10-Q 1 g69411e10-q.txt DIGITAL TRANSMISSION SYSTEMS, INC. 1 ================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q [X] QUARTERLY REPORT UNDER SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Quarterly Period Ended March 31, 2001 [ ] 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 registrant 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 (Registrant'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 preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [x] No [ ] The number of shares outstanding of the registrant's common stock as of May 14, 2001 was 11,796,594. ================================================================================ 2 DIGITAL TRANSMISSION SYSTEMS, INC. FORM 10-Q FOR THE QUARTER ENDED MARCH 31, 2001 INDEX

Page 2 3 DIGITAL TRANSMISSION SYSTEMS, INC. AND SUBSIDIARIES Condensed Consolidated Balance Sheets (unaudited) (in thousands, except share data)

See accompanying notes to condensed consolidated financial statements. Page 3 4 DIGITAL TRANSMISSION SYSTEMS, INC. AND SUBSIDIARIES Condensed Consolidated Statements Of Operations (unaudited) (in thousands, except per share data)

(1) Potentially dilutive securities not included for the three months ended March 31, 2001 as their effect would be anti-dilutive See accompanying notes to condensed consolidated financial statements. Page 4 5 DIGITAL TRANSMISSION SYSTEMS, INC. AND SUBSIDIARIES Condensed Consolidated Statements Of Operations (unaudited) (in thousands, except per share data)

(1) Potentially dilutive securities not included as their effect would be anti-dilutive See accompanying notes to condensed consolidated financial statements. Page 5 6 DIGITAL TRANSMISSION SYSTEMS, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited - in thousands)

See accompanying notes to consolidated financial statements. Page 6 7 DIGITAL TRANSMISSION SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS MARCH 31, 2001 (UNAUDITED) 1. DESCRIPTION OF THE BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES. Digital Transmission Systems, Inc. ("DTS") and subsidiaries (collectively termed the "Company") designs, manufactures, repairs, refurbishes, and markets a broad range of products for the wireless telecommunications ("telecom") industry. The Company's primary customers are domestic and international wireless service providers, including those offering cellular telephone services and Personal Communication Services ("PCS"), and domestic and international resellers/integrators who sell to and service wireless and wireline with telecom equipment. The Company's products of original design, consisting of proprietary software and hardware modules, facilitate the control, monitoring, and efficient transmission of high-speed digital information through wireless public or private telecommunications networks. The Company's network access products enable wireless service providers to give their customers economical, high quality access to public and private networks and various telecommunications services. Important product requirements in the market segments the Company serves 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. Through its wholly-owned subsidiary, Asurent Technologies, Inc. ("Asurent Technologies" formerly known as Telcor Communications, Inc.), the Company also acquires and markets de-installed and refurbished telecom equipment originally designed and manufactured by leading telecom equipment suppliers such as Nokia, Lucent, and Ericsson. In addition, Asurent Technologies offers repair services to its customers on products from third party vendors. Major customers of DTS and Asurent Technologies also include Nextel, Alltel Wireless and Alltel Supply, Dobson Cellular, Lucent, and Verizon. The Company markets its products through a direct sales force employing inside and outside sales representatives 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. The Company also utilizes telecommunications equipment resellers and agents in the United States and other countries to market to customers. The 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'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, and to obtain additional financing or refinancing as may be required. Heretofore, the Company has been able to satisfy its immediate short-term cash requirements through increasing equipment sales and accelerating collections coupled with managing vendor accounts and relationships. The Company is actively pursuing additional equity financing through discussions with potential investors. The accompanying unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q. 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 nine months ended March 31, 2001 are not necessarily indicative of the results that may be expected for the year ended June 30, 2001. For further information, refer to the financial statements and footnotes thereto included in the Company's Form 10-K for the year ended June 30, 2000. 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-K. Page 7 8 2. INCOME (LOSS) PER COMMON SHARE Basic earnings (loss) per share ("EPS") is calculated as income (loss) available to common shareholders divided by the weighted-average number of common shares outstanding during each period. Diluted EPS is calculated as income (loss) available to common shareholders divided by the weighted-average number of common shares outstanding during each period plus the effect of any potential dilutive common shares, such as those attributable to convertible debt, convertible preferred stock, warrants, or stock options. A total of 2,939,052 of additional common shares related to the potential conversion of warrants and shares attributable to convertible securities were excluded from the computation of diluted net loss per share in the three months ended March 31, 2001, because the exercise price of these securities was greater than the average market price of the Company's common stock. In addition, the Company excluded all remaining convertible preferred stock, warrants, outstanding stock options and convertible debentures from the calculations of diluted net loss per share as all such securities are anti-dilutive for the three months ended March 31, 2001. The total potential number of dilutive equivalent common shares excluded was 3,283,467 for the three month period ended March 31, 2001. 3. LEGAL MATTERS The Company is involved in various claims and legal actions arising in the ordinary course of business. In the opinion of management, the ultimate disposition of these matters will not have a material adverse effect on the Company's financial position, results of operations, or liquidity. 4. INVENTORIES 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 offering wireless services. The Company purchases both new and used hardware for applications in telecommunications and computer networking required by wireless service providers. Used hardware is refurbished and tested prior to shipment. Inventories are stated at the lower of cost or market. Cost is determined using average cost which approximates the first-in, first-out (FIFO) method. The Company purchases de-installed telecom equipment individually and in bulk lots. Cost is allocated to individual items in bulk purchases based on management's assessment of each item's value in relation to the total cost of the purchase. The Company has established a valuation allowance for inventories based on a review of composition, quantity, and expected future usage or sales of inventories including expected sales prices. The Company plans on conducting a complete physical inventory observation for all inventories on hand at June 30, 2001. 5. COMPREHENSIVE INCOME (LOSS) No statements of comprehensive income (loss) have been included in the accompanying condensed consolidated financial statements since comprehensive income (loss) and net income (loss) presented in the accompanying condensed consolidated statements of operations would be the same. 6. SEGMENT REPORTING The Company's operations are classified into two reportable business segments for the three and nine months ended March 31, 2001: Asurent Technologies, Inc. (formerly Telcor Communications, Inc.) and DTS. Prior to the acquisition of Asurent Technologies on March 31, 2000, the Company operated in one reportable segment: developer of proprietary equipment for wireless service providers. The Company's two reportable segments are currently managed as separate divisions; however, the Company is in the process of integrating several functions of the two divisions. Page 8 9 Segment information for the three months ended March 31, 2001: A reconciliation of the Company's segment information for the three months ended March 31, 2001 to the respective information in the condensed consolidated financial statements is as follows:

Segment information for the nine months ended March 31, 2001: A reconciliation of the Company's segment information for the nine months ended March 31, 2001 to the respective information in the condensed consolidated financial statements is as follows:

7. UNAUDITED PRO FORMA DATA The following unaudited pro forma combined financial data of Digital Transmission Systems, Inc. ("DTS") and Asurent Technologies, Inc. (formerly Telcor Communications, Inc.) combine the consolidated financial information of DTS for the three and nine months ended March 31, 2000 with the consolidated financial information of Asurent Technologies for the three and nine months ended March 31, 2000. We have prepared the unaudited pro forma information using the purchase method of accounting as if the acquisition took place at the beginning of the periods presented. The pro forma information does not give effect to any restructuring costs, expenses due to terminated full-time or contract employees, discontinued product lines, inventory write-downs, increased reserves, one-time cost of sales adjustments, merger transactional expenses or to any potential expense savings or other operating efficiencies that could result from the merger. The unaudited pro forma combined financial information is not intended to represent what the combined company's financial position or results of operations would have been had the merger occurred at the beginning of the earliest period presented or to project the combined financial position or results of operations for any future date or period. PRO FORMA DATA - THREE AND NINE MONTHS ENDED MARCH 31, 2000 (000'S OMITTED)

Page 9 10 8. INTANGIBLE ASSETS The Company reviews long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to future net cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value of the assets. Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to sell. During the quarter ended March 31, 2001, the Company formally changed the name of its wholly-owned subsidiary from Telcor Communications, Inc. to Asurent Technologies, Inc. As such, the Company began accelerating the amortization of that portion of goodwill that was assigned to the value of the inherited trade name - "Telcor Communications, Inc." - as recorded at the time of acquisition on March 31, 2000. The accelerated amortization will serve to write off the remaining balance of the trade name intangible asset by June 30, 2001. The accelerated amortization resulted in an additional $672,000 in amortization expense recognized during the quarter ended March 31, 2001. As of March 31, 2001, the unamortized portion of the trade name intangible asset is $3,961,226. Page 10 11 ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS GENERAL Digital Transmission Systems, Inc. ("DTS") and subsidiaries (collectively termed the "Company") designs, manufactures, repairs, refurbishes, and markets a broad range of products for the wireless telecommunications ("telecom") industry. The Company's primary customers are domestic and international wireless service providers, including those offering cellular telephone services and Personal Communication Services ("PCS"), and domestic and international resellers/integrators who sell to and service wireless and wireline with telecom equipment. The Company's products of original design, consisting of proprietary software and hardware modules, facilitate the control, monitoring, and efficient transmission of high-speed digital information through wireless public or private telecommunications networks. The Company's network access products enable wireless service providers to give their customers economical, high quality access to public and private networks and various telecommunications services. Important product requirements in the market segments the Company serves 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. Through its wholly-owned subsidiary, Asurent Technologies, Inc. ("Asurent Technologies" formerly known as Telcor Communications, Inc.), the Company also acquires and markets de-installed and refurbished telecom equipment originally designed and manufactured by leading telecom equipment suppliers such as Nokia, Lucent, and Ericsson. In addition, Asurent Technologies offers repair services to its customers on products from third party vendors. Major customers of DTS and Asurent Technologies also include Nextel, Alltel Wireless and Alltel Supply, Dobson Cellular, Lucent, and Verizon. The Company markets its products through a direct sales force employing inside and outside sales representatives 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. The Company also utilizes telecommunications equipment resellers and agents in the United States and other countries to market to customers. RESULTS OF OPERATIONS THREE MONTHS ENDED MARCH 31, 2001 AND MARCH 31, 2000 The following table sets forth certain financial data derived from the Company's statement of operations for the three months ended March 31, 2001 and March 31, 2000 (dollars in thousands).

Page 11 12 NET SALES. Net sales increased by 303%, to $12,673,000 for the three months ended March 31, 2001 from $3,145,000 for the three months ended March 31, 2000. The increase in sales was due in large part to the inclusion of revenue from the Company's' wholly-owned subsidiary, Asurent Technologies, Inc. The sales mix, and the corresponding percentage of total sales of the Company's products, is set forth in the chart below (dollars in thousands):

Revenues from the Company's FlexT1/E1 product line increased 6% from $2,938,000 for the three months ended March 31, 2000 to $3,122,000 for the three months ended March 31, 2001 due to greater demand for the Company's network access products from its two largest customers. Equipment sales of $9,386,000 and $0 were recorded for the three month periods ended March 31, 2001 and 2000, respectively. The increase is due to the acquisition of Telcor Communications, Inc. (now Asurent Technologies) on March 31, 2000. The Company began consolidating the results of operations of Asurent Technologies on April 1, 2000 and, accordingly, no equipment sales were recorded during the three month period ended March 31, 2000. Asurent Technologies sales for the three month period ended March 31, 2001 were less than the same period a year ago due to discontinuance of certain consumer oriented product lines and other products not targeted to wireless carriers. 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 211% from $1,188,000 for the three month period ended March 31, 2000 to $3,691,000 for the three month period ended March 31, 2001. As a percentage of sales, gross profit decreased from 38% for the three month period ended March 31, 2000 to 29% for the three month period ended March 31, 2001. The decrease reflects the inclusion of a significant portion of lower margin sales of new and refurbished equipment as realized by the Company's subsidiary, Asurent Technologies, during the three month period ended March 31, 2001. Margins on new and refurbished equipment sales at Asurent Technologies have historically ranged from 25% to 35% depending upon the product mix and customer. PRODUCT DEVELOPMENT. Product development expense consists of personnel costs, consulting, supplies and prototyping expenses. Product development expenses increased 310%, to $459,000 for the three months ended March 31, 2001 from $112,000 for the three months ended March 31, 2000. The increase in product development expense for the three month period ended March 31, 2001 is primarily due to increased spending on new development projects. As a percentage of sales, product development costs remained consistent at 4% of sales for the three month periods ended March 31, 2001 and 2000. 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 increased by 316%, to $3,177,000 for the three months ended March 31, 2001 from $763,000 for the three months ended March 31, 2000. The increase is attributable to the Company's acquisition of Telcor Communications, Inc. (now named Asurent Technologies, Inc.) on March 31, 2000. The Company began consolidating the results of operations of Asurent Technologies on April 1, 2000 and, as such, no comparable selling, general and administrative expense was recorded Page 12 13 during the three month period ended March 31, 2000. For the three month period ended March 31, 2001, Asurent Technologies contributed $2,471,000 to total selling, general and administrative expenses. Excluding the Asurent Technologies contribution, selling, general and administrative expenses decreased by $57,000, or 7%, for the three month period ended March 31, 2001 as compared to the same period ended March 31, 2000. The decrease is attributable to reduced professional and legal fees as compared to the same period in the prior year. As of March 31, 2001 the Company had approximately 112 full-time employees reflecting an increase in overall headcount of 82, from 30 full-time employees as of March 31, 2000. Total selling, general and administrative costs were 25% of total sales for the three months ended March 31, 2001 as compared to 24% of sales for the three months ended March 31, 2000. NET LOSS. For the three month period ended March 31, 2001, the Company recorded a net loss of $2,264,000 as compared to a net profit of $153,000 reported for the three month period ended March 31, 2000. The increase in the net loss is primarily a result of amortization of intangible assets recorded as a result of the Asurent Technologies (formerly "Telcor") acquisition on March 31, 2000, additional selling general and administrative expenses, and increased interest costs. Interest expense of the Company increased from $81,000 for the three months ended March 31, 2000 to $350,000 for the three months ended March 31, 2001. Excluding depreciation and amortization charges, the Company would have recorded operating income of $55,000 for the three month period ended March 31, 2001. NINE MONTHS ENDED MARCH 31, 2001 AND MARCH 31, 2000 The following table sets forth certain financial data derived from the Company's statement of operations for the nine months ended March 31, 2001 and March 31, 2000 (dollars in thousands).

Page 13 14 NET SALES. Net sales increased 426%, to $36,212,000 for the nine months ended March 31, 2001 from $6,887,000 for the nine months ended March 31, 2000. The sales mix, and the corresponding percentage of total sales of the Company's products, is set forth in the chart below (dollars in thousands):

Revenues from the Company's FlexT1/E1 product line increased 19% from $6,548,000 for the nine months ended March 31, 2000 to $7,802,000 for the nine months ended March 31, 2001. Equipment sales of $28,000,000 and $0 were recorded for the nine month periods ended March 31, 2001 and 2000, respectively. The increase is due to the acquisition of Telcor Communications, Inc. (now Asurent Technologies) on March 31, 2000. The Company began consolidating the results of operations of Asurent Technologies on April 1, 2000 and, accordingly, no equipment sales were recorded during the nine month period ended March 31, 2000. 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 329% from $2,598,000 for the nine month period ended March 31, 2000 to $11,136,000 for the nine month period ended March 31, 2001. As a percentage of sales, gross profit decreased from 38% for the nine month period ended March 31, 2000 to 31% for the nine month period ended March 31, 2001. The decrease reflects the inclusion of a significant portion of lower margin sales of new and refurbished equipment as realized by the Company's subsidiary, Asurent Technologies, Inc. during the nine month period ended March 31, 2001. Margins on new and refurbished equipment sales at Asurent Technologies have historically ranged from 25% to 35% depending upon the product mix and customer. PRODUCT DEVELOPMENT. Product development expense consists of personnel costs, consulting, supplies and prototyping expenses. Product development expenses increased 95%, to $1,010,000 for the nine months ended March 31, 2001 from $519,000 for the nine months ended March 31, 2000. The increase in product development expense for the nine month period ended March 31, 2001 is primarily due to increased spending on new development projects and an increase in engineering headcount. Further, approximately $105,000 of development costs related to new projects were capitalized for the nine month period ended March 31, 2001 as compared to $175,000 for the nine month period ended March 31, 2000. As a percentage of sales, product development costs were 3% for the nine months ended March 31, 2001 and 8% for the nine months ended March 31, 2000. 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 increased by 622%, to $11,077,000 for the nine months ended March 31, 2001 from $1,535,000 for the nine months ended March 31, 2000. The increase is primarily attributable to the Company's acquisition of Telcor Communications, Inc. (now named Asurent Technologies, Inc.) on March 31, 2000. The Company began consolidating the results of operations of Asurent Technologies on April 1, 2000 and, as such, no comparable selling, general and administrative expense was recorded during the nine month period ended March 31, 2000. For the nine month period ended March 31, 2001, Asurent Technologies contributed $9,008,000 to total selling, general and administrative expenses. Excluding the Asurent Technologies contribution, selling, general and administrative expenses increased by $534,000 for the nine Page 14 15 month period ended March 31, 2001 as compared to the same period ended March 31, 2000. The increase is attributable to additional personnel compensation costs as a result of an overall increase in headcount. As of March 31, 2001, the Company had approximately 112 full-time employees reflecting an increase in overall headcount of 82, from 30 full-time employees as of March 31, 2000. Total selling, general and administrative costs were 31% of total sales for the nine months ended March 31, 2001 as compared to 22% of sales for the nine months ended March 31, 2000. NET LOSS. The net loss increased to $6,440,000 for the nine months ended March 31, 2001, from $104,000 for the nine months ended March 31, 2000. The increase in the net loss is primarily a result of amortization of intangible assets recorded as a result of the Asurent Technologies (formerly "Telcor") acquisition on March 31, 2000, additional selling general and administrative expenses, and increased interest costs. Interest expense of the Company increased from $291,000 for the nine months ended March 31, 2000 to $1,248,000 for the nine months ended March 31, 2001. Excluding depreciation and amortization charges, the Company's operating loss for the nine month period ended March 31, 2001 would have been $951,000 which reflects additional product development charges and increased general and administrative expenses of the Company. LIQUIDITY AND CAPITAL RESOURCES OVERVIEW. The accompanying financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. As shown in the accompanying financial statements during the nine months ended March 31, 2001, the Company incurred a net loss of $6,440,000. Although the Company has an accumulated deficit of $25,548,000 as of March 31, 2001, the Company has made substantial progress over the past several quarters with respect to its overall financial position. As of March 31, 2001 total net equity of the Company increased to $16,488,000 as compared to net equity of $4,811,000 as of March 31, 2000. Additionally, the Company received monetary support from a significant investor during fiscal year 2000. Such support enabled the Company to more effectively manage its cash commitments and indebtedness. Additional equity may be required during the upcoming quarters in calendar 2001 and the Company is actively pursuing various financing alternatives. As of March 31, 2001 the Company's cash position is $689,000. Additionally, available borrowings under the Company's notes payable to banks at March 31, 2001 is $215,000. Such availability will be utilized in the near term to address the Company's existing accounts payable, notes payable and inventory purchase commitments. The Company believes its current cash position and availability under its credit facilities may be inadequate to address immediate cash requirements as dictated by the Company's existing commitments. As such, the Company continues to actively pursuing any and all potential financing alternatives to raise immediate short-term cash. Potential additional sources of cash for use in future periods may include, but are not limited to, private or public placements of the Company's securities, securing additional financing with certain financial institutions and the sale of existing Company assets. In the event the Company is able to raise additional capital, the Company intends on using such proceeds to accelerate product development initiatives, add additional personnel as may be required and to pay down existing and any additional indebtedness. The Company has been unsuccessful to date in obtaining external financing from both current and prospective investors but plans to continue to seek external funding to further the Company's strategic direction. EQUITY. On October 14, 1998, NASDAQ delisted the Company because the Company did not meet the listing requirement of minimum net assets. 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, the Company employed several programs in an effort to help the Company preserve cash which, in the first and second fiscal quarters of 1999, was used to fund severance costs of terminated employees, to fund payroll and essential expenses and the purchase of supplies from critical vendors. First, a group of employees and affiliates volunteered to forego or delay salary, commission and other compensation payments through a restricted stock for cash program offered by Board resolution on August 10, 1998. Under that program a total of approximately 395,612 common shares were approved by the Board to compensate those employees and affiliates in return for cancellation of salary or other compensation payments totaling $52,320 and a delay of payment of another $62,206. These shares could not be pledged, sold or traded until November 30, 1999 at which time, under Rule 144, the restricted legend was removed from the certificates and the certificates are now freely tradable. Page 15 16 On December 29, 1999, the Company entered into an agreement with Wi-LAN Inc. ("Wi-LAN"), a leading provider of wireless data communications technology and products, to sell Wi-LAN $1.5 million in convertible debentures (the "1999 debentures"). The debentures, convertible into the Company's common stock at any time by the holder, have a four-year term with a 10% interest rate with principal and interest due at maturity. The Company has no buy-back provision, and the conversion rate is one share per $1 in debentures, which approximated the fair value of the Company's common stock on the date the Company entered into the agreement. On January 7, 2000, a closing on the Wi-LAN debentures was held whereby the Company received the proceeds from the first tranche of the debentures of $400,000. The remaining $1,100,000 in proceeds from the issuance of debentures was received prior to March 31, 2000. In connection with various transactions subsequent to the sale of the $1.5 million in debentures and through June 30, 2000, Wi-LAN has converted $1,278,900 of the 1999 debentures into 1,278,900 shares of the Company's common stock. The outstanding amount of these 1999 debentures as of March 31, 2001 is $221,100. In connection with the agreement, Wi-LAN also received an option to purchase additional debentures of $1.5 million with similar terms but at a conversion rate to be determined by the market price of the Company's common stock at the time the option is exercised. The expiration on the option to purchase additional debentures of $1.5 million is January 7, 2002. Apart from the transactions described above, in January 2000, Wi-LAN purchased 1,738,159 shares of the Company's common stock from MicroTel, another DTS shareholder, and the outstanding $2 million in debentures (the "1997 debentures") with outstanding warrants from Finova Mezzanine Capital, a DTS lender. By converting $1,310,000 of the 1997 debentures, Wi-LAN received 1,310,000 shares of the Company's common stock and gained over 50% of the outstanding common stock of the Company. Through the transaction with Finova, Wi-LAN also received outstanding warrants for 702,615 shares of common stock at an exercise price of $1 per share which expire in March 2004. All 702,615 warrants remain outstanding and exercisable as of March 31, 2001. Additionally, Wi-LAN converted another $190,000 of the 1997 debentures into 190,000 shares of the Company's common stock through September 30, 2000. The outstanding amount of the 1997 debentures as of March 31, 2001 is $500,000. On March 31, 2000, Wi-LAN purchased 454,737 shares of the Company's Series B preferred stock for $3 million in cash. The Company's Series B Preferred Stock is convertible into common shares at $7.125 per share, the market closing price of the Company's common stock on March 30, 2000. In June 2000, Digital Transmission Systems, Inc. announced that Wi-LAN Inc. entered into a purchase and assignment agreement with the two former shareholders of Telcor to acquire the right to receive approximately 31% of the merger consideration still due to the former Telcor shareholders. According to the agreement, Wi-LAN acquired $6,100,000 of the original $20 million acquisition payable for $500,000 in cash and $5,600,000 by issuing the former Telcor shareholders a right to receive $5,600,000 of Wi-LAN common shares based on the market value of Wi-LAN shares on July 17, 2000, subject to a specified maximum number of shares. Wi-LAN may redeem all or part of the right for cash. In addition, Wi-LAN granted the former Telcor shareholders an option exercisable by August 31, 2000, to sell between $2,000,000 and $4,000,000 of additional merger consideration to Wi-LAN for the issuance of a right to receive Wi-LAN shares of equivalent value, based on the market value of Wi-LAN shares at October 30, 2000, subject to a specified maximum number of shares. The former Telcor shareholders exercised the option (mentioned above) on October 31, 2000 and agreed to sell $4,000,000 of merger consideration to Wi-LAN, Inc. On November 30, 2000, the Company paid down the entire remaining acquisition payable balance of $7,655,400 through the issuance of common and Preferred stock. The Company issued 638,273 shares of its common stock valued at $2.064 per share and remitted a cash payment of $117,605 to the former shareholders of Telcor as final consideration owed to the former Telcor shareholders under the amended merger agreement. The value of $2.064 per share represents the share value calculated by the parties pursuant to the terms of the merger agreement as executed on March 31, 2000. Further, the Company issued 683,543 common shares valued at $2.064 per share and 2,330,217 shares of Series C Preferred Stock convertible into the Company's common stock at $2.064 per share to Wi-LAN, Inc. also reflecting final payment of all remaining merger consideration then payable. The total consideration paid under the above transactions was $7,655,400 and represented the final payments for all amounts owed under the merger agreement, as amended, to the former shareholders of Telcor and to Wi-LAN, Inc. On January 25, 2000, the Board of Directors of the Company approved a plan whereby certain compensation obligations of the Company to employees and Board members could be satisfied through the issuance of restricted common stock at the option of the holder. Approximately 30,000 shares of the Company's common stock were issued to satisfy such obligations. The shares were Page 16 17 issued at $3.56 per share (a 25% discount from the market closing price on January 25, 2000) and are restricted as to trade, pledge, or sale until January 25, 2001. The Company recorded $143,000 in compensation expense to reflect the satisfaction of these obligations which represented the fair market value of the shares issued. LINE OF CREDIT ARRANGEMENTS. On April 10, 1997, DTS established a bank line of credit agreement with Silicon Valley Bank which makes available $2,500,000 in borrowings with availability based on DTS'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% of eligible receivables plus 30% of eligible inventory, as defined, through the maturity date of April 10, 2000. The loan is secured by DTS's assets and bears interest at the rate of prime plus 2.25%. A net worth covenant was amended on March 16, 1998, requiring DTS to maintain a net worth of $1,000,000. In September 1998, DTS agreed to a UCC filing whereby all assets of DTS became 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. DTS issued 60,000 two year warrants to Silicon Valley Bank at a strike price of $5.25 each as consideration for the amended agreement. On February 25, 1999, DTS signed an amendment to the loan agreement with Silicon Valley Bank which modified previous loan covenants and revised the maximum borrowing amount to $1,500,000. The revised covenants are primarily based upon minimum monthly and quarterly revenue levels. As consideration for the amended agreement, DTS issued 250,000 two year warrants for common stock of the Company at $0.119 per share which represents the market price of the Company's common stock at the close of business on December 2, 1998 when the new agreement was reached. On February 24, 2000, DTS signed an additional amendment to the loan agreement with Silicon Valley Bank which modified previous terms. Under the modified terms, the revised loan agreement bears a maturity date of April 10, 2001. Additionally, the revised and amended agreement increased the maximum borrowing to $2,500,000 and bears interest at prime plus 2 1/4 (10.25% at March 31, 2001). Covenants under the agreement were further revised to require certain minimum quarterly revenue and monthly income requirements. On February 16, 2001, DTS signed an additional amendment to the loan agreement with Silicon Valley Bank which modified previous terms. Under the modified terms, covenants imposed by the agreement were revised. All revenue and income covenants previously enforced were removed and replaced with a single covenant requiring a minimum level of net tangible equity on a monthly basis. DTS was in compliance with all covenants imposed by the agreement as of March 31, 2001. Amounts outstanding under the DTS line of credit facility were $1,552,000 and $2,068,000 at March 31, 2001 and 2000, respectively. On April 10, 2001, DTS signed an additional amendment to the loan agreement with Silicon Valley Bank that extended the maturity date of the loan agreement to April 10, 2002. No other terms of the agreement were changed. Additionally, the Company's wholly-owned subsidiary, Asurent Technologies, Inc. ("Asurent Technologies" formerly Telcor Communications, Inc.) has a revolving credit facility with a commercial bank (PNC Bank) at LIBOR plus 2.5% or prime, whichever is lower, the interest on which is payable monthly. Under the agreement, Asurent Technologies is allowed to borrow up to 85% of eligible accounts receivable and 50% of eligible inventory with an established limit of $11,000,000 as of March 31, 2001. On February 8th, 2001 Asurent Technologies ammended their agreement with PNC Bank. The new ammendment reduced the established limit of the line of credit from $17,000,000 to $11,000,000. At March 31, 2001, amounts outstanding under the Asurent Technologies line of credit facility are $8,565,000, and the interest rate was 8.0%. The line is collateralized by Asurent Technologies' trade accounts receivable, inventories, and all other assets. The Asurent Technologies revolving line of credit is scheduled to expire on May 11, 2002. Under the agreement, Asurent Technologies is required to comply with certain covenants which include, but are not limited to, maintaining minimum requirements for debt to equity, net worth, cash flows, and capital expenditures. At March 31, 2001, Asurent Technologies was not in compliance with all covenants imposed by the line of credit agreement. Page 17 18 CASH. As of March 31, 2001, the Company had approximately $689,000 in cash and cash equivalents. For the nine months ended March 31, 2001, $2,434,000 was used in operating activities as compared to cash provided by operations of $637,000 for the nine months ended March 31, 2000. The net loss for the nine months ended March 31, 2001 of $6,440,000 includes non-cash charges relating to depreciation and amortization of $4,183,000. Exclusive of non-cash charges, cash was used in operations primarily through an increase in accounts receivable of $719,000 and a net decrease in accounts payable, accrued expenses and warranty costs of $397,000. Heretofore, the Company has been able to satisfy its immediate short-term cash requirements through increasing equipment sales and accelerating collections coupled with managing vendor accounts and relationships. The Company purchased $871,000 and $26,000 of property and equipment during the nine months ended March 31, 2001 and 2000, respectively. In addition, the Company capitalized certain software development costs paid to outside contractors. During the nine months ended March 31, 2001, the Company capitalized $105,000 of such costs as compared to capitalized costs of $175,000 for the nine months ended March 31, 2000. OTHER MANAGEMENT DISCUSSION AND ANALYSIS Subsidiary Name Change. On March 1, 2001, the Company's wholly-owned subsidiary, Telcor Communications, Inc., changed its name from Telcor Communications to Asurent Technologies, Inc. to reflect the subsidiary's new management structure and global vision as it enters the new millennium. The Company further plans on changing its overall corporate identity and structure from Digital Transmission Systems, Inc. to Asurent, Inc. before the end of calendar year 2001. Asurent, Inc. will serve as a holding company for two wholly-owned subsidiaries - Asurent Wireless, Inc. and Asurent Technologies, Inc. The overall corporate identity change is subject to shareholder approval at the Company's annual shareholder meeting scheduled for late 2001. Additional details and background information on the identity change will be properly included with any mailing of shareholder voting materials. New Product Direction. The Company had announced previously that it had intentions of developing products for the LMDS market by licensing and incorporating W-OFDM technology from Wi-LAN, the Company's major investor. After developing a business case that reviewed current LMDS competitors, product standards, frequency allocation in various global markets and investment requirements, the Company has determined that the investment requirements and market risk associated with such products do not justify expected returns. The Company has now abandoned all efforts to develop LMDS products and will continue to focus on developing products for its core market - network access equipment for wireless carriers. Shareholder Debt. On March 22, 2001 the Company notified former shareholder's of Telcor Communications, Inc. that a $3 million note due and payable on April 1, 2001 would not be paid by the Company until an adequate assessment of the Company's claims submitted pursuant to its rights under the Agreement and Plan of Merger By and Among Telcor Communications, Inc., ICT Acquisition Corp. and Digital Transmission Systems, Inc. has been performed. It is the Company's position that any amounts deemed owed the Company pursuant to the claims review can be used to offset any amounts owed the former shareholder's of Telcor. Management Changes/Consulting Agreement. Lance Weller, co-founder of Telcor Communications, Inc. (now Asurent Technologies, Inc.), remained an employee of the Company through February 9, 2001, a little more than 10 months after the merger with DTS. During that time Mr. Weller was engaged in the management transition whereby a new President and other officers were recruited and installed as the operational management team at Asurent Technologies. Through February 9, 2002 Mr. Weller will be paid a severance compensation, amounting to a base pay of approximately $20,833 a month, which is in compliance with the employment agreement he signed at the time of the merger and for which he agreed to certain non-compete conditions. In return, Mr. Weller has agreed to serve as a consultant to the Company, assisting in marketing and sales whereby he may be involved in the purchase and sale of equipment on behalf of the Company but only under the supervision and consent of the Company's sales management. 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 Page 18 19 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. The Company's backlog for its network access products at March 31, 2001 is $3,990,019 and is primarily deliverable through June 30, 2001. NEW ACCOUNTING PRONOUNCEMENTS In June 1999, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 137, "Accounting for Derivative Instruments and Hedging Activities - Deferral of the Effective Date of FASB Statement No. 133," which deferred implementation of SFAS 133 until fiscal quarters of fiscal years beginning after June 15, 2000. SFAS 133 requires all derivatives to be carried on the balance sheet at fair value. Changes in the fair value of derivatives must be recognized in the Company's Consolidated Statement of Operations when they occur; however there is an exception for derivatives that qualify as hedges as defined by SFAS 133. If a derivative qualifies as a hedge, a company can elect to use "hedge accounting" to eliminate or reduce the income statement volatility that would arise from reporting changes in a derivative's fair value. In June 2000, the FASB issued SFAS No. 138, "Accounting for Derivative Instruments and Hedging Activities - an amendment of FASB Statement No. 133." SFAS No.138 adds to the guidance related to accounting for derivative instruments and hedging activities. This statement should be adopted concurrently with SFAS 133. The adoption of both SFAS 133 and 138 has not materially impacted the Company's financial results. In December 1999, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 101 ("SAB 101"), "Revenue Recognition in Financial Statements." SAB 101 summarizes existing guidance on revenue recognition. The implementation date of SAB 101 is no later than the fourth quarter of fiscal years beginning after December 15, 1999. The Company believes that implementation of SAB 101 will not have a material impact on the Company's financial statements. In March 2000, the FASB issued FASB Interpretation No. 44 (FIN 44), "Accounting for Certain Transactions involving Stock Compensation - an Interpretation of Accounting Principles Board Opinion No. 25." FIN 44 provides guidance for certain issues that arose in applying APB 25. The provisions were effective July 1, 2000, and, generally, are applied prospectively. Adoption of FIN 44 has not materially impacted the Company's financial results. 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 Page 19 20 adverse outcomes in such litigation; (xii) failure to successfully implement the Company's Year 2000 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 the occurrence of unanticipated events. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK The Company is exposed to market risk from changes in interest rates on variable rate indebtedness. The Company's primary interest rate risk relates to its variable rate bank credit facilities. At March 31, 2001, the Company's total variable rate debt obligations was $10,117,000. A hypothetical 1% increase in the Company's variable interest rate for a duration of one year would result in additional interest expense of approximately $101,000. Page 20 21 PART II. OTHER INFORMATION PART II. OTHER INFORMATION -------------------------------------------------------------------------------- ITEMS 1 - 5 ARE NOT APPLICABLE. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (A) EXHIBITS None. (B) REPORTS ON FORM 8-K The registrant did not file any reports on Form 8-K during the three months ended March 31, 2001. -------------------------------------------------------------------------------- Page 21 22 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: May 14, 2001 By: /s/ Andres C. Salazar ------------------------------ Andres C. Salazar Chief Executive Officer Date: May 14, 2001 By: /s/ Clive N. W. Marsh -------------------------------- Clive N. W. Marsh, V.P. Finance (Principal Accounting Officer) Page 22

DIGITAL TRANSMISSION SYSTEMS INC \DE\ 10-Q