10-Q 1 g74256e10-q.txt DIGITAL TRANSMISSION SYSTEMS, INC. =============================================================================== 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 December 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.) 3400 RIVER GREEN COURT, DULUTH, GA 30096 (Address of principal executive office) (Zip Code) (770) 622-1200 (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 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 February 14, 2002 was 16,238,470. =============================================================================== DIGITAL TRANSMISSION SYSTEMS, INC. FORM 10-Q FOR THE QUARTER ENDED DECEMBER 31, 2001 INDEX

Page 2 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 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 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 as their effect would be anti-dilutive See accompanying notes to condensed consolidated financial statements. Page 5 DIGITAL TRANSMISSION SYSTEMS, INC. AND SUBSIDIARIES Condensed Consolidated Statements of Cash Flows (unaudited) (in thousands)

See accompanying notes to condensed consolidated financial statements. Page 6 DIGITAL TRANSMISSION SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2001 (UNAUDITED) 1. DESCRIPTION OF THE BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES. Digital Transmission Systems, Inc. ("DTS") and subsidiaries, Asurent Wireless ("AW") and Asurent Technologies ("AT"), (collectively termed the "Company") designs, manufactures, repairs and markets a broad range of products for the telecommunications ("telecom") industry. AW's primary customers are long-distance carriers, 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 end users with telecom equipment. AW'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 public or private telecommunications networks. AW'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, access to the Internet and video and desktop conferencing. Important product requirements in the market segments AW serves include high feature density, modularity, quality performance and compactness. AW's products meet these requirements and are suitable for both wireline and wireless service environments. Major customers of AW include Nextel Communications, Nextel Partners, Alltel Wireless and Alltel Supply. AW 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. AW also utilizes telecommunications equipment resellers and agents in the United States and other countries to market to private network customers. In late fiscal 2001, the Company's Board of Directors approved a plan to divest of its de-installed telecommunications equipment business (AT - formerly Telcor Communications). The financial statements have been reclassified to account for the operating results of AT as discontinued operations. The following discussion relates only to the Company's continuing operations. The decision for divestiture was based on a thorough strategic and financial review of the Company's operations and subsidiaries coupled with the consideration of the severe macroeconomic conditions in the telecommunications industry. The Company decided to only retain those segments that will potentially provide self-generated positive and profitable growth in the near-term as access to external financing has been difficult to obtain in recent periods. For further information refer to Note 6 to the condensed consolidated financial statements. 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 Page 7 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, 2001 are not necessarily indicative of the results that may be expected for the year ended June 30, 2002. 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, 2001. 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. 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 1,653,848 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 December 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, and outstanding stock options from the calculations of diluted net loss per share as all such securities are anti-dilutive for the three months ended December 31, 2001. The total potential number of dilutive equivalent common shares excluded was 1,963,848 for the three month period ended December 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 AW'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. AW purchases new hardware for applications in telecommunications and computer networking. Cost is determined using average cost which approximates the first-in, first-out (FIFO) method. AW has established a valuation allowance for inventories based on a review of the composition, quantity, and expected future usage or sales of inventories including expected sales prices. 5. COMPREHENSIVE INCOME (LOSS) No statements of comprehensive income (loss) have been included in the accompanying consolidated financial statements since comprehensive loss and net loss presented in the accompanying consolidated statements of operations would be the same. 6. SALE OF DISCONTINUED SUBSIDIARY The Company's subsidiary - Asurent Technologies ("AT") - completed a transaction on October 10, 2001 in which it sold to Somera Communications, Inc. ("Somera") a substantial portion of its assets. All financial results of AT have been reported as discontinued operations for the year ended June 30, 2001 and for the three and six months ended December 31, 2001 given the Company's decision in late fiscal 2001 to divest of AT. The significant terms of the transaction called for Somera to purchase certain accounts receivable, inventory and property, plant and equipment of AT at book value as of August 31, 2001 coupled with the assumption of certain AT liabilities as defined in the agreement. Somera paid $6,000,000 in cash to AT as consideration for the asset purchase. The Page 8 proceeds from the transaction were used to pay down AT's secured creditors, including PNC Bank, as of the transaction date. Immediately following the sale, the Company began liquidating all remaining assets of AT in order to pay down unsecured trade debt. As of December 31, 2001, net liabilities of discontinued operations (AT) approximates $10,566,000 and represents outstanding unsecured trade payables of AT. AT is currently negotiating settlements with all unsecured creditors of AT that are being funded as the remaining assets at AT are liquidated. DTS and Asurent Wireless (AW) have not guaranteed the remaining unsecured AT indebtedness in any way and are not party to the obligations. 7. FORMATION OF EMPLOYEE STOCK OWNERSHIP PLAN AND PURCHASE OF SHARES FROM WI-LAN, INC. Formation of ESOP - On approval of the DTS Board of Directors, an Employee Stock Ownership Program ("ESOP") was formed on December 31, 2001 for the benefit of the employees of DTS and its major subsidiary - Asurent Wireless, Inc. Under the plan, all full-time employees and part-time employees with at least 20 hrs/week are eligible to participate in the plan. Participants are permitted to contribute up to 5% of their annual salary with a 100% match by the Company for such individual contributions. The Company may also make discretionary contributions to the plan but cannot exceed 5% of each individual's salary. Employer contributions will vest over five years on a straight line basis. All contributions to the ESOP will be used to purchase common stock of the Company for the ESOP at 10 cents per share. Each year, on December 31, a third party will provide an independent valuation of the Company's common stock. This valuation will serve as the basis for valuing participant accounts for that given period. Purchase of stock from Wi-LAN, Inc. - In a transaction executed on December 31, 2001, the DTS ESOP entered into a stock purchase agreement with Wi-LAN, Inc., then a major shareholder in DTS. The agreement stipulated that the DTS ESOP would purchase all of Wi-LAN's equity holdings in DTS once converted into common shares. All preferred securities, convertible debentures including accrued interest to date and warrants as held by Wi-LAN, Inc. were converted into common stock of the Company. An initial deposit of $103,000 towards a programmed installment purchase of the shares was delivered by the ESOP to Wi-LAN on December 31, 2001. The agreement allowed the ESOP assignment rights in the purchase of the shares and a rescission date of no later than February 28, 2002. As a result of the ESOP transaction with Wi-LAN, Inc., the number of common shares outstanding now approximates 15.8 million shares with approximately 10.3 million shares being held by the DTS ESOP. Additional disclosures regarding the DTS ESOP can be found on page 15 of this report. 8. CHANGES IN EXECUTIVE LEADERSHIP AND BOARD OF DIRECTOR MEMBERSHIP In compliance with the agreement between Wi-LAN and the DTS ESOP, Hatim Zaghloul and Robert Schulz, DTS Board members, tendered their resignations from the Company's Board of Directors effective December 31, 2001. Both individuals are members of the Wi-LAN, Inc. Board of Directors and had served on the Company's Board of Directors during the time that Wi-LAN held a majority of the Company's common stock. On January 9, 2002, the DTS Board of Directors appointed Soren Pihlman, President and COO of Asurent Wireless, DTS' major subsidiary, to the DTS Board. Simultaneously, Andy Salazar was appointed Chairman of the Board. Mr. Salazar announced his retirement as a full-time DTS employee effective February 1, 2002. However, Mr. Salazar will be available to consult with DTS, Asurent Wireless or Asurent Technologies on an as-needed basis under consulting agreements which compensate him at his previous salary level on a pro-rata basis. Page 9 ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS GENERAL Digital Transmission Systems, Inc. ("DTS") and subsidiaries, Asurent Wireless ("AW") and Asurent Technologies ("AT"), (collectively termed the "Company") designs, manufactures, repairs and markets a broad range of products for the telecommunications ("telecom") industry. AW's primary customers are long-distance carriers, 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 end users with telecom equipment. AW'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 public or private telecommunications networks. AW'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, access to the Internet and video and desktop conferencing. Important product requirements in the market segments AW serves include high feature density, modularity, quality performance and compactness. AW's products meet these requirements and are suitable for both wireline and wireless service environments. Major customers of AW include Nextel Communications, Nextel Partners, Alltel Wireless and Alltel Supply. AW 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. AW also utilizes telecommunications equipment resellers and agents in the United States and other countries to market to private network customers. RESULTS OF OPERATIONS THREE MONTHS ENDED DECEMBER 31, 2001 AND DECEMBER 31, 2000 The following table sets forth certain financial data derived from the Company's statements of operations for the three months ended December 31, 2001 and December 31, 2000 (dollars in thousands).

Page 10 NET SALES. Net sales decreased by 21%, to $1,778,000 for the three months ended December 31, 2001 from $2,261,000 for the three months ended December 31, 2000. The sales mix, and the corresponding percentage of total sales of AW products, is set forth in the chart below (dollars in thousands):

For the three months ended December 31, 2001, revenues from the Company's FlexT1/E1 product line decreased 21% from $2,261,000 for the three months ended December 31, 2000 to $1,778,000 for the three months ended December 31, 2001. The decrease is primarily due to a shift to more conservative capital spending in the wireless carrier market during recent months. Further, network infrastructure investments of AW's primary customers were delayed due to expectations of reduced subscriber growth as a result of current economic conditions in the marketplace. The Company expects capital spending by its customers to gradually increase and return to more normal and historical levels in future periods as the overall condition of the U.S. economy and the telecommunications marketplace improves. GROSS PROFIT. Cost of sales consists of component costs, compensation costs and the overhead costs related to the production and shipping of AW's products, along with the support and warranty expense associated with such products. Gross profit decreased 45% from $860,000 for the three month period ended December 31, 2000, to $473,000 for the three month period ended December 31, 2001 due to the accompanying decrease in sales noted for the same period. As a percentage of sales, gross profit decreased from 38% to 27% of sales for the three month period ended December 31, 2001 as compared to the same period ended December 31, 2000. The decrease is due to a lower margin product mix, primarily OEM products, for sales recorded during the three months ended December 31, 2001. PRODUCT DEVELOPMENT. Product development expense consists of personnel costs, consulting, supplies and prototyping expenses. Product development expenses decreased 23%, to $271,000 for the three months ended December 31, 2001 from $350,000 for the three months ended December 31, 2000. The decrease in product development expense for the three month period ended December 31, 2001 is primarily due to decreased spending on new development projects and reduced engineering headcount as compared to the three months ended December 31, 2000. Further, no product development costs related to new projects were capitalized for the three month period ended December 31, 2001 as compared to $34,000 for the three month period ended December 31, 2000. As a percentage of sales, product development costs were 15% for both the three months ended December 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 decreased by 38%, to $528,000 for the three months ended December 31, 2001 from $849,000 for the three months ended December 31, 2000. The decrease is primarily attributable to reduced headcount during the quarter ended December 31, 2001 as compared to December 31, 2000. Total selling, general and administrative costs were 30% of sales for the three months ended December 31, 2001 as compared to 38% of sales for the three months ended December 31, 2000. LOSS FROM CONTINUING OPERATIONS.. For the three month period ended December 31, 2001 the Company recorded a loss from continuing operations of $416,000 as compared to a loss from continuing operations of $490,000 Page 11 reported for the three month period ended December 31, 2000. The decrease in the loss from continuing operations is primarily a result of reduced general and administrative expenses incurred during the quarter ended December 31, 2001 as compared to the quarter ended December 31, 2000. SIX MONTHS ENDED DECEMBER 31, 2001 AND DECEMBER 31, 2000 The following table sets forth certain financial data derived from the Company's statements of operations for the six months ended December 31, 2001 and December 31, 2000 (dollars in thousands).

NET SALES. Net sales decreased 22%, to $3,656,000 for the six months ended December 31, 2001 from $4,680,000 for the six months ended December 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):

For the six months ended December 31, 2001, revenues from the Company's FlexT1/E1 product line decreased 19% from $4,493,000 for the six months ended December 31, 2000 to $3,656,000 for the six months ended December 31, 2001. The decrease is primarily due to a shift to more conservative capital spending in the wireless carrier market during recent months. Further, network infrastructure investments of AW's primary customers were delayed due to expectations of reduced subscriber growth as a result of current economic conditions in the marketplace. The Company expects capital spending by its customers to gradually increase and return to more normal and historical levels in future periods as the overall condition of the U.S. economy and the telecommunications marketplace improves. 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 41% from $2,000,000 for the six month period ended December 31, 2000 to $1,185,000 for the six month period ended December 31, 2001. As a percentage of sales, gross profit decreased Page 12 from 43% for the six month period ended December 31, 2000 to 32% for the six month period ended December 31, 2001. The decrease is due to a lower margin product mix, primarily OEM products, for sales recorded during the six months ended December 31, 2001. PRODUCT DEVELOPMENT. Product development expense consists of personnel costs, consulting, supplies and prototyping expenses. Product development expenses increased 6%, to $582,000 for the six months ended December 31, 2001 from $551,000 for the six months ended December 31, 2000. The increase in product development expense for the six month period ended December 31, 2001 is primarily due to increased engineering headcount during the July 2001 through September 2001 timeframe. Further, no development costs related to new projects were capitalized for the six month period ended December 31, 2001 as compared to $105,000 for the six month period ended December 31, 2000. As a percentage of sales, product development costs were 16% for the six months ended December 31, 2001 and 12% for the six months ended December 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 decreased 34%, to $1,130,000 for the six months ended December 31, 2001 from $1,713,000 for the six months ended December 31, 2000. The decrease is primarily attributable to reduced headcount during the six months ended December 31, 2001 coupled with conscious cost-cutting efforts and initiatives instituted by Company management during July 2001. Total selling, general and administrative costs were 31% of sales for the six months ended December 31, 2001 as compared to 37% of sales for the six months ended December 31, 2000. LOSS FROM CONTINUING OPERATIONS. For the six month period ended December 31, 2001 the Company recorded a loss from continuing operations of $737,000 as compared to a loss from continuing operations of $661,000 reported for the six month period ended December 31, 2000. The increase in the loss from continuing operations is primarily a result of the reduction in gross product margin realized for the six months ended December 31, 2001. 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 financial statements during the six months ended December 31, 2001 and 2000, the Company's continuing operations incurred losses of $737,000 and $661,000, respectively. The Company continues to require additional capital to properly service its debt and fund future product development. Additional equity may be required during fiscal year 2002 and the Company is actively pursuing various financing alternatives. The Company attempted to raise capital throughout fiscal 2001 and was unable to secure adequate financing to assure the long term growth and profitability of the entire organization given the severity of the current downturn in the telecommunications industry. As such, the Board of Directors of the Company decided to approve a plan to divest of Asurent Technologies (formerly Telcor Communications). The Company is now focusing on the continued growth and profitability of its network access product division (Asurent Wireless or "AW") and will continue to explore financing alternatives for working capital and product development initiatives throughout fiscal 2002. The financial statements do not include any adjustments relating to the recoverability and classification of assets and liabilities that might be necessary should the Company be unable to continue as a going concern. 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 or debt financing through discussions with potential lenders and investors. 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 and securing additional financing from certain financial institutions. 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. Page 13 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. 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, 2001, Wi-LAN has converted $1,278,900 of the 1999 debentures into 1,278,900 shares of the Company's common stock. 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 was 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. Additionally, Wi-LAN converted another $190,000 of the 1997 debentures into 190,000 shares of the Company's common stock during January 2000. 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, the Company 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. On August 31, 2000, the former shareholders of Telcor exercised the aforementioned option and sold $4,000,000 of merger consideration to Wi-LAN in exchange for Wi-LAN shares as discussed above. On November 30, 2000, the Company paid down the entire remaining acquisition payable balance of $7,655,400, which was payable in either cash or stock at a value of $2.064 per share under the terms of the merger agreement, 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 Page 14 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. ESOP Transaction with Wi-LAN, Inc. Formation of ESOP - On approval of the DTS Board of Directors, an Employee Stock Ownership Program ("ESOP") was formed on December 31, 2001 for the benefit of the employees of DTS and its major subsidiary - Asurent Wireless, Inc. Under the plan, all full-time employees and part-time employees with at least 20 hrs/week are eligible to participate in the plan. Participants are permitted to contribute up to 5% of their annual salary with a 100% match by the Company for such individual contributions. The Company may also make discretionary contributions to the plan but cannot exceed 5% of each individual's salary. Employer contributions will vest over five years on a straight line basis. All contributions to the ESOP will be used to purchase common stock of the Company for the ESOP at 10 cents per share. Each year, on December 31, a third party will provide an independent valuation of the Company's common stock. This valuation will serve as the basis for valuing participant accounts for that given period. Purchase of stock from Wi-LAN, Inc. - In a transaction executed on December 31, 2001, the DTS ESOP entered into a stock purchase agreement with Wi-LAN, Inc., then a major shareholder in DTS. The agreement stipulated that the DTS ESOP would purchase all of Wi-LAN's equity holdings in DTS once converted into common shares. All preferred securities, convertible debentures including accrued interest to date and warrants as held by Wi-LAN, Inc. were converted into common stock of the Company. An initial deposit of $103,000 towards a programmed installment purchase of the shares was delivered by the ESOP to Wi-LAN on December 31, 2001. The agreement allowed the ESOP assignment rights in the purchase of the shares and a rescission date of no later than February 28, 2002. As a result of the ESOP transaction with Wi-LAN, Inc., the number of common shares outstanding now approximates 15.8 million shares with approximately 10.3 million shares being held by the DTS ESOP. Payment of the ESOP obligation - In accordance with the terms of the ESOP agreement, DTS is obligated to pay Wi-LAN, Inc. the amount of $9,992 per month commencing January 31, 2002 through December 31, 2011 for their conversion and release of all DTS common stock as referenced above. Aggregate principal payments under the note will total $900,000 and the note accrues interest at a 6% annual rate. Cash to fund the ESOP obligation will be generated primarily through our existing cash balances, revenue generated from operations, and through our line of credit with Silicon Valley Bank. In the event existing cash balances are not adequate to cover the future ESOP obligations, an event of default will occur which will cause the ESOP note to be due and payable immediately at the option of Wi-LAN. Right of Recision - DTS has the right to rescind the transaction in the event that it is unable to obtain an independent opinion of an appraiser that the price paid for the common shares is no more than fair market value and that the transaction is fair to DTS from a financial point of view (the "Appraisal"). Within 30 days of receipt of the Appraisal which states that the price paid exceeds the fair market value, or if DTS is unable to obtain an Appraisal, but in no event later than February 28, 2002, DTS must in writing notify Wi-LAN that the transaction is rescinded. In the event such notice is given, the parties shall have the following options: (a) The parties can adjust the terms of the transaction and the balance due on the Note so that DTS has paid no more than fair market value for the common shares; (b) DTS shall have the ability to keep $103,837 of the common shares at such price as determined by the Appraisal and to return the balance of the shares pledged as collateral for the note to Wi-LAN in return for cancellation of the note; or (c) The parties shall have the right to reverse the transaction and return all cash paid to DTS and return all shares received by DTS to Wi-LAN combined with the cancellation of all obligations under the ESOP. Refinancing of ESOP Obligation - DTS shall notify Wi-LAN by November 30, 2002 of its intent to refinance the ESOP note or of its inability to refinance the note. If DTS is unable to refinance the note by December 31, 2002 with a financial institution, Wi-LAN shall have the right to terminate the Loan as follows: (a) If the fair market Page 15 value of the shares serving as collateral as of the date of the loan termination, as determined by the valuation and fairness opinion obtained by DTS, exceeds the outstanding principal amount on the note, then Wi-LAN shall receive a number of common shares which would equal in value such outstanding principal amount due on the note; or (b) If the fair market value of the shares serving as collateral, as determined by the valuation and fairness opinion obtained by DTS, does not exceed the outstanding principal amount on the note, then Wi-LAN shall receive the collateralized shares and the note and all of DTS's obligations under said note and the ESOP agreement shall be cancelled. If the note is refinanced, then DTS shall cause the entire amount of the note then outstanding to be prepaid in accordance with the terms of the ESOP agreement, on or before December 31, 2002. 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. 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 had a maturity date of April 10, 2001. Additionally, the revised and amended agreement increased the maximum borrowing to $2,500,000 with interest at prime plus 2.25% (7.00% at December 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 consolidated net tangible equity on a monthly basis. 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. On November 29, 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 consolidated net tangible equity covenants previously enforced were removed and replaced with a revised equity covenant that calls for a minimum level of tangible equity to be maintained by Asurent Wireless on a monthly basis. The Company was in full compliance with the revised covenants as of December 31, 2001. CASH. For the six months ended December 31, 2001, cash of $1,124,000 was provided by continuing operating activities as compared to cash used in continuing operations of $530,000 for the six months ended December 31, 2000. The loss from continuing operations for the six months ended December 31, 2001 of $737,000 includes non-cash charges relating to depreciation and amortization of $55,000 and interest expense of $161,000. During the six months ended December 31, 2001 cash was provided by continuing operating activities primarily through a decrease in accounts receivable of $1,189,000. The Company's current cash burn rate approximates $250,000 per month and represents payments required to fund certain fixed costs of the Company such as occupancy costs and personnel compensation. The Company intends to fund potential future operating losses and capital expenditures required to pursue its current business plan out of its existing cash balance, revenue generated from operations and borrowings under its line of credit with Silicon Valley Bank. Page 16 The Company's additional cash requirements necessary for debt service will need to be funded through debt facilities and equity financings not yet arranged. The Company is actively seeking external investment to ensure existing and future debt is adequately serviced thereby preventing any interruption in operations. However, there can be no assurance that sufficient financing will be available on terms acceptable to the Company. If such financing is not available, the Company will have to curtail or alter its current business plan. The Company purchased $33,000 and $126,000 of property, plant and equipment during the six months ended December 31, 2001 and 2000, respectively. In addition, the Company capitalized certain software development costs paid to outside contractors. During the six months ended December 31, 2001, the Company capitalized $0 of such costs as compared to capitalized costs of $105,000 for the six months ended December 31, 2000. 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 build-out of the telecommunications infrastructure during certain months of the year. 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. LEGAL PROCEEDINGS 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. RECENT ACCOUNTING PRONOUNCEMENTS 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 for the Company was for the quarter ended June 30, 2001. The implementation of SAB 101 did not have a material impact on the Company's financial statements. In March 2000, the Financial Accounting Standards Board ("FASB") issued FASB Interpretation No. 44 (FIN 44), Accounting for Certain Transactions involving Stock Compensation - an Interpretation of APB Opinion No. 25. FIN 44 provides guidance for certain issues that arose in applying APB Opinion No. 25. The provisions of FIN 44 were effective for the Company on July 1, 2000. Adoption of FIN 44 did not materially affect the Company's financial results. In June 2001, the FASB issued Statement No. 141, Business Combinations, and Statement No. 142, Goodwill and Other Intangible Assets. Statement 141 requires that the purchase method of accounting be used for all business combinations initiated after June 30, 2001, as well as all purchase method business combinations completed after June 30, 2001. Statement 141 also provides that intangible assets acquired in a purchase method business combination must meet certain specified criteria in order to be recognized and reported apart from goodwill, noting that any purchase price allocable to an assembled workforce may not be accounted for separately. Statement 142 will require that goodwill and intangible assets with indefinite useful lives no longer be amortized, but instead tested for impairment at least annually in accordance with the provisions of Statement 142. Statement 142 will also require that intangible assets with estimable useful lives be amortized over their respective estimated useful lives to their estimated residual values, and reviewed for impairment in accordance with FASB Statement No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of. Page 17 The Company is required to adopt the provisions of Statement 141 immediately, and Statement 142 effective July 1, 2002. Furthermore, goodwill and intangible assets determined to have an indefinite useful life acquired in a purchase business combination completed after June 30, 2001, but before Statement 142 is adopted in full will not be amortized, but will continue to be evaluated for impairment in accordance with the appropriate pre-Statement 142 accounting literature. The Company does not expect Statement 141 or 142 to have a significant impact on its financial statements. Also, in June 2001, the FASB issued Statement No. 143, Accounting for Asset Retirement Obligations. Statement 143 requires entities to record the fair value of a liability for an asset retirement obligation in the period in which it is incurred. When the liability is initially recorded, the entity capitalizes a cost by increasing the carrying amount of the related long-lived asset. Over time, the liability is accreted to its present value each period, and the capitalized cost is depreciated over the useful life of the related asset. Upon settlement of the liability, an entity either settles the obligation for its recorded amount or incurs a gain or loss upon settlement. Statement 143 is effective for the Company beginning July 1, 2002. The Company does not expect Statement 143 to have a significant impact on its financial statements. In August 2001, the FASB issued Statement No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets (Statement 144), which supersedes both FASB Statement No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of (Statement 121) and the accounting and reporting provisions of APB Opinion No. 30, Reporting the Results of Operations--Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions (Opinion 30), for the disposal of a segment of a business (as previously defined in that Opinion). Statement 144 retains the fundamental provisions in Statement 121 for recognizing and measuring impairment losses on long-lived assets held for use and long-lived assets to be disposed of by sale, while also resolving significant implementation issues associated with Statement 121. For example, Statement 144 provides guidance on how a long-lived asset that is used as part of a group should be evaluated for impairment, establishes criteria for when a long-lived asset is held for sale, and prescribes the accounting for a long-lived asset that will be disposed of other than by sale. Statement 144 retains the basic provisions of Opinion 30 on how to present discontinued operations in the income statement but broadens that presentation to include a component of an entity (rather than a segment of a business). Unlike Statement 121, an impairment assessment under Statement 144 will never result in a write-down of goodwill. Rather, goodwill is evaluated for impairment under Statement No. 142, Goodwill and Other Intangible Assets. The Company is required to adopt Statement 144 no later than July 1, 2002. Management does not expect the adoption of Statement 144 for long-lived assets held for use to have a material impact on the Company's financial statements because the impairment assessment under Statement 144 is largely unchanged from Statement 121. The provisions of Statement 144 for assets held for sale or other disposal generally are required to be applied prospectively after the adoption date to newly initiated disposal activities. Therefore, management cannot determine the potential effects that adoption of Statement 144 will have on the Company's financial statements. 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, Page 18 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 and (xii) 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 December 31, 2001, the Company's total variable rate debt obligations was $971,000. 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 $10,000. Page 19 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 six months ended December 31, 2001. Page 20 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 14, 2002 By: /s/ Soren Pihlman ----------------------------------- Soren Pihlman, Director President and COO - Asurent Wireless, Inc. Date: February 14, 2002 By: /s/ Clive N. W. Marsh ----------------------------------- Clive N. W. Marsh V.P. Corporate Finance Page 21

DIGITAL TRANSMISSION SYSTEMS INC \DE\ 10-Q