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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-KSB
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(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED JUNE 30, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ________ TO ________
COMMISSION FILE NUMBER 1-14198
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DIGITAL TRANSMISSION SYSTEMS, INC.
(Exact name of small business issuer as specified in its charter)
<TABLE>
<S> <C>
DELAWARE 58-2037949
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
3000 NORTHWOODS PARKWAY,
BUILDING 330,
NORCROSS, GA 30071
(Address of principal executive office) (Zip Code)
</TABLE>
(770) 798-1300
(Issuer's telephone number, including area code)
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
<TABLE>
<CAPTION>
NAME OF EACH EXCHANGE
TITLE OF EACH CLASS ON WHICH REGISTERED
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<S> <C>
Common Stock........................ Philadelphia and Boston Stock Exchanges
Warrants............................ Philadelphia and Boston Stock Exchanges
</TABLE>
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
Common Stock and Warrants
(Title of Class)
Check whether the issuer (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the 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 [ ]
Check if disclosure of delinquent filers in response to Item 405 of
Regulation S-B is not contained in this form, and no disclosure will be
contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-KSB
or any amendment to this Form 10-KSB. [ ]
Total revenues for the registrant for the fiscal year ended June 30, 1999
were: $7,538,000.
At September 28, 1999, there were 4,646,221 shares of common stock
outstanding. The aggregate market value of the common stock held by
non-affiliates (based upon the closing price quoted on the OTC Bulletin Board at
September 28, 1999 was approximately $1,451,944.
Transitional Small Business Disclosure Format (check one): Yes [ ] No [X]
DOCUMENTS INCORPORATED BY REFERENCE
Part III of this Annual Report on Form 10-KSB incorporates by reference
information (to the extent specific sections are referred to herein) from the
Company's Proxy Statement for its Annual Meeting of Shareholders to be held on
or before January 31, 2000 (the "1999 Proxy Statement").
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PART I
ITEM 1. BUSINESS
GENERAL
Digital Transmission Systems, Inc., a Delaware corporation ("DTS" or the
"Company"), designs, manufactures, and markets a broad range of products for
the telecommunications industry. The Company's primary customers are domestic
wireless service providers, including those offering cellular telephone
services and Personal Communications Services ("PCS") and domestic and
international resellers who sell to and service end users with telecom
equipment. Customers include Nextel, Alltel Wireless and Alltel Supply,
AirTouch, GTE Wireless and Somera Communications.
The Company's products, consisting of proprietary software and hardware
modules, facilitate the control, monitoring and efficient transmission of
high-speed digital information through public or private telecommunications
networks. The Company's network access products enable telecommunications
service providers to give their customers economical, high-quality access to
public and private networks and various telecommunications services. These
services include voice and high-speed data transmission, the Internet and video
and desktop conferencing. Important product requirements in these market
segments include high feature density, modularity, quality performance and
compactness. The Company's products meet these requirements and are suitable
for both wireline and wireless service environments.
DTS markets its products through a direct sales force and several reseller
channels. Domestically, wireless service providers, including cellular,
Specialized Mobile Radio ("SMR") and PCS service companies, are targeted as
prospective customers directly by the Company's sales force. DTS utilizes
telecommunications equipment resellers in the United States and other countries
to market to private network customers.
BACKGROUND
The telecommunications industry is undergoing rapid and fundamental changes.
Enhanced communication services such as those offering multimedia applications,
the Internet, video and desktop conferencing, facsimile transmission,
compressed voice communications and data communications between computers
necessitate the increased use of high-speed digital, rather than analog,
transmissions. The increased demand for digital transmission capacity has led
to significant network infrastructure growth and efforts to improve the
efficiency of current telecommunications systems. For all participants in the
telecommunications industry, including long distance carriers, telephone
operating companies and wireless service providers, the need for efficient
transmission of high-speed digitized signals, lower operating costs, seamless
connectivity and the assurance of quality service between networks is of vital
importance. Continued growth in traditional wireline and alternative services
will increase the need for products like those offered by the Company which are
designed to address these requirements. The Company believes the following
trends are contributing and will continue to contribute to the growth in demand
for its products:
GROWTH IN WIRELESS SERVICES. According to industry sources, the wireless market
is currently estimated to include over 52 million cellular customers in the
United States and is expected to grow to over 60 million customers by the year
2001. Service revenues from the cellular industry for 1996 were $23.6 billion
in the United States, and are expected to grow worldwide to $600 billion by
2010. The growth of the cellular industry, along with the deployment of new
wireless packet data offerings such as Cellular Digital Packet Data ("CDPD"),
has created the need for highly integrated, multi-functional, high-speed
network access products to speed deployment of cellular services, ease the
maintainability of networks, lower cell site costs and simplify the day-to-day
operation of the associated network.
DEPLOYMENT OF PCS. The Company believes that significant infrastructure
investments will be made over the next few years as PCS licensees build new
communications networks. In March 1996, over $8.2 billion was bid for the
licenses to provide broadband PCS service (similar to currently available
cellular service) in several consumer markets around the nation. Additional PCS
licenses are scheduled to be auctioned within the next year. The establishment
of a PCS network involves the construction of a significant infrastructure
which must be reliably
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connected to existing wireline and cellular services. Each of these networks
will require efficient equipment to control and monitor the flow of digital
information without significant dependency on the local telephone company for
links between cell sites or major switching centers.
GROWTH IN WIRELINE SERVICES. The Company believes the markets for traditional
wireline service will continue to grow and estimates that the market for packet
data services alone exceeded $2.1 billion in 1998. Internet access is expanding
and the Company believes the trend of increased telecommuting is likely to
continue, because of declining costs of telecommunications equipment and
services, employer cost-cutting and desires to improve employee productivity,
availability and convenience of improved technology and environmental concerns.
The increasing number of public telecommunications services has created the
need for high-speed connection devices which give service providers the ability
to economically expand their networks to provide new service offerings without
drastic changes in technology and the associated infrastructure costs. The
ability to quickly connect existing customers to these new services without
changing access technologies usually means lower costs to end users and
simplification of network construction for the service provider.
PROLIFERATION OF COMPETITIVE ACCESS PROVIDERS. Deregulation of the
telecommunications industry has resulted in an increase in competitive
alternatives for local access to network services. These Competitive Access
Providers ("CAPs"), such as cable TV companies, utilities and long distance
telephone service providers, have targeted major metropolitan markets in the
United States to offer local telephone and network services and are courting
large corporate customers who have traditionally been serviced by the local
Regional Bell Operating Companies ("RBOCs"). These CAPs have unique connection
requirements for access to the public network which are creating opportunities
for wireless digital transport equipment providers. Bridging two buildings
separated by 100 yards or two locations 30 miles apart with wireless transport
equipment allows companies to avoid the expense of leased lines from the local
RBOC. The market for equipment which connects the various networks is one that
the Company believes will continue to grow through the late 1990s.
GROWTH OF INTERNATIONAL MARKETS. Many countries throughout the world lag behind
the United States in telecommunications infrastructure development. As
customers in such countries begin to demand new or enhanced communications
services, service providers will seek the ability to upgrade telecommunication
networks quickly without sacrificing service quality. Service providers in
developing countries are faced with the need to promptly connect high-speed
digital lines to public networks, provide telecommunications to rural areas and
provide extensions for thin route cellular services.
GROWTH IN USAGE OF INTERNET PROTOCOL (IP) PACKET SYSTEMS. The proliferation of
packet based data systems using the IP format has led to the advent of IP based
telephone services. It is envisioned that future voice communications and data
transmission through carrier networks will be increasingly accomplished through
IP packet formatted systems. This trend will revolutionize the processing of
voice calls and will lead to new services that many carriers are eager to
offer.
All of these trends have created and will continue to create the need for
cost-effective, quality high-speed network control and network access products,
such as those offered by the Company, that permit carriers to economically
build and operate networks to address the service requirements of their
customers.
THE DTS SOLUTION
DTS has developed an integrated, systems-based, high-speed network control and
access solution for wireless and wireline networks that consists of the family
of access devices - FlexT1(R), FlexE1(TM), microFlex(TM) and the IP Processor.
In fiscal 1998 the Company introduced microFlex, a DS-1 cross connect switch
which addresses the need for high speed line concentration in wireless carrier
networks and in wireline applications. In April 1999 the Company introduced the
IP Processor, a device which allows the connectivity to the internet from cell
sites in a wireless carrier network. The Company believes that its products can
be combined to offer whole product solutions that provide significant
differentiation from competitive offerings in the marketplace with respect to
size, price, feature density and reliability.
The FlexT1 and FlexE1 network access products provide integrated access to
public network services for both domestic ("T1") and international ("E1")
markets. The FlexT1 and FlexE1 are provided in a compact physical
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package, are expandable and allow an end user to access many of the business
services available from the public network. These products also enable the
sharing of telecommunication facilities among the different services, such as
voice, video, the Internet and facsimile, thus reducing the number of access
lines the user must lease and potentially reducing overall telecommunications
expenses. A companion product to the FlexT1/E1 family is microFlex(TM), a cross
connect switch or "DACS" (Digital Access Cross Connect Switch). The microFlex
offers non-blocking DS0 cross connect capability for up to sixteen T1's or E1's
in a one RU (1.75 in.) high package. This product has applications in hubbing
or grooming environments involving many aggregate lines such as those found
when concentration of voice lines from several cell sites are necessary before
transport to the central switching center.
COMPANY STRATEGY
The Company's goal is to become a leading worldwide supplier of network control
and access products for both public and private high-speed telecommunications
networks. In order to realize these goals the Company plans to:
CONCENTRATE ON THE DOMESTIC AND INTERNATIONAL EXPANDING CELLULAR AND PCS
MARKETS. The Company has a sales force and support staff to further penetrate
the growing domestic and international Cellular and PCS markets. The Company's
network access products have numerous wireless applications and offer what the
Company believes is a unique integrated solution to the wireless carriers' need
to monitor and control transmission facilities to hundreds of remote cell
sites.
DEVELOP AND EXPAND ON FLEXIBLE AND MODULAR PLATFORMS. The Company continues to
expand upon its modular Flex and microFlex and IP Processor line of network
access products and plans to add various modules for feature enhancements,
facilitating continued utilization of Flex products as new applications are
developed.
The Company was certified in December 1994 as an ISO 9001 supplier, thus
establishing its quality assurance credentials for the international arena.
PRODUCTS AND TECHNOLOGY
The Company's products facilitate network access, bandwidth management, network
control and delivery of high-speed digital telecommunications services.
MICROFLEX PRODUCT
During fiscal 1998 the Company introduced microFlex which in conjunction with
FlexT1/E1 allows more efficient use of high speed lines which a wireless
carrier utilizes to connect voice and other traffic between cell sites and its
switching center. In particular, microFlex offers cross connect functionality
between segments of one high speed line (T1 or E1) with another in a total set
of up to sixteen high speed lines.
FLEXT1 AND FLEXE1 PRODUCT FAMILY
The FlexT1 family of products provides integrated access to public network
telecommunications services. The FlexT1 consists of single and multi-slot
enclosures that are customized with various card sets to satisfy a wide range
of network access applications. The FlexE1 provides much of the same
functionality currently available in the FlexT1 for countries using the E1
(international) standard. Customer equipment needs include N x 56/64 Kbps and
full T1 interfaces for data, voice and video applications.
FLEXT1/E1 SYSTEM ARCHITECTURE
The FlexT1/E1 bandwidth management features are derived from an advanced
architecture with two independent Time Division Multiplexed ("TDM") busses
available to each card position within a FlexT1/E1 enclosure. This architecture
allows users to pay only for the functions and features needed for a particular
application. Bandwidth managers connect directly to the service provider's
network and user traffic is interfaced through card sets that connect directly
to voice, data and video terminals. All card sets within the product family can
be upgraded with software as new features become available.
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IP PROCESSOR PRODUCTS
The IP Processor product from DTS provides wireless carriers a means for
connecting cell sites in their network to the internet. This connectivity
enhances the ability of the carrier to remotely access various pieces of
equipment at the cell site for maintenance and network control purposes. This
password protected access would be available from any personal computer
connected to the internet. In addition, a craftsperson at the cell site would
have access to the internet resources for accessing equipment user manual
information.
The Company offers its complete set of products to wireless and wireline
service providers through a direct sales force. A secondary channel to
telecommunications service providers exists through selected reseller
arrangements. Reseller agreements were signed with Alltel Supply and Somera
Communications who distribute telecommunications equipment to telephone service
providers and private network users. Additionally, the Company has recently
expanded its list of customers to include major wireless service providers such
as Nextel, GTE Wireless, DigiPH, Aliant Cellular and U.S. West Wireless.
COMPETITION
The market for telecommunications products is highly competitive and subject to
rapid technological change, regulatory developments and emerging industry
standards. The Company believes that the principal competitive factors in its
markets are: support for multiple types of carrier services, conformance of
products to multiple public carrier standards, reliability and safety, the
development and rapid introduction of new product features, price, performance,
and quality of customer support.
The Company's principal competition to date has come from major
telecommunications equipment suppliers active in certain market segments. In
the network access marketplace, ADC Kentrox (a subsidiary of ADC
Telecommunications Inc.), Premisys Corporation, Digital Link Corporation,
Carrier Access Corporation, Paragon Networks, Inc., Adtran Inc. and Newbridge
Networks, Inc. are competitors.
The Company expects increased competition from existing competitors as they
develop products with functionality similar to that of the Company's products.
In addition, the Company expects to compete with other new entrants to the
telecommunications access equipment marketplace, including those targeting
bandwidth on demand services and broadband integrated access products. To the
extent that current or potential competitors can expand their current offerings
to include monitoring and maintaining network facilities in an integrated
product, the Company's business and operating results could be materially
adversely affected.
MANUFACTURING
DTS currently outsources most subassembly kitting, board assembly and testing
to high quality suppliers which are ISO 9002 certified.
For several of the DTS products subassemblies and finished circuit boards are
brought to DTS headquarters for final assembly, system integration, testing and
product burn-in. Defective subassemblies are returned to the contract
manufacturers for root cause analysis and process problem resolution. System
test development is jointly done by the Company's engineering and quality
assurance personnel. Most DTS product board assemblies contain surface mount
technology ("SMT") components so that only minor touch-up is possible by DTS
manufacturing personnel.
High quality is demanded by all DTS' customers. The Company continues to strive
for quality in the design and the manufacturing of products in order to attain
a competitive advantage. All key procedures in the Company have been documented
and Company policy requires that employees follow these procedures. It is the
Company's belief that this policy promotes consistency in the delivery of value
to the customer. This effort led to ISO 9001 certification for the Company in
December, 1994 and numerous successful follow-up compliance surveillance
audits. The Company believes that ISO 9001 certification has become important
for international trade, since overseas customers can feel assured that
quality-based processes have been followed.
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PRODUCT DEVELOPMENT
The market value of the Company's diversified network access and control
systems is based upon its core technologies in customer terminal interfaces for
voice and high-speed data applications, T1 networking and microwave radio
applications. Additionally, the Company has valuable experience in public,
private and cellular T1 networking standards and control systems. The Company's
product development efforts are currently concentrated in the T1 network
access, transport and control areas.
The Company's resident core technologies resulting from the developments of the
Flex and microFlex products include:
- - T1/E1 multiplexing of voice and high speed data signals
- - T1/E1 alarm reporting and trunk conditioning
- - Network performance monitoring and testing
- - TI ESF data link message transport
- - SNMP protocol processing
- - TCP/IP protocol message handling
- - 10Base5 and 10BaseT Ethernet Media Access Control
- - Microprocessor-based product design
- - Real time processing of control and data signals
- - Design of programmable logic device
The Company's product development efforts have also resulted in the development
of a number of relevant technologies for products targeted toward the wireless
infrastructure and CAP market segments. These technologies include hardware and
software modules for high-speed digital modems, high data rate QAM modulation
algorithms, error correcting coding, automatic equalization methods utilizing
digital signal processing, VLSI devices, RF filtering for microwave products,
point-to-point and multipoint networking protocols, X.25 interfaces, voice
compression, voice telephony interfaces and T1 digital cross connects.
The technologies listed above are being used by the Company's product
development group to design wireless products and enhancements for the
FlexT1/E1 platform.
INTELLECTUAL PROPERTY
The Company's proprietary technology is protected by one patent granted and two
patents pending which relate to channel bank design and ISDN signal coding.
Core technologies described in the "Product Development" section are
incorporated in the Company's products through proprietary hardware and
software modules which embed original algorithmic and device circuitry.
Although some of these original designs are protected by the patent or patent
applications mentioned above, most of the designs are secured only by a claim
of trade secret rights.
The Company currently owns the trademarks of "FlexT1," "FlexE1," "microFlex,."
It has also filed federal trademark applications for FlexSentry, FlexCell,
FlexE1 internationally, and these applications were published for opposition in
the Trademark Office after examination. The applications for FlexCell and
FlexE1 were formally opposed by Fujitsu Network Transmission Systems, Inc.
Fujitsu has alleged that the trademark registrations should be denied because
of their prior rights filed on a trademark application for FlexR, for certain
access controllers. The Company and Fujitsu have reached an agreement whereby
the DTS trademarks can be used with few restrictions.
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The Company also relies upon trade secret protection for its confidential and
proprietary information. There can be no assurance that competitors or
potential competitors of the Company will not independently develop
substantially equivalent proprietary information and techniques or otherwise
gain access to the Company's trade secrets or disclose such technology, or that
the Company can meaningfully protect its trade secrets. Failure to obtain
needed patents or licenses or proprietary information held by others could have
a material adverse effect on the Company.
RESEARCH AND DEVELOPMENT COSTS
During fiscal years 1999 and 1998, the Company's expenditures in product
development were $1.4 million and $2.4 million, respectively. The decrease in
spending from 1999 to 1998 is primarily due to the divestiture of SouthTech,
Inc., the Company's international subsidiary, and to a corporate downsizing
executed in the summer of 1998. During fiscal 1999, the Company capitalized
approximately $136,000 primarily for the development of an Enhanced Lightning
Protection FlexT1 CSU (ELP) and the continuing development of the Internet
Protocol Processor card set. During fiscal 1998, the Company capitalized
approximately $583,000 primarily for the development of the Company's
international product line. It was determined that the future recoverability of
the capitalized costs of certain features developed for the aforementioned
product line was not assured and that the value of the asset was impaired. As a
result, approximately $414,000 of the asset was written off during the year
ended June 30, 1998 and appropriately charged to Cost of Sales in the
accompanying 1998 financial statement data.
GOVERNMENT REGULATION
The FCC has regulated the design of telecommunications equipment for use in the
United States by restricting radio frequency signal emissions and by licensing
frequency usage. Compliance with electronic product safety regulations is also
required for every new product design. It is possible that a government agency
such as the FCC could issue regulations which would require the modification of
DTS equipment in order to comply with the new regulations. A change in FCC
rules may impact sales of DTS products should it occur. International standards
for electronic product design in the areas of safety and signal emissions are
different in many cases from those issued by United States government agencies.
Sales of telecommunications equipment in a foreign country are often restricted
by equipment design standards and regulations adopted by a centralized
governmental agency similar to the FCC. The Company has to date experienced no
material difficulties in complying with the various laws and regulations
affecting its business.
YEAR 2000 (Y2K) IMPACT ON COMPANY'S INFORMATION TECHNOLOGY
The Company operates an Enterprise Resource Planning ("ERP") software system
which has modules supporting order entry, planning, inventory management,
operations, and general ledger functions. The vendor of this information system
has sent the Company a letter indicating the ERP system is Y2K compliant. The
hardware platform vendor, through its web presence, also indicates that the
system is Y2K compliant.
Most of the desktop computing systems used at the Company were manufactured
after 1995. They use operating system and document preparation software from
Microsoft Corporation. These systems are generally compliant with the Year 2000
requirements. The Company does operate older PC's in its manufacturing and
engineering organizations, but they are not used in time or date critical
operations.
The Company's products are designed to be Year 2000 compliant and have been
adequately tested as to conformance with Year 2000 date processing. All
products tested passed the conformance test and have been appropriately
certified as Year 2000 compliant by the Company. The Company did not incur and
does not expect to incur any material costs to address Year 2000 compliance
issues. The Company is in the process of developing a contingency plan to
address any instances of Year 2000 non-compliance and expects to complete such
a contingency plan by October 1999. The Company has a number of material
relationships with third parties and is aware of the risks involved and is
currently analyzing the potential impact on future operations. The Company is,
however, aware of the risk that third parties, including vendors and customers
of the Company, will not adequately address the Year 2000 problem and the
resultant potential adverse impact on the Company.
Notwithstanding the above, there can be no assurance that the Company's
internal systems or products will operate beyond 1999 or that major business
disruptions will not occur in mission critical systems and processes.
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EMPLOYEES
As of June 30, 1999, the Company had approximately 29 full-time employees, of
whom 7 are technical personnel engaged in developing the Company's products, 6
are marketing and sales personnel, approximately 7 are quality assurance and
operations personnel and 9 are involved in administration and finance. All of
the Company's employees are full-time. The Company's employees are not
unionized and the Company believes that its employee relations are good.
BACKGROUND OF THE COMPANY
A predecessor by merger to the Company was incorporated in Delaware in 1984.
The Company was originally incorporated in Delaware in 1992 as Netra Inc. and
changed its name to Digital Transmission Systems, Inc. in 1995 in conjunction
with the merger with its wholly-owned subsidiary Digital Transmission Systems,
Inc., a California corporation. On March 4, 1996, the Company completed a
public offering of 1,220,700 Units each consisting of one share of Common Stock
and one warrant to purchase one share of Common Stock at a price of 120% of the
unit offering price of $7.50. On February 18, 1997, trading of the Units was
split into separate trading of the underlying Common Stock and Warrants. The
Company stock was delisted from the NASDAQ small cap exchange on October 15,
1998 and is currently being traded as an OTC Bulletin Board issue.
ITEM 2. PROPERTIES
The Company's operations are located in an approximately 18,000 square foot
facility in a technology park in Norcross (in the greater Atlanta, Georgia
area). In May of 1993, the Company entered into a six year lease for its
current facility with a three year extension signed in May 1998. The lease was
re-negotiated in late 1998 concerning the amount of leased space dropping from
24,000 square feet to 18,000 square feet. The base annual triple-net rate for
this space is $7.02 per square foot, including amortization of build-out costs
of approximately $150,000, and escalates by 4% per year. Approximately 6,000
square feet is sub-leased to the Company's affiliate - Linkanet Labs under a
services agreement. The Company believes its facilities are suitable and
adequate for its purposes.
ITEM 3. 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, including the litigation discussed in the
previous paragraph, will not have a material adverse effect on the Company's
financial position, results of operations, or liquidity. The Company is not a
party to any material legal proceedings. From time to time, the Company is
involved in various routine legal proceedings incidental to the conduct of its
business.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
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PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS.
On October 14, 1998, the Company was de-listed from NASDAQ due to noncompliance
with a net worth requirement of $2,000,000 for continued listing. The Company's
common stock, with symbol DTSX, continues to trade on the OTC Bulletin Board.
On March 4, 1996, the Company completed a public offering of 1,220,700 Units
("Units"), each consisting of one share of Common Stock ("Common Stock") and
one Warrant ("Warrant") to purchase one share of Common Stock at an exercise
price per share equal to 120% of the initial public offering price of the
Units. The shares of Common Stock and Warrants were not detachable or
separately transferable, and could only have been traded as part of a Unit
until February 18, 1997 (the "Separation Date"), when each Unit was separated
into one share of Common Stock and one Warrant. The Common Stock and Warrants
have been listed on the NASDAQ SmallCap Market, the Company's principal market,
under the symbols DTSX and DTSXW, respectively, and were listed on the
Philadelphia Stock Exchange and the Boston Stock Exchange under the symbols DTS
and DTS.W, respectively. The Units previously traded on the NASDAQ Market and
the Philadelphia and Boston exchanges. The price per Unit reflected in the
table below represents the range of low and high closing sale prices for the
Company's Units as reported by the NASDAQ Stock Market for the quarters
indicated:
<TABLE>
<CAPTION>
Quarter Ended High Price Low Price
- ---------------------------------------------------- ---------- ----------
<S> <C> <C>
Commencing March 4, 1996 and ending March 30, 1996 $ 9.375 $ 8
June 30, 1996 $ 14.75 $ 9
September 30, 1996 $ 15.50 $ 14
December 31, 1996 $ 16.25 $ 14.125
Commencing January 1, 1997 and ending February 14, 1997 $ 18.00 $ 13.875
</TABLE>
On February 18, 1997 the Common Stock and Warrants underlying the Units began
trading separately and the Units ceased to trade. Both the Common Stock and
Warrants traded on the NASDAQ Market and the Philadelphia and Boston exchanges.
On October 14, 1998, the Company's securities ceased to be listed on NASDAQ and
continue to trade on the OTC Bulletin Board. The price per share of the
Company's Common Stock in the table below represents the range of low and high
closing sale prices as reported by the NASDAQ Stock Market or the OTC Bulletin
Board for the quarters indicated:
<TABLE>
<CAPTION>
Quarter Ended High Price Low Price
- ---------------------------------------------------- ---------- ----------
<S> <C> <C>
Commencing February 18, 1997 and ending March 31, 1997 $ 13 $ 10.75
June 30, 1997 $ 12.50 $ 10.25
September 30, 1997 $ 11.25 $ 9
December 31, 1997 $ 9.438 $ 3.50
March 31, 1998 $ 6.875 $ 4
June 30, 1998 $ 6.875 $ 2.875
September 30, 1998 $ 3.125 $ 0.75
December 31, 1998 $ 0.875 $ 0.10
March 31, 1999 $ 0.8125 $ 0.20
June 30, 1999 $ 0.8125 $ 0.2187
</TABLE>
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The price per share of the Company's Warrants in the table below represents the
range of low and high closing sale prices as reported by the NASDAQ Stock
Market or the OTC Bulletin Board for the quarters indicated:
<TABLE>
<CAPTION>
Quarter Ended High Price Low Price
- ---------------------------------------------------- ---------- ----------
<S> <C> <C>
Commencing February 18, 1997 and ending March 31, 1997 $ 5 $ 2.875
June 30, 1997 $ 4.25 $ 2.375
September 30, 1997 $ 3.25 $ 2.50
December 31, 1997 $ 2 $ 1.50
March 31, 1998 $ 1 $ 0.50
June 30, 1998 $ 0.50 $ 0.20
September 30, 1998 $ 0.375 $ 0.0312
December 31, 1998 $ 0.0312 $ 0.0001
March 31, 1999 $ 0.125 $ 0.0001
June 30, 1999 $ 0.001 $ 0.0001
</TABLE>
The closing sale price of the Company's Common Stock as reported by the OTC
Bulletin Board on June 30, 1999 was $0.3125. The closing sale price of the
Company's Warrants as reported by the OTC Bulletin Board on June 30, 1999 was
$0.0001.
The total number of shareholders of record of the Company's common shares as of
September 27, 1999 was approximately 45. Because a substantial portion of
shares are held by brokers and other institutions on behalf of shareholders,
the Company is unable to estimate the total number of shareholders represented
by these record holders.
The Company has never paid cash dividends on its Common Stock. The Company
currently intends to retain any earnings for use in the business and does not
anticipate paying any cash dividends in the foreseeable future.
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ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
The following discussion of the results of operations and financial condition
should be read in conjunction with the Company's audited financial statements
and notes thereto.
OVERVIEW
In fiscal 1999 the Company undertook a significant downsizing by selling its
international division - SouthTech, Inc. and by completing an over 40% reduction
in staff of the domestic business. These actions were undertaken in order to
continue operations under severe working capital constraints. Substantial
operating losses were experienced by SouthTech, Inc. over a period of several
years. Negotiations during the 1999 fiscal year with the Company's bank, its
debt holder and various suppliers have resulted in renewed compliance with debt
covenants and an orderly pay down of trade debt over a longer period of time -
usually a year or longer. Due to this restructuring and the Company's
constraints in working capital, net sales for the 1999 fiscal year decreased
nearly fifty percent from a historical high of $15.5 million in fiscal 1998 to
$7.5 million in fiscal 1999. However, the Company posted a loss of $424,000
for fiscal 1999 as compared to a loss of $8.38 million for fiscal 1998
representing a substantial decrease of approximately 95%. The operational
contribution to the net loss was realized in the first fiscal half of 1999
whereas the second fiscal half witnessed consecutive profitable quarters both
operationally and on a net income basis. The third quarter of fiscal 1999 was
the first operationally profitable quarter for the Company in three years.
One-time gains from the sale of SouthTech, Inc. were realized in both second
half quarters and are included as a separately captioned line item on the
accompanying financial statements. However, there can be no assurance that the
Company will be profitable in any future quarters.
The FlexT1/E1 products contribute the bulk of the Company's domestic revenues.
They are sold primarily to major USA based wireless service providers while
SKYPLEX products, consisting of spread spectrum radio modules, were associated
with the Company's international subsidiary - SouthTech, Inc. - and found many
applications for unlicensed microwave network connections in Latin American and
Asia Pacific markets.
International sales decreased approximately 74% from $5.3 million in fiscal
1998 to $1.4 million in fiscal 1999. As a percentage of the Company's sales,
international sales accounted for 19% of total revenue in fiscal 1999 as
compared to 34% of total revenue in fiscal 1998. Domestic sales decreased
approximately 40% from $10.2 million in fiscal 1998 to $6.1 million in fiscal
1999.
Industry trends which may also affect the Company's operating results include
the rate of demand for cellular and PCS services, the market acceptance of high
speed wireline service from telecommunications service providers, and the level
of investment in telecommunications infrastructure by developing countries over
the next few years
COMPARISON OF YEARS ENDED JUNE 30, 1999 AND JUNE 30, 1998
The following table sets forth certain financial data derived from the
Company's Statements of Operations (dollars in thousands):
<TABLE>
<CAPTION>
YEAR ENDED YEAR ENDED
JUNE 30, 1999 JUNE 30, 1998
----------------------- ------------------------
% of % of
$ Sales $ Sales
--------- --------- ---------- ---------
<S> <C> <C> <C> <C>
Net sales $ 7,538 100 $ 15,579 100
Gross profit 2,774 37 1,858 12
Product development 1,353 18 2,367 15
Selling, general and administrative 3,014 40 7,018 45
Net loss (424) (6) (8,380) (54)
</TABLE>
10
<PAGE> 12
NET SALES. Net sales decreased by 52%, to $7,538,000 for the year ended June
30, 1999, from $15,579,000 for the year ended June 30, 1998. The sales mix, and
the resulting percentage of total sales, is shown in the table below (dollars
in thousands):
<TABLE>
<CAPTION>
PERCENTAGE OF
TOTAL
FISCAL YEAR FISCAL YEAR
ENDED JUNE 30, ENDED JUNE 30,
------------------- ---------------
1999 1998 1999 1998
------ ------- ------ ------
<S> <C> <C> <C> <C>
FlexT1/E1 $5,623 $ 9,960 75 64
SKYPLEX 1,402 5,224 18 34
MicroFlex 459 214 6 1
Other products 54 181 1 1
------ ------- --- ---
Totals $7,538 $15,579 100 100
------ ------- --- ---
</TABLE>
During the year ended June 30, 1999, two customers accounted for greater than
10% each of the Company's sales. Nextel represented 30% of total sales and
Alltel (a reseller/integrator of telecommunications products) accounted for
approximately 35% of the Company's sales. Revenues from the Company's FlexT1/E1
product line decreased over 44% from $9,960,000 in the year ended June 30, 1998
to $5,623,000 in the year ended June 30, 1999. Revenues from SKYPLEX (both
international and domestic customers) decreased by 73% from $5,224,000 in the
year ended June 30, 1998 to $1,402,000 in the year ended June 30, 1999, the
decrease partly due to sales registered only through February 5, 1999, the date
of the sale of SouthTech, Inc. The microFlex product, introduced in fiscal
1998, realized $459,000 in sales for fiscal 1999 compared to $214,000 in sales
in fiscal 1998, an increase of 114%. Total international sales decreased by
approximately 74% from $5,333,000 in the year ended June 30, 1998 to $1,402.000
in the year ended June 30, 1999.
GROSS PROFIT. Gross profit for the year ended June 30, 1999 increased 49% to
$2,774,000 from $1,858,000 for the year ended June 30, 1998. As a percentage of
sales, gross profit increased from 12% for the year ended June 30, 1998 to 37%
for the year ended June 30, 1999. The increase is primarily due to the increase
in the higher margin product mix (FlexT1 and microFlex) for the year ended June
30, 1999 as compared to June 30, 1998. For the year ended June 30, 1999 and
1998, sales of the Company's FlexT1 and microFlex products represented
approximately 81% and 65%, respectively, of total sales recorded for each
respective fiscal year.
PRODUCT DEVELOPMENT. Product development expenses decreased from $2,367,000 for
the year ended June 30, 1998 to $1,353,000 for the year ended June 30, 1999.
Approximately $136,000 of development costs related to new products were
capitalized during the fiscal 1999 year, as compared to $583,000 during the
year ended June 30, 1998. During the fourth quarter of the year ended June 30,
1998, management determined that, given the anticipated direction of the
Company's product line, certain product features that had been developed for
the SKYPLEX international product line and capitalized as product development
costs would not be implemented in the foreseeable future. Consequently, it was
determined that the future recoverability of the cost of those features was not
assured and that the value of the asset was impaired. Accordingly, the Company
wrote off $414,000 of these capitalized costs during the year ended June 30,
1998. As a percentage of sales, total product development costs increased from
15% for the year ended June 30, 1998 to 18% for the year ended June 30, 1999.
SELLING, GENERAL AND ADMINISTRATIVE. Selling, general and administrative
expenses decreased 57%, from $7,018,000 for the year ended June 30, 1998 to
$3,014,000 for the year ended June 30, 1999. Selling expenses decreased by 58%
from $4,854,000 for the year ended June 30, 1998 to $2,026,000 for the year
ended June 30, 1999. The decrease resulted from the decrease in revenue of
approximately 52% coupled with sales personnel reductions and cost saving
measures instituted during early fiscal 1999. Selling expenses as a percentage
of net sales decreased from 31% for the year ended June 30, 1998 to 27% for the
year ended June 30, 1999. General and administrative expenses decreased from
$2,164,000 for the year ended June 30, 1998 to $988,000 for the year ended June
30,1999. As a percentage of net sales, general and administrative expenses
decreased slightly from 14% for the year ended June 30, 1998 to 13% in the year
ended June 30, 1999.
NET INCOME/(LOSS). The net loss decreased from $8,380,000 for the year ended
June 30, 1998 to a loss of $424,000 for the year ended June 30, 1999. This
decrease resulted primarily from significant expense reductions and an
increased sales mix percentage of the Company's higher margin FlexT1 product
line as compared to the prior year.
11
<PAGE> 13
COMPARISON OF YEARS ENDED JUNE 30, 1998 AND JUNE 30, 1997
The following table sets forth certain financial data derived from the Company's
Statements of Operations (dollars in thousands):
<TABLE>
<CAPTION>
YEAR ENDED YEAR ENDED
JUNE 30, 1998 JUNE 30, 1997
-------------------- ---------------------
% of % of
$ Sales $ Sales
-------- ------- -------- --------
<S> <C> <C> <C> <C>
Net sales $ 15,579 100 $ 14,484 100
Gross profit 1,858 12 4,639 32
Product development 2,367 15 2,458 17
Selling, general and administrative 7,018 45 6,331 44
Net income (loss) (8,380) (54) (4,190) (29)
</TABLE>
NET SALES. Net sales increased by 8%, to $15,579,000 for the year ended June
30, 1998, from $14,484,000 for the year ended June 30, 1997. The sales mix, and
the resulting percentage of total sales, is shown in the table below (dollars
in thousands):
<TABLE>
<CAPTION>
PERCENTAGE OF
TOTAL
FISCAL YEAR FISCAL YEAR
ENDED JUNE 30, ENDED JUNE 30,
-------------------- ----------------
1998 1997 1998 1997
------- ------- ------- -------
<S> <C> <C> <C> <C>
MCI network control -- $ 4,394 -- 30
Other network control -- 940 -- 6
FlexT1 / E1 $ 9,960 4,861 64 34
SKYPLEX 5,224 3,342 34 23
DIV modem 10 556 -- 4
Other products 385 391 2 3
------- ------- --- ---
Totals $15,579 $14,484 100 100
======= ======= === ===
</TABLE>
During the year ended June 30, 1998, two customers accounted for greater than
10% each of the Company's sales. Nextel represented 35% of total sales and
Walker (a reseller/integrator of telecommunications products) accounted for
approximately 13% of the Company's sales. Revenues from the Company's FlexT1/E1
product line increased over 100% from $4,861,000 in the year ended June 30,
1997 to $9,960,000 in the year ended June 30, 1998 and revenues from SKYPLEX
grew by 56% from $3,342,000 in the year ended June 30, 1997 to $5,224,000 in
the year ended June 30, 1998. A new product, microFlex - introduced in fiscal
1998, realized $214,000 in sales and is being sold into the same markets as
FlexT1/E1. Total international sales increased by approximately 42% from
$3,766,000 in the year ended June 30, 1997 to $5,333,000 in the year ended June
30, 1998.
Net Sales for the 4th quarter of fiscal 1998 decreased to $2.9 million from the
third quarter total of $6.1 million. This decrease was due primarily to the
fulfillment of a large order for FlexT1 products from Nextel in approximately
seven months of the fiscal year, most of the shipments occurring in the 3rd
quarter. Some shipments, anticipated by the Company to occur in the 4th
quarter, were postponed by customers into fiscal 1999. Simultaneously,
international shipments also experienced a decrease, contributing somewhat to
the overall decline in sales from the 3rd quarter to the 4th quarter.
GROSS PROFIT. Gross profit decreased by 60% to $1,858,000 for the year ended
June 30, 1998 from $4,639,000 for the year ended June 30, 1997. As a percentage
of sales, gross profit decreased from 32% for the year ended June 30, 1997 to
12% for the year ended June 30, 1998. This decrease is due to the increase in
product and service costs of newer products, particularly the SKYPLEX radio
products, and a one-time charge of $414,000 to write off certain capitalized
product development for products that will not be realized in future years,
additional reserves to record potential inventory obsolescence and to recognize
additional warranty costs and a shift in product mix from higher margin network
control products to the newer products in the Flex and SKYPLEX product lines.
The product and service cost increase and warranty accrual increases was caused
in part by a vendor of the Company that had difficulty meeting Company and
customer specifications for certain products.
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<PAGE> 14
PRODUCT DEVELOPMENT. Product development expenses decreased slightly from
$2,458,000 for the year ended June 30, 1997 to $2,367,000 for the year ended
June 30, 1998. Beginning at the end of the fiscal year ended June 30, 1997 and
continuing through most of the year ended June 30, 1998, the Company was
involved in the development of a new product line, the microFlex network access
product. Approximately $583,000 of development costs related to new products
were capitalized during the fiscal 1998 year, as compared to $1,432,000 during
the year ended June 30, 1997. During the fourth quarter of the year ended June
30, 1998, management determined that, given the anticipated direction of the
Company's product line, certain product features that had been developed for
SKYPLEX and capitalized as product development costs would not be implemented
in the foreseeable future. Consequently, it was determined that the future
recoverability of the cost of those features was not assured and that the value
of the asset was impaired. Accordingly, the Company wrote off $414,000 of these
capitalized costs during the year ended June 30, 1998, as compared to
write-offs of $555,000 in capitalized product costs during the year ended June
30, 1997. As a percentage of sales, total product development costs decreased
from 17% in the year ended June 30, 1997 to 15% in the year ended June 30,
1998.
SELLING, GENERAL AND ADMINISTRATIVE. Selling, general and administrative
expenses increased by 12%, from $6,331,000 for the year ended June 30, 1997 to
$7,018,000 for the year ended June 30, 1998. Selling expenses increased by less
than 1% from $4,820,000 in the year ended June 30, 1997 to $4,854,000 in the
year ended June 30, 1998. The increase resulted from the growth in revenue in
the U.S. as well as from increased sales activity outside the U.S. Selling
expenses as a percentage of net sales decreased from 33% for the year ended
June 30, 1997 to 31% for the year ended June 30, 1998 primarily due to the
increased sales activity. General and administrative expenses increased from
$1,511,000 in the year ended June 30, 1997 to $2,164,000 in the year ended June
30, 1998 due primarily to one increases in administrative and infrastructure
costs needed to support the operations of the business with expanded product
lines and distribution channels. As a percentage of net sales, general and
administrative expenses increased from 10% in the year ended June 30, 1997 to
14% in the year ended June 30, 1998.
NET INCOME/(LOSS). The net loss increased from $4,190,000 for the year ended
June 30, 1997 to a loss of $8,380,000 for the year ended June 30, 1998. This
increase resulted primarily from higher general and administrative expenses,
higher product and service costs of newer products, increases in inventory
obsolescence and warranty reserves, a write off of the deferred tax asset and
the shift in product mix to lower margin products.
SALE OF DTS STOCK BY SIGNIFICANT SHAREHOLDER - PEREGRINE VENTURES
On December 31, 1998 an option to purchase 1,738,159 common shares of DTS stock
was granted to MicroTel International ("MicroTel") by Peregrine Ventures, a
California based limited partnership and shareholder of DTS, in consideration
for a certain amount of MicroTel common stock. On the same date, the two DTS
Board members representing Peregrine Ventures interests, tendered their
resignations effective immediately. The option, due to expire on January 31,
1999, was exercised by MicroTel and thus became DTS' largest single
shareholder, holding approximately 40% of the then outstanding stock. Two
MicroTel representatives were subsequently elected to the DTS Board of
Directors at the DTS Shareholders Meeting held on April 13, 1999. MicroTel is a
Delaware corporation whose stock is publicly traded on the OTC Bulletin Board
under the ticker symbol MCTL. In addition to various subsidiaries whose
principal business is to manufacture and market power supplies, keypads, video
displays, circuit boards and other electronic assemblies to a variety of
aerospace and communications clients MicroTel also owns two CXR subsidiaries -
CXR Telcom and CXR S.A. which manufacture and market telecommunications
products to telco and private network users.
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 years ended June 30, 1999 and 1998, the Company
incurred losses of $424,000 and $8,380,000, respectively, and has a net capital
deficit of $2,428,000 as of June 30, 1999. These factors, among others, raise
substantial doubt about the Company's ability to continue as a going concern
for a reasonable period of time. The condensed consolidated financial
statements do not include any adjustments relating to the recoverability and
classification of assets and liabilities that might be necessary should the
Company be unable to continue as a going concern. The Company'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. The Company is pursuing additional
13
<PAGE> 15
equity financing through discussions with potential investors and is pursuing
potential merger or acquisition candidates.
The Company's line of credit agreement with Silicon Valley Bank and Debenture
Purchase Agreement with Sirrom Capital (FINOVA) was amended on February 25, 1999
and February 5, 1999, respectively, and has enabled the Company to come into
compliance with all revised loan covenants as set forth in the amended
agreements. Additionally, the Company's net deficit has been reduced from
$3,568,000 as of June 30, 1998 to $2,428,000 as of June 30, 1999. These
accomplishments and the profitability of the last half of the fiscal year ended
June 30, 1999 have improved the Company's financial condition from June 30,
1998. However, there can be no assurance that the Company will be profitable in
the future.
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 cannot be pledged, sold or
traded until November 30, 1999 at which time, under Rule 144, they will have
the restricted legend removed from their certificates and are freely tradable.
Secondly, another program to preserve cash has been to work out extended
payment terms with certain key material suppliers for overdue amounts payable.
The Company completed formal negotiations with three critical suppliers and
established extended payment terms (over a 12 month period) for overdue amounts
payable. Third, non-critical suppliers have been offered settlements in the
form of uniform terms and reduced but immediate cash payments for cancellation
of long standing past due amounts. A total of $402,000 of amounts payable have
been settled for a reduced amount under these conditions. The Company has
recorded an extraordinary gain of $359,000 to reflect the settlement
transactions closed during the third quarter of fiscal 1999 and is included in
the accompanying financial statements.
LINE OF CREDIT ARRANGEMENT. On April 10, 1997, the Company established a bank
line of credit agreement with Silicon Valley Bank which made available
$2,500,000 in borrowings with availability based on the Company's accounts
receivable. The loan was amended on March 18, 1998 to increase the maximum
eligible borrowing to the lesser of $4,000,000 or 80% eligible receivables plus
30% of eligible inventory, as defined, through the maturity date of April 10,
2000. The loan is secured by the Company's assets and bore interest at the rate
of prime plus 2.25% (10% at June 30, 1999). A net worth covenant was amended on
March 16, 1998, requiring the Company to have a net worth of $1,000,000. In
September 1998, the Company agreed to a UCC filing whereby all assets of the
Company become collateral under the Agreement. The loan required 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 was two years with an
automatic renewal each year unless written notice of termination was given by
one of the parties. The Company issued 60,000 two year warrants to Silicon
Valley Bank at a strike price of $5.25 each as consideration for the amended
agreement. On February 25, 1999 the Company formally signed an amendment to the
loan agreement with Silicon Valley Bank which modified previous loan covenants.
The revised covenants are primarily based upon minimum monthly and quarterly
revenue levels. As consideration for the amended agreement, the Company 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. The financial
and accounting value of the warrants issued is immaterial to the Company's
financial statements and has not been recorded as of June 30, 1999. Under the
revised agreement the maximum borrowing has been reduced to the lesser of a
total of $1,500,000 or 80% of eligible receivables plus the lesser of 30% of
eligible inventory or $600,000; limited to $500,000 as of December 15, 1998 and
$400,000 as of January 15, 1999. On March 3, 1999, the credit limit was again
modified to the lesser of 30% of eligible inventory or $475,000, with such limit
reduced by $25,000 every two weeks until such limit is $400,000. The Company was
in compliance with all loan covenants as set forth in the revised bank agreement
as of June 30, 1999.
LONG TERM DEBT. During fiscal 1998, the Company issued $4 million of 11.5%
subordinated debentures to Sirrom Capital of Nashville, Tennessee. During March
1999, The FINOVA Group consummated its previously announced acquisition of
Sirrom Capital Corporation. Sirrom Capital subsequently began operating as
FINOVA Mezzanine Capital, ("Finova"), a specialty finance company,
headquartered in Nashville, Tennessee. The
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<PAGE> 16
aforementioned debentures were issued on September 25, 1997 with a contractual
due date of September 25, 2002. The Debenture Purchase Agreement contained
numerous rights, privileges, and conditions in favor of the lender, only
certain of which have been included herein. The debentures were convertible at
any time by the lender into common stock of the Company at a conversion price
of $10.25 per share, subject to adjustment in certain events. The conversion
price would change to $8.00 per share if the Company's common stock were
trading for less than that amount on September 25, 1998. The debentures were
redeemable by the Company after September 1999 provided that (a) the Company
pays the lender additional interest such that the lender would receive an
effective compounded 20% interest rate from inception of the loan or (b) the
20-day average bid price for the Company's stock exceeds $15.00 per share.
The debentures may be required to be redeemed by the Company at the option of
the lender at any time prior to maturity if (a) there is a change in control,
as defined in the Debenture Agreement, (b) the Company's common stock is
delisted from NASDAQ, or (c) the Company's common stock ceases to be publicly
traded at the sum of the principal amount of the debentures tendered for
redemption, plus any accrued and/or unpaid interest outstanding related to the
debentures, plus 15% interest on outstanding principal and interest amounts
due, plus any expense or costs owed to the lender as set forth in the Debenture
Agreement. Due to continued noncompliance with debt covenants and the NASDAQ
listing criteria, (the Company's stock was delisted as of October 14, 1998),
the Company was in default of the debt agreement with Finova during the first
half of fiscal 1999. However, accompanying the sale of the Company's
international subsidiary, SouthTech, Inc., Finova agreed to restructure the
$4,000,000 debenture with the Company by transferring $1,000,000 to SouthTech,
Inc. as it was sold to Chapala Communications. In addition, Finova agreed to
convert $1,000,000 along with accrued but unpaid interest of $314,333 into
Series A convertible preferred stock which bears no dividends and is
convertible into the Company's common stock at $1.00 per share. The remaining
$2,000,000 debenture, convertible now at $1.00 per share and bearing interest
at 10% per annum, requires an interest payment of $200,000 on February 5, 2000.
After February 5, 2000, interest under the debenture is to be paid (i) on each
June 1, September 1, December 1, and February 1 until and including February 1,
2002 (ii) on the first day of each month commencing March 1, 2002 and (iii) on
the final maturity date of February 5, 2004. Monthly interest payments shall be
accompanied by payments of principal on the first day of each month (i)
beginning on February 1, 2002, in the amount of $55,555 each, and (ii)
beginning on February 1, 2003 in the amount of $111,111 each, and (iii) all
remaining principal shall become due on February 5, 2004. As consideration for
the restructuring of the convertible debenture by Finova, the Company granted
702,615 warrants to Finova with a strike price of $1.00 per share. The warrants
were valued at $188,000 and has been allocated to Other Assets within the
accompanying balance sheet. The warrant value will be amortized over the life
of the amended debenture agreement which approximates 5 years.
CASH. As of June 30, 1999, the Company had approximately $217,000 in cash and
cash equivalents. For the year ended June 30, 1999, $305,000 was provided by
operating activities as compared to cash used in operations of $2,786,000 for
the year ended June 30, 1998. The net loss for the period ended June 30, 1999
of $424,000 includes non-cash depreciation and amortization charges of
$853,000, a non-cash recorded gain of $1,461,000 recognized upon the sale of
the Company's international subsidiary, SouthTech, Inc. and an additional
non-cash recorded gain of $359,000 recognized in conjunction with certain debt
restructuring. Exclusive of the non-cash charges, cash was provided for
operations primarily through a decrease in accounts receivable and inventory of
$899,000 and $1,392,000, respectively.
The Company purchased $85,000 and $658,000 of property, plant and equipment
during the year ended June 30, 1999 and 1998, respectively. In addition, the
Company capitalized certain product development expenses paid to outside
contractors. During the year ended June 30, 1999, the Company capitalized
$136,000 of such costs as compared to capitalized costs of $583,000 for the
year ended June 30, 1998.
CREATION AND SALE OF SOUTHTECH, INC.
At its April 1998 meeting the DTS Board of Directors approved the creation of a
wholly owned subsidiary - SouthTech, Inc. ("SouthTech"), to which certain
assets and liabilities will pertain and whose business purpose is the
administration and growth of the Company's international business. The
subsidiary was legally created as a Georgia corporation in July 1998. The
SKYPLEX and DIV product lines and associated intellectual property together
with the payables and receivables pertaining to the sales realized from those
product lines form part of the assets and
15
<PAGE> 17
liabilities transferred. Since its creation, investment capital had been sought
for the subsidiary in order to fund its operating losses which have been
substantial in the past for the Company's international business. Cash
resources of the Company had been used for the purposes of developing the
SKYPLEX I product line, a set of microwave radio products utilizing spread
spectrum technology, and developing sales distribution channels in Latin
America, Asia Pacific and the Mid-East global sectors.
The Company entertained an offer from a private group of investors to buy
SouthTech, Inc. in the latter part of 1998 but the offer was later withdrawn on
November 10, 1998. In late November 1998, Chapala Communications, Inc.
("Chapala"), a Georgia based company, offered to purchase the stock of
SouthTech. The sale involved the transfer of certain assets and liabilities of
SouthTech, Inc. to Chapala. The transaction resulted in approximately $981,000
of assets and $2,081,000 of liabilities being transferred to Chapala. As
additional consideration for the sale, the Company received 19.5% of Chapala
stock ownership. SouthTech was later merged into Chapala and the resulting
entity was named Linkanet Labs, Inc. ("Linkanet"). The Company has assigned
zero value to its interest in Linkanet within the accompanying financial
statements and has no obligations to fund the Linkanet's future operations or
present liabilities. The SouthTech purchase and sale transaction was closed on
February 5, 1999.
In conjunction with the sale of SouthTech, Inc., the Company was issued a note
from Chapala Communications in the amount of $900,000 on February 5, 1999. The
note represented the portion of a significant vendor liability that Chapala
(later Linkanet) would be assuming upon the Company obtaining formal waivers
and consents from the vendor. In lieu of the formal consent or novation from
the vendor on February 5, 1999, the Company accepted the $900,000 note from
Chapala and deferred $900,000 of the gain associated with the transaction. The
Company received a formal consent from the vendor with respect to transfer of a
portion of the $900,000 liability during the 4th quarter of fiscal 1999 and has
recognized the additional gain in the same fiscal quarter of 1999. After
consideration of the vendor novation and payments or credits made towards the
vendor payable, the balance owed from the original note of $900,000 was reduced
to $127,300 as of June 30, 1999.
Accompanying the sale of SouthTech, the Company completed the restructuring of
the Finova convertible debenture originally issued September 25, 1997 (as
discussed within Long Term Debt above).
SHAREHOLDER MEETING AND ELECTION OF BOARD MEMBERS - APRIL 13, 1999
On December 31, 1998, Frank LaHaye (first elected in 1993) and Gene Miller
(first elected in 1990), two DTS Board members representing Peregrine Ventures,
a venture capital firm and the Company's then largest single shareholder,
tendered their resignations effective the same day. The Board of Directors
accepted their resignations and subsequently proposed two replacement
candidates for election to the DTS Board of Directors at the Shareholder
Meeting scheduled for Tuesday, April 13, 1999 at the Company headquarters. With
90% of the shares outstanding voting in the affirmative, two candidates from
MicroTel - Carmine T. Oliva and Jim Butler - were elected to the DTS Board of
Directors at the April 13, 1999 Shareholders Meeting. Further, Mr. Oliva was
elected Chairman of the Board at a DTS Board meeting held April 13, 1999 (Mr.
Oliva later resigned his position as DTS Chairman, effective July 28, 1999).
The term for Mr. Robert Francis (appointed in 1995 and elected for a two year
term in October 1996) expired in October 1998. However, Mr. Francis continued
to serve on the DTS Board until April 12, 1999 with the consent of the other
Board Members. The current Board of Directors of the Company consists of Mr.
Edwin Kantor (Co-CEO and Co-Chairman, HCFP Brenner Securities); Mr. Carmine T.
Oliva (Chairman and CEO, MicroTel International, Inc.); Mr. Jim Butler (CFO,
MicroTel International, Inc.); Mr. Andres C. Salazar (CEO, DTS).
Two other proposals were voted on at the April 13, 1999 Shareholder Meeting
with both being voted in the affirmative by a substantial margin from the
ballots received by the Company. One proposal concerned the increase of stock
options for employees and affiliates as a amendment to the Company's 1996 Stock
Incentive Plan. An additional 400,000 options were added to the current option
pool of that Plan. The remaining proposal requested that KPMG LLP be approved
and retained as the Company's independent auditors. The firm has been providing
auditing services to the Company since July 1996.
16
<PAGE> 18
MANAGEMENT AND EMPLOYMENT AGREEMENTS
At the Board Meeting held on April 13, 1999, a resolution was passed that
approved certain management changes and accompanying employment agreements. Mr.
Andres C. Salazar, then DTS President and CEO was re-appointed CEO and granted
an employment agreement for one year, renewable annually for two one-year
extensions. Simultaneously, Mr. Salazar was appointed Senior Vice President and
Group Executive for MicroTel International by the MicroTel Board of Directors.
In that role, Mr. Salazar is expected to perform strategic planning services
for MicroTel. His advisory services, expected to take up approximately 60% of
his time, and expenses incurred on behalf of MicroTel will be reimbursed to DTS
by MicroTel. Mr. Woodrow B. Cannon, then DTS Executive Vice President and
General Manager, was appointed DTS President and Chief Operating Officer and
granted an employment agreement for two years, renewable annually for one year
after the first two years for two one-year extensions. Copies of both of these
agreements with commencement dates of March 2, 1999 can be found in adjunct SEC
filings by the Company.
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.
YEAR 2000 (Y2K) IMPACT ON COMPANY'S INFORMATION TECHNOLOGY
The Company operates an Enterprise Resource Planning ("ERP") software system
which has modules supporting order entry, planning, inventory management,
operations, and general ledger functions. The vendor of this information system
has sent the Company a letter indicating the ERP system is Y2K compliant. The
hardware platform vendor, through its web presence, also indicates that the
system is Y2K compliant.
Most of the desktop computing systems used at the Company were manufactured
after 1995. They use operating system and document preparation software from
Microsoft Corporation. These systems are generally compliant with the Year 2000
requirements. The Company does operate older PC's in its manufacturing and
engineering organizations, but they are not used in time or date critical
operations.
The Company's products are designed to be Year 2000 compliant and have been
adequately tested as to conformance with Year 2000 date processing. All
products tested passed the conformance test and have been appropriately
certified as Year 2000 compliant by the Company. The Company did not incur and
does not expect to incur any material costs to address Year 2000 compliance
issues. The Company is in the process of developing a contingency plan to
address any instances of Year 2000 non-compliance and expects to complete such
a contingency plan by October 1999. The Company has a number of material
relationships with third parties and is aware of the risks involved and is
currently analyzing the potential impact on future operations. The Company is,
however, aware of the risk that third parties, including vendors and customers
of the Company, will not adequately address the Year 2000 problem and the
resultant potential adverse impact on the Company.
Notwithstanding the above, there can be no assurance that the Company's
internal systems or products will operate beyond 1999 or that major business
disruptions will not occur in mission critical systems and processes.
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, including the litigation discussed in the
previous paragraph, will not have a material adverse effect on the Company's
financial position, results of operations, or liquidity.
17
<PAGE> 19
NEW ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standard No. 133, or SFAS No. 133, Accounting for
Derivative Instruments and Hedging Activities. SFAS No. 133 establishes
accounting and reporting standards for derivative instruments, including
derivative instruments embedded in other contracts, and for hedging activities.
SFAS No. 133 is effective for all fiscal years beginning after June 15, 1999.
Subsequently, the effective date was deferred until June 15, 2000. We do not
anticipate any material impact on the financial statements as a result of the
adoption of SFAS No. 133.
IMPORTANT CONSIDERATIONS RELATED TO FORWARD-LOOKING STATEMENTS
It should be noted that this discussion contains forward-looking statements
which are subject to substantial known and unknown risks and uncertainties.
There are a number of factors which could cause actual results to differ
materially from those anticipated in statements made herein. Such factors
include, but are not limited to, changes in general economic conditions, the
growth rate of the market for the Company's products and services, the effect
of competitive products and pricing, and the irregular pattern of revenues, as
well as a number of other risk factors which could affect the future
performance of the Company.
18
<PAGE> 20
ITEM 7. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
Please see pages F-1 through F-21.
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
On July 11, 1996, the Company dismissed its independent public accountants,
Price Waterhouse LLP. Prior to July 11, 1996, Price Waterhouse LLP was engaged
as the principal accountant to audit the Company's financial statements. The
reports by Price Waterhouse LLP on the Company's financial statements for the
fiscal years ended June 30, 1995, June 30, 1994, and subsequent interim periods
did not contain any adverse opinion or disclaimer of opinion, nor were they
qualified or modified as to uncertainty, audit scope or accounting principles.
The dismissal of the former accountants was recommended by the Company's Audit
Committee and approved by the Company's Board of Directors.
During the Company's fiscal years ended June 30, 1995 and June 30, 1994, and
during the subsequent interim fiscal periods through the date of dismissal,
there were no disagreements with Price Waterhouse LLP on any matter of
accounting principles or practices, financial statement disclosure, or auditing
scope or procedure, which disagreements, if not resolved to the satisfaction of
Price Waterhouse LLP, would have caused it to make reference to the subject
matter of the disagreement in their reports. Also, there were no reportable
events of the nature described in Rule 304(a)(1)(v) during the Company's fiscal
years ended June 30, 1995 and June 30, 1994, or during the subsequent interim
fiscal periods following the Company's fiscal year ended June 30, 1995 through
the date of dismissal.
On July 11, 1996, the Company announced the appointment of KPMG LLP as
independent public accountants to audit the Company's financial statements as of
and for the year ended June 30, 1996. Continued engagement of KPMG LLP as the
Company's independent public accountants has been ratified at all subsequent DTS
Shareholder Meetings.
19
<PAGE> 21
PART III
ITEM 9. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
The information required herein will be included in the Company's Proxy
Statement for the Annual Meeting of Shareholder expected to be filed with the
Commission on or before January 31, 2000 under the captions "Election of
Directors" and "Executive Officers" and is incorporated by reference herein.
ITEM 10. EXECUTIVE COMPENSATION.
The information required herein will be included in the Company's Proxy
Statement for the Annual Meeting of Shareholder expected to be filed with the
Commission on or before January 31, 2000 under the captions "Election of
Directors" and "Executive Officers" and is incorporated by reference herein.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The information required herein will be included in the Company's Proxy
Statement for the Annual Meeting of Shareholder expected to be filed with the
Commission on or before January 31, 2000 under the captions "Election of
Directors" and "Executive Officers" and is incorporated by reference herein.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The information required herein will be included in the Company's Proxy
Statement for the Annual Meeting of Shareholder expected to be filed with the
Commission on or before January 31, 2000 under the captions "Election of
Directors" and "Executive Officers" and is incorporated by reference herein.
ITEM 13. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
(a) Exhibits.
The Exhibits are listed in the Index to Exhibits on page E - 1.
(b) Reports on Form 8-K.
Form 8-K dated February 5, 1999, filed with the Securities and Exchange
Commission on February 22, 1999, as amended by Form 8-K/A filed with the
Securities and Exchange Commission on February 23, 1999.
20
<PAGE> 22
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
DIGITAL TRANSMISSION SYSTEMS, INC.
September 27, 1999 /s/ Andres C Salazar
------------------ -----------------------------------
by: Andres C. Salazar,
Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
<S> <C> <C>
/s/ Andres C. Salazar Chief Executive Officer, September 27, 1999
- ------------------------------ Director (Principal Executive Officer)
Andres C. Salazar
/s/ Clive N. W. Marsh Controller September 27, 1999
- ------------------------------ (Principal Financial and Accounting Officer)
Clive N. W. Marsh
/s/ Ed Kantor Director September 27, 1999
- ------------------------------
Ed Kantor
/s/ Carmine Oliva Director September 27, 1999
- ------------------------------
Carmine Oliva
/s/ Jim Butler Director September 27, 1999
- ------------------------------
Jim Butler
</TABLE>
21
<PAGE> 23
Index to Financial Statements
Balance Sheets as of June 30, 1999 and 1998
Statements of Operations for the years ended June 30, 1999 and 1998
Statements of Shareholders' (Deficit) Equity for the years ended June 30, 1999
and 1998
Statements of Cash Flows for the years ended June 30, 1999 and 1998
Notes to Financial Statements
Independent Auditors' Report - KPMG LLP
22
<PAGE> 24
REPORT OF INDEPENDENT AUDITORS
The Board of Directors and Shareholders
Digital Transmission Systems, Inc.
We have audited the accompanying balance sheets of Digital Transmission
Systems, Inc. as of June 30, 1999 and 1998, and the related statements of
operations, shareholders' (deficit) equity, and cash flows for the years then
ended. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Digital Transmission Systems,
Inc. as of June 30, 1999 and 1998, and the results of its operations and its
cash flows for the years then ended in conformity with generally accepted
accounting principles.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in note 1(b) to the
financial statements, the Company has suffered recurring losses from
operations, and has a net capital deficiency that raises substantial doubt
about its ability to continue as a going concern. Management's plans in regard
to these matters are also described in note 1(b). The financial statements do
not include any adjustments that might result from the outcome of this
uncertainty.
/s/ KPMG LLP
Atlanta, Georgia
August 27, 1999
23
<PAGE> 25
DIGITAL TRANSMISSION SYSTEMS, INC.
Balance Sheets
June 30, 1999 and 1998
(in thousands, except share data)
<TABLE>
<CAPTION>
ASSETS 1999 1998
-------- -------
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 217 91
Trade accounts receivable, net of allowances for
returns and doubtful accounts of $1,238 and
$733 at June 30, 1999 and 1998, respectively 1,133 2,283
Accounts receivable from related parties 43 --
Inventories 903 2,469
Prepaid expenses and other current assets 25 105
-------- -------
Total current assets 2,321 4,948
Property and equipment, net of accumulated depreciation
and amortization 410 886
Note receivable from a related party 127 --
Intangible assets 423 1,045
Other assets 526 329
-------- -------
Total assets $ 3,807 7,208
======== =======
LIABILITIES AND SHAREHOLDERS' DEFICIT
Current liabilities:
Line of credit $ 1,365 1,329
Accounts payable and accrued liabilities 1,749 1,749
Accounts payable to related parties 69 --
Accrued payroll and benefits 167 248
Notes payable 561 --
Warranty accrual 197 618
Convertible debentures -- 4,000
-------- -------
Total current liabilities 4,108 10,776
-------- -------
Long-term liabilities:
Convertible debentures 2,000 --
Deferred gain on sale of subsidiary 127 --
-------- -------
Total long-term liabilities 2,127 --
-------- -------
Shareholders' deficit:
Preferred stock - 3,000,000 shares authorized; 1,314,333 shares
issued and outstanding 1,314 --
Common stock - $.01 par value; 15,000,000 shares
authorized; 4,646,221 and 4,191,460 shares issued
and outstanding at June 30, 1999 and 1998, respectively 47 42
Additional paid-in capital 11,651 11,462
Deferred compensation -- (56)
Notes receivable from stock sales (63) (63)
Accumulated deficit (15,377) (14,953)
-------- -------
Total shareholders' deficit (2,428) (3,568)
Commitments and contingencies
-------- -------
Total liabilities and shareholders' deficit $ 3,807 7,208
======== =======
</TABLE>
See accompanying notes to financial statements
24
<PAGE> 26
DIGITAL TRANSMISSION SYSTEMS, INC.
Statements of Operations Years ended
June 30, 1999 and 1998
(in thousands, except share data)
<TABLE>
<CAPTION>
1999 1998
------- -------
<S> <C> <C>
Net sales $ 7,538 15,579
------- -------
Cost of sales, including $-0- and $414 in write-offs of
capitalized product development costs in 1999 and 1998,
respectively 4,764 13,721
------- -------
Gross profit 2,774 1,858
------- -------
Selling, general, and administrative expenses 3,014 7,018
Product development 1,353 2,367
------- -------
Total operating expenses 4,367 9,385
------- -------
Operating loss (1,593) (7,527)
-------- --------
Interest expense, net of interest income (651) (576)
Gain on sale of subsidiary 1,461 --
Other income (expense) -- 8
------- -------
Total other income (expense) 810 (568)
------- -------
Loss before income tax expense (783) (8,095)
------- -------
Income tax expense -- (285)
------- -------
Loss before extraordinary items (783) (8,380)
------- -------
Extraordinary gain on settlement of trade payables 359 --
------- -------
Net loss $ (424) (8,380)
======= =======
Net loss per share-basic and diluted:
Loss per share before extraordinary items $ (0.18) (2.01)
Extraordinary gain on settlement of trade payables 0.08 --
------- -------
Loss per share-basic and diluted $ (0.10) (2.01)
======= =======
Weighted-average common and common equivalent shares
outstanding 4,318 4,160
======= =======
</TABLE>
See accompanying notes to financial statements
25
<PAGE> 27
DIGITAL TRANSMISSION SYSTEMS, INC.
Statements of Shareholders' (Deficit) Equity
Years ended June 30, 1999 and 1998
(in thousands)
<TABLE>
<CAPTION>
PREFERRED STOCK COMMON STOCK
------------------ -------------------
NUMBER NUMBER ADDITIONAL
OF SHARES OF SHARES PAID-IN DEFERRED
ISSUED AMOUNT ISSUED AMOUNT CAPITAL COMPENSATION
--------- ------ --------- ------ ---------- -------------
<S> <C> <C> <C> <C> <C> <C>
Balance at June 30, 1997 -- $ -- 4,121 41 11,232 (124)
Exercise of stock options -- -- 70 1 64 --
Compensation expense -- -- -- -- -- 68
Issuance of warrants to purchase -- --
common shares -- -- -- -- 166 --
Net loss -- -- -- -- -- --
------ ------ ------ ------ ------ ------
Balance at June 30, 1998 -- -- 4,191 42 11,462 (56)
Conversion of convertible debentures
to preferred stock 1,314 1,314 -- -- -- --
Exercise of stock options -- -- 59 1 1 --
Issuance of stock in lieu of
compensation -- -- 396 4 -- --
Compensation expense -- -- -- -- -- 56
Issuance of warrants to purchase
common shares -- -- -- -- 188 --
Net loss -- -- -- -- -- --
------ ------ ------ ------ ------ ------
Balance at June 30, 1999 1,314 $1,314 4,646 47 11,651 --
====== ====== ====== ====== ====== ======
<CAPTION>
NOTES TOTAL
RECEIVABLE SHAREHOLDERS'
FROM STOCK ACCUMULATED (DEFICIT)
SALES DEFICIT EQUITY
------------ ----------- ------------
<S> <C> <C> <C>
Balance at June 30, 1997 (33) (6,573) 4,543
Exercise of stock options (30) -- 35
Compensation expense -- -- 68
Issuance of warrants to purchase
common shares -- -- 166
Net loss -- (8,380) (8,380)
------- ------- -------
Balance at June 30, 1998 (63) (14,953) (3,568)
Conversion of convertible debentures
to preferred stock -- -- 1,314
Exercise of stock options -- -- 2
Issuance of stock in lieu of
compensation -- -- 4
Compensation expense -- -- 56
Issuance of warrants to purchase
common shares -- -- 188
Net loss -- (424) (424)
------- ------- -------
Balance at June 30, 1999 (63) (15,377) (2,428)
======= ======= =======
</TABLE>
See accompanying notes to financial statements.
26
<PAGE> 28
DIGITAL TRANSMISSION SYSTEMS, INC.
Statements of Cash Flows
Years ended June 30, 1999 and 1998
(in thousands)
<TABLE>
<CAPTION>
1999 1998
------- -------
<S> <C> <C>
Cash flows from operating activities:
Net loss $ (424) (8,380)
Adjustments to reconcile net loss to net
cash provided by (used in) operating activities:
Depreciation and amortization 853 1,219
Gain on sale of subsidiary (1,461) --
Extraordinary gain on settlement of trade payables (359) --
Write-off of capitalized product development costs -- 414
Amortization of deferred compensation expense 56 68
Deferred tax expense -- 285
Change in assets and liabilities:
Trade accounts receivable 899 1,940
Inventories 1,392 (29)
Prepaid expenses and other current assets 80 204
Accounts payable and accrued liabilities (492) 1,565
Accrued payroll and benefits (81) (343)
Warranty reserve (16) 415
Other (142) (144)
------- -------
Net cash provided by (used in) operating activities 305 (2,786)
------- -------
Cash flows from investing activities:
Purchases of property and equipment (85) (658)
Additions to capitalized product development costs (136) (583)
------- -------
Net cash used in investing activities (221) (1,241)
------- -------
Cash flows from financing activities:
Net borrowings (payments) under line of
credit agreements 36 (629)
Proceeds from sale of convertible debentures -- 4,000
Proceeds from exercise of stock options 2 35
Proceeds from issuance of common stock 4 --
------- -------
Net cash provided by financing activities 42 3,406
------- -------
Net increase (decrease) in cash and cash equivalents 126 (621)
Cash and cash equivalents at beginning of year 91 712
------- -------
Cash and cash equivalents at end of year $ 217 91
======= =======
Supplemental disclosure of cash paid for interest $ 158 517
======= =======
Supplemental disclosure of non-cash operating
and financing activities:
Issuance of note receivable in conjunction with
a subsidiary liability $ 127 $ --
======= =======
Conversion of $1000 of convertible debentures
plus accrued interest to Series A convertible
preferred stock $ 1,314 $ --
======= =======
Issuance of warrants relating to conversion
of debentures $ 188 $ --
======= =======
Sale of subsidiary:
Assets disposed of $ 981 --
Liabilities disposed of (2,442) --
------- -------
$(1,461) --
======= =======
</TABLE>
See accompanying notes to financial statements.
27
<PAGE> 29
DIGITAL TRANSMISSION SYSTEMS, INC.
Notes to Financial Statements
June 30, 1999 and 1998
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(A) DESCRIPTION OF BUSINESS
Digital Transmission Systems, Inc. (the "Company") designs,
manufactures, markets, and services a broad range of products for
the telecommunications industry. The Company's primary customers
are long distance carriers and wireless service providers. The
Company'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.
(B) GOING CONCERN MATTERS
The accompanying financial statements have been prepared on a
going concern basis, which contemplates the realization of assets
and the satisfaction of liabilities in the normal course of
business. As shown in the financial statements during the years
ended June 30, 1999 and 1998, the Company incurred losses of
$424,000 and $8,380,000, respectively, and has a net capital
deficit of $2,428,000 as of June 30, 1999. These factors, among
others, raise substantial doubt about the Company's ability to
continue as a going concern for a reasonable period of time.
The financial statements do not include any adjustments relating
to the recoverability and classification of assets and
liabilities that might be necessary should the Company be unable
to continue as a going concern. The Company's continuation as a
going concern is dependent upon its ability to generate
sufficient cash flow to meet its obligations on a timely basis,
to comply with the terms of its financing agreements, to obtain
additional financing or refinancing as may be required, and
ultimately to attain profitability. The Company is actively
pursuing additional equity financing through discussions with
potential investors, and is also pursuing potential merger or
acquisition candidates.
(C) CASH AND CASH EQUIVALENTS
Cash and cash equivalents include cash on deposit in banks and
money market accounts. All cash and cash equivalents are carried
at cost which approximates market. For purposes of the statements
of cash flows, the Company considers all highly liquid
investments with original maturities of three months or less to
be cash equivalents.
(D) INVENTORIES
Inventories are stated at the lower of cost or market. Cost is
determined using average cost which approximates the first-in,
first-out (FIFO) method.
(Continued)
28
<PAGE> 30
DIGITAL TRANSMISSION SYSTEMS, INC.
Notes to Financial Statements
June 30, 1999 and 1998
Management of the Company has established a valuation allowance
for inventory obsolescence based on review of the composition,
quantity, and expected future sales levels of inventory on hand.
The amount of inventory obsolescence ultimately incurred could
differ materially in the near term from the allowance recorded in
these financial statements.
(E) PROPERTY AND EQUIPMENT
Property and equipment are stated at cost less accumulated
depreciation and amortization. Depreciation is calculated on the
straight-line method over the estimated useful lives of the
assets as follows:
<TABLE>
<CAPTION>
<S> <C>
Computer Hardware, Software, and Test Equipment 3 years
Prototypes 1 year
Furniture and Fixtures 3 years
Leasehold Improvements Shorter of 3 years or lease terms
</TABLE>
(F) INTANGIBLE ASSETS AND RESEARCH AND DEVELOPMENT EXPENDITURES
Capitalized product development costs, goodwill, and other
intangible assets are being amortized on a straight-line basis
over a three-year period. The Company evaluates the
recoverability of these intangible assets at each period end
using the undiscounted estimated future cash flows expected to be
derived from such assets. If such evaluation indicates a
potential impairment, the Company measures it based on projected
discounted future operating cash flows using a discount rate
reflecting the Company's average cost of funds.
The assessment of the recoverability of these intangible assets
will be impacted if estimated future operating cash flows are not
achieved. During the year ended June 30, 1998, approximately
$414,000 in write-offs were recognized due to impairment of net
realizable value.
Research and development costs related to new product development
that has not reached product design phase are expensed as
incurred. The Company capitalizes product development costs for
outside contractors from the time that product design has been
completed for the product to the time that the product is ready
for production. The determination of completion of the product
design phase and the ongoing assessment of recoverability of
capitalized product development costs require considerable
judgment by management with respect to certain external factors,
including, but not limited to, anticipated future revenues,
estimated economic life, and changes in technologies.
(Continued)
29
<PAGE> 31
DIGITAL TRANSMISSION SYSTEMS, INC.
Notes to Financial Statements
June 30, 1999 and 1998
(G) IMPAIRMENT OF LONG-LIVED ASSETS AND LONG-LIVED ASSETS TO BE
DISPOSED OF
Long-lived assets are accounted for under the provisions of
Statement of Financial Accounting Standards No. 121 ("SFAS"),
Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to Be Disposed Of ("SFAS 121"), which requires
that long-lived assets and certain identifiable intangibles be
reviewed for impairment whenever events or changes in
circumstances indicate that the carrying amount of an asset may
not be recoverable. Recoverability of assets to be held and used
is measured by a comparison of the carrying amount of an asset to
future net cash flows expected to be generated by the asset. If
such assets are considered to be impaired, the impairment to be
recognized is measured by the amount by which the carrying amount
of the assets exceeds the fair value of the assets. Assets to be
disposed of are reported at the lower of the carrying amount or
fair value less costs to sell. The Company recorded no
adjustments related to SFAS 121 during the years ended June 30,
1999 or 1998.
(H) FINANCIAL INSTRUMENTS
Financial instruments which potentially subject the Company to
concentrations of credit risk are primarily cash, cash
equivalents, and accounts receivable. The Company's cash
equivalents are in money market accounts. The Company believes no
significant concentration of credit risk exists with respect to
these financial instruments.
Accounts receivable arise from Company sales of its products
primarily to long-distance carriers, wireless service providers,
and resellers/integrators in the telecommunications industry,
domestically. Generally, the Company requires no collateral on
trade receivables, but believes that any credit risks are
substantially mitigated by its credit evaluation process. The
Company maintains allowances for potential credit losses, but
historically has not experienced significant losses related to
groups of customers in any particular geographic area.
(I) REVENUE RECOGNITION
Revenue from the sale of equipment is recognized at the time of
shipment. The Company estimates and records provisions for sales
returns, discounts, and allowances in the period the sale is
reported, based on its experience and other relevant factors.
Certain of the Company's contractual arrangements allow for
limited right of return. Management of the Company has provided
an allowance for expected sales returns, discounts, and
allowances related to these customers based on the historical
return rates and expected future returns of sales to these
customers. The amounts of sales discounts, returns, and
allowances ultimately incurred could differ materially in the
near term from the allowances recorded in these financial
statements.
(Continued)
30
<PAGE> 32
DIGITAL TRANSMISSION SYSTEMS, INC.
Notes to Financial Statements
June 30, 1999 and 1998
(J) WARRANTY ACCRUAL
The Company warrants its products against defects in design,
materials, and workmanship for periods ranging from two to five
years. A provision for estimated future costs relating to
warranty expense is recorded when the products are shipped based
on historical claims and projected future experience.
Certain of the Company's product lines have been recently
introduced to market and therefore limited historical data has
been available on which to base estimates of future returns for
warranty repairs. Management of the Company has provided for
warranty expense related to these new products based on the
historical return rates and repair costs of established products
lines, as well as recent and expected return rates and repair
costs of these new products. The amount of warranty expense
ultimately incurred could differ materially in the near term from
the accrual recorded in these financial statements.
(K) INCOME TAXES
Income taxes are accounted for under the asset and liability
method. Deferred tax assets and liabilities are recognized for
the future tax consequences attributable to differences between
the financial statement carrying amounts of existing assets and
liabilities and their respective tax bases and operating loss and
tax credit carryforwards. Deferred tax assets and liabilities are
measured using enacted tax rates expected to apply to taxable
income in the years in which those temporary differences are
expected to be recovered or settled. The effect on deferred tax
assets and liabilities of a change in tax rates is recognized in
income in the period that includes the enactment date.
(L) STOCK OPTION PLAN
SFAS No. 123, Accounting for Stock-Based Compensation, permits
entities to recognize as expense over the vesting period the fair
value of all stock-based awards on the date of grant.
Alternatively, SFAS No. 123 also allows entities to continue to
apply the provisions of APB Opinion No. 25, Accounting for Stock
Issued to Employees, under which compensation expense would be
recorded on the date of grant only if the current market price of
the underlying stock exceeded the exercise price, while providing
pro forma net income and pro forma earnings per share disclosures
for employee stock option grants made in fiscal 1996 and
subsequent years as if the fair-value-based method defined in
SFAS No. 123 had been applied. The Company has elected to
continue to apply the provisions of APB Opinion No. 25 and
provide the pro forma disclosure provisions of SFAS No. 123.
(Continued)
31
<PAGE> 33
DIGITAL TRANSMISSION SYSTEMS, INC.
Notes to Financial Statements
June 30, 1999 and 1998
(M) EARNINGS (LOSS) PER SHARE
The Company has presented earnings (loss) per share in accordance
with the provisions of SFAS No. 128, Earnings Per Share ("SFAS
128"), which requires companies that have publicly held common
stock or potential common stock to present both basic and diluted
earnings (loss) per share (EPS) on the face of the income
statement. Basic EPS is calculated as income (loss) available to
common shareholders divided by the weighted-average number of
common shares outstanding during the period. Diluted EPS is
calculated as income (loss) available to common shareholders
divided by the weighted-average number of common shares
outstanding during the period plus any dilutive potential common
shares, such as convertible debt or stock options. To the extent
that the Company reports a loss, these dilutive potential common
shares are not included in the diluted EPS calculation as they
would have an anti-dilutive effect.
(N) USE OF ESTIMATES
The preparation of financial statements in conformity with
generally accepted accounting principles requires management to
make estimates and assumptions that affect the amounts reported
in the financial statements and accompanying notes.
Actual results could differ from those estimates.
(O) OPERATING SEGMENTS
On July 1, 1998, the Company adopted Statement of Financial
Accounting Standards No. 131, Disclosures About Segments of
an Enterprise and Related Information. During 1998, the
Company operated in two segments: domestic and international
(see note 14).
(P) COMPREHENSIVE INCOME
On July 1, 1998, the Company adopted Statement of Financial
Accounting Standards No. 130, Reporting Comprehensive Income
("SFAS 130"). SFAS 130 establishes standards for reporting and
presentation of comprehensive income and its components in a full
set of financial statements. The Company has no "other
comprehensive income" to report for the two years ended June 30,
1999.
(Continued)
32
<PAGE> 34
DIGITAL TRANSMISSION SYSTEMS, INC.
Notes to Financial Statements
June 30, 1999 and 1998
(2) SALE OF SUBSIDIARY
On February 5, 1999, the Company disposed of assets and liabilities of a
wholly-owned subsidiary, SouthTech, Inc. The sale involved the transfer
of certain assets and liabilities of SouthTech, Inc. to Chapala
Communications, Inc. ("Chapala"). As additional consideration for the
sale, the Company received 19.5% of Chapala stock ownership. The Company
accounts for the investment on the cost method at $0. In connection
with the sale of SouthTech, Inc., the Company received a note from
SouthTech, Inc. in the amount of $127,000 at June 30, 1999. The note
represents a portion of a vendor liability that was not assumed by
Chapala. The Company has also deferred $127,000 of the gain associated
with the sale.
(3) RELATED PARTIES
Microtel International ("Microtel"), a shareholder, has an agreement with
the CEO of the Company which appoints him as Senior Vice President and
Group Executive for Microtel. His advisory services are estimated to take
approximately 60% of his time, and the Company has recorded a receivable
from Microtel for these services. No amounts have been collected from
Microtel for these services since the inception of the agreement. The
related party receivable related to the services provided by the
Company's CEO is $21,000 at June 30, 1999.
Linkanet Labs, formerly Chapala, sells certain products to the Company
which the Company resells to customers. The Company also sells certain
products to Linkanet labs. Amounts payable for products purchased from
Linkanet Labs total $69,000 at June 30, 1999. Amounts receivable for
products sold to Linkanet Labs total $22,000 at June 30, 1999.
(4) INTANGIBLE ASSETS
Intangible assets consist of the following as of June 30, 1999 and 1998
(in thousands):
<TABLE>
<CAPTION>
1999 1998
------ ------
<S> <C> <C>
Capitalized product development costs $ 739 1,254
Intangible asset related to the acquisition
of SKYPLEX rights -- 200
------ ------
1,454
Less accumulated amortization 316 409
------ ------
$ 423 1,045
====== ======
</TABLE>
Amortization expense recorded for the years ended June 30, 1999 and 1998
was approximately $356,000 and $261,000, respectively.
(5) INVENTORIES
Inventories consist of the following at June 30, 1999 and 1998 (in
thousands):
<TABLE>
<CAPTION>
1999 1998
------- -------
<S> <C> <C>
Raw materials $ 1,164 2,149
Work in process 227 458
Finished goods 444 1,189
Inventory reserve (932) (1,327)
------- -------
$ 903 2,469
======= =======
</TABLE>
(Continued)
33
<PAGE> 35
DIGITAL TRANSMISSION SYSTEMS, INC.
Notes to Financial Statements
June 30, 1999 and 1998
(6) PROPERTY AND EQUIPMENT
Property and equipment consist of the following at June 30, 1999 and
1998 (in thousands):
<TABLE>
<CAPTION>
1999 1998
------ ------
<S> <C> <C>
Computer and test equipment $2,201 2,906
Software 349 339
Furniture and fixtures 140 159
Leasehold improvements 217 228
------ ------
2,907 3,632
Less accumulated depreciation and amortization 2,497 2,746
------ ------
$ 410 886
====== ======
</TABLE>
(7) CONVERTIBLE DEBENTURES
On September 25, 1997, the Company issued $4 million of 11.5%
subordinated debentures due September 25, 2002. The Debenture Purchase
Agreement (the "Debenture Agreement") contains numerous rights,
privileges, conditions, etc., in favor of the lender, only certain of
which have been included herein. Accordingly, the Debenture Agreement
should be read in conjunction with this summary note. The debentures are
convertible at any time by the lender into common stock of the Company
at a conversion price of $10.25 per share, subject to adjustment in
certain events. The debentures are redeemable by the Company after
September 1999 provided that (a) the Company pays the lender additional
interest such that the lender would receive an effective compounded 20%
interest rate from inception of the loan or (b) the 20-day average bid
price for the Company's stock exceeds $15.00 per share.
The debentures may be required to be redeemed by the Company at the
option of the lender at any time prior to maturity if (a) there is a
change in control, as defined in the Debenture Agreement, (b) the
Company's common stock is delisted from NASDAQ, or (c) the Company's
common stock ceases to be publicly traded at the sum of the principal
amount of the debentures tendered for redemption, plus any accrued, plus
unpaid interest outstanding related to the debentures, plus 15% interest
on outstanding principal and interest amounts due, plus any expenses and
costs owed to the lender as set forth in the Debenture Agreement. The
Debenture Agreement imposes certain covenants as defined in the
Debenture Agreement. The Company was not in compliance with NASDAQ
listing criteria as of June 30, 1999; however, a waiver was obtained
through July 2, 2000.
On February 5, 1999, the debenture was restructured as part of the sale
of the Company's subsidiary, SouthTech, Inc. As part of the
restructuring, $1,000,000 of the debenture was transferred to the
acquiring company. In addition $1,000,000 in principal was converted,
along with accrued but unpaid interest of $314,333, into Series "A"
convertible redeemable preferred stock which bears no dividends
(Continued)
34
<PAGE> 36
DIGITAL TRANSMISSION SYSTEMS, INC.
Notes to Financial Statements
June 30, 1999 and 1998
and is convertible into common stock at $1.00 per share. The remaining
$2,000,000 debenture, convertible at $1.00 per share and bearing
interest at 10% per annum, requires an interest payment of $200,000 on
February 5, 2000. After February 5, 2000, interest under the debenture
is to be paid (i) on each June 1, September 1, and February 1 until and
including February 1, 2002 (ii) on the first day of each month
commencing March 1, 2002 and (iii) on the final maturity date of
February 5, 2004. Monthly interest payment shall be accompanied by
payments of principal on the first day of each month (ii) beginning on
February 1, 2002, in the amount of $55,555 each, and (ii) beginning on
February 1, 2003 in the amount of $111,111 each, and (iii) all remaining
principal shall become due on February 5, 2004. Approximate aggregate
minimum annual payments due on long-term debt subsequent to June 30,
1999 are as follows: 2000, $-0-; 2001, $-0-; 2002, $278,000; 2003,
$944,000; and 2004, $778,000.
(8) LINE OF CREDIT AGREEMENT
In April 1997, the Company executed a line of credit agreement with a
financial institution whereby it could borrow the lesser of $2,500,000
or 80% of eligible receivables, as defined in the Loan and Security
Agreement (the "Agreement"). In March 1998, the Agreement was amended to
increase the maximum eligible borrowing to the lesser of $4,000,000 or
80% of eligible receivables plus 30% of eligible inventory, as defined,
through the maturity date of April 10, 2000. On December 2, 1998, the
Company signed an amendment to the loan agreement, which modified the
credit limit decreasing the amount of the credit limit to the lesser of
a total of $1,500,000 or 80% of eligible receivables plus the lesser of
30% of eligible inventory or $600,000; limited to $500,000 as of
December 15, 1998 and $400,000 as of January 15, 1999. On March 3, 1999,
the credit limit was again modified to the lesser of a total of
$1,500,000 or 80% of eligible receivable plus the lesser of 30% of
eligible inventory or $475,000, with such limit reduced by $25,000 every
two weeks until such limit is $400,000.
Amounts outstanding under the Agreement were $1,365,067 and $1,329,352
at June 30, 1999 and 1998, respectively. Borrowings accrue interest at
the prime rate plus 2.25% (10.0% and 10.75% at June 30, 1999 and 1998,
respectively) and are secured by accounts receivable, inventory, and
certain other assets as defined in the Agreement. A commitment fee of
.125% of the unused portion of the line of credit and a $1,000
collateral fee are payable monthly under the terms of the Agreement.
The Agreement imposes certain covenants as defined in the Agreement, and
amended March 3, 1999, with which the Company was in compliance as of
June 30, 1999. In consideration of the revised terms executed on
December 2, 1998, the Company issued five-year warrants to the financial
institution to purchase 250,000 shares of common stock at $0.119 per
share.
(Continued)
35
<PAGE> 37
DIGITAL TRANSMISSION SYSTEMS, INC.
Notes to Financial Statements
June 30, 1999 and 1998
(9) INCOME TAXES
A reconciliation of the expected income tax benefit (at the statutory
federal income tax rate of 34%) to the actual income taxes reported in
the statement of operations is as follows (in thousands):
<TABLE>
<CAPTION>
1999 1998
------ ------
<S> <C> <C>
Computed "expected" income tax benefit
at Federal statutory rate of 34% $ (144) (2,752)
State income taxes, net of Federal benefit (17) (321)
Increase in valuation allowance 180 3,435
Other, net (19) (77)
------ ------
$ -- 285
====== ======
</TABLE>
The income tax effects of the temporary differences that give rise to
significant portions of the Company's deferred tax assets at June 30,
1999 and 1998 are presented below (in thousands):
<TABLE>
<CAPTION>
1999 1998
------ ------
<S> <C> <C>
Deferred tax assets:
Allowance for doubtful accounts $ 85 278
Inventory valuation allowance 354 504
Accrued expenses not reduced for tax purposes 105 249
Property and equipment depreciation 165 141
Net operating loss carryforwards 5,974 5,331
Product and development tax credit
carryforwards 441 441
------ ------
Gross deferred tax asset 7,124 6,944
Less valuation allowance 7,124 6,944
------ ------
Net deferred tax assets $ -- --
====== ======
</TABLE>
The valuation allowance for deferred tax assets as of June 30, 1999 and
1998 was $7,124,000 and $6,944,000, respectively. The net change in the
total valuation allowance for the years ended June 30, 1999 and 1998 was
an increase of approximately $180,000 and $3,435,000, respectively. In
assessing the realizability of deferred tax assets, management considers
whether it is more likely than not that some portion or all of the
deferred tax assets will not be realized. The ultimate realization of
deferred tax assets is dependent upon the generation of future taxable
income during the periods in which those temporary differences become
deductible. Management considers the scheduled reversal of deferred tax
liabilities, projected future taxable income, and tax planning
strategies in making this assessment. In order to fully realize the
deferred tax asset, the Company will need to generate future taxable
income of approximately $16,000,000 prior to the expiration of the net
operating loss carryforwards beginning in 2007. Taxable loss for the
years ended June 30, 1999 and 1998 was approximately $(1,694,000) and
$(5,956,000), respectively. Based upon the level of historical taxable
income and
(Continued)
36
<PAGE> 38
DIGITAL TRANSMISSION SYSTEMS, INC.
Notes to Financial Statements
June 30, 1999 and 1998
projections for future taxable income over the periods in which the
deferred tax assets are deductible, management believes it is more
likely than not the Company will not realize the benefits of these
deductible differences. Therefore, management has established a 100% net
valuation allowance.
At June 30, 1999, the Company has net operating loss carryforwards for
federal income tax purposes of approximately $15,720,000 which are
available to offset future federal taxable income, if any, through 2019.
In addition, the Company has product development tax credit
carryforwards of approximately $441,000 which are available to reduce
future federal regular income taxes, if any, and have expiration dates
beginning in 2005.
The amount of net operating loss and research and experimentation credit
carryforwards may be limited due to an ownership change, as defined in
the Internal Revenue Service regulations. In the event of an ownership
change, the amount of taxable income of a loss corporation for any
postchange year which may be offset by prechange losses shall not exceed
the Internal Revenue Code Section 382 limitation for such year.
Generally, an ownership change occurs if a 5% stockholder or any equity
structure shift increases the percentage of the stock of the loss
corporation owned by more than 50 percentage points over the lowest
percentage of stock of the loss corporation owned by such stockholders
at any time during a three-year look-back testing period. The annual
Section 382 limitation is equal to the value of the old loss corporation
(before the ownership change) multiplied by the Federal long-term,
tax-exempt rate.
(10) SHAREHOLDERS' EQUITY
(A) INITIAL PUBLIC OFFERING
On March 4, 1996, the Company completed a public stock offering
(the "Offering") of 1,220,700 units, each consisting of one share
of common stock and one warrant to purchase one share of common
stock at an exercise price per share of $9. Through this
Offering, the Company raised approximately $6,931,000 net of
expenses.
The 1,220,700 shares of common stock included in the units were
shown as outstanding shares as of June 30, 1996 for the purpose
of the statement of stockholders' (deficit) equity.
(B) CONVERSION OF SERIES A, SERIES B, AND
SERIES C REDEEMABLE CONVERTIBLE PREFERRED STOCK
Concurrent with the Offering, the Company converted the 358,563,
90,850, and 1,363,876 outstanding shares of Series A, Series B,
and Series C Redeemable Convertible Preferred Stock,
respectively, to shares of $.01 par value Common Stock on a 1:1
basis. At the time of the conversion, $523,400 was accrued in
dividends on the redeemable convertible preferred stock.
(Continued)
37
<PAGE> 39
DIGITAL TRANSMISSION SYSTEMS, INC.
Notes to Financial Statements
June 30, 1999 and 1998
The Company paid $200,000 in cash and issued 69,383 shares of
common stock as payment for the remainder. The owners of this
common stock have retained certain demand registration rights.
(C) SHAREHOLDER LOCK-UP AGREEMENTS
Certain holders of the 2,700,000 shares of common stock
outstanding prior to the Offering entered into agreements that
they would not sell any common stock owned by them without the
prior written consent of the underwriter for a period of one year
from the date of the Offering, and some of these agreements were
extended beyond one year. No lock-up agreements remain in effect
as of June 30, 1999.
(D) SEPARATION OF UNITS
The shares of common stock and warrants included in the 1,220,700
units sold in the Offering were not separately detachable or
separately transferable, and could only be traded as units, until
365 days from the date of the Offering or such earlier date as
the underwriter could determine (the "Separation Date"). On
February 18, 1997, the units separated so that the common stock
and warrants underlying the units began trading separately and
the units ceased to trade.
(E) WARRANTS
The 1,220,700 warrants included in the units sold in the Offering
were separated on February 18, 1997 as discussed in (d) above.
These warrants entitle the holder to purchase one share of common
stock at an exercise price of $9, and expire March 4, 2001. All
1,220,700 warrants remain outstanding and exercisable as of June
30, 1999.
In connection with the March 1998 amendment to the line of credit
agreement, the Company issued five-year warrants to the financial
institution which permit them to purchase 60,000 shares of the
Company's common stock at $5.50 per share. Using the
Black-Scholes option pricing model, the Company has calculated
the fair market value of the warrants granted to be approximately
$166,000 as of the date of grant.
This amount was recorded as additional paid-in capital and debt
issuance costs, which will be amortized as interest expense over
the remaining term of the Agreement. Total amortization expense
of $80,000 and $20,000 was recorded to interest expense during
the year ended June 30, 1999 and 1998, respectively. All 60,000
warrants remain outstanding and exercisable as of June 30, 1999.
In connection with the December 1998 amendment to the line of
credit agreement, the Company issued warrants to the financial
institution which permitted them to purchase 250,000 shares of
the Company's common stock at the exercise price of $.119 per
share, expiring on December 2,
(Continued)
38
<PAGE> 40
DIGITAL TRANSMISSION SYSTEMS, INC.
Notes to Financial Statements
June 30, 1999 and 1998
2003. The fair value of the warrant issued is immaterial to the
Company's financial statements and has not been recorded. All
250,000 warrants remain outstanding and exercisable as of June
30, 1999.
In connection with the February 1999 amendment to the subordinated
debentures outstanding, the Company issued warrants to Tandem
Capital, which permitted them to purchase 702,615 shares of the
Company's common stock at the exercise of $1.00 per share,
expiring on March 1, 2004. Using the Black-Scholes option pricing
model, the Company has calculated the fair market value of the
warrant granted to be approximately $188,000 as of the date of
grant. This amount was recorded as additional paid-in capital and
debt issuance costs, which will be amortized as interest expense
over the remaining term of the Agreement. Total amortization
expense of $15,000 was recorded to interest expense during the
year ended June 30, 1999. All 702,615 warrants remain outstanding
and exercisable as of June 30, 1999.
(F) STOCK OPTIONS
Effective October 1992, the Board of Directors adopted the 1992
Stock Incentive Plan (the "1992 Plan") which provides for the
grant of stock options for up to 840,946 shares of common stock.
The 1992 Plan also permits the Board of Directors to grant stock
appreciation rights, stock bonuses, and restricted stock awards
in accordance with the provisions of the Plan. The Plan remains
in effect until October 2002 unless sooner terminated by the
Board of Directors.
Effective January 1996, the Board of Directors adopted the 1996
Stock Incentive Plan (the "1996 Plan") which provides for the
grant of stock options for up to 200,000 shares of common stock.
In October 1996, the Board of Directors voted to increase the
number of shares of common stock authorized under the 1996 Plan
from 200,000 shares to 440,000 shares. Additionally, effective
April 1999, shareholders of the Company voted to increase the
number of shares of common stock authorized under the 1996 Plan
from 440,000 shares to 840,000 shares. The 1996 Plan also permits
the Board of Directors to grant stock appreciation rights, stock
bonuses, and restricted stock awards in accordance with the
provisions of the Plan. The Plan remains in effect until January
2006 unless sooner terminated by the Board of Directors.
Options granted under the 1992 and 1996 Plans may be incentive
stock options or nonqualified stock options, as determined by the
Board of Directors at the time of grant. Incentive stock options
are granted at a price not less than the fair market value of the
stock on the grant date, and nonqualified options are granted at
a price to be determined by the Board of Directors provided that
such exercise price is not less than 85% of the fair market value
of the stock on the grant date. Option vesting terms are
established by the Board of Directors at the time of grant, and
presently range from three to five years. The expiration date of
options granted under the 1992 and 1996 Plans are determined at
the time of grant and may not exceed ten years from the date of
the grant.
(Continued)
39
<PAGE> 41
DIGITAL TRANSMISSION SYSTEMS, INC.
Notes to Financial Statements
June 30, 1999 and 1998
As of June 30, 1999, there were no options available for
grant under the 1992 Plan, and there were 389,942 options
available for grant under the 1996 Plan.
On March 4, 1996, pursuant to the Underwriter's Agreement, the
Company issued options to the underwriter to purchase 107,000
units (consisting of one share of common stock and one warrant to
purchase one share of common stock at an exercise price of
$14.85). The options have an exercise price per unit of $12.375
and expire March 4, 2001. The options were assigned a fair value
of $-0- when issued due to the stated exercise prices which
greatly exceeded the market value at the grant date. As of June
30, 1999, 107,000 options were outstanding and exercisable.
The Company also issues options to members of the Board of
Directors as compensation for board representation and
attendance. Options are issued at the fair market value at the
date of grant and vest at the conclusion of each fiscal year. As
of June 30, 1999, 3,000 of these options were outstanding of
which 3,000 were exercisable.
During fiscal year 1998, the Company lowered the exercise price
of 272,015 options to $4.15 from exercise prices previously
ranging from $4.25 to $12.875. On August 10, 1998, the Board of
Directors approved a reissuance of employee options whereby all
optionholders under the 1992 and 1996 Plans could forfeit their
outstanding options and receive instead new options at an
exercise price of $.75, the fair market value of the Company's
stock on the approval date. The reissued options vest quarterly
over three years, but none can be exercised prior to February 10,
1999. 305,894 options were subject to reissue under the terms of
this arrangement. The impact of the stock option repricing was
not material to the June 30, 1998 or 1999 financial statements.
The per share weighted-average fair value of all stock options
granted during the years ended June 30, 1999 and 1998 was $0.33
and $2.48 on the date of grant using the Black-Scholes
option-pricing model with the following weighted-average
assumptions: 1999 -- expected dividend yield 0%, expected
volatility 50%, risk-free interest rate of 5.8%, and an expected
life of five years; 1998 -- expected dividend yield 0%, expected
volatility 50%, risk-free interest rate of 5.8%, and an expected
life of four years.
The Company applies APB Opinion No. 25 in accounting for its
Plans and, accordingly, no compensation cost has been recognized
for its stock options issued at fair value in the financial
statements. Had the Company determined compensation cost based on
the fair value at the grant date for its stock options under SFAS
No. 123, the Company's net loss would have been adjusted by the
pro forma amounts indicated below (in thousands, except share
data):
<TABLE>
<CAPTION>
JUNE 30,
----------------------
1999 1998
-------- --------
<S> <C> <C> <C>
Net loss attributable to common As reported $ (424) (8,380)
shareholders Pro forma (602) (8,850)
Net loss per common share and As reported $ (.10) (2.01)
common share equivalent Pro forma (.14) (2.13)
</TABLE>
(Continued)
40
<PAGE> 42
DIGITAL TRANSMISSION SYSTEMS, INC.
Notes to Financial Statements
June 30, 1999 and 1998
Pro forma net loss reflects only options granted during the years
ended June 30, 1996 through 1999. Therefore, the full impact of
calculating compensation cost for stock options under SFAS 123 is
not reflected in the pro forma loss amounts presented above
because compensation cost is reflected over the options' vesting
periods ranging from one to five years, and compensation cost for
options granted prior to July 1, 1995 is not considered.
The following summarizes stock option activity, excluding
underwriter options, for the years ended June 30, 1999 and 1998:
<TABLE>
<CAPTION>
EXERCISE PRICE PER SHARE
--------------------------------------
NUMBER OF WEIGHTED
SHARES RANGE AVERAGE
--------- ------------------------ ----------
<S> <C> <C> <C> <C>
Outstanding at June 30, 1997 722,221 $ .0085 -- 12.8750
========================
Granted 288,722 $ 4.25 -- 10.50
Exercised (70,317) .067 -- 4.73
Canceled or expired (242,511) .067 -- 12.25
-------- ------------------------
Outstanding at June 30, 1998 698,115 $ .0085 -- 11.490
======== ========================
Granted 708,085 $ .375 -- .75 .58
Exercised (59,149) .0085 -- .213 .03
Canceled or expired (650,155) .067 -- 12.875 4.72
-------- ------------------------ -------
Outstanding at June 30, 1999 696,896 $ .375 -- 4.73 0.59
======== ======================== =======
</TABLE>
At June 30, 1999, the weighted-average remaining contractual life
of outstanding options, excluding underwriter options, was 9.34
years. At June 30, 1999 and 1998, the number of options
exercisable was 310,565 and 281,267, respectively, and the
weighted-average exercise price of those options was $.71 and
$3.16, respectively.
(G) NOTES RECEIVABLE FROM STOCK SALES
Notes receivable from stock sales result from the exercise of
stock options for full recourse promissory notes during the year
ended June 30, 1998.
(Continued)
41
<PAGE> 43
DIGITAL TRANSMISSION SYSTEMS, INC.
Notes to Financial Statements
June 30, 1999 and 1998
(H) STOCK COMPENSATION EXPENSE
Unearned compensation expense of $269,000 was recorded as a
reduction of shareholders' equity for the fiscal year ended June
30, 1996 for 62,089 options issued at an exercise price less than
fair market value. Compensation expense of approximately $56,000
and $68,000 was recorded in the Statement of Operations during
the years ended June 30, 1999 and 1998, respectively, for the
options that vested during these years.
(I) EMPLOYEE STOCK PURCHASE PLAN
Effective November 7, 1996, the Board of Directors adopted the
1996 Employee Stock Purchase Plan (the "Plan"), under which, the
Company is authorized to issue up to 150,000 shares of common
stock to its full-time employees. Substantially all of the
Company's employees are eligible to participate. Under the terms
of the Plan, employees can choose each year to have up to 10% of
their annual base earnings withheld to purchase the Company's
common stock. The purchase price of the stock is 85% of the lower
of its beginning-of-year or end-of-year market price. Under the
plan, the Company sold no shares to employees in 1998 and 1999.
(11) EXTRAORDINARY GAIN
During fiscal year 1999, suppliers were offered a number of concessions
and credits to amounts recorded as payables. The Company has recorded an
extraordinary gain of $359,000, net of expenses to settle, to reflect the
settlement transactions between the Company and certain suppliers during
1999. There was no income tax effect on the extraordinary gain.
(12) CONCENTRATION OF SALES AND CREDIT RISKS
For the years ended June 30, 1999 and 1998, 60% and 48%, respectively,
of the Company's revenues were derived from two customers. Additionally,
the Company's accounts receivable from these two customers represented
67% and 49% of total accounts receivable at June 30, 1999 and 1998,
respectively.
For the years ended June 30, 1999 and 1998, international sales were
approximately 19% and 34%, respectively, of total sales of the Company.
International sales and gross profit were as follows (in thousands):
<TABLE>
<CAPTION>
1999 1998
------ ------
<S> <C> <C>
Sales $1,402 5,333
Gross profit 154 402
</TABLE>
(Continued)
42
<PAGE> 44
DIGITAL TRANSMISSION SYSTEMS, INC.
Notes to Financial Statements
June 30, 1999 and 1998
(13) COMMITMENTS AND CONTINGENCIES
(A) LEASES
The Company leases a building and certain equipment under
noncancelable operating lease agreements which expire at various
times through 2001 and provide for minimum annual rentals as
follows:
<TABLE>
<CAPTION>
YEAR ENDING
JUNE 30, (IN THOUSANDS)
----------- --------------
<S> <C>
2000 $ 205
2001 183
-----
$ 388
======
</TABLE>
Rental expense under all lease agreements for the years ended
June 30, 1999 and 1998 was approximately $356,000 and
$406,000, respectively.
(B) 401(K) PLAN
The Company sponsors the Digital Transmission Systems, Inc.
401(k) Savings Plan (the "Plan") for the benefit of eligible
employees and their beneficiaries. Employees may elect to
contribute from 1% to 20% of their gross compensation to the
Plan. The Plan was amended during the year ended June 30, 1997 to
provide for a Company match of 25% of employee contributions up
to 6% of their eligible compensation. The Company can also make
an additional annual discretionary contribution that is allocated
to employees based upon relative levels of compensation. The
Company recorded matching expense of approximately $27,000 and
$32,000 for the years ended June 30, 1999 and 1998, respectively.
The Company elected to make no discretionary contributions to the
Plan during the years ended June 30, 1999 and 1998.
(C) PRODUCT DEVELOPMENT AGREEMENTS
During the years ended June 30, 1999 and 1998, the Company had
agreements with certain outside subcontractors for the
development of new product technology. The agreements defined
milestones which, upon completion, called for the payment of
agreed-upon fees. Portions of these payments were capitalized as
product development costs, as discussed in note 1. There were no
firm commitments remaining in effect as of June 30, 1999.
(Continued)
43
<PAGE> 45
DIGITAL TRANSMISSION SYSTEMS, INC.
Notes to Financial Statements
June 30, 1999 and 1998
(D) LEGAL MATTERS
The Company is also involved in various claims and legal actions
arising in the ordinary course of business. In the opinion of
management, the ultimate disposition of these matters, including
the litigation discussed in the previous paragraph, will not have
a material adverse effect on the Company's financial position,
results of operations, or liquidity.
(14) SEGMENTS
During fiscal year 1999, the Company operated in two segments: (i)
domestic product sales and (ii) international product sales. On February
5, 1999, the international subsidiary was sold (see note 3). The
accounting policies of the segments are the same as those described in
note 1. The Company evaluates performance of the segments based on
revenues and operating earnings (loss) of the segments. Segment
information for the year ended June 30, 1999 and 1998 is as follows:
<TABLE>
<CAPTION>
<S> <C> <C>
1999 1999
------- -------
Revenue:
Domestic $ 6,136 10,246
International 1,402 5,333
------- -------
Total revenue $ 7,538 15,579
======= =======
Operating loss:
Domestic $ (434) (2,515)
International (1,159) (5,865)
------- -------
Total operating loss $(1,593) (8,380)
======= =======
Identifiable assets including:
Trade accounts receivable
Inventories
Intangible assets
Domestic 2,459 2,994
International -- 2,803
------- -------
Total identifiable assets $ 2,459 5,797
======= =======
</TABLE>
(Continued)
44
<PAGE> 46
DIGITAL TRANSMISSION SYSTEMS, INC.
Notes to Financial Statements
June 30, 1999 and 1998
INDEX TO EXHIBITS
EXHIBIT
NUMBER DESCRIPTION
*3.1 - Form of Amended and Restated Certificate of
Incorporation of the Company.
*3.2 - Form of Amended and Restated Bylaws of the Company.
*4.1 - See Article 4 of the Company's Amended and Restated
Certificate of Incorporation -- located within
Exhibit 3.1.
*4.2 - See Article 3 of the Company's Amended and Restated
Bylaws located within Exhibit 3.2.
*10.1 - Loan Agreement, dated October 10, 1995, by and
between the Company and SunTrust Bank.
*10.2 - Lease Agreement, dated September 14, 1994, by and
between the Company and Advanta Leasing Corp.
*10.3 - The Company's 401 (K) Savings Plan.
*10.4 - Lease Agreement, dated January 28, 1991, by and
between the Company and Colonial Pacific Leasing
Corporation.
*10.5 - Lease Agreement, dated January 4, 1994, by and
between the Company and Amplicon, Inc.
*10.6 - Form of Reseller Agreement.
*10.7 (1) - Proprietary Information, Noncompetition and
Inventions Agreement, dated August 20, 1990, by and
between the Company and Thomas C. Mock
*10.8 - Form of Confidentiality and Invention Assignment
Agreement.
*10.9 (1) - Proprietary Information, Noncompetition and
Invention Agreement, dated August 20, 1990, by and
between the Company and James W. Chamberlin
*10.10 - Acquisition Agreement, dated December 1, 1995, by
and between the Company and Technology Ventures
International, Inc.
*10.11 - Lease Agreement, dated March 19, 1993, by and
between New England Mutual Life Insurance Company
and the Company.
*10.12 - Manufacturing Agreement, dated May 8, 1995, by and
between the Company and Comptronix Corporation.
*10.13 (1) - FY95 Employee Profit Sharing Plan.
*10.14 (1) - FY96 Management Bonus Plan.
*10.15 (1) - 1992 Stock Incentive Plan.
*10.16 (1) - FY96 Sales Commission Plan for Bobby Boykin.
*10.17 - Equipment Lease, dated December 17, 1991, by and
between the Company and General Electric Capital
Corporation.
(Continued)
45
<PAGE> 47
*10.18 (1) - Form of Employment Agreement to be entered into by
and between the Company and each of Mr. Salazar,
Mr. Boykin and Mr. Nelson.
*10.19 (1) - 1996 Incentive Compensation Plan.
*10.20 - Form of Consent of Series C Preferred Stockholders.
*10.21 - Agreement, dated January 7, 1994, by and between
the Company and Wiltron Company.
**10.22 (1) - Form of Digital Transmission Systems, Inc. Employee
Stock Purchase Plan
**10.23 - Form of Amendment to the Company's 401 (K) Savings
Plan
***10.24 - Form of Debenture Agreement between Sirrom Capital
d/b/a Tandem Capital and the Company
****10.25 - Second Amendment to Debenture Purchase Agreement
between Sirrom Capital and the Company.
****10.26 - Second Amendment to Subordinated Debenture Agreement
between Sirrom Capital and the Company.
****10.27 - Stock Purchase Warrant Agreement between Sirrom
Capital and the Company.
****10.28 - Shareholders' Agreement with respect to shares of
Chapala Communications, Inc. and the Company.
****10.29 - Pledge and Security Agreement between MicroTel
International, Inc. and Sirrom Capital.
****10.30 - Promissory Note between SouthTech, Inc. and the
Company.
****10.31 - Security Agreement between SouthTech, Inc. and the
Company.
****10.32 - Stock Purchase Agreement between Chapala
Communications, Inc. and the Company.
****10.33 - Employment Agreement between Woodrow B. Cannon
and the Company.
****10.34 - Employment Agreement between Andres C. Salazar and
the Company.
*23.1 - Consent of Price Waterhouse LLP
*23.2 - Consent of Sutherland, Asbill & Brennan (included
in the opinion filed as Exhibit No. 5.1 to the
Registration Statement.)
27 - Financial Data Schedule (for SEC use only)
* Incorporated by reference to the corresponding exhibit of the
Registrant's registration statement on Form SB-2 (File Number
1-14198).
** Incorporated by reference to the corresponding exhibit of the
Registrant's Form 10-KSB filed 9/30/96.
*** Incorporated by reference to the corresponding exhibit of the
Registrant's Form 10-KSB filed 10/14/97.
**** Incorporated by reference to the corresponding exhibit of the
Registrant's Form 10-QSB held May 15, 1999.
(1) Constitutes a management contract or compensatory plan or
arrangement required to be filed.
(Continued)
46
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
FINANCIAL STATEMENTS OF DIGITAL TRANSMISSION SYSTEMS, INC. FOR THE TWELVE
MONTHS ENDED JUNE 30, 1999 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH
FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> JUN-30-1999
<PERIOD-START> JUL-01-1998
<PERIOD-END> JUN-30-1999
<CASH> 217
<SECURITIES> 0
<RECEIVABLES> 2,371
<ALLOWANCES> 1,238
<INVENTORY> 903
<CURRENT-ASSETS> 2,321
<PP&E> 2,907
<DEPRECIATION> 2,497
<TOTAL-ASSETS> 3,807
<CURRENT-LIABILITIES> 4,108
<BONDS> 0
0
1,314
<COMMON> 47
<OTHER-SE> (3,789)
<TOTAL-LIABILITY-AND-EQUITY> 3,807
<SALES> 7,538
<TOTAL-REVENUES> 7,538
<CGS> 4,764
<TOTAL-COSTS> 4,367
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 651
<INCOME-PRETAX> (783)
<INCOME-TAX> 0
<INCOME-CONTINUING> 0
<DISCONTINUED> 0
<EXTRAORDINARY> 359
<CHANGES> 0
<NET-INCOME> (424)
<EPS-BASIC> (0.10)
<EPS-DILUTED> (0.10)
</TABLE>
