and have been appropriately 
certified as Year 2000 compliant by the Company. The Company did not incur and 
does not expect to incur any material costs to address Year 2000 compliance 
issues. The Company is in the process of developing a contingency plan to 
address any instances of Year 2000 non-compliance and expects to complete such 
a contingency plan by September 1999.

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 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

Certain statements contained in this filing which are not statements of
historical fact constitute forward-looking statements within the meaning of the
Private Securities Litigation Reform Act (the Act). In addition, certain
statements in future filings by the Company with the Securities and Exchange
Commission, in press releases, and in oral and written statements made by or
with the approval of the Company which are not statements of historical fact
constitute forward-looking statements within the meaning of the Act. Examples of
forward-looking statements include, but are not limited to: (i) projections of
revenue, income or loss, earnings or loss per share, the payment or nonpayment
of dividends, capital structure and other financial items; (ii) statements of
plans and objectives of the company's management or Board of Directors,
including those relating to products or services; (iii) statements of future
economic performance; and (iv) statements of assumptions underlying such
statements. Words such as "believes," "anticipates," "expects", "intends," 
"targeted," and similar expressions are intended to identify forward-looking
statements but are not the exclusive means of identifying such statements.

Forward-looking statements involve risks and uncertainties which may cause
actual results to differ materially from those in such statements. Factors that
could cause actual results to differ from those discussed in the forward-looking
statements include, but are not limited to: (i) the strength of the U.S. economy
in general and relevant foreign economies; (ii) the Company's performance under
current and future contracts; (iii) inflation and interest rate fluctuations;
(iv) timely and successful implementation of processing systems to provide new
products, improved functionality and increased efficiencies; (v) technological
changes; (vi) acquisitions; (vii) the ability to increase market share and
control expenses; (viii) changes in laws or regulations or other industry
standards affecting the Company's business which require significant product
redevelopment efforts; (ix) the effect of changes in accounting policies and
practices as may be adopted by the Financial Accounting Standards Board; (x)
changes in the Company's organization, compensation and benefit plans; (xi)
the costs and effects of litigation and of unexpected or adverse outcomes in
such litigation; (xii) failure to successfully implement the Company's Year
2000


                                    Page 15
<PAGE>   16

modification plans substantially as scheduled and budgeted; and (xiii) the
success of the Company at managing the risks involved in the foregoing.

Such forward-looking statements speak only as of the date on which statements
are made, and the Company undertakes no obligation to update any
forward-looking statement to reflect events or circumstances after the date on
which such statement is made to reflect to occurrence of unanticipated events.



                                    Page 16
<PAGE>   17




                           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 December 31,
1998. The Company is specifically in default of minimum tangible net worth
covenants and required NASDAQ listing covenants as of December 31, 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 December 31, 1998 were $4,268,331 and $1,083,000
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 December 31,
1998.

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

(A)      EXHIBITS

          Exhibit
          Number          Description of Exhibits
          ------          -----------------------

           27.0           Financial Data Schedule (for SEC use only)


(B)      REPORTS ON FORM 8-K

The registrant did not file any reports on Form 8-K during the three months
ended December 31, 1998.






                                    Page 17
<PAGE>   18




                                   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:   February 15, 1999                By: /s/ Andres C. Salazar         
                                            -------------------------------
                                            Andres C. Salazar, President and
                                            Chief Executive Officer


Date:   February 15, 1999                By: /s/ Clive N. W. Marsh
                                            -----------------------
                                            Clive N. W. Marsh, Controller
                                            (Principal Accounting Officer)




                                    Page 18