The reset pin is an input not an output. Can you explain why you connected it?
GLCD FunctionPanel BMega Pins +5 volts2+5V.........Reset17Reset
The ks0108 datasheet says the reset pin should be taken low for a brief period afterpower is applied. The diagrams show the display's reset pin connected to the Arduinoreset pin and this will automatically reset the display when the Arduino resets.
What may be causing such an issue?
I suspect that the idea to tie the resets together is to reset both the display and processor at the same time. I would think that provide the display is a "reset-not" input, line the processor, then they should be compatible.
So do you think that when the DTR goes low the isolation capacitor is to small to reset both boards? That maybe the LCD board also has a pull up resistor and the two resistors in parallel provide too much pull up to be pulled down far enough or long enough by the reset circuit? I.E. the pull-up resistor on the LCD board is throwing off the RC time constant?
If this is the case then there should only be a problem when uploading a new sketch. The sketch would not upload and there will be some sort of error message. To these this, I would try manually resetting the board at the "appropriate" time. That time would be when the compile is compete and the "Uploading ..." first appears.