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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549



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FORM 10-K



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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 December 31, 2006

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: 0-21669



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Digital Lightwave, Inc.

(Exact name of Registrant as specified in its charter)



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|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|Delaware                                                       |  | 95-4313013                          
|(State or Other Jurisdiction of Incorporation or Organization) |  | (I.R.S. Employer Identification No.)



|                                         |  |           
|---------------------------------------- |  | ----------
|5775 Rio Vista Drive Clearwater, Florida |  | 33760     
|(Address of principal executive offices) |  | (Zip Code)

Registrant's telephone number, including area code: (727) 442-6677

Securities registered pursuant to Section 12(b) of the Act:

None

Securities registered pursuant to Section 12(g) of the Act:

Common Stock, $0.0001 par value per share



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Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.

Yes ̈No   x

Indicate by check mark if the Registrant is not required to file
reports pursuant to Section 13 or Section 15 of the Act.

Yes ̈No   x

Indicate by
check mark whether Registrant: (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 periods that Registrant was required to file
such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No ̈

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K is not contained herein, and will not be contained, to the best of Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Report or any amendment to this Form
10-K. ̈

Indicate by check
mark whether the Registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act. (Check one):

Large Accelerated Filer ̈Accelerated Filer ̈Non-Accelerated Filer  x

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange
Act).    Yes ̈No  x

The aggregate market value of Registrant's voting and non-voting common equity held by non-affiliates as of the last business day of the Registrants most recently
completed second fiscal quarter, June 30, 2006, was approximately $6,822,000 based on the last-sale price of $0.30 for shares of the Registrants Common Stock on such date as reported by the OTC Bulletin Board. Shares of Common Stock held
by each officer, director and holder of 5% or more of the outstanding Common Stock have been excluded in that such persons may be deemed affiliates. This determination of affiliate status is not necessarily a conclusive determination for other
purposes.

The number of shares of Registrant's Common Stock issued and outstanding as of March 19, 2007, was 255,467,346.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the
definitive Proxy Statement for the Annual Meeting of Stockholders, which will be filed within 120 days after the close of the Registrants fiscal year ended December 31, 2006, are incorporated by reference into Part III.



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##### Table of Contents

FORM 10-K

For the Year Ended December 31, 2006

Index



|         |  |                                                                                                             |  |     
|-------- |  | ----------------------------------------------------------------------------------------------------------- |  | ----
|         |  |                                                                                                             |  | Page
|PART I  
|         |  |                                                                                                            
|Item 1.  |  | Business                                                                                                    |  | 1   
|Item 1A. |  | Risk Factors                                                                                                |  | 6   
|Item 1B. |  | Unresolved Staff Comments                                                                                   |  | 16  
|Item 2.  |  | Properties                                                                                                  |  | 16  
|Item 3.  |  | Legal Proceedings                                                                                           |  | 16  
|Item 4.  |  | Submission of Matters to a Vote of Security Holders                                                         |  | 16  
|        
|PART II 
|         |  |                                                                                                            
|Item 5.  |  | Market for Registrant's Common Stock, Related Stockholder Matters and Issuer Purchases of Equity Securities |  | 17  
|Item 6.  |  | Selected Financial Data                                                                                     |  | 19  
|Item 7.  |  | Management's Discussion and Analysis of Financial Condition and Results of Operations                       |  | 20  
|Item 7A. |  | Quantitative and Qualitative Disclosures about Market Risk                                                  |  | 30  
|Item 8.  |  | Financial Statements and Supplementary Data                                                                 |  | 30  
|Item 9.  |  | Changes in and Disagreements with Accountants on Accounting and Financial Disclosure                        |  | 30  
|Item 9A. |  | Controls and Procedures                                                                                     |  | 30  
|Item 9B. |  | Other Information                                                                                           |  | 30  
|        
|PART III
|         |  |                                                                                                            
|Item 10. |  | Directors, Executive Officers, and Corporate Governance                                                     |  | 31  
|Item 11. |  | Executive Compensation                                                                                      |  | 31  
|Item 12. |  | Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters              |  | 31  
|Item 13. |  | Certain Relationships and Related Transactions and Director Independence                                    |  | 31  
|Item 14. |  | Principal Accountant Fees and Services                                                                      |  | 31  
|        
|PART IV 
|         |  |                                                                                                            
|Item 15. |  | Exhibits and Financial Statement Schedules                                                                  |  | 32  



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PART I

This Report contains forward-looking statements within the meaning of Section 27A of the Securities Act of
1933 and Section 21E of the Securities Exchange Act of 1934. These statements relate to future events or our future financial performance. In some cases, you can identify forward-looking statements by terminology such as may, will, should,
expect, plan, anticipate, believe, estimate, predict, potential or continue, the negative of terms like these or other comparable terminology. Additionally, statements concerning future matters such as the development of new products, enhancements
or technologies, possible changes in legislation and other statements regarding matters that are not historical are forward-looking statements. These statements are only predictions. These statements involve known and unknown risks and uncertainties
and other factors that may cause actual events or results to differ materially from the results and outcomes discussed in the forward-looking statements. All forward-looking statements included in this document are based on information available to
us on the date of filing, and we assume no obligation to update any such forward-looking statements, except as required by law. In evaluating these statements, you should specifically consider various factors, including the risks outlined under the
caption Risk Factors set forth in Item 1A and those contained from time to time in our other filings with the SEC. We caution you that our business and financial performance are subject to substantial risks and uncertainties.



|Item 1. | Business
|------- | --------

Recent Developments

We continue to have insufficient short-term resources for the payment of our current liabilities. During the twelve months ended December 31,
2006, we addressed this shortfall by obtaining financing from Optel Capital, LLC (Optel), an entity controlled by our largest stockholder and current chairman of the board of directors, Dr. Bryan J. Zwan. Our ability to meet
cash requirements and maintain sufficient liquidity over the next 12 months is dependent on our ability to obtain additional financing from funding sources which may include, but may not be limited to, Optel. If we are not able to obtain financing,
we expect that we will not have sufficient cash to fund our working capital and capital expenditure requirements for the near term and that we will not have the resources required for the payment of our current liabilities when they become due.
Optel currently continues to be our principal source of financing. We have not identified any funding source other than Optel that would be prepared to provide current or future financing to the Company.

On September 16, 2004, we borrowed $27.0 million from Optel pursuant to a secured convertible promissory note (the Secured Convertible Promissory Note)
that bore interest at 10% per annum and was secured by a first priority security interest in substantially all of our assets. The conversion feature of the Secured Convertible Promissory Note was approved by our disinterested stockholders at a
special meeting of our stockholders on February 10, 2005. The transactions with Optel were approved by the Companys board of directors, upon the recommendation of a special committee of the board. The special committee is composed solely
of independent directors. Accordingly, all or any portion of such debt was convertible into the Companys common stock at the option of Optel at any time. The conversion price was based upon the volume-weighted average trading price of the
Companys common stock during the five-day period preceding the date of any conversion. The Company is required to file a registration statement covering the offer and sale by Optel of the shares of common stock issuable upon conversion and to
keep the registration statement effective until the date that is two years after the date that such registration statement is declared effective.

On
March 11, 2005, Optel converted $1.0 million of the indebtedness outstanding under the Secured Convertible Promissory Note into 981,258 shares of our common stock. On January 4, 2007, Optel converted the remaining indebtedness, or $34.8
million, outstanding under the Secured Convertible Promissory Note into 220,222,515 shares of our common stock. As a result, our obligations of repayment of debt under the Secured Convertible Promissory Note were satisfied as of January 4,
2007. As a result of the conversion of the amount outstanding under the Secured Convertible Promissory Note, Optel and other entities controlled by Dr. Zwan control, in the aggregate, approximately 91.1% of the issued outstanding shares of the
Companys common stock.

As of March 19, 2007, we owed Optel approximately $27.6 million in principal plus approximately $4.4 million in accrued
interest thereon, which debt is secured by a first priority security interest in substantially all of our assets and such debt accrues interest at a rate of 10% per annum (Short Term Notes). The $27.6 million in principal plus
accrued interest is now currently due and payable on demand at any time. The indebtedness evidenced by the Short Term Notes is in addition to the indebtedness formerly evidenced by the Secured Convertible Promissory Note, and therefore it was not
affected by Optels conversion of the indebtedness evidenced by the Secured Convertible Promissory Note into common stock in March 2005 and January 2007.



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Overview

Digital
Lightwave, Inc. provides the global fiber-optic communications industry with products and technology used to develop, install, maintain, monitor and manage fiber-optic communication networks. Telecommunications service providers, owners of private
networks (utilities, government and large enterprises) and equipment manufacturers deploy our products to provide quality assurance and ensure optimum performance of advanced optical communications networks and network equipment. Our products are
sold worldwide to telecommunications service providers, owners of private networks (utilities, government and large enterprises), telecommunications equipment manufacturers, equipment leasing companies and international distributors.

Our revenue has been generated primarily from the sale of products from our original product line, the Network Information Computers (NIC). NICs are portable instruments
used for the installation and maintenance testing of advanced, high-speed networks and transmission equipment. The NIC product family provides diagnostic capabilities for testing the performance of both optical and legacy electrical networks with an
array of communications standards and transmission rates.

Our product lines also include the Network Access Agent (NAA) and the Optical Wavelength Manager
(OWM). NAAs are unattended, software-controlled, performance monitoring and diagnostic systems permanently installed within optical-based networks, allowing centralized remote network monitoring and management. The OWM remotely monitors up to eight
optical fibers providing fast and highly accurate analysis of optical wavelengths. The OWM also provides remote analysis and management via a web-enabled PC interface as well as software interfaces allowing for control by industry-standard network
management systems.

Digital Lightwave, Inc. was incorporated in California in 1990 and reincorporated in Delaware in 1996. Unless the context indicates
otherwise, the "Company," "we," "our," and "Digital Lightwave," as used in this Report, refer to Digital Lightwave, Inc., a Delaware corporation, and its predecessor entity. Our principal executive offices are located at 5775 Rio Vista Drive,
Clearwater, Florida, 33760, and the telephone number is (727) 442-6677. The Digital Lightwave web site address is www.lightwave.com.

Industry

The telecommunications industry has experienced a modest stabilization after an abrupt halt of new investment and network
expansion projects in 2002 through mid 2005. Consolidation, mergers and acquisitions, and business failures have resulted in fewer service providers competing for global market share, resulting in a significantly more stable market environment into
which the Company sells its products and technologies. The bandwidth installed from 1997  2001 has been utilized and carriers are being forced to add capacity. Additionally, announcements by major local access providers in North America have
provided a new catalyst for the fiber optic networking industry through the planned expansion of fiber to the home (FTTH), fiber to the premise (FTTP) as well as a variety of combined fiber build outs matched to communities specific existing
local loop infrastructure, collectively known as (FTTx). Multi-year FTTx projects have begun in several regions of the United States. Whereas well-established network infrastructure exists in North America, leading to a slowdown in new development,
aggressive network build outs in international markets are ongoing and will facilitate the use and implementation of a group of loosely related technologies known as Next Generation (NextGen) technologies. NextGen technologies facilitate efficient
usage of the SONET/SDH bandwidth and though applicable in the United States, its adoption would force the upgrade of existing terminal equipment which carriers are reluctant to do. However, in certain developing international markets where there is
no installed base to replace, carriers will generally opt to deploy NextGen.

The Digital Lightwave Solution

Digital Lightwave provides products and technologies that are designed to support networking technologies in North America as well as the group of NextGen technologies
primarily used outside of the United States. The Company embraces the most advanced networking standards, and has designed its flagship product, the NIC, with a flexible architecture in anticipation of a continual upgrade path as new technologies
are developed, standardized and brought to market.

The Company designs and manufactures its products in portable and embedded form factors to serve its
varied customer types. Portable products are lightweight, self-contained test instruments that are used for field applications such as network diagnostics, maintenance and troubleshooting. The Company provides the same technologies in a
rack-mountable product offering, designed for deployment at key points throughout the network, namely at central offices (CO), data centers, and co-location facilities. The rack-mounted equipment provides for remote monitoring from a centralized
network management console residing at the service providers network operations center (NOC). Having remotely-deployed equipment allows service providers to monitor and manage their network on a full-time basis, thereby optimizing labor
resources and minimizing time and expense of diagnosis and resolution of network emergencies and repairs.



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Digital Lightwave products are also applicable to laboratory and manufacturing applications. Network equipment
manufacturers use our products during the research and development phase to ensure new equipment performs to designed specifications and conforms to international standards. Service providers and private network operators use Digital Lightwave
products in the laboratory environment to confirm network equipment functionality, compatibility and conformance to international standards. The Companys products are also used as part of the manufacturing process for network equipment
providers throughout the world.

Products and Services

Digital Lightwaves products are used to verify that telecommunications products and systems function and perform properly and to troubleshoot data signal impairments in high-speed communication networks. Specific customer applications
of the Companys diagnostic equipment include the testing of actual performance during the research and development of new network equipment by manufacturers, the qualification of products during manufacturing, the verification of service
during network installation and the monitoring and maintenance of deployed networks.

Network Installation and Maintenance Products

Consisting primarily of the Companys original product line of Network Information Computers (NIC), our Network Installation and Maintenance Products include
portable test devices used by network technicians. These devices provide a compact, lightweight, and easy-to-use product offering significant functionality.

The NIC (i) is an integrated test instrument that is capable of analyzing multiple protocols concurrently and independently; (ii) utilizes an intuitive Microsoft Windows-based graphical user interface (GUI) with a touch sensor
display to create an easy-to-use diagnostic tool; and (iii) is a software-based solution that can be easily upgraded and customized.

These products
are based on modular and scalable hardware and software platforms and a flexible architecture that allow customers to easily upgrade existing systems to accommodate new technologies and thereby preserve the value of their original investment. We are
utilizing the core technology within our NIC product line to continue developing portable and embedded products that address the evolving needs of the optical networking industry. Current platforms include:



| |  |  | NIC 2.5G®, NIC 10G®, and NIC GigE are small units that accommodate two (2) modules. They offer lightweight portability and ease of use through a 10.4 color touch-screen. NIC 2.5G® and NIC 10G® provide SONET/SDH test capability while NIC GigE provides Ethernet test capability. On customer request, both Ethernet and SONET/SDH
modules may be integrated into any platform to provide converged telecom and datacom testing.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | NIC Plus® is a larger scalable testing platform that accommodates up to 5 test modules. The slightly bigger platform offers a 12.1 color touch-screen with the same easy to use GUI as the
smaller NIC platforms, but provides the space and power for multiple modules or Jitter/Wander measurement capability up to 10Gbps.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | NIC EP®is an embedded platform designed for remotely operated embedded testing and is actually part of the NAA product line. It mounts in a 19 or 23 equipment rack
and accommodates up to 5 test modules.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Available modules include:



| |  |  | Next Generation Optical Multi-rate Module provides SONET/SDH test capability from 52Mbps to 2.5Gbps, with options for 10Gbps, ATM, ODU Multiplexing,
Virtual Concatenation (VCAT), Generic Framing Procedure (GFP), Link Adjustment Scheme (LCAS), Optical Transport Network (OTN), 10GigE LAN and WAN and 10GigE with Forward Error Correction (FEC).
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | PDH Module simultaneously and independently analyzes global electrical networks (T-carrier/PDH rates: DS0, DS1, DS3, E1, E3, E4), operating at
transmission rates ranging from 1.5Mbps to 139Mbps.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | PDH Jitter Module provides all of the features of the PDH Module, but adds Jitter and Wander measurement capability.
| | - |  | --------------------------------------------------------------------------------------------------------------------



| |  |  | Optical Multi-rate Moduleprovides a low-cost solution for SONET/SDH applications that do not require Next Generation features. It verifies and qualifies the
performance of global high-speed optical networks, operating at transmission rates ranging from 52Mbps to 2.5Gbps.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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| |  |  | High Density Ethernet Module provides simultaneous and independent testing for four (4) optical GigE ports and eight (8) electrical
10/100/1000 BaseT ports. It is available with a 10GigE LAN/WAN test option.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | 2.5Gbps Jitter Module provides jitter and wander testing from 155Mbps to 2.6Gbps. It is available only in the NIC Plus®or NIC EP® platforms.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | 10Gbps Jitter Module provides jitter and wander testing at the 10Gbps/10.7Gpbs rates. It is available only in the NIC Plus®or NIC EP® platforms.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Serial Interface Test Module provides testing of RS-530 and RS-232 interfaces.
| | - |  | ------------------------------------------------------------------------------

This modular approach allows the Company to support customers with specialized needs by creating custom configurations, as well as those who require a more standard
configuration.

Sales of Network Installation and Maintenance Products generated approximately 68%, 68% and 74% of our net sales for the years ended
December 31, 2006, 2005 and 2004, respectively.

Network Management Systems

This product category is comprised of the Companys Network Access Agent (NAA) products and Optical Wavelength Manager (OWM) products. Using our products analysis capabilities, a network operator is able to
monitor signal degradation, diagnose and isolate network failures, and maintain a constant view of the network. This ensures fulfillment of service-level agreements (SLA) with the operators customers and enables the operator to perform
predictive analysis of certain situations in order to prevent potential network interruptions or failures.

The first version NAA was introduced in 1998,
utilizing the core technology of the NIC platform. NAAs are software-controlled performance monitoring and diagnostic equipment that is permanently embedded at multiple access points within optical networks, providing real-time analysis and network
management from a centralized location, thereby reducing truck rolls.

The OWM is a highly sophisticated Dense Wave Division Multiplexing (DWDM) analysis
system that provides more functionality and reliability than traditional optical spectrum analyzers at a significantly lower cost. The OWM is available in a compact rack-mountable form factor providing remote analysis and management via a
web-enabled PC interface. The OWM remotely monitors up to eight optical fibers and provides fast and highly accurate analysis of optical wavelengths.

Customers

Since inception and through December 31, 2006, the Company has sold over 6,000 units of the Network Information Computer and
over 130 Network Access Agents to over 520 customers. The Company has sold 79 units under the Optical Wavelength Manager product line since October 2002. The Companys products are purchased and used by domestic and international customers in
the following industry segments:



| |  |  | Incumbent Local Exchange Carriers;
| | - |  | ----------------------------------



| |  |  | Inter-Exchange Carriers;
| | - |  | ------------------------



| |  |  | Competitive Local Exchange Carriers;
| | - |  | ------------------------------------



| |  |  | Internet Service Providers;
| | - |  | ---------------------------



| |  |  | Communications Equipment Manufacturers;
| | - |  | ---------------------------------------



| |  |  | Carriers Carriers;
| | - |  | -------------------



| |  |  | Utility Companies;
| | - |  | ------------------



| |  |  | Equipment Rental and Leasing Companies;
| | - |  | ---------------------------------------



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| |  |  | Wireless Service Providers;
| | - |  | ---------------------------



| |  |  | Enterprise Network Operators; and
| | - |  | ---------------------------------



| |  |  | Government Agencies.
| | - |  | --------------------

The Company also sells its
products to other segments of the telecommunications industry, including independent telephone companies and private network operators.

The Company
involves key customers in the evaluation of products in development and continually solicits suggestions from customers regarding additional desirable features of products that we have introduced or plan to develop. The Company has generally been
able to satisfy requests for additional feature sets by providing software upgrades for loading into its products in the field.

For the year ended
December 31, 2006, two customers combined to account for approximately 27% of net sales. For the year ended December 31, 2005, three customers combined to account for approximately 32% of net sales. For the year ended December 31,
2004, one customer accounted for approximately 21% of net sales. No other customer accounted for sales of 10% or more during those years.

Sales,
Marketing and Customer Support

Sales

The Company
primarily sells its products in the United States through a direct sales force to telecommunications service providers and network equipment manufacturers. Sales of our products have tended to be concentrated with a few major customers, and we
expect sales will continue to be concentrated with a few major customers in the future. In the third quarter of 2005, the Company opened a direct sales office in Dubai, managed by our Vice President of International Sales, to facilitate the
Companys growing market penetration of the Middle East, India and Far East markets. Our direct sales force consisted of five employees as of March 19, 2007.

Marketing

The Company focuses its marketing efforts for the Network Information Computer on the divisions of
telecommunications service providers that are responsible for planning and installing extensions of the network and on the divisions of telecommunications equipment manufacturers that are responsible for quality assurance. The Company has directed
its marketing efforts for the Network Access Agent on the strategic planning divisions of telecommunications service providers and private network operators in order to define customer requirements. The Company seeks to build awareness of its
products through a variety of marketing channels and methodologies, including industry trade shows, conferences and internet-based marketing activities to targeted customers and association groups.

Customer Support

The Company offers technical support to its
customers 24 hours a day, seven days a week. The customer support organization is comprised of highly skilled employees with extensive experience across a broad range of fiber optics network equipment and technologies. All service and repair work is
performed at certified facilities in Florida, Italy, Australia, Mexico, India and Thailand. The Company offers a warranty of one to three years depending on the product as well as an extended warranty program.

Production

The Companys NIC and NAA products are currently
produced in Clearwater, Florida. The Company subcontracts the manufacture of computer systems, boards, plastic molds and metal chassis and certain subassemblies and components for the NIC and NAA products. The Company performs final assembly and
programs the products with our software. The Company implements strict quality control procedures throughout each stage of the manufacturing process and tests the boards and subassemblies at various stages in the process, including final test and
qualification of the product. The Company also obtains other equipment manufacturers products for resale to customers.



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Engineering and Development

The Company has organized its engineering and development efforts into product or project teams. These teams are organized around the development of a particular product, and each team is responsible for all aspects of the development of
that product and any enhanced features or upgrades.

During fiscal years 2006, 2005, and 2004, the Company spent approximately $4.5 million, $7.8 million,
and $5.1 million, respectively, on engineering and development activities.

Intellectual Property

As of March 19, 2007, we had eight issued patents, six issued patents in the United States relating to the NIC and NAA technology, and two issued patents relating to
the DWDM technology. We currently have 14 applications for additional United States Patents.

Seasonality

Our sales are generally seasonal with the largest portion of quarterly sales tied to telecommunications industry purchasing patterns and tend to decrease during the first
calendar quarter of each year.

International

The
Company sells its products in domestic and international markets. Our domestic sales represented approximately 72%, 64%, and 73% of our net sales for the years ending 2006, 2005, and 2004, respectively. The Companys international sales
represented approximately 28%, 36% and 27% total net sales for the years ended 2006, 2005, and 2004, respectively.

Employees

As of March 19, 2007, we employed a full-time staff of 35 employees. None of the Companys employees are represented by labor unions, and we believe our
relations with our employees are good.



|Item 1A. | Risk Factors
|-------- | ------------

Our business is subject to
various risks, including those described below. You should carefully consider the following risks, together with all of the other information included in this document before deciding to invest in our securities. Any of these risks could materially
adversely affect our business, operating results and financial condition.

Our ability to continue as a going concern is uncertain.

Our consolidated financial statements have been prepared on the assumption that we will continue as a going concern, which contemplates the realization
of assets and liquidation of liabilities in the normal course of business. The independent registered public accounting firms report on our consolidated financial statements as of and for the fiscal year ended December 31, 2006, includes
an explanatory paragraph that states we have suffered recurring losses from operations and have a working capital deficiency that raise substantial doubt about our ability to continue as a going concern.

Beginning in the third quarter of 2001 and continuing through December 31, 2006, we incurred combined net losses of $163.8 million. For the years ended
December 31, 2006, and December 31, 2005, we reported net losses of approximately $14.5 million and $21.1 million, respectively, and cash flows used by operations of $7.9 million and $13.6 million, respectively. We anticipate that our
operating losses will continue in fiscal year 2007. Management has taken actions to reduce operating expenses and capital expenditures, including restructuring operations to more closely align operating costs with net sales.

Our ability to meet cash and future liquidity requirements is dependent on various factors, including our ability to raise additional capital, successfully negotiate
extended payment terms with certain creditors, attain our business objectives, maintain tight controls over spending and release new products and product upgrades on a timely basis. If our cash requirements cannot be satisfied from cash flows from
operations and the infusion of additional capital, we may be forced to implement further expense reduction measures, including, but not limited to, workforce reductions, the sale of assets, the consolidation of operations or the delay, cancellation
or reduction of certain product development, marketing, licensing, or other operational programs.



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We are unable to meet our current obligations.

As of December 31, 2006, we had approximately $425,000 of unrestricted cash and cash equivalents and a working capital deficit of approximately $62.9 million. In addition to the unrestricted cash and cash
equivalents, our current assets included approximately $2.4 million in net accounts receivable and approximately $2.7 million in net inventory. Our current liabilities included approximately $2.3 million in accounts payable and accrued liabilities,
$11.7 million in accrued interest and approximately $54.7 million in current notes payable. We are currently unable to pay our liabilities as they become due.

We need to raise additional financing.

We continue to have insufficient short-term resources for the payment of our current liabilities. As
of March 19, 2007, we owed Optel approximately $27.6 million in principal plus approximately $4.4 million in accrued interest thereon, which debt is secured by a first priority security interest in substantially all of our assets and such debt
accrues interest at a rate of 10% per annum (Short Term Notes). The $27.6 million in principal plus accrued interest is now currently due and payable on demand at any time. Optel from time to time also guarantees certain of our
indebtedness and provides us with other credit support.

While we have been exploring alternative financing to raise additional funding, we have not
identified a funding source other than Optel that would be willing to provide current or future financing. In the future, if we issue additional equity securities to raise funds, the ownership percentage of the existing stockholders would be
diluted, and the new investors may demand rights, preferences or privileges senior to those of existing holders of our common stock. Additional debt incurred by us would be senior to equity with respect to the ability of the debt holders to make
claims on our assets. In addition, the terms of any debt issued could impose restrictions on our operations. If adequate funds are not available to satisfy either short- or long-term capital requirements, we may be required to curtail our operations
significantly or to seek funds through arrangements with strategic partners or other parties that may require us to relinquish material rights to certain of our products, technologies or potential markets, or we may be forced to seek protection
under bankruptcy laws.

We are dependent on contract manufacturers to produce our printed circuit assemblies and rely on sole and limited source
suppliers which could adversely affect our operations.

Our NIC and NAA products are currently produced in Clearwater, Florida. We subcontract the
manufacture of computer systems, boards, plastic molds and metal chassis and certain subassemblies and components for the NIC and NAA products. We perform final assembly and program the products with our software. We implement strict quality control
procedures throughout each stage of the manufacturing process and test the boards and subassemblies at various stages in the process, including final test and qualification of the product. Effective as of January 31, 2005, we entered into a
letter agreement with MC Test Service, Inc. of Melbourne, Florida, to provide our subcontract manufacturing services. In the future, any failure to maintain our agreements with MC Test Service or enter into a substitute manufacturing agreement in a
timely fashion could interrupt our operations and adversely impact our ability to manufacture our products, book sales and fulfill customer orders.

We
currently utilize several key components in the manufacture of our products from sole-source or limited-source suppliers. Certain laser and laser amplifier components, power supplies, touch-screen sensors, single-board computers and semiconductor
devices used in our NIC and the NAA products are sourced from a single or a limited number of suppliers. We purchase a controller board and an interface board from a single or limited number of suppliers for the NAA product. The loss of a supplier
for any of these key components could seriously disrupt our operations.

As our technology has evolved, we rely less and less on application specific
integrated circuits and more on programmable logic from major vendors. This approach has lessened our dependence on devices, which may go obsolete as well allowing us to move the technology forward into new designs and lower cost parts. On our newer
designs we have also utilized industry standard pluggable optical transponders which are available from multiple vendors. Nonetheless, we continually monitor end-of-life notices constantly and perform last time buys or redesign as needed.

We forecast product sales on a quarterly basis and order materials and components based on these forecasts. Lead times for materials and components that
we order vary significantly and depend on factors such as the specific supplier, purchase terms and demand for a component at a given time. There may be excess or inadequate inventory of certain materials and components if actual orders vary
significantly from forecasts.

In the past, there have been industry-wide shortages in some of the optical components used in our products. If such
shortages occur



7



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again, suppliers may be forced to allocate available quantities among their customers and we may not be able to obtain components and material in a timely
manner, if at all. These shortages could lead to delays in shipping our products to our customers, which could significantly harm our business. Additionally, if prices of these components increase significantly, the margins on our products will
decrease.

Our largest stockholder has substantial influence over us as a result of his interests as our largest stockholder and principal creditor.

As of March 19, 2007, Dr. Bryan J. Zwan, our chairman of the board, beneficially owned 232,722,523 shares of our common stock, which
represented approximately 91.1% of our outstanding common stock as of that date. As the beneficial holder of over 90% of the common stock of the Company, Dr. Zwan has substantial control over matters to be determined by the stockholders of the
Company, which control may be exercised in a manner adverse to the interests of other stockholders of the Company.

In addition, as of March 19, 2007,
we owed Optel Capital, LLC, approximately $27.6 million plus accrued interest, which debt is secured by a first priority security interest in substantially all of our assets, and Optel has entered into various other commercial and financial
arrangements with us, our creditors and our vendors. Approximately $27.6 million in principal plus accrued interest is now currently due and payable on demand (Short Term Notes). (See We need to raise additional financing
under the caption entitled Risk Factors). Should Optel demand payment upon the Short Term Notes, the Company would not have the resources to satisfy its obligations to Optel, and Optel may seek legal remedies, including filing a petition for
involuntary bankruptcy, or we may elect to seek relief by filing a voluntary bankruptcy petition.

We experience fluctuations in our operating results.

Our quarterly operating results have fluctuated in the past, and future quarterly operating results are likely to vary significantly due to a variety
of factors which are outside our control. Factors that could affect our quarterly operating results include the following:



| |  |  | fluctuations in capital expenditures and the uneven buying patterns by customers within the telecommunications industry;
| | - |  | ------------------------------------------------------------------------------------------------------------------------



| |  |  | pricing changes by our competitors;
| | - |  | -----------------------------------



| |  |  | the limited number of our major customers;
| | - |  | ------------------------------------------



| |  |  | the product mix, volume, timing and number of orders received from our customers;
| | - |  | ---------------------------------------------------------------------------------



| |  |  | the long sales cycle for obtaining new orders;
| | - |  | ----------------------------------------------



| |  |  | the timing of introduction and market acceptance of new products;
| | - |  | -----------------------------------------------------------------



| |  |  | our success in developing, introducing and shipping product enhancements and new products;
| | - |  | ------------------------------------------------------------------------------------------



| |  |  | our ability to enter into long-term agreements or blanket purchase orders with customers;
| | - |  | -----------------------------------------------------------------------------------------



| |  |  | our ability to obtain sufficient supplies of sole or limited source components for our products;
| | - |  | ------------------------------------------------------------------------------------------------



| |  |  | our ability to attain and maintain production volumes and quality levels for our current and future products;
| | - |  | -------------------------------------------------------------------------------------------------------------



| |  |  | changes in costs of materials, labor and overhead; and
| | - |  | ------------------------------------------------------



| |  |  | the financial condition of our customers.
| | - |  | -----------------------------------------

Our
operating results for any particular quarter may not be indicative of future operating results, in part because our sales often reflect orders shipped in the same quarter in which they are received, which makes our sales vulnerable to short-term
fluctuations. These factors have historically been and are expected to continue to be difficult to forecast. Any unfavorable changes in these or other factors could have a material adverse effect on our business, financial condition and results of
operations.



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Our net sales and operating results generally depend on the volume and timing of the orders we receive from customers and
our ability to fulfill the orders received. Orders may be cancelled, modified or rescheduled after receipt. Most of our operating expenses are relatively fixed and cannot be reduced in response to decreases in net sales. The timing of orders and any
subsequent cancellation, modification or rescheduling of orders have affected and will continue to affect our results of operations from quarter to quarter. The deferral of any large order from one quarter to another could have a material adverse
effect on our business, financial condition and results of operations. We must obtain orders during each quarter for shipment in that quarter to achieve our net sales and profit objectives. There can be no assurance regarding the amount or timing of
purchases by any customer in any future period, and business fluctuations affecting our customers have affected and will continue to affect our business.

We believe that backlog is not a meaningful indicator of future business prospects and financial results. Backlog, as we define it, generally represents cumulative outstanding orders that are scheduled for delivery within a three-month
period. We have not entered into long-term agreements or blanket purchase orders for the sale of our products and, accordingly, do not carry substantial backlog from quarter-to-quarter. Our sales during a particular quarter are highly dependent upon
orders placed by customers during that period. Consequently, sales may fluctuate significantly from quarter-to-quarter and year-to-year reflecting the timing and amount of our customers ordering trends. Because most of our operating expenses are
relatively fixed and cannot be easily reduced in response to decreased revenues, quarterly fluctuations in sales may have a significant effect on net income.

The initiatives we have undertaken to reduce costs may have long-term adverse effects on our business.

Since 2005, we have undertaken a
number of initiatives to reduce costs. These measures have included significant reductions in workforce, temporary executive salary reductions and the relocation of our headquarters to a smaller facility that better meets our needs.

There are several risks inherent in our efforts to transition to a reduced cost structure, including, but not limited to, the risk that we will not be able to sustain
our cost structure at a level necessary to restore profitability, resulting in the need for further restructuring initiatives that would entail additional charges and the risk that our ability to effectively develop and market products and remain
competitive in the industries in which we compete will be impaired. Our cost-cutting measures could have long-term effects on our business by reducing our pool of technical talent, decreasing or slowing improvements in our products, making it more
difficult for us to respond to customers, limiting our ability to increase production quickly if the demand for our products increases, limiting our ability to maintain and update information systems and limiting our ability to hire and retain key
personnel. These circumstances could have a material adverse effect on our business, financial condition and results of operations.

Changes in United
States and worldwide economies and fluctuations in capital expenditures within the telecommunications industry could adversely affect us.

Our products
are mainly purchased and used by telecommunications customers. Our sales are affected by the following marketplace conditions:



| |  |  | fluctuations in the economic conditions in the United States and global markets that could result in decreased capital expenditures by telecommunication equipment
manufacturers and equipment rental and leasing companies;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | bankruptcies and decreased capital expenditures that could result in the telecommunications sector in the United States and global markets by competitive local
exchange carriers, internet service providers and enterprise network operator segments; and
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | changes in the implementation of bandwidth expansion strategies by the incumbent local exchange carriers.
| | - |  | ---------------------------------------------------------------------------------------------------------

These marketplace conditions may contribute to quarterly or annual fluctuations in our operating results and could have a material adverse effect on our business,
financial condition and results of operations. In addition, the threat of terrorism and war may cause further disruptions to the economy, create further uncertainties and have a material adverse effect on our business, operating results, and
financial condition.



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Economic, political and other risks associated with international sales and operations could adversely affect our
results of operations.

Because we sell our products worldwide, our business is subject to risks associated with doing business internationally. For the
fiscal year December 31, 2006, net sales from international customers represented approximately 28% of our total net sales for that period. We anticipate that net sales from international customers will continue to represent a significant
portion of our total net sales. In addition, many of our new distributors and service and sales personnel are increasingly located outside the U.S. Accordingly, our future results could be harmed by a variety of factors, including:



| |  |  | changes in foreign currency exchange rates;
| | - |  | -------------------------------------------



| |  |  | changes in a specific countrys or regions political, economic or other conditions;
| | - |  | ------------------------------------------------------------------------------------



| |  |  | stability and performance of new distributors, exposure to collection of receivables, sales returns and allowances;
| | - |  | -------------------------------------------------------------------------------------------------------------------



| |  |  | trade protection measures and import or export licensing requirements;
| | - |  | ----------------------------------------------------------------------



| |  |  | negative consequences from changes in tax laws; and
| | - |  | ---------------------------------------------------



| |  |  | difficulty in staffing and managing widespread operations.
| | - |  | ----------------------------------------------------------

We may not be able to achieve sustained operating profitability.

We shipped our first product, the NIC, in February 1996, and we have
shipped in excess of 6,000 units. However, we have experienced limited product shipments with respect to our NAA and OWM products. In addition, we have incurred substantial costs, including costs to:



| |  |  | develop and enhance our technology and products;
| | - |  | ------------------------------------------------



| |  |  | develop our engineering, production and quality assurance operations;
| | - |  | ---------------------------------------------------------------------



| |  |  | recruit and train sales, marketing and customer service groups;
| | - |  | ---------------------------------------------------------------



| |  |  | build administrative and operational support organizations; and
| | - |  | ---------------------------------------------------------------



| |  |  | establish international sales channels and strengthen existing domestic sales channels.
| | - |  | ---------------------------------------------------------------------------------------

Our net losses totaled approximately $14.5 million and $21.1 million for the years ended December 31, 2006 and December 31, 2005, respectively. We anticipate
that our operating losses will continue in fiscal year 2007 as we create and introduce new products and technologies and develop additional distribution channels. We expect that any related increases in net sales will lag behind these cost increases
associated with introducing new products and technologies and developing additional distribution channels for the foreseeable future. If we cannot fund expected losses until we achieve operating profitability or positive cash flow from operations,
we may not be able to meet our cash and working capital requirements, which would have a material adverse effect on our business, financial condition and results of operations.

Future changes in financial accounting standards or taxation rules may adversely affect our reported results of operations.

A change in accounting standards or a change in existing taxation rules can have a significant effect on our reported results of operations. New accounting pronouncements and taxation rules and varying interpretations of accounting
pronouncements have occurred and may occur in the future. These new accounting pronouncements and taxation rules may adversely affect our reported financial results or the way we conduct our business.



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In July 2006, the FASB issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes ("FIN
48"), an interpretation of FASB No. 109, Accounting for Income Taxes ("FASB 109"). FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken
in a tax return. We must determine whether it is more-likely-than-not that a tax position will be sustained upon examination, including resolution of any related appeals or litigation processes, based on the technical merits of the
position. Once it is determined that a position meets the more-likely-than-not recognition threshold, the position is measured to determine the amount of benefit to recognize in the financial statements. FIN 48 applies to all tax positions
related to income taxes subject to FASB 109. We anticipate adopting the provisions of FIN 48 beginning in the first quarter of fiscal 2007. We are currently assessing the impact of this Interpretation on our consolidated financial
statements.

We may engage in acquisitions, mergers, strategic alliances, joint ventures and divestitures that could result in financial results that
are different than expected.

In the normal course of business, we engage in discussions with third parties relating to possible acquisitions, mergers,
strategic alliances, joint ventures and divestitures. As part of our business strategy, we completed two asset acquisitions during 2002. Acquisition transactions are accompanied by a number of risks, including:



| |  |  | use of significant amounts of cash;
| | - |  | -----------------------------------



| |  |  | potentially dilutive issuances of equity securities on potentially unfavorable terms;
| | - |  | -------------------------------------------------------------------------------------



| |  |  | incurrence of debt on potentially unfavorable terms as well as amortization expenses related to certain intangible assets; and
| | - |  | ------------------------------------------------------------------------------------------------------------------------------



| |  |  | the possibility that we may pay too much cash or issue too much of our stock as consideration for an acquisition relative to the economic benefits that we
ultimately derive from such acquisition.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

The process of integrating any acquisition may create unforeseen operating difficulties and
expenditures including the following:



| |  |  | diversion of management time during the period of negotiation through closing and further diversion of such time after closing from focus on operating the business
to issues of integration and future products;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | decline in employee morale and retention issues resulting from changes in compensation, reporting relationships, future prospects or the direction of the business;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | the need to integrate each companys accounting, management information, human resource and other administrative systems to permit effective management, and
the lack of control if such integration is delayed or not implemented;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | the need to implement controls, procedures and policies appropriate for a larger public company at companies that prior to acquisition had been smaller, private
companies;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | the need to incorporate acquired technology, content or rights into our products and unanticipated expenses related to such integration; and
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | the need to successfully develop an acquired in-process technology to achieve the value currently capitalized as intangible assets.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------

From time to time, we may engage in discussions with candidates regarding the potential acquisition of our product lines, technologies and businesses. If such
divestiture were to occur, there can be no assurance that our business, operating results and financial condition will not be materially and adversely affected. A successful divestiture depends on various factors, including our ability to:



| |  |  | effectively transfer liabilities, contracts, facilities and employees to the purchaser;
| | - |  | ---------------------------------------------------------------------------------------



| |  |  | identify and separate the intellectual property to be divested from the intellectual property that we retain; and
| | - |  | -----------------------------------------------------------------------------------------------------------------



| |  |  | reduce fixed costs previously associated with the divested assets or business.
| | - |  | ------------------------------------------------------------------------------



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In addition, if customers of the divested business do not receive the same level of service from the new owners, this may
adversely affect our other businesses to the extent that these customers also purchase other Digital Lightwave products. All of these efforts require varying levels of management resources, which may divert attention from other business operations.
Further, if market conditions or other factors lead us to change our strategic direction, we may not realize the expected value from such transactions. If we do not realize the expected benefits or synergies of such transactions, our consolidated
financial position, results of operations, cash flows and stock price could be negatively affected.

We are dependent on key personnel and our ability
to recruit and retain such personnel may affect our business.

Our success depends to a significant degree upon the continued contributions of key
management and other personnel, some of whom could be difficult to replace. We do not currently maintain key-man life insurance covering our officers. Our success will depend on the performance of our officers, our ability to retain and motivate our
officers, our ability to integrate new officers into our operations and the ability of all personnel to work together effectively as a team. We have had significant turnover of our executive officers in the past and could continue to have problems
retaining and recruiting executive officers in the future. Our failure to retain and recruit officers and other key personnel could have a material adverse effect on our business, financial condition and results of operations.

We are dependent on a limited number of products and are uncertain of the market for our current products and planned new products.

The majority of our sales are from our initial product, the NIC, and we expect that sales of NIC will continue to account for a substantial portion of our sales for the
foreseeable future. We are uncertain about the size and scope of the market for our current and future products, including the product lines we have acquired. Our future performance will depend on increased sales of the NIC, market penetration of
the NAA and OWM product lines, and the successful development, introduction and market acceptance of other new and enhanced products.

Market acceptance of
our products and our credibility with our customers might be diminished if we are delayed in introducing or producing new products or fail to detect software or hardware errors in new products (which frequently occur when new products are first
introduced). Any delay in introducing or producing new products or failure to detect software or hardware errors in new products could have a material adverse effect on our business, financial condition and results of operations.

Our industry is subject to rapid technological change.

To remain
competitive, we must respond to the rapid technological change in our industry by developing, manufacturing and selling new products and technology and improving our existing products and technology. The market in which we compete is characterized
by the following:



| |  |  | rapid technological change;
| | - |  | ---------------------------



| |  |  | changes in customer requirements and preferences;
| | - |  | -------------------------------------------------



| |  |  | frequent new product introductions; and
| | - |  | ---------------------------------------



| |  |  | the emergence of new industry standards and practices.
| | - |  | ------------------------------------------------------

These factors could cause our sales to decrease or render our current products obsolete. Our success will depend on our ability to:



| |  |  | create improvements on and enhancements to our existing products;
| | - |  | -----------------------------------------------------------------



| |  |  | develop, manufacture and sell new products to address the increasingly sophisticated and varied needs of our current and prospective customers;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | respond to technological advances and emerging industry standards and practices on a cost-effective and timely basis; and
| | - |  | -------------------------------------------------------------------------------------------------------------------------



| |  |  | increase market acceptance of our products.
| | - |  | -------------------------------------------



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The failure to meet these objectives or to adapt to changing market conditions or customer requirements could have a
material adverse effect on our business, financial condition and results of operations.

Our products serve an industry that is extremely competitive,
and such competition may negatively affect our business.

The market for our products is intensely competitive and is subject to rapid technological
change, frequent product introductions with improved performance, competitive pricing and shifting industry standards. We believe that the principal factors on which we compete include the following:



| |  |  | product performance;
| | - |  | --------------------



| |  |  | product quality;
| | - |  | ----------------



| |  |  | product reliability;
| | - |  | --------------------



| |  |  | value;
| | - |  | ------



| |  |  | customer service and support; and
| | - |  | ---------------------------------



| |  |  | length of operating history, industry experience and name recognition.
| | - |  | ----------------------------------------------------------------------

We believe that the principal competitors for our Network Installation and Maintenance Products are Agilent Technologies, Anritsu, EXFO Electro-Optical Engineering, Inc., JDSU, and Sunrise Telecom. We believe the
principal competitors for our Network Management System are Agilent, EXFO, and Spirent. Many of our competitors and certain prospective competitors have significantly longer operating histories, larger installed bases, greater name recognition and
significantly greater technical, financial, manufacturing and marketing resources. In addition, a number of these competitors have long-established relationships with our customers and potential customers. We expect that competition will increase in
the future and that new competitors will enter the market for most, if not all, of the products we currently do and will offer. Increased competition could reduce our profit margins and cause us to lose, or prevent us from gaining, market share. Any
of these events could have a material adverse effect on our business, financial condition and results of operations.

We are dependent on a limited
number of major customers and a decrease in orders from any major customer could decrease our net sales.

For the year ended December 31, 2006, two
customers combined to account for approximately 27% of net sales. For the year ended December 31, 2005, three customers combined to account for approximately 32% of net sales. For the year ended December 31, 2004, one customer accounted
for approximately 21% of net sales. No other customer accounted for sales of 10% or more during those years.

Our success depends on our ability to broaden
our customer base to increase the level of sales. None of our customers has a written agreement with us that obligates them to purchase additional products from us. If one or more of our major customers decide not to purchase additional products or
cancels orders previously placed, our net sales could decrease which could have a material adverse effect on our business, financial condition and results of operations.

We are dependent on our products continuing to meet changing regulatory and industry standards.

Our products must
meet industry standards and regulations that are evolving as new technologies are deployed. In the United States, our products must comply with various regulations promulgated by the Federal Communications Commission and Underwriters Laboratories,
as well as industry standards established by the American National Standards Institute and other organizations. Internationally, our products must comply with standards established by the European Union and communication authorities in other
countries as well as with recommendations of the International Telecommunication Union. Some of our planned products may be required to be certified by Telcordia in order to be commercially viable. The failure of our products to comply, or delays in
compliance, with the various existing and evolving regulations could prevent us from selling our products in certain markets which could have a material adverse effect on our business, financial condition and results of operations.



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We are dependent on proprietary technology.

Our success and our ability to compete depend upon our proprietary technology that is protected through a combination of patent, copyright, trade secret and trademark law. As of March 19, 2007, we had six issued
patents relating to the NIC and NAA technology and two issued patents relating to the Dense Wavelength Division Multiplexing technology in the United States. We can make no assurances the patents for which we have applied or intend to apply will be
issued or that the steps that we take to protect our technology will be adequate to prevent misappropriation. Our competitors may independently develop technologies that are substantially equivalent or superior to our technology. Our business
strategy includes a plan to continue the increase in net sales in international markets, and the laws of some foreign countries may not protect our proprietary rights to the same extent as do the laws of the United States. In addition, the Company
may either license its proprietary rights to third parties or license certain technologies from third parties for use in the Companys products

To
further protect our proprietary information, we generally enter into non-disclosure agreements and proprietary information and invention assignment agreements with our employees and suppliers and limit access to, and distribution of, our proprietary
information. It may be possible, despite these precautions, for third parties to copy or otherwise obtain and use our technology without authorization.

We
may either license our proprietary rights to third parties or license certain technologies from third parties for use in our products. The telecommunications industry is characterized by the existence of a large number of patents and frequent
litigation based on allegations of patent infringement. We believe that our technology does not infringe on the proprietary rights of others, and we have not received any notice of claimed infringements. However, third parties may assert
infringement claims against us in the future that may or may not be successful. We could incur substantial costs regardless of the merits of the claims if we must defend ourselves or our customers against such claims. Parties making such claims may
be able to obtain injunctive or other equitable relief that could effectively block our ability to sell our products and could obtain an award of substantial damages. We may be required to obtain one or more licenses from third parties, including
our customers, in the event of a successful claim of infringement against us. Any such claim could have a material adverse effect on our business, financial condition and results of operations.

Conversely, we may be required to spend significant resources to monitor and police our intellectual property rights. We may not be able to detect infringement and our
competitive position may be harmed before such detection takes place. In addition, competitors may design around our technology or develop competing technologies. Intellectual property rights may also be unavailable or limited in some foreign
countries, which could make it easier for competitors to capture market share. Furthermore, some intellectual property rights are licensed to other companies, allowing them to compete with us using that intellectual property.

The market price of our common stock may be volatile.

The market
price of our common stock has been and is likely in the future to be highly volatile. Our common stock price may fluctuate significantly in response to factors such as:



| |  |  | quarterly variations in operating results;
| | - |  | ------------------------------------------



| |  |  | announcements of technological innovations;
| | - |  | -------------------------------------------



| |  |  | new product introductions by us or our competitors;
| | - |  | ---------------------------------------------------



| |  |  | competitive activities;
| | - |  | -----------------------



| |  |  | changes in earnings estimates by analysts or our failure to meet such earnings estimates;
| | - |  | -----------------------------------------------------------------------------------------



| |  |  | significant issuances of warrants to purchase common stock;
| | - |  | -----------------------------------------------------------



| |  |  | the conversion of significant outstanding debt into common stock;
| | - |  | -----------------------------------------------------------------



| |  |  | announcements by us regarding significant acquisitions, strategic relationships or capital expenditure commitments;
| | - |  | -------------------------------------------------------------------------------------------------------------------



| |  |  | additions or departures of key personnel;
| | - |  | -----------------------------------------



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| |  |  | issuances of convertible or equity securities for general or merger and acquisition purposes;
| | - |  | ---------------------------------------------------------------------------------------------



| |  |  | issuances of debt or convertible debt for general or merger and acquisition purposes;
| | - |  | -------------------------------------------------------------------------------------



| |  |  | changes in federal, state or foreign regulations affecting the telecommunications industry;
| | - |  | -------------------------------------------------------------------------------------------



| |  |  | general market and economic conditions; and
| | - |  | -------------------------------------------



| |  |  | developments relating to future significant litigation.
| | - |  | -------------------------------------------------------

The stocks of technology companies have experienced extreme price and volume fluctuations. These fluctuations often have been unrelated or disproportionate to the operating performance of these companies. These broad market and industry
factors listed above may have a material adverse effect on the market price of our common stock, regardless of our actual operating performance, and fluctuations in the market price of our common stock could have a material adverse effect on our
business, financial condition and results of operations.

The sale or issuance of a significant number of shares of our stock could depress the price of
our stock.

Sales or issuances of a large number of shares of our common stock in the public market or the perception that sales may occur could cause
the market price of our common stock to decline. As of March 19, 2007, 255,467,346 shares of our common stock were outstanding. Of these shares, 24,748,439 are eligible for sale in the public market without restriction, including 5,000,000
shares held by an entity controlled by Dr. Zwan, our largest stockholder, that are registered for resale. In addition, entities controlled by Dr. Zwan hold an additional 227,722,523 shares of outstanding common stock. As an
affiliate of the Company (as defined under Rule 144 of the Securities Act of 1933, as amended), Dr. Zwan may only sell shares of common stock in the public market in compliance with the volume limitations of Rule 144 or pursuant to
an effective registration statement.

The conversion feature of the Secured Convertible Promissory Note was approved by our disinterested stockholders at a
special meeting of our stockholders on February 10, 2005. The transactions with Optel were approved by the Companys board of directors, upon the recommendation of a special committee of the board. The special committee is composed solely
of independent directors. Accordingly, all or any portion of such debt was convertible into the Companys common stock at the option of Optel at any time. The conversion price was based upon the volume-weighted average trading price of the
Companys common stock during the five-day period preceding the date of any conversion. On March 11, 2005, Optel converted $1.0 million of the indebtedness outstanding under the Secured Convertible Promissory Note into 981,258 shares of
our common stock. On January 4, 2007, Optel converted the remaining indebtedness, or $34.8 million, outstanding under the Secured Convertible Promissory Note into 220,222,515 shares of our common stock.The Company is required to file a
registration statement covering the offer and sale by Optel of the shares of common stock issuable upon conversion and to keep the registration statement effective until the date that is two years after the date that such registration statement is
declared effective.

We are exposed to various risks related to legal proceedings or claims.

We have been, and in the future may be, involved in legal proceedings or claims regarding employment law issues, contractual claims, securities laws violations and other
matters. We are currently not involved in any legal proceedings or claims. Any future legal proceedings and claims, whether with or without merit, could be time-consuming and expensive to prosecute or defend and could divert managements
attention and resources. There can be no assurance regarding the outcome of legal proceedings. We may incur significant litigation expenses associated with legal proceedings and claims, which could have a material adverse effect on our business,
financial condition and results of operations.



15



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##### Table of Contents

Our common stock is classified as a penny stock under SEC rules, which may make it more difficult for our
stockholders to resell our common stock.

Our common stock is quoted on the OTC Bulletin Board. As a result, the holders of our common stock may find it
more difficult to obtain accurate quotations concerning the market value of the stock. Stockholders also may experience greater difficulties in attempting to sell the stock than if it was listed on a national securities exchange or quoted on The
NASDAQ Stock Market. Because our common stock is not traded on a stock exchange or on The NASDAQ Stock Market, and the market price of the common stock is less than $5.00 per share, the common stock is classified as a penny stock. Rule
15g-9 of the Securities Exchange Act of 1934, as amended, imposes additional sales practice requirements on broker-dealers that recommend the purchase or sale of penny stocks to persons other than those who qualify as an established
customer or an accredited investor. These include the requirement that a broker-dealer must make a determination that investments in penny stocks are suitable for the customer and must make special disclosures to the customer
concerning the risks of penny stocks. Application of the penny stock rules to our common stock could adversely affect the market liquidity of the shares, which in turn may affect the ability of holders of our common stock to resell the stock.



|Item 1B. | Unresolved Staff Comments
|-------- | -------------------------

Not applicable.



|Item 2. | Properties
|------- | ----------

Our corporate headquarters and
production and shipping facilities are located at 5775 Rio Vista Drive, Clearwater, Florida. We currently lease the building space from Bay Vista TIC. The lease expires in July 2011.

We lease a warehousing facility are located at 11316 N. 46thStreet, Tampa, Florida. We currently lease the building space from Fowler DC, LLC. The lease expires in May 2007.

We also lease a facility located at 85 Rangeway Rd. Building 1, Floor 2, North Billerica, Massachusetts from Forrest Realty Corporation. The lease expires July 31,
2007. We currently sublet this property.

We believe these facilities are adequate and suitable for our present and foreseeable business requirements.



|Item 3. | Legal Proceedings
|------- | -----------------

The Company from time to time may
be involved in various lawsuits and actions by third parties arising in the ordinary course of business. The Company is not aware of any pending litigation, claims or assessments that would have a material adverse effect on the Company's business,
financial condition and results of operations.



|Item 4. | Submission of Matters to a Vote of Security Holders
|------- | ---------------------------------------------------

During the fourth quarter of 2006, no matters were submitted to a vote of stockholders through the solicitation of proxies or otherwise.



16



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##### Table of Contents

PART II



|Item 5. | Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
|------- | ------------------------------------------------------------------------------------------------------------

The Company's shares of Common Stock have been quoted on the OTCBB under the symbol DIGL since June 8, 2005. Prior to that, the Companys shares
were quoted on the Nasdaq SmallCap Market under the same symbol since September 23, 2004 and prior to that on the Nasdaq National Market, also under the same symbol since February 7, 1997. The following table sets forth the high and low
prices of our Common Stock as reported by the Nasdaq National Market, the Nasdaq SmallCap Market and OTCBB, as applicable, during the periods indicated for fiscal years ended December 31, 2006 and 2005. Prices reported by the OTCBB represent
the range of high and low bid quotations and reflect inter-dealer prices, without retail mark-up, mark-down or commission and may not necessarily represent actual transactions.



|            |  |              |      |     |   |     
|----------- |  | ------------ | ---- | --- | - | ----
|            |  | Common Stock
|            |  | High         |      | Low
|2005        |  |              |      |     |   |     
|1st Quarter |  | $            | 1.34 |     | $ | 0.75
|2nd Quarter |  | $            | 0.95 |     | $ | 0.25
|3rd Quarter |  | $            | 0.31 |     | $ | 0.21
|4th Quarter |  | $            | 0.40 |     | $ | 0.12
|            |  |             
|2006        |  |              |      |     |   |     
|1st Quarter |  | $            | 0.58 |     | $ | 0.21
|2nd Quarter |  | $            | 0.51 |     | $ | 0.25
|3rd Quarter |  | $            | 0.30 |     | $ | 0.24
|4th Quarter |  | $            | 0.23 |     | $ | 0.15

On March 19, 2007, the last sale price of the Company's Common Stock was $0.24 per share. As of
March 19, 2007, there were approximately 625 holders of record of the Company's Common Stock.

2006 Equity Compensation Table

The following table provides information as of December 31, 2006 with respect to shares of common stock that may be issued under the Companys existing equity
compensation plans.



|                                                           |  |                                                                                         |  |                                                                          |      |                                                                                                                             |          
|---------------------------------------------------------- |  | --------------------------------------------------------------------------------------- |  | ------------------------------------------------------------------------ | ---- | --------------------------------------------------------------------------------------------------------------------------- | ---------
|                                                           |  | Column (a)                                                                              |  | Column (b)                                                               |      | Column (c)                                                                                                                 
|Plan Category                                              |  | Number of securitiesto be issued uponexercise ofoutstanding options,warrants and rights |  | Weighted averageexercise price ofoutstanding options,warrants and rights |      | Number of securitiesremaining for futureissuance underequity compensationplans
(excludingsecurities reflected incolumn (a))
|Equity compensation plans approved by security holders     |  | 2,823,021                                                                               |  | $                                                                        | 2.59 |                                                                                                                             | 8,973,175
|Equity compensation plans not approved by security holders |  |                                                                                        |  | $                                                                        |     |                                                                                                                             |         
|Total                                                      |  | 2,823,021                                                                               |  | $                                                                        | 2.59 |                                                                                                                             | 8,973,175



17



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##### Table of Contents

Stock Performance Graph

The following performance graph represents the cumulative total shareholder return for the period December 31, 2001 to December 31, 2006, for our common stock, as compared to the NASDAQ Total Return Index and the NASDAQ
Non-Financial Index. The graph assumes that $100.00 was invested in our common stock and in each index on December 31, 2001. Although we have not declared a dividend on our common stock, the total return for each index assumes the reinvestment
of dividends.

LOGO

The comparisons in this table are required by the SEC and, therefore not intended to forecast or to be indicative of possible
future performance of our common stock.

Dividend Policy

The Company has not paid any dividends since its inception and does not contemplate payment of dividends in the foreseeable future. We anticipate that any earnings in the near future will be retained for the development and expansion of our
business.

Recent Sales of Unregistered Securities

During the fiscal years ended December 31, 2006 and 2005, there were no sales of unregistered securities, except for those disclosed in a previously filed Quarterly Report on Form 10-Q or Current Report on Form 8-K.



18



---

##### Table of Contents

|Item 6. | Selected Financial Data
|------- | -----------------------

SELECTED FINANCIAL DATA

(In thousands, except share and per share data)

The following selected financial data are derived from the Consolidated Financial Statements of the Company. The selected financial data should be read in conjunction
with Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations, and the Consolidated Financial Statements of the Company and Notes thereto.



|                                                                 |  |                                  |            |   |      |   |            |      |  |   |            |     |  |      |            |      |  |   |            |     
|---------------------------------------------------------------- |  | -------------------------------- | ---------- | - | ---- | - | ---------- | ---- |  | - | ---------- | --- |  | ---- | ---------- | ---- |  | - | ---------- | ----
|                                                                 |  | For the Years Ended December 31, |           
|                                                                 |  | 2006                             |            |   | 2005 |   |            | 2004 |  |   | 2003       |     |  | 2002 |           
|Consolidated Statement of Operations:                            |  |                                  |            |   |      |   |            |      |  |   |            |     |  |      |            |      |  |   |            |     
|Net sales                                                        |  | $                                | 10,481     |   |      | $ | 12,882     |      |  | $ | 13,739     |     |  | $    | 7,514      |      |  | $ | 17,823     |     
|Gross profit (loss)                                              |  | $                                | 2,326      |   |      | $ | 1,872      |      |  | $ | 1,097      | (1) |  | $    | (9,450     | )(2) |  | $ | (8,957     | )(2)
|Operating expenses:                                              |  |                                  |            |   |      |   |            |      |  |   |            |     |  |      |            |      |  |   |            |     
|Engineering and development                                      |  |                                  | 4,509      |   |      |   | 7,752      |      |  |   | 5,133      |     |  |      | 5,535      |      |  |   | 14,798     |     
|Sales and marketing                                              |  |                                  | 3,011      |   |      |   | 5,774      |      |  |   | 6,113      |     |  |      | 8,033      |      |  |   | 12,756     |     
|General and administrative                                       |  |                                  | 3,510      |   |      |   | 3,461      |      |  |   | 3,932      |     |  |      | 7,527      |      |  |   | 7,904      |     
|Restructuring charge                                             |  |                                  |           |   |      |   |           |      |  |   | 40         | (3) |  |      | 744        | (3)  |  |   | 1,646      | (3) 
|Litigation settlements and charges                               |  |                                  |           |   |      |   |           |      |  |   |           |     |  |      |           |      |  |   | 1,512      | (4) 
|Impairment of long-lived assets                                  |  |                                  |           |   |      |   | 3,369      | (5)  |  |   | 322        | (5) |  |      | 3,302      | (5)  |  |   | 15,945     | (5) 
|                                                                 |  |                                  |            |   |      |   |            |      |  |   |            |     |  |      |            |      |  |   |            |     
|Total operating expenses                                         |  |                                  | 11,030     |   |      |   | 20,356     |      |  |   | 15,540     |     |  |      | 25,141     |      |  |   | 54,561     |     
|                                                                 |  |                                  |            |   |      |   |            |      |  |   |            |     |  |      |            |      |  |   |            |     
|Loss from operations                                             |  |                                  | 8,704      |   |      |   | (18,484    | )    |  |   | (14,443    | )   |  |      | (34,591    | )    |  |   | (63,518    | )   
|Other income (loss)                                              |  |                                  | (5,784     | ) |      |   | (2,609     | )    |  |   | 1,565      |     |  |      | 2,175      |      |  |   | (22        | )   
|                                                                 |  |                                  |            |   |      |   |            |      |  |   |            |     |  |      |            |      |  |   |            |     
|Net loss                                                         |  | $                                | 14,488     |   |      | $ | (21,093    | )    |  | $ | (12,878    | )   |  | $    | (32,416    | )    |  | $ | (63,540    | )   
|                                                                 |  |                                  |            |   |      |   |            |      |  |   |            |     |  |      |            |      |  |   |            |     
|Basic and diluted net loss per share (6)                         |  | $                                | (0.41      | ) |      | $ | (0.60      | )    |  | $ | (0.39      | )   |  | $    | (1.03      | )    |  | $ | (2.03      | )   
|                                                                 |  |                                  |            |   |      |   |            |      |  |   |            |     |  |      |            |      |  |   |            |     
|Weighted average common and common equivalent shares outstanding |  |                                  | 35,228,948 |   |      |   | 35,094,986 |      |  |   | 33,065,582 |     |  |      | 31,489,642 |      |  |   | 31,361,412 |     
|                                                                 |  |                                  |            |   |     
|Consolidated Balance Sheet Data:                                 |  |                                  |            |   |      |   |            |      |  |   |            |     |  |      |            |      |  |   |            |     
|Cash and cash equivalents                                        |  | $                                | 425        |   |      | $ | 499        |      |  | $ | 809        |     |  | $    | 312        |      |  | $ | 612        |     
|Working capital (deficit)                                        |  | $                                | (63,096    | ) |      | $ | (48,789    | )    |  | $ | (31,920    | )   |  | $    | (25,930    | )    |  | $ | (2,018     | )   
|Total assets                                                     |  | $                                | 6,301      |   |      | $ | 8,314      |      |  | $ | 12,554     |     |  | $    | 17,924     |      |  | $ | 42,398     |     
|Total long-term liabilities                                      |  | $                                | 239        |   |      | $ | 438        |      |  | $ | 265        |     |  | $    | 517        |      |  | $ | 783        |     
|Stockholders' equity (deficit)                                   |  | $                                | (62,878    | ) |      | $ | (49,190    | )    |  | $ | (29,146    | )   |  | $    | (21,140    | )    |  | $ | 10,764     |     

---

|(1) | Includes the benefit of $800,000 resulting from settlement with Jabil Circuit, Inc., offset by a $617,000 inventory adjustment and a charge of $1.3 million for excess and obsolete
inventory for the year ending December 31, 2004.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) | Includes a charge of $4.0 million for the year ended December 31, 2003, and $12.7 million for the year ended December 31, 2002, for obsolete inventory as described in Note
2 of the Consolidated Financial Statements  Inventory. Additionally, for the year ended December 31, 2003, includes a charge of approximately $4.0 million for inventory claims for inventory held at Jabil as discussed in Note
15 of the Consolidated Financial Statements  Legal Proceedings.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(3) | Includes restructuring expense of $40,000, $700,000, and $1.6 million for fiscal years ended December 31, 2004, 2003, and 2002, respectively for charges as described under
Item 7 Management's Discussion and Analysis of Financial Condition and Results of Operations  Overview and Note 14 of the Consolidated Financial Statements  Restructuring
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(4) | Includes a charge of $1.5 million made in connection with the Seth Joseph arbitration .
|--- | ---------------------------------------------------------------------------------------

|(5) | Includes an impairment charge for long-lived assets of $3.4 million, $322,000, $3.3 million and $15.9 million, for the years ended December 31, 2005, December 31,
2004, December 31, 2003, and December 31, 2002, respectively. The impairments are a result of the carrying value of property and equipment and other long-lived assets being in excess of the estimated fair value of such assets as
described in Note 1 of the Consolidated Financial Statements  Summary of Significant Accounting Policies.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(6) | Incremental shares for common stock equivalents are not included in the loss per share calculations due to the antidilutive effect.
|--- | ------------------------------------------------------------------------------------------------------------------------------------



19



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##### Table of Contents

|Item 7. | Management's Discussion and Analysis of Financial Condition and Results of Operations
|------- | -------------------------------------------------------------------------------------

This Report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange
Act of 1934. These statements relate to future events or our future financial performance. In some cases, you can identify forward-looking statements by terminology such as may, will, should, expect, plan, anticipate, believe, estimate, predict,
potential or continue, the negative of terms like these or other comparable terminology. Additionally, statements concerning future matters such as the development of new products, enhancements or technologies, possible changes in legislation and
other statements regarding matters that are not historical are forward-looking statements. These statements are only predictions. These statements involve known and unknown risks and uncertainties and other factors that may cause actual events or
results to differ materially from the results and outcomes discussed in the forward-looking statements. All forward-looking statements included in this document are based on information available to us on the date of filing, and we assume no
obligation to update any such forward-looking statements, except as required by law. In evaluating these statements, you should specifically consider various factors, including the risks outlined under the caption Risk Factors set forth
in Item 1A and those contained from time to time in our other filings with the SEC. We caution you that our business and financial performance are subject to substantial risks and uncertainties. The following discussion should be read in
conjunction with the Consolidated Financial Statements and related Notes thereto that appear elsewhere in this Report.

Executive Summary

The Company continues to have insufficient short-term resources for the payment of its current liabilities. During the twelve months ended
December 31, 2006, the Company addressed this shortfall by obtaining financing from Optel Capital, LLC (Optel), an entity controlled by the Companys largest stockholder and current chairman of the board of directors,
Dr. Bryan J. Zwan. As of December 31, 2006, the Company owed Optel approximately $27.6 million in principal plus approximately $4.0 million in accrued interest thereon, which debt is secured by a first priority security interest in
substantially all of our assets and such debt accrues interest at a rate of 10% per annum (Short Term Notes).

As of December 31,
2006, the Company also owed Optel approximately $27.0 million in principal plus approximately $7.7 million in accrued interest thereon pursuant to a secured convertible note that was issued to Optel in September 2004 (Secured Convertible
Promissory Note). However, Optel converted the entire indebtedness outstanding under the Secured Convertible Promissory Note into shares of the Companys common stock in January 2007.

The Companys ability to meet cash requirements and maintain sufficient liquidity over the next 12 months is dependent on the Companys ability to obtain
additional financing from funding sources which may include, but may not be limited to, Optel. Optel currently is and continues to be the principal source of financing for the Company. The Company has not identified any funding source other than
Optel that would be prepared to provide current or future financing to the Company. If the Company is not able to obtain additional financing, it expects that it will not have sufficient cash to fund its working capital and capital expenditure
requirements for the near term and will not have the resources required for the payment of its current liabilities when they become due. The Company cannot assure that it will be able to obtain adequate financing, that it will achieve profitability
or, if it achieves profitability that the profitability will be sustainable or that it will continue as a going concern. As a result, our independent certified public accountants have included an explanatory paragraph emphasizing the substantial
doubt about the Companys ability to continue as a going concern in their report for the year ended December 31, 2006.

Overview

Digital Lightwave, Inc. provides the global fiber-optic communications industry with products and technology used to develop, install, maintain,
monitor and manage fiber optic-based networks. Telecommunications service providers, owners of private networks (utilities, government and large enterprises) and equipment manufacturers deploy the Companys products to provide quality assurance
and ensure optimum performance of advanced optical communications networks and network equipment. The Companys products are sold worldwide to leading and emerging telecommunications service providers, telecommunications equipment
manufacturers, equipment leasing companies and international distributors.

The Companys net sales are generated from sales of its products less an
estimate for customer returns. We expect that the average selling price of our products will fluctuate based on a variety of factors, including market demand, product configuration, potential volume discounts to customers, the timing of new product
introductions and enhancements and the introduction of competitive products. Because the cost of goods sold tends to remain relatively stable for any given product, fluctuations in the average selling price may have a material adverse effect on our
business, financial condition and results of operations.



20



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##### Table of Contents

Sales of our products have tended to be concentrated with a few major customers and we expect sales will continue to be
concentrated with a few major customers in the future. For the year ended December 31, 2006, two customers combined to account for approximately 27% of net sales. For the year ended December 31, 2005, three customers combined to account
for approximately 32% of net sales. For the year ended December 31, 2004, one customer accounted for approximately 21% of net sales. No other customer accounted for sales of 10% or more during those years.

The Company recognizes revenue from the sale of products when persuasive evidence of an arrangement exists, the product has been delivered, the price is fixed and
determinable and collection of the resulting receivable is reasonably assured. When selling through a distributor to an end-user customer, we either obtain an end-user purchase order documenting the order placed with the distributor or proof of
delivery to the end-user as evidence that a sales arrangement exists. No revenue is recognized on products shipped on a trial basis. We believe that our accrued warranty reserve is sufficient to meet our responsibilities for potential future
warranty work on products sold.

The Company has not entered into long-term agreements or blanket purchase orders for the sale of our products and,
accordingly, does not carry substantial backlog from quarter-to-quarter. Our sales during a particular quarter are highly dependent upon orders placed by customers during that period. Consequently, sales may fluctuate significantly from
quarter-to-quarter and year-to-year reflecting the timing and amount of our customers ordering trends. Because most of our operating expenses are relatively fixed and cannot be easily reduced in response to decreased revenues, quarterly fluctuations
in sales may have a significant effect on net income.

To maintain our market share, we are focused on maintaining technological leadership with our
product lines and expanding our sales network to identify emerging opportunities and improve our account presence. During fiscal years 2005 and 2006, we expanded our international presence through the use of local distributors in Europe, Asia and
the Middle East, while maintaining strong relationships with important domestic customers. Technologically, we continue to develop new applications for our installed product base to be realized with the use of new modular add-ons and enhancements to
meet the growing needs of global high-speed data service requirements. During fiscal years 2005 and 2006, we broadened our product offering and capabilities with the following important new products and enhancements:

Fiscal Year 2005



| |  |  | Introduction of 2.6 GHz OTN Jitter/Wander to NIC,allows for Jitter and Wander testing of 2.6 GHz OTN Jitter/Wander networks.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------



| |  |  | High Density Ethernet added to the NIC,the high density Ethernet circuit pack supports 8 electrical 10/100/1000 Mbps ports and 4 optical 1-Gbps Ethernet
ports simultaneously. The optical ports are user accessible SFP modules.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | 10 Gbps Ethernet added to the NIC,the 10 Gbps Ethernet circuit pack supports both LAN and WAN interfaces and works simultaneously with the High Density
Ethernet card. The optical port is a user accessible XFP module.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | System Controller II Upgrade added to the NIC,the system controller II enhances processing power, drive space, supports enhanced BITS/SETS Jitter/Wander
features and reduces boot time.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Mini Operational Support System (MOSS) added to support NIC and SpanView product families,the MOSS software system provides a user friendly interface that
monitors all NIC and SpanView products in a customer network. The MOSS consolidates all the elements in the network in a single view, collects performance data and provides an SQL interface for integration into other companies' Operational Support
System (OSS).
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



21



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##### Table of Contents

Fiscal Year 2006



| |  |  | Introduction of 1.5, 2, 34, 45 and 139Mbps Jitter/Wander to NIC,allows for Jitter and Wander testing of PDH and T-Carrier networks and enables a single NIC
Plus or NIC EP chassis to support Jitter and Wander testing from 1.5Mbps to 10.7Gbps.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Introduction of Next-Gen Multi-Rate (NGMR) module for NIC platform,an updated version of Optical Multi-Rate (OMR) module for SONET/SDH/OTN testing from
51Mbps to 10.7Gbps plus several test options including NextGen features that are delivered by use of license keys. Uses pluggable SFP and XFP optics.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | 10 Gbps Ethernet functionality test option added to the NGMR module,enables Ethernet testing at 10Gbps LAN+WAN in the same module that supports
SONET/SDH/OTN.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | 10 Gbps Ethernet FEC test option added to the NGMR module,enabling the testing of Ethernet traffic embedded in OTN OTU-2 signal.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------



| |  |  | ODU-1 to ODU-2 multiplexing test option added to NGMR module,enables the testing of multiplexing/de-multiplexing four ODU-1 streams into a single ODU-2.
This was an industry first.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Introduction of NextGen SONET/SDH test options for the NGMR,including VCAT (Virtual Concatenation), LCAS (Link Capacity Adjustment Scheme) and GFP (Generic
Framing Procedure)
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

We believe that these new products and product enhancements, strategic partnerships, and third-party distribution
agreements will further complement our product portfolio and enable us to offer a broader range of products to our global customers.

Critical
Accounting Policies

We believe that estimating valuation allowances and accrued liabilities are critical in the portrayal of our financial condition
and results of operations and they require difficult, subjective and complex judgments that are often the results of estimates that are inherently uncertain.Specifically, we believe the following estimates to be critical:



| |  |  | revenue recognition and sales returns and other allowances;
| | - |  | -----------------------------------------------------------



| |  |  | reserve for uncollectible accounts;
| | - |  | -----------------------------------



| |  |  | reserve for excess and obsolete inventory;
| | - |  | ------------------------------------------



| |  |  | impairment of long-lived assets;
| | - |  | --------------------------------



| |  |  | deferred tax valuation allowance;
| | - |  | ---------------------------------



| |  |  | warranty reserve; and
| | - |  | ---------------------



| |  |  | pending litigation.
| | - |  | -------------------

We make significant judgments
and estimates and assumptions in connection with establishing the above-mentioned valuation allowances. If we made different judgments or used different estimates or assumptions for establishing such amounts, it is likely that the amount and timing
of our revenue or operating expenses for any period would be materially different.

We derive our revenues principally from product sales. We recognize
revenue from the sale of products when persuasive evidence of an arrangement exists, the product has been delivered, the price is fixed and determinable and collection of the resulting receivable is reasonably assured. We estimate the amount of
potential future product returns related to current period product revenue. We consider many factors when making our estimates, including analyzing historical returns, current economic trends, changes in customer demand and acceptance of our
products to evaluate the adequacy of the sales returns and other allowances. Our estimate for the provision for sales returns and other allowances as of December 31, 2006 was approximately $54,000.



22



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##### Table of Contents

We also estimate the collectibility of our accounts receivable. We consider many factors when making our estimates,
including analyzing accounts receivable and historical bad debts, customer concentrations, customer credit-worthiness, current economic trends and changes in our customer payment terms when evaluating the adequacy of the reserve for uncollectible
accounts. Our accounts receivable balance as of December 31, 2006 was $2.4 million, net of our estimated reserve for uncollectible accounts of approximately $84,000.

We estimate the amount of excess and obsolete inventory. We consider many factors when making our estimates, including analyzing current and expected sales trends, the amount of current parts on hand, the current
market value of parts on hand and the viability and technical obsolescence of our products. The assumptions made relative to expected sales trends are subjective in nature and have a material impact on the estimate of the reserve requirement. Should
future sales trends, in total or by product line, fluctuate from that used in our estimates, this reserve could be overstated or understated. Our inventory balance was $2.7 million as of December 31, 2006, net of our estimated reserve for
excess and obsolete inventory of approximately $15.5 million. During 2007, we will be assessing the utility of our inventory and will determine the potential disposition of any obsolete items.

We estimate the impairment of long-lived assets. We monitor events and changes in circumstances that indicate whether carrying amounts of long-lived assets may not be
recoverable. These events and circumstances include decrease in market price of a long-lived asset, change in the manner in which a long-lived asset is used, changes in legal factors and a current-period operating loss or cash flow loss combined
with a history of operating losses or cash flow losses or a forecast that demonstrates continuing losses associated with the use of long-lived assets. When such an event or changes in circumstance occur, we assess the recoverability of long-lived
assets by determining whether the carrying value of such assets will be recovered through undiscounted expected future cash flows. We recognize impairment when there is an excess of the assets carrying value over the fair value as estimated using a
discounted expected future cash flows model. In estimating undiscounted expected future cash flows, we must make judgments and estimates related to future sales and profitability. Should future sales trends or profitability be significantly less
than that forecasted, our impairment could be understated. We could be required to take an additional impairment charge in the future should our actual cash flows be less than forecasted. During the year ended December 31, 2006, a review of the
carrying value of our long-lived assets and the probability of recovering such value indicated that no additional impairment charge was required.

We
recognize deferred tax liabilities and assets for expected future tax consequences of events that have been included in the consolidated financial statements or tax returns. Deferred tax liabilities and assets are determined based on the difference
between the consolidated financial statements and the tax basis of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. We provide for a valuation allowance for the deferred tax
assets when it concludes that it is more likely than not that the deferred tax assets will not be realized.

We estimate the amount of our warranty
reserve. We consider many factors when making our estimate, including historical trends, the number of products under warranty, the costs of replacement parts and the expected reliability of our products. We believe that our accrued warranty reserve
is sufficient to meet our responsibilities for potential future warranty work on products sold. Our accrued warranty reserve as of December 31, 2006 was approximately $487,000.

We estimate the amount of liability the Company may incur as a result of pending litigation. As of December 31, 2006, we are not aware of any pending litigation, claims or assessments. Accordingly, there is no
accrual for pending litigation at December 31, 2006.



23



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##### Table of Contents

Results of Operations

The following table sets forth certain financial data expressed as a percentage of net sales.



|                                |  |                         |    |  |      |    |  |      |   
|------------------------------- |  | ----------------------- | -- |  | ---- | -- |  | ---- | --
|                                |  | Year Ended December 31, |   
|                                |  | 2006                    |    |  | 2005 |    |  | 2004 |   
|Net sales                       |  | 100                     | %  |  | 100  | %  |  | 100  | % 
|Cost of goods sold              |  | 78                      |    |  | 85   |    |  | 92   |   
|                                |  |                         |    |  |      |    |  |      |   
|Gross profit                    |  | 22                      |    |  | 15   |    |  | 8    |   
|                                |  |                         |   
|Operating expenses:             |  |                         |    |  |      |    |  |      |   
|Engineering and development     |  | 43                      |    |  | 60   |    |  | 38   |   
|Sales and marketing             |  | 29                      |    |  | 45   |    |  | 44   |   
|General and administrative      |  | 33                      |    |  | 27   |    |  | 29   |   
|Impairment of long-lived assets |  |                        |    |  | 26   |    |  | 2    |   
|                                |  |                         |    |  |      |    |  |      |   
|Total operating expenses        |  | 105                     |    |  | 158  |    |  | 113  |   
|                                |  |                         |    |  |      |    |  |      |   
|Operating loss                  |  | (83                     | )  |  | (143 | )  |  | (105 | ) 
|Interest income                 |  |                        |    |  |     |    |  | 1    |   
|                                |  |                         |   
|Interest expense                |  | (55                     | )  |  | (32  | )  |  | (18  | ) 
|Other income (expense), net     |  |                        |    |  | 11   |    |  | 29   |   
|                                |  |                         |    |  |      |    |  |      |   
|Loss before income taxes        |  | (138                    | )  |  | (164 | )  |  | (94  | ) 
|                                |  |                         |    |  |      |    |  |      |   
|                                |  |                         |   
|Net loss                        |  | (138                    | )% |  | (164 | )% |  | (94  | )%
|                                |  |                         |    |  |      |    |  |      |   

---

|- | Represents less than 1% of net sales.
|- | -------------------------------------

Year Ended December 31,
2006 Compared With Year Ended December 31, 2005

Net Sales

Net sales for the year ended December 31, 2006, decreased by $2.4 million, or 19%, to $10.5 million from $12.9 million for the year ended December 31, 2005. Sales to repeat customers for the year represented
approximately 86% of sales, or $9.0 million as compared to approximately 78% of sales, or $10.1 million for 2005. During 2006, the Company shipped 200 total NIC and NAA units as compared to 309 units for the year ended December 31, 2005. The
decrease in net sales was a result of enforcement of a higher margin policy for all sales and the reduction of the sales force throughout 2006.

International sales for the year ended December 31, 2006, as a percentage of net sales, decreased from 36% to 28% of net sales. For the year ended December 31, 2006, international sales decreased by $1.9 million or 40% to $2.8
million from $4.7 million over the prior year.

Cost of Goods Sold

Cost of goods sold includes direct material costs and the costs of material purchased from third party manufacturers as well as labor and overhead for production and service. Cost of goods sold for the year ended
December 31, 2006 decreased by $2.8 million, or 26%, to $8.2 million as compared to $11.0 million for the year ended December 31, 2005. The decrease in cost of goods sold was due to lower overall sales and the percentage decrease was the
result of enforcement of higher margin policy for all sales.



24



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##### Table of Contents

Gross Profit

Gross
profit for the year ended December 31, 2006, improved to $2.3 million from $1.9 million for the year ended December 31, 2005. Gross margins for the years ended December 31, 2006 and 2005, were approximately 22% and 15%, respectively.
The increase in gross profit is attributable to the enforcement of higher margin policy for all sales.

Engineering and Development

Engineering and development expenses principally include salaries for engineering, development and certain operations personnel, depreciation of product development
assets, outside consulting fees and other development expenses. Engineering and development expenses for the year ended December 31, 2006, decreased by $3.3 million to $4.5 million, or 43% of net sales, from $7.8 million, or 60% of net sales,
for the year ended December 31, 2005. The decrease in spending reflected the elimination of prototyping costs associated with some hardware developments, which were completed in 2005, as well as a reduction in engineering personnel. These
decreases were partially offset by additional expense related to stock compensation.

Sales and Marketing

Sales and marketing expenses principally include salaries for sales, commissions, travel, tradeshows, promotional materials, depreciation of demonstration units, bad debt
and warranty expenses. Sales and marketing expenses for the year ended December 31, 2006, decreased by $2.8 million to $3.0 million, or 29% of net sales, from $5.8 million, or 45% of net sales, for the year ended December 31, 2005. The
decrease was primarily attributable to the decreases in sales staff and travel expenses.

General and Administrative

General and administrative expenses principally include salaries, other compensation, professional fees, facility rentals, and information systems related to general
management functions. General and administrative expenses for the year ended December 31, 2006, increased by $49,000 to $3.5 million, or 33% of net sales, from $3.5 million, or 27% of net sales, for the year ended December 31, 2005. This
increase included approximately $2.1 million in termination fees resulting from the Companys execution and delivery of the expiration agreement for the property located at 15550 Lightwave Drive, Clearwater, Florida, offset by a decrease in
fees for professional services, facility rentals and a reduction in the general and administrative workforce.

Impairment of Property and Equipment

During the fiscal year ended December 31, 2006, the Company did not incur a non-cash impairment charge. For fiscal year ended December 31,
2005, the Company recorded a total non-cash impairment charge for the remaining balance of its long-lived assets, which included $3.2 million and $200,000 on its property and equipment and other assets, respectively. (See Note 1 to the Consolidated
Financial Statements  Summary of Significant Accounting Policies)

Other Income (Expense)

Other expense for the year ended December 31, 2006, increased by $3.2 million to $5.8 million from $2.6 million of other expense in the year ended December 31,
2005. The increase was primarily attributable to increased interest expense on the outstanding debt owed to Optel. In 2005 the Company benefited from the forgiveness of indebtedness owed to Jabil Circuit, Inc. and CIT totaling approximately $1.6
million, which was offset by interest expense of approximately $1.1 million.

Provision for Income Taxes

No provision for income taxes was made for the years ended December 31, 2006 and 2005 due to the Companys expected annual net losses. Any tax benefits
resulting from the Companys net loss have not been recognized due to a full valuation allowance for deferred tax assets being recorded as a result of managements belief it is more likely than not that future tax benefits will not be
realized as a result of future income.



25



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##### Table of Contents

Net Loss

For the
reasons discussed above, net loss for the year ended December 31, 2006, was $14.5 million, or $0.41 per diluted share, a decrease of approximately $6.6 million, from a net loss of $21.1 million, or $0.60 per diluted share, for the year ended
December 31, 2005.

Year Ended December 31, 2005 Compared With Year Ended December 31, 2004

Net Sales

Net sales for the year ended December 31, 2005,
decreased by $857,000, or 6%, to $12.9 million from $13.7 million for the year ended December 31, 2004. Sales to repeat customers for the year represented approximately 78% of sales, or $10.1 million as compared to approximately 89% of sales,
or $12.1 million for 2004. During 2005, the Company shipped 309 total NIC and NAA units as compared to 370 units for the year ended December 31, 2004.

International sales for the year ended December 31, 2005, as a percentage of net sales, increased from 27% to 36% of net sales. For the year ended December 31, 2005, international sales increased by $959,000, or 26%, to $4.7
million from $3.7 million during the prior year.

Cost of Goods Sold

Cost of goods sold for the year ended December 31, 2005 decreased by $1.6 million, or 13%, to $11.0 million as compared to $12.6 million for the year ended December 31, 2004. The decrease in cost of goods
sold was due to a reduction in charges related to excess and obsolete inventory and other inventory claims as well as lower product sales. During 2004, there was a charge of approximately $1.3 million to increase the excess and obsolete inventory
reserve.

Gross Profit

Gross profit for the year ended
December 31, 2005, improved by 72%, to $1.9 million from $1.1 million for the year ended December 31, 2004. Gross profit for the year ended December 31, 2004, excluding the charges related to excess and obsolete inventory and the
write-off of inventory claims for inventory held at Jabil Circuit, was $2.4 million. Gross margins for the years ended December 31, 2005 and 2004, were approximately 15% and 18%, respectively. The decrease in gross margin year over year was
attributable to a decrease in the volume of sales spread over the fixed portion of the cost of goods sold.

Engineering and Development

Engineering and development expenses for the year ended December 31, 2005, increased by $2.6 million to $7.8 million, or 60% of net sales, from $5.1 million, or
38% of net sales, for the year ended December 31, 2004. The increase in spending during the year reflected additional investment in product development through the increase of engineering staff and planned controlled spending initiatives to
further the development of technologies and corresponding new products.

Sales and Marketing

Sales and marketing expenses for the year ended December 31, 2005, decreased by $339,000 to $5.8 million, or 45% of net sales, from $6.1 million, or 44% of net
sales, for the year ended December 31, 2004. The decrease in expenses represents a reduction in depreciation due to fixed assets being fully impaired (See Note 1 to the Consolidated Financial StatementsSummary of Significant Accounting
Policies), partially offset by increases in lease of competitors units for demonstration at customer sites, consultant fees for international and new product accounts and third party and/or distributor commissions.



26



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##### Table of Contents

General and Administrative

General and administrative expenses for the year ended December 31, 2005, decreased by $471,000 to $3.5 million, or 27% of net sales, from $3.9 million, or 29% of net sales for the year ended December 31, 2004. The decrease
related to reductions in depreciation reflecting full impairment of the remaining long-lived assets carrying value, adjustments of estimated remaining liabilities, less consultant fees and contract services as well as reductions in the board
of directors fees as negotiated. These were partially offset by $445,000 of severance and debt forgiveness costs relating to the resignation of the Companys former Chief Executive Officer, James R. Green during the fiscal year ended
December 31, 2005.

Impairment of Property and Equipment

For the year ended December 31, 2005, the Companys analysis, calculated in accordance with the guidelines set forth in SFAS 144, indicated future cash flows from the Companys operations were insufficient to cover the
carrying value of the Companys long-lived assets. Therefore, the Company calculated an impairment using the probability-weighted approach with an average life of five years, and risk-free rate of interest of 3%. As a result during the fiscal
year ended December 31, 2005, the Company recorded a total non-cash impairment charge for the remaining balance of its long-lived assets, which included $3.2 million and $200,000 on its property and equipment and other assets, respectively.
During 2004, the Company recorded asset impairment charges of $322,000 related to certain of its long-lived assets (See Note 1 to the Consolidated Financial Statements  Summary of Significant Accounting Policies)

Other Income (Expense)

Other expense for the year ended
December 31, 2005, decreased by $4.2 million to $2.6 million from $1.6 million of other income in the year ended December 31, 2004. The decrease represents a reduction of other income resulting from settlement of debt and payables to
approximately $1.5 million in 2005 compared to $4.0 million in 2004, as well as the increase in interest expense of approximately $1.6 million associated with the increase in notes payable.

Net Loss

For the reasons discussed above, net loss for the year
ended December 31, 2005, was $21.1 million, or $0.60 per diluted share, an increase of approximately $8.2 million, from a net loss of $12.9 million, or $0.39 per diluted share, for the year ended December 31, 2004.

Liquidity and Capital Resources

As of December 31, 2006, the
Companys unrestricted cash and cash equivalents were approximately $425,000, a decrease of $74,000 from December 31, 2005. As of December 31, 2006, the Companys working capital deficit was approximately $62.9 million as
compared to a working capital deficit of $48.8 million as of December 31, 2005. During 2006, we incurred a net loss of $14.5 million and cash flows used by operations of $7.9 million. In 2005, we incurred a net loss of $21.1 million and cash
flows used by operations of $13.6 million. We had an accumulated deficit of $151 million as of December 31, 2006.

Beginning in the third quarter of
2001 and continuing through December 31, 2006, the Company has incurred combined net losses of $163.8 million. The Company expects to continue to incur operating losses in fiscal year 2007. Management has taken actions to reduce operating
expenses and capital expenditures. These actions include restructuring operations to more closely align operating costs with revenues. As further discussed below, our ability to maintain sufficient liquidity in the future is dependent on us raising
additional capital, successfully negotiating extended payment terms with certain vendors and other creditors, maintaining tight controls over spending, successfully achieving our product release schedules and attaining our forecasted sales
objectives.

The Company continues to have insufficient short-term resources for the payment of its current liabilities. During the twelve months ended
December 31, 2006, the Company addressed this shortfall by obtaining financing from Optel Capital, LLC (Optel), an entity controlled by the Companys largest stockholder and current chairman of the board of directors,
Dr. Bryan J. Zwan. The Company has used the financing provided by Optel to fund (i) the satisfaction of substantially all of its outstanding debt and liabilities owed to creditors other than Optel, and (ii) the Companys
short-term working capital needs.



27



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##### Table of Contents

As of September 16, 2004, the Company had borrowed $27.0 million from Optel pursuant to a secured convertible
promissory note (the Secured Convertible Promissory Note) that bore interest at 10% per annum and was secured by a first priority security interest in substantially all of our assets. The conversion feature of the Secured
Convertible Promissory Note was approved by the Companys disinterested stockholders at a special meeting of stockholders on February 10, 2005. On March 11, 2005, Optel converted $1.0 million of the indebtedness outstanding under the
Secured Convertible Promissory Note into 981,258 shares of common stock. On January 4, 2007, Optel converted the remaining indebtedness, or $34.8 million, outstanding under the Secured Convertible Promissory Note into 220,222,515 shares of
common stock. As a result, the Companys obligations of debt repayment under the Secured Convertible Promissory Note were satisfied as of January 4, 2007.

As of December 31, 2006, the Company owed Optel approximately $27.6 million in principal plus approximately $4.0 million in accrued interest thereon, which debt is secured by a first priority security interest in
substantially all of our assets and such debt accrues interest at a rate of 10% per annum (Short Term Notes). The $27.6 million in principal plus accrued interest is now currently due and payable on demand at any time. The
indebtedness evidenced by the Short Term Notes is in addition to the indebtedness formerly evidenced by the Secured Convertible Promissory Note and therefore it was not affected by Optels conversion of the indebtedness evidenced by the Secured
Convertible Promissory Note into common stock in March 2005 and January 2007. On May 15, 2006, Optel established an irrevocable letter of credit in the amount of approximately $278,339 on the Companys behalf and naming Highwoods/Florida
Holdings, L.P., the Companys landlord, as beneficiary. The letter of credit expires July 31, 2011.

The Company has entered into discussions
with Optel to restructure the Short Term Notes by extending the maturity date of such debt, to arrange for additional short-term working capital. If we do not reach an agreement to restructure the Short Term Notes, and obtain additional financing
from Optel, we will be unable to meet our obligations to Optel and our other creditors, and in an attempt to collect payment, our creditors, including Optel, may seek legal remedies, including filing a petition for involuntary bankruptcy, or we may
elect to seek relief by filing a voluntary bankruptcy petition.

The Companys ability to meet cash requirements and maintain sufficient liquidity
over the next 12 months is dependent on its ability to obtain additional financing from funding sources which may include, but may not be limited to, Optel. If the Company is not able to obtain additional financing, it expects that it will not have
sufficient cash to fund its working capital and capital expenditure requirements for the near term and will not have the resources required for the payment of its current liabilities when they become due. Optel currently continues to be the
principal source of financing for the Company. The Company has not identified any funding source other than Optel that would be prepared to provide current or future financing to the Company.

The Company cannot assure that it will be able to obtain adequate financing, that it will achieve profitability or, if it achieves profitability that the profitability
will be sustainable or that it will continue as a going concern. As a result, our independent certified public accountants have included an explanatory paragraph emphasizing the substantial doubt about the Companys ability to continue as a
going concern in their report for the year ended December 31, 2006.

Operating Activities

Net cash used in operating activities for the year ended December 31, 2006, was $7.9 million. This was primarily attributable to the net loss in 2006 of $14.5
million. Included in the net loss from operations was an increase in the provision for excess and obsolete inventory of $1.0 million. The increase in accounts payable and accrued expenses, which totaled approximately $3.6 million, resulted primarily
from accrued but unpaid interest expenses of $5.8 million and from unpaid trade accounts payable of $1.2 million. Usage of on-hand inventory provided operating cash of $1.1 million. An increase in prepaid expenses and other assets used operating
cash of $114,000. Accounts receivable produced operating cash of approximately $287,000 on net sales of approximately $10.5 million, as cash collections outpaced new customer billings.

Net cash used in operating activities for the year ended December 31, 2005, was $13.6 million. This was primarily attributable to the net loss in 2005 of $21.1 million. The net loss from operations was favorably
adjusted for a $3.4 million impairment charge, $374,000 forgiveness of a related party note receivable, $879,000 of depreciation and amortization; and offset by a $1.7 million gain on settlement of accounts payable and accrued litigation and a
decrease in the provision for excess and obsolete inventory of $539,000. The increase in accounts payable and accrued expenses which totaled approximately $5.1 million resulted primarily from accrued but unpaid interest expenses of $2.9 million,
unpaid trade accounts payable of $1.6 million, and from the conversion of $1.0 million of debt to stock, which was applied first to accrued interest. Usage of on-hand inventory and prepaid expenses and other assets provided operating cash of
$276,000 and $326,000, respectively. Accounts receivable used operating cash of approximately $603,000 on net sales of approximately $12.9 million, as new customer billings outpaced cash collections.



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##### Table of Contents

Net cash used in operating activities for the year ended December 31, 2004, was $17.4 million. This reflected a net
loss in 2004 of $12.9 million, coupled with decreases in accrued litigation charges of $5.8 million, settlements of accounts payable and accrued litigation of $4.4 million, increases in accounts receivable of $963,000 and increases in prepaid
expenses and other assets of $364,000. These were partially offset by a $2.6 million decrease in net inventories, a $1.5 million increase in accounts payable and accrued expenses as well as $2.1 million of non-cash expenses including, but not
limited to, depreciation and amortization of $2.3 million and an impairment charge for long-lived assets of $322,000.

Investing Activities

No investing activities took place during the year ended December 31, 2006.

Net cash used in investing activities was approximately $262,000 for the year ended December 31, 2005. This was primarily the result of the purchase of property and equipment to further the development of
technologies and corresponding new products.

Net cash provided from investing activities was approximately $1.9 million for the year ended
December 31, 2004. This was generated by the release of restricted cash of approximately $2.0 million, partially offset by $133,000 of purchases of property and equipment.

Financing Activities

Net cash provided by financing activities for the year ended December 31, 2006 of $7.9
million was principally a result of $7.9 million additional financing provided by Optel, LLC and Optel Capital, LLC (see Note 11 to the Consolidated Financial Statements  Related Party Transactions).

Net cash provided by financing activities for the year ended December 31, 2005 of $13.5 million was principally a result of $15.4 million additional financing
provided by Optel, LLC and Optel Capital, LLC (see Note 11 to the Consolidated Financial Statements  Related Party Transactions) offset by payments of $1.9 million made on notes payable to Jabil in conjunction with scheduled payments and the
Settlement Agreement (See Note 2 to the Consolidated Financial Statements  Inventories). The proceeds provided by Optels financing were used to fund the operating losses.

Net cash provided by financing activities for the year ended December 31, 2004, was approximately $16.1 million. This was primarily attributable to $17.8 million in financing provided by Optel, LLC and Optel
Capital, LLC. (See Note 11 to the Consolidated Financial Statements  Related Party Transactions) Financing proceeds were used to fund operating losses, settlement payments and payments made on notes to Jabil Circuit, Inc. of $1.8 million. (See
Note 8 to the Consolidated Financial Statements  Notes Payable, Line of Credit and Letter of Credit)

Legal Proceedings

As of the date of this report, the Company is not aware of any pending litigation, claims or assessments that would have a material adverse effect on the Company's
business, financial condition and results of operations. (See Note 15 to the Consolidated Financial StatementsLegal Proceedings)

New Accounting
Pronouncements

In June 2006, the Emerging Issues Task Force (EITF) ratified Issue No. 06-3, How Taxes Collected From Customers and
Remitted to Governmental Authorities Should be Presented in the Income Statement (i.e., Gross versus Net Presentation), which applies to financial reports for interim and annual reporting periods beginning after December 15, 2006. Under the EITF
guidance, the Company may elect to present sales in the Statements of Operations on either a gross (that is, include tax collections within revenue) or a net (that is, excluded from revenue) basis. The Company does not plan to change its reporting
as a result of this EITF guidance. Our practice has been to report such items on a net basis.

In July 2006, the FASB issued FASB Interpretation No. 48,
Accounting for Uncertainty in Income Taxes (FIN 48), an interpretation of FASB No. 109, Accounting for Income Taxes (FASB 109). FIN 48 prescribes a recognition threshold and measurement attribute for the
financial statement recognition and measurement of a tax position taken in a tax return. The Company must determine whether it is more-likely-than-not that a tax position will be sustained upon examination, including resolution of any
related appeals or litigation processes, based on the technical merits of the position. Once it is determined that a position meets the more-likely-than-not recognition threshold, the position is measured to determine the amount of benefit to
recognize in the financial statements. FIN 48 applies to all tax positions related to income taxes subject to FASB 109. The Company anticipates adopting the provisions of FIN 48 beginning in the first quarter of fiscal 2007. The Company is currently
assessing the impact of this Interpretation on its consolidated financial statements.

In September 2006, the FASB issued SFAS No. 157 (SFAS
157), Fair Value Measurements. SFAS 157 defines fair value, establishes a framework for measuring fair value and requires enhanced disclosures about fair value measurements. SFAS 157 creates a fair value hierarchy, which prioritizes the inputs
that should be used in determining fair value. Under this pronouncement, companies must provide disclosures containing relevant information in the financial statements, allowing users to assess inputs used to measure fair value, as well as the
effect of those measurements on earnings for the periods presented, including a reconciliation of the beginning and ending balances separately for each major category of assets and liabilities. SFAS 157 is effective for financial statements issued
for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. The Company has not determined the impact of adopting SFAS 157 on their financial position.

In September 2006, the SEC released Staff Accounting Bulletin 108, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year
Financial Statements (SAB 108). SAB 108 provides guidance on how the effects of the carryover or reversal of prior year misstatements should be considered in quantifying a current year misstatement. In some situations, companies will be
required to record errors that occurred in prior years even though those errors were immaterial for each year in which they arose. Companies may choose to either restate all previously presented financial statements or record the cumulative effect
of such errors as an adjustment to retained earnings at the beginning of the period in which SAB 108 is applied. SAB 108 is effective for fiscal years ending after November 15, 2006, and was adopted by the Company on December 31, 2006. The adoption
of SAB 108 had no effect on the Companys financial statements.



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Off-Balance Sheet Arrangements

During the fiscal year ended December 31, 2006, the Company did not engage in any off-balance sheet arrangements as defined in Item 303(a)(4) of Regulation S-K.

Other Material Commitments

The Companys contractual cash
obligations as of December 31, 2006 are summarized (in thousands) in the table below.



|                                   |  |       |        |          |   |            |  |            |     |          |   |     |  |   |  
|---------------------------------- |  | ----- | ------ | -------- | - | ---------- |  | ---------- | --- | -------- | - | --- |  | - | -
|Contractual Cash Obligations       |  | Total |        | < 1 year |   | 1 - 3years |  | 3 - 5years |     | > 5years
|Notes PayableRelated Party (1)    |  | $     | 54,645 |          | $ | 54,645     |  | $          |    |          | $ |    |  | $ | 
|Interest PayableRelated Party (1) |  |       | 11,743 |          |   | 11,743     |  |            |    |          |   |    |  |   | 
|Operating leases                   |  |       | 1,209  |          |   | 276        |  |            | 509 |          |   | 424 |  |   | 
|Non-cancelable purchase orders (2) |  |       | 840    |          |   | 840        |  |            |    |          |   |    |  |   | 
|Notes PayableOther (1)            |  |       | 50     |          |   | 50         |  |            |    |          |   |    |  |   | 
|                                   |  |       |        |          |   |            |  |            |     |          |   |     |  |   |  
|Total contractual cash obligations |  | $     | 68,487 |          | $ | 67,554     |  | $          | 509 |          | $ | 424 |  | $ | 
|                                   |  |       |        |          |   |            |  |            |     |          |   |     |  |   |  

---

|(1) | See Note 8 to the Consolidated Financial StatementsNotes Payable, Line of Credit and Letter of Credit
|--- | ------------------------------------------------------------------------------------------------------

|(2) | Reflects non-cancelable inventory purchase orders.
|--- | --------------------------------------------------

Trends and
Uncertainties

During 2006, the telecommunications industry experienced a modest recovery, aided by the broader improvement in the global economy. This
recovery follows a period from 2001 to 2003 where the economy in general and the telecommunications industry specifically experienced a significant downturn. While there can be no assurance of the continuation of the current positive trends in the
economy and in the telecom industry, we see the recovery in the telecommunications sector and fiber optic test equipment market continuing in the near term.



|Item 7A. | Quantitative and Qualitative Disclosures about Market Risk
|-------- | ----------------------------------------------------------

We are not exposed to material fluctuations in currency exchange rates because the majority of our sales and expenses are denominated in U.S. dollars. Our cash balances are invested in short-term, interest-bearing
money market accounts. We believe that the impact of a 10% increase or decline in interest rates would not be material to our investment income.



|Item 8. | Consolidated Financial Statements and Supplementary Data
|------- | --------------------------------------------------------

The financial statements required by this Item are set forth at the end of this Annual Report on Form 10-K.



|Item 9. | Changes in and Disagreements with Accountants on Accounting and Financial Disclosures
|------- | -------------------------------------------------------------------------------------

None.



|Item 9A. | Controls and Procedures
|-------- | -----------------------

Our
principal executive officer and principal financial officer evaluated the effectiveness of our disclosure controls and procedures pursuant to the Securities Exchange Act of 1934, as amended (the Exchange Act), as defined in Rules
13a-15(e) and 15d-15(e) under the Exchange Act, as of December 31, 2006. Based on this evaluation, our principal executive officer and principal financial officer concluded that, as of December 31, 2006, (1) our disclosure controls
and procedures are not sufficiently effective pursuant to the requirements of the Sarbanes-Oxley Act of 2002 for companies our size, (2) information to be disclosed in reports we file under the Exchange Act is recorded, processed, summarized
and reported within the time periods specified by the rules and forms promulgated under the Exchange Act, and (3) information required to be disclosed in reports filed under the Exchange Act is accumulated and communicated to the principal
executive officer and principal financial officer as appropriate to allow timely decisions regarding required disclosure. There were no changes in the Companys internal control over financial reporting that occurred during the Companys
last fiscal quarter that have materially affected or are reasonably likely to materially affect, the Companys internal control over financial reporting.



|Item 9B. | Other Information
|-------- | -----------------

None.



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##### Table of Contents

PART III

Certain information required by Part III is omitted from this report in that the registrant intends to file a
definitive proxy statement pursuant to Regulation 14A (the Proxy Statement) not later than 120 days after the end of the fiscal year covered by this Report, and certain information included therein is incorporated herein by reference.



|Item 10. | Directors, Executive Officers and Corporate Governance
|-------- | ------------------------------------------------------

The information required by this Item will be set forth in the Proxy Statement, which information is hereby incorporated herein by reference.

Compliance with Section 16(a) of the Exchange Act

Section 16(a) under the Securities Exchange Act of 1934, as amended, requires
the Company's officers and directors, and persons who own more than ten percent (10%) of a registered class of the Company's equity securities, to file reports of ownership and changes in ownership with the SEC. Officers, directors and greater
than ten percent (10%) stockholders are required by regulations of the SEC to furnish the Company with copies of all Section 16(a) forms that they file. To the Company's knowledge, based solely on review of the copies of such reports
furnished to the Company and written representations that no other reports were required, the Company's officers, directors and greater than ten percent (10%) stockholders complied with all applicable Section 16(a) filing requirements for
the fiscal year ended December 31, 2006, except that Form 4 filings for Dr. Bryan J Zwan, ZG Nevada Limited Partnership and ZG Nevada, Inc. were filed late to report the maturity of certain forward sale contracts.

Policies on Business Conduct and Ethics

The Company has adopted a
code of business conduct and ethics that is applicable to all of its directors, offices and employees (the Code of Ethics). A copy of the Code of Ethics is available upon request, free of charge, by contacting the Company at
(727) 442-6677.



|Item 11. | Executive Compensation
|-------- | ----------------------

The information
required by this Item will be set forth in the Proxy Statement, which information is hereby incorporated herein by reference.



|Item 12. | Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
|-------- | ----------------------------------------------------------------------------------------------

The information required by this Item will be set forth in the Proxy Statement, which information is hereby incorporated herein by reference.



|Item 13. | Certain Relationships and Related Transactions, and Director Independence
|-------- | -------------------------------------------------------------------------

The information required by this Item will be set forth in the Proxy Statement, which information is hereby incorporated herein by reference.



|Item 14. | Principal Accountant Fees and Services
|-------- | --------------------------------------

The
information required by this Item will be set forth in the Proxy Statement, which information is hereby incorporated herein by reference.



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##### Table of Contents

PART IV



|Item 15. | Exhibits and Financial Statement Schedules
|-------- | ------------------------------------------

(a) The following documents are filed as a part of this report:



| | 1. | Financial Statements. See the Consolidated Financial Statements included with this report, the index to which is set forth on page F-1.
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------



| | 2. | Financial Statement Schedules. See the last page of the Consolidated Financial Statements.
| | -- | ------------------------------------------------------------------------------------------



| | 3. | Exhibits. The following sets forth a list of the exhibits required by Item 601 of Regulation S-K and Item 15(b) of this form:
| | -- | -----------------------------------------------------------------------------------------------------------------------------



|            |  |      |    |  |   |  |                                                                                                                                                               
|----------- |  | ---- | -- |  | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |  | Ref. |    |  |   |  | Description                                                                                                                                                   
|3.1         |  | (1   | )  |  |  |  | Certificate of Incorporation of the Company.                                                                                                                  
|            |  |      |   
|3.2         |  | (2   | )  |  |  |  | Amendment to Certificate of Incorporation of the Company dated June 21, 2002.                                                                                 
|            |  |      |   
|3.3         |  | (2   | )  |  |  |  | Amended and Restated By-laws of the Company dated June 21,2002.                                                                                               
|            |  |      |   
|3.4         |  | (15  | )  |  |  |  | Certificate of Amendment to the Amended and Restated Certificate of Incorporation.                                                                            
|            |  |      |   
|4.1         |  | (1   | )  |  |  |  | Specimen Certificate for the Common Stock.                                                                                                                    
|            |  |      |   
|10.1        |  | (1   | )* |  |  |  | Form of Indemnification Agreement between the Company and officers and directors of the Company.                                                              
|            |  |      |   
|10.2        |  | (1   | )  |  |  |  | Digital Lightwave, Inc. 1996 Stock Option Plan.                                                                                                               
|            |  |      |   
|10.3        |  | (3   | )* |  |  |  | Amendment to 1997 Employee Stock Purchase Plan.                                                                                                               
|            |  |      |   
|10.4        |  | (4   | )  |  |  |  | Settlement agreement between the Company and Arrow Electronics, Inc. dated January 24,2004.                                                                   
|            |  |      |   
|10.5        |  | (5   | )  |  |  |  | Settlement Agreement dated May 11, 2004, between Jabil Circuit, Inc. and Digital Lightwave, Inc.                                                              
|            |  |      |   
|10.6        |  | (5   | )  |  |  |  | Promissory Note in the principal amount of $3,011,404, dated effective as of May 11, 2004, executed by Digital Lightwave, Inc. in favor of Jabil Circuit, Inc.
|            |  |      |   
|10.7        |  | (5   | )  |  |  |  | Promissory Note in the principal amount of $2,227,500, dated effective as of May 11, 2004, executed by Digital Lightwave, Inc. in favor of Jabil Circuit, Inc.
|            |  |      |   
|10.8        |  | (6   | )* |  |  |  | Settlement Agreement between George J. Matz and Digital Lightwave, Inc dated as of April 30, 2004.                                                            
|            |  |      |   
|10.9        |  | (6   | )* |  |  |  | Settlement Agreement between Glenn Dunlap and Digital Lightwave, Inc dated as of May 6, 2004.                                                                 
|            |  |      |   
|10.10       |  | (7   | )  |  |  |  | Settlement and Renewal Agreement dated May 26, 2004 between Plaut Sigma Solutions, Inc. and Digital Lightwave, Inc. and Optel Capital, LLC.                   
|            |  |      |   
|10.11       |  | (8   | )  |  |  |  | Mediation Settlement Agreement dated June 8, 2004 between CIT Technologies Corporation and Digital Lightwave, Inc.                                            
|            |  |      |   
|10.12       |  | (9   | )  |  |  |  | Loan and Restructuring Agreement between Digital Lightwave, Inc. and Optel Capital, LLC dated as of September 16, 2004.                                       
|            |  |      |   
|10.13       |  | (9   | )  |  |  |  | Twenty Second Amended and Restated Security Agreement between Digital Lightwave, Inc. and Optel Capital, LLC dated as of September 16, 2004.                  
|            |  |      |   
|10.14       |  | (9   | )  |  |  |  | Secured Convertible Promissory Note issued by Digital Lightwave, Inc. to Optel Capital, LLC on September 16, 2004.                                            
|            |  |      |   
|10.15       |  | (9   | )  |  |  |  | Registration Rights Agreement between Digital Lightwave, Inc. and Optel Capital, LLC dated as of September 16, 2004.                                          
|            |  |      |   
|10.16       |  | (10  | )  |  |  |  | Secured Promissory Note issued by Digital Lightwave, Inc. to Optel Capital, LLC on January 28, 2005.                                                          
|            |  |      |   
|10.17       |  | (11  | )  |  |  |  | Secured Promissory Note issued by Digital Lightwave, Inc. to Optel Capital, LLC on February 11, 2005.                                                         
|            |  |      |   
|10.18       |  | (12  | )  |  |  |  | Secured Promissory Note issued by Digital Lightwave, Inc. to Optel Capital, LLC on February 25, 2005.                                                         
|            |  |      |   
|10.19       |  | (13  | )  |  |  |  | Secured Promissory Note issued by Digital Lightwave, Inc. to Optel Capital, LLC on March 11, 2005.                                                            
|            |  |      |   
|10.20       |  | (14  | )  |  |  |  | Secured Promissory Note issued by Digital Lightwave, Inc. to Optel Capital, LLC on March 23, 2005.                                                            
|            |  |      |   
|10.21       |  | (15  | )  |  |  |  | Secured Promissory Note issued by Digital Lightwave, Inc. to Optel Capital, LLC on April 14, 2005.                                                            



32



---

##### Table of Contents

|      |  |     |    |  |   |  |                                                                                                                                         
|----- |  | --- | -- |  | - |  | ----------------------------------------------------------------------------------------------------------------------------------------
|      |  |     |   
|10.22 |  | (16 | )* |  |  |  | Amended and Restated 2001 Stock Option Plan.                                                                                            
|      |  |     |   
|10.23 |  | (16 | )* |  |  |  | Severance Agreement between Digital Lightwave, Inc. and James R. Green dated February 15, 2005.                                         
|      |  |     |   
|10.24 |  | (17 | )  |  |  |  | Secured Promissory Note issued by Digital Lightwave, Inc. to Optel Capital, LLC on April 28, 2005.                                      
|      |  |     |   
|10.25 |  | (18 | )  |  |  |  | Secured Promissory Note issued by Digital Lightwave, Inc. to Optel Capital, LLC on May 12, 2005.                                        
|      |  |     |   
|10.26 |  | (19 | )  |  |  |  | Secured Promissory Note issued by Digital Lightwave, Inc. to Optel Capital, LLC on May 26, 2005.                                        
|      |  |     |   
|10.27 |  | (20 | )  |  |  |  | Secured Promissory Note issued by Digital Lightwave, Inc. to Optel Capital, LLC on June 15, 2005.                                       
|      |  |     |   
|10.28 |  | (21 | )  |  |  |  | Secured Promissory Note issued by Digital Lightwave, Inc. to Optel Capital, LLC on June 29, 2005.                                       
|      |  |     |   
|10.29 |  | (22 | )  |  |  |  | Secured Promissory Note issued by Digital Lightwave, Inc. to Optel Capital, LLC on July 14, 2005.                                       
|      |  |     |   
|10.30 |  | (23 | )  |  |  |  | Secured Promissory Note issued by Digital Lightwave, Inc. to Optel Capital, LLC on August 12, 2005.                                     
|      |  |     |   
|10.31 |  | (24 | )  |  |  |  | Secured Promissory Note issued by Digital Lightwave, Inc. to Optel Capital, LLC on August 31, 2005.                                     
|      |  |     |   
|10.32 |  | (25 | )  |  |  |  | Secured Promissory Note issued by Digital Lightwave, Inc. to Optel Capital, LLC on September 14, 2005.                                  
|      |  |     |   
|10.33 |  | (26 | )  |  |  |  | Secured Promissory Note issued by Digital Lightwave, Inc. to Optel Capital, LLC on September 29, 2005.                                  
|      |  |     |   
|10.34 |  | (27 | )  |  |  |  | Secured Promissory Note issued by Digital Lightwave, Inc. to Optel Capital, LLC on November 21, 2005.                                   
|      |  |     |   
|10.35 |  | (28 | )  |  |  |  | Secured Promissory Note issued by Digital Lightwave, Inc. to Optel Capital, LLC on December 8, 2005.                                    
|      |  |     |   
|10.36 |  | (28 | )  |  |  |  | Secured Promissory Note issued by Digital Lightwave, Inc. to Optel Capital, LLC on December 12, 2005.                                   
|      |  |     |   
|10.37 |  | (29 | )  |  |  |  | Secured Promissory Note issued by Digital Lightwave, Inc. to Optel Capital, LLC on December 23, 2005.                                   
|      |  |     |   
|10.38 |  | (30 | )  |  |  |  | Secured Promissory Note issued by Digital Lightwave, Inc. to Optel Capital, LLC on January 20, 2006.                                    
|      |  |     |   
|10.39 |  | (30 | )  |  |  |  | Secured Promissory Note issued by Digital Lightwave, Inc. to Optel Capital, LLC on January 23, 2006.                                    
|      |  |     |   
|10.40 |  | (31 | )  |  |  |  | Secured Promissory Note issued by Digital Lightwave, Inc. to Optel Capital, LLC on February 2, 2006.                                    
|      |  |     |   
|10.41 |  | (32 | )  |  |  |  | Secured Promissory Note issued by Digital Lightwave, Inc. to Optel Capital, LLC on February 13, 2006.                                   
|      |  |     |   
|10.42 |  | (33 | )  |  |  |  | Secured Promissory Note issued by Digital Lightwave, Inc. to Optel Capital, LLC on February 15, 2006.                                   
|      |  |     |   
|10.43 |  | (34 | )  |  |  |  | Secured Promissory Note issued by Digital Lightwave, Inc. to Optel Capital, LLC on March 1, 2006                                        
|      |  |     |   
|10.44 |  | (35 | )  |  |  |  | Secured Promissory Note issued by Digital Lightwave, Inc. to Optel Capital, LLC on March 14, 2006.                                      
|      |  |     |   
|10.45 |  | (36 | )  |  |  |  | Secured Promissory Note issued by Digital Lightwave, Inc. to Optel Capital, LLC on March 29, 2006.                                      
|      |  |     |   
|10.46 |  | (37 | )  |  |  |  | Secured Promissory Note issued by Digital Lightwave, Inc. to Optel Capital, LLC on March 31, 2006.                                      
|      |  |     |   
|10.47 |  | (38 | )  |  |  |  | Secured Promissory Note issued by Digital Lightwave, Inc. to Optel Capital, LLC on April 13, 2006.                                      
|      |  |     |   
|10.48 |  | (39 | )  |  |  |  | Secured Promissory Note issued by Digital Lightwave, Inc. to Optel Capital, LLC on April 18, 2006.                                      
|      |  |     |   
|10.49 |  | (40 | )  |  |  |  | Secured Promissory Note issued by Digital Lightwave, Inc. to Optel Capital, LLC on April 25, 2006.                                      
|      |  |     |   
|10.50 |  | (41 | )  |  |  |  | Lease Expiration Agreement between Digital Lightwave, Inc. and Lightwave Drive, L.L.C., dated as of May 1, 2006 (executed May 15, 2006).
|      |  |     |   
|10.51 |  | (41 | )  |  |  |  | Service Center Building Lease between Digital Lightwave, Inc and Florida Holdings, L.P dated May 15, 2006.                              
|      |  |     |   
|10.52 |  | (41 | )  |  |  |  | Fowler Distribution Center Lease between Digital Lightwave, Inc. and Fowler DC, LLC. Dated May 16, 2006.                                
|      |  |     |   
|10.53 |  | (41 | )  |  |  |  | Secured Promissory Note issued by Digital Lightwave, Inc. to Optel Capital, LLC on May 15, 2006.                                        
|      |  |     |   
|10.54 |  | (42 | )  |  |  |  | Secured Promissory Note issued by Digital Lightwave, Inc. to Optel Capital, LLC on July 12, 2006                                        
|      |  |     |   
|10.55 |  | (43 | )  |  |  |  | Secured Promissory Note issued by Digital Lightwave, Inc. to Optel Capital, LLC on July 18, 2006.                                       
|      |  |     |   
|10.56 |  | (44 | )  |  |  |  | Secured Promissory Note issued by Digital Lightwave, Inc. to Optel Capital, LLC on August 5, 2006.                                      
|      |  |     |   
|10.57 |  | (45 | )  |  |  |  | Secured Promissory Note issued by Digital Lightwave, Inc. to Optel Capital, LLC on October 4, 2006                                      
|      |  |     |   
|10.58 |  | (46 | )  |  |  |  | Secured Promissory Note issued by Digital Lightwave, Inc. to Optel Capital, LLC on December 27, 2006                                    
|      |  |     |   
|23.1  |  | +   |    |  |  |  | Consent of Grant Thornton LLP.                                                                                                          



33



---

##### Table of Contents

|     |  |   |  |   |  |                                                                                                                                                           
|---- |  | - |  | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------
|24.1 |  | + |  |  |  | Power of Attorney (included as part of signature page)                                                                                                    
|     |  |   | 
|31.1 |  | + |  |  |  | Certification of the Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                   
|     |  |   | 
|31.2 |  | + |  |  |  | Certification of the Principal Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                               
|     |  |   | 
|32.1 |  | + |  |  |  | Certification by the Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.    
|     |  |   | 
|32.2 |  | + |  |  |  | Certification by the Principal Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

---

|* | Indicates management contract or compensatory plan or arrangement.
|- | ------------------------------------------------------------------

|+ | Filed with this report.
|- | -----------------------

|(1) | Incorporated by reference to the similarly described exhibits filed in connection with the Registrant's Registration Statement on Form S-1, File No. 333-09457, declared
effective by the Securities and Exchange Commission on February 5, 1997.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) | Incorporated by reference to the similarly described exhibits filed in connection with the Registrant's Form 10-Q for the quarter ended March 31, 2002.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------

|(3) | Incorporated by reference to Appendix B to the registrants Proxy Statement file April 22, 2002 for the 2002 Annual Meeting of Stockholders held on May 20, 2002.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------

|(4) | Incorporated by reference to the similarly described exhibits filed in connection with the Registrants Form 10-K on April 14, 2004.
|--- | ------------------------------------------------------------------------------------------------------------------------------------

|(5) | Incorporated by reference to the similarly described exhibits filed in connection with the Registrants Form 8-K on May 13, 2004.
|--- | ---------------------------------------------------------------------------------------------------------------------------------

|(6) | Incorporated by reference to the similarly described exhibits filed in connection with the Registrants Form 10-Q on May 17, 2004.
|--- | ----------------------------------------------------------------------------------------------------------------------------------

|(7) | Incorporated by reference to the similarly described exhibits filed in connection with the Registrants Form 8-K on June 10, 2004.
|--- | ----------------------------------------------------------------------------------------------------------------------------------

|(8) | Incorporated by reference to the similarly described exhibits filed in connection with the Registrants Form 8-K on June 14, 2004.
|--- | ----------------------------------------------------------------------------------------------------------------------------------

|(9) | Incorporated by reference to the similarly described exhibits filed in connection with the Registrants Form 8-K on September 21, 2004.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------

|(10) | Incorporated by reference to the similarly described exhibits filed in connection with the Registrants Form 8-K on February 3, 2005.
|---- | -------------------------------------------------------------------------------------------------------------------------------------

|(11) | Incorporated by reference to the similarly described exhibits filed in connection with the Registrants Form 8-K on February 16, 2005.
|---- | --------------------------------------------------------------------------------------------------------------------------------------

|(12) | Incorporated by reference to the similarly described exhibits filed in connection with the Registrants Form 8-K on March 3, 2005.
|---- | ----------------------------------------------------------------------------------------------------------------------------------

|(13) | Incorporated by reference to the similarly described exhibits filed in connection with the Registrants Form 8-K on March 15, 2005.
|---- | -----------------------------------------------------------------------------------------------------------------------------------

|(14) | Incorporated by reference to the similarly described exhibits filed in connection with the Registrants Form 8-K on March 25, 2005.
|---- | -----------------------------------------------------------------------------------------------------------------------------------

|(15) | Incorporated by reference to the similarly described exhibits filed in connection with the Registrants Form 8-K on April 15, 2005.
|---- | -----------------------------------------------------------------------------------------------------------------------------------

|(16) | Incorporated by reference to Appendix A to the registrants Proxy Statement filed January 4, 2005, for a Special Meeting of Stockholders held on February 10, 2005.
|---- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(17) | Incorporated by reference to the similarly described exhibits filed in connection with the Registrants Form 8-K on May 2, 2005.
|---- | --------------------------------------------------------------------------------------------------------------------------------

|(18) | Incorporated by reference to the similarly described exhibits filed in connection with the Registrants Form 8-K on May 18, 2005.
|---- | ---------------------------------------------------------------------------------------------------------------------------------

|(19) | Incorporated by reference to the similarly described exhibits filed in connection with the Registrants Form 8-K on June 2, 2005.
|---- | ---------------------------------------------------------------------------------------------------------------------------------

|(20) | Incorporated by reference to the similarly described exhibits filed in connection with the Registrants Form 8-K on June 20, 2005.
|---- | ----------------------------------------------------------------------------------------------------------------------------------

|(21) | Incorporated by reference to the similarly described exhibits filed in connection with the Registrants Form 8-K on June 29, 2005.
|---- | ----------------------------------------------------------------------------------------------------------------------------------

|(22) | Incorporated by reference to the similarly described exhibits filed in connection with the Registrants Form 8-K on July 19, 2005.
|---- | ----------------------------------------------------------------------------------------------------------------------------------

|(23) | Incorporated by reference to the similarly described exhibits filed in connection with the Registrants Form 8-K on August 18, 2005.
|---- | ------------------------------------------------------------------------------------------------------------------------------------



34



---

##### Table of Contents

|(24) | Incorporated by reference to the similarly described exhibits filed in connection with the Registrants Form 8-K on September 7, 2005.
|---- | --------------------------------------------------------------------------------------------------------------------------------------



|(25) | Incorporated by reference to the similarly described exhibits filed in connection with the Registrants Form 8-K on September 20, 2005.
|---- | ---------------------------------------------------------------------------------------------------------------------------------------



|(26) | Incorporated by reference to the similarly described exhibits filed in connection with the Registrants Form 8-K on October 4, 2005.
|---- | ------------------------------------------------------------------------------------------------------------------------------------



|(27) | Incorporated by reference to the similarly described exhibits filed in connection with the Registrants Form 8-K on November 25, 2005.
|---- | --------------------------------------------------------------------------------------------------------------------------------------



|(28) | Incorporated by reference to the similarly described exhibits filed in connection with the Registrants Form 8-K on December 12, 2005.
|---- | --------------------------------------------------------------------------------------------------------------------------------------



|(29) | Incorporated by reference to the similarly described exhibits filed in connection with the Registrants Form 8-K on December 23, 2005.
|---- | --------------------------------------------------------------------------------------------------------------------------------------



|(30) | Incorporated by reference to the similarly described exhibits filed in connection with the Registrants Form 8-K on January 26, 2006.
|---- | -------------------------------------------------------------------------------------------------------------------------------------



|(31) | Incorporated by reference to the similarly described exhibits filed in connection with the Registrants Form 8-K on February 7, 2006.
|---- | -------------------------------------------------------------------------------------------------------------------------------------



|(32) | Incorporated by reference to the similarly described exhibits filed in connection with the Registrants Form 8-K on February 16, 2006.
|---- | --------------------------------------------------------------------------------------------------------------------------------------



|(33) | Incorporated by reference to the similarly described exhibits filed in connection with the Registrants Form 8-K on February 21, 2006.
|---- | --------------------------------------------------------------------------------------------------------------------------------------



|(34) | Incorporated by reference to the similarly described exhibits filed in connection with the Registrants Form 8-K on March 7, 2006.
|---- | ----------------------------------------------------------------------------------------------------------------------------------



|(35) | Incorporated by reference to the similarly described exhibits filed in connection with the Registrants Form 8-K on March 20, 2006.
|---- | -----------------------------------------------------------------------------------------------------------------------------------



|(36) | Incorporated by reference to the similarly described exhibits filed in connection with the Registrants Form 8-K on March 30, 2006.
|---- | -----------------------------------------------------------------------------------------------------------------------------------



|(37) | Incorporated by reference to the similarly described exhibits filed in connection with the Registrants Form 8-K on April 4, 2006.
|---- | ----------------------------------------------------------------------------------------------------------------------------------



|(38) | Incorporated by reference to the similarly described exhibits filed in connection with the Registrants Form 8-K on April 19, 2006.
|---- | -----------------------------------------------------------------------------------------------------------------------------------



|(39) | Incorporated by reference to the similarly described exhibits filed in connection with the Registrants Form 8-K on April 24, 2006.
|---- | -----------------------------------------------------------------------------------------------------------------------------------



|(40) | Incorporated by reference to the similarly described exhibits filed in connection with the Registrants Form 8-K on May 1, 2006.
|---- | --------------------------------------------------------------------------------------------------------------------------------



|(41) | Incorporated by reference to the similarly described exhibits filed in connection with the Registrants Form 8-K on May 18, 2006.
|---- | ---------------------------------------------------------------------------------------------------------------------------------



|(42) | Incorporated by reference to the similarly described exhibits filed in connection with the Registrants Form 8-K on July 18, 2006.
|---- | ----------------------------------------------------------------------------------------------------------------------------------



|(43) | Incorporated by reference to the similarly described exhibits filed in connection with the Registrants Form 8-K on July 24, 2006.
|---- | ----------------------------------------------------------------------------------------------------------------------------------



|(44) | Incorporated by reference to the similarly described exhibits filed in connection with the Registrants Form 8-K on August 10, 2006.
|---- | ------------------------------------------------------------------------------------------------------------------------------------



|(45) | Incorporated by reference to the similarly described exhibits filed in connection with the Registrants Form 8-K on October 10, 2006.
|---- | -------------------------------------------------------------------------------------------------------------------------------------



|(46) | Incorporated by reference to the similarly described exhibits filed in connection with the Registrants Form 8-K on January 3, 2007.
|---- | ------------------------------------------------------------------------------------------------------------------------------------

---

|(b) | Exhibits. The exhibits listed in Item 15(a)(3) above are filed as part of, or incorporated by reference into, this report.
|--- | --------------------------------------------------------------------------------------------------------------------------

|(c) | Financial Statement Schedules. See Item 15(a)(2) above.
|--- | -------------------------------------------------------



35



---

##### Table of Contents

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 LIGHTWAVE, INC.By:

/s/ KENNETH T. MYERSKenneth T. MyersPresident and Chief Executive Officer


Date: April 5, 2007

We the undersigned directors and officers of the Registrant, hereby severally constitute Kenneth T. Myers our true lawful attorney with full power to him to sign for us, in our names, in the capacities indicated below, any and all
amendments to this Annual Report on Form 10-K filed with the Securities and Exchange Commission.

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 and in the capacities and on the dates indicated.



|                      |  |                                                                     |  |              
|--------------------- |  | ------------------------------------------------------------------- |  | -------------
|NAME                  |  | TITLE                                                               |  | DATE         
|                      |  |                                                                    
|/s/ KENNETH T. MYERS  |  | President and Chief Executive Officer (Principal Executive Officer) |  | April 5, 2007
|Kenneth T. Myers      |  |                                                                     | 
|                      |  |                                                                    
|/s/ KENNETH T. MYERS  |  | Interim Chief Accounting Officer (Principal Accounting Officer)     |  | April 5, 2007
|Kenneth T. Myers      |  |                                                                     | 
|                      |  |                                                                    
|/s/ DR. BRYAN J. ZWAN |  | Chairman of the Board                                               |  | April 5, 2007
|Dr. Bryan J. Zwan     |  |                                                                     |  |              
|                      |  |                                                                    
|/s/ PETER H. COLLINS  |  | Director                                                            |  | April 5, 2007
|Peter H. Collins      |  |                                                                     |  |              
|                      |  |                                                                    
|/s/ GERALD A. FALLON  |  | Director                                                            |  | April 5, 2007
|Gerald A. Fallon      |  |                                                                     |  |              
|                      |  |                                                                    
|/s/ ROBERT F. HUSSEY  |  | Director                                                            |  | April 5, 2007
|Robert F. Hussey      |  |                                                                     |  |              
|                      |  |                                                                    
|/s/ ROBERT MOREYRA    |  | Director                                                            |  | April 5, 2007
|Robert Moreyra        |  |                                                                     |  |              



36



---

##### Table of Contents

Index to Financial Statements



|                                                          |  |     
|--------------------------------------------------------- |  | ----
|                                                          |  | Page
|Financial Statements                                      |  |     
|                                                          | 
|Report of Independent Registered Public Accounting Firm   |  | F-2 
|                                                          | 
|Consolidated Balance Sheets                               |  | F-3 
|                                                          | 
|Consolidated Statements of Operations                     |  | F-4 
|                                                          | 
|Consolidated Statements of Stockholders' Equity (Deficit) |  | F-5 
|                                                          | 
|Consolidated Statements of Cash Flows                     |  | F-6 
|                                                          | 
|Notes to Consolidated Financial Statements                |  | F-7 
|                                                          | 
|Financial Statement Schedule                              |  |     
|                                                          | 
|Schedule II  Valuation and qualifying accounts           |  | F-26



F-1



---

##### Table of Contents

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders of

Digital Lightwave, Inc. and its subsidiaries

We have audited the
accompanying consolidated balance sheets of Digital Lightwave, Inc. (a Delaware corporation) and subsidiaries as of December 31, 2006 and 2005, and the related consolidated statements of operations, stockholders' equity, and cash flows for each
of the three years in the period ended December 31, 2006. These consolidated 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 the standards of the Public Company Accounting Oversight Board (United States of America). Those
standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its
internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an
opinion on the effectiveness of the Companys internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the
financial statements, 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 consolidated financial statements referred to above present fairly, in all material respect, the financial position of
Digital Lightwave, Inc. and subsidiaries as of December 31, 2006, and 2005, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2006, in conformity with accounting
principles generally accepted in the United States of America.

Our audit was conducted for the purpose of forming an opinion on the basic financial
statements taken as a whole. Schedule II is presented for purposes of additional analysis and is not a required part of the basic financial statements. This schedule has been subjected to the auditing procedures applied in the audit of the basic
financial statements and, in our opinion, is fairly stated in all material respects in relation to the basic financial statements taken as a whole.

The
accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 1, the Company has incurred net losses of $14.5 million in 2006 and $21.1 million in 2005 and as of
December 31, 2006, has a working capital deficit of $62.9 million and a stockholders deficit of $62.9 million. These factors, among others, as discussed in Note 1 to the financial statements, raise substantial doubt about the
Companys ability to continue as a going concern. Managements plans in regard to these matters are also described in Note 1. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.

As discussed in Note 1 to the consolidated financial statements, the Company adopted SFAS 123R Share Based Payment on a modified prospective
transition basis as of January 1, 2006.



|                      
|----------------------
|/s/ GRANT THORNTON LLP

Tampa, Florida

April
4, 2007



F-2



---

##### Table of Contents

DIGITAL LIGHTWAVE, INC.

CONSOLIDATED BALANCE SHEETS

(In thousands, except share data)



|                                                                                                                                                      |  |                   |          |   |                   |   |          |  
|----------------------------------------------------------------------------------------------------------------------------------------------------- |  | ----------------- | -------- | - | ----------------- | - | -------- | -
|                                                                                                                                                      |  | December 31, 2006 |          |   | December 31, 2005 |  
|ASSETS                                                                                                                                                |  |                   |          |   |                   |   |          |  
|Current assets:                                                                                                                                       |  |                   |          |   |                   |   |          |  
|Cash and cash equivalents                                                                                                                             |  | $                 | 425      |   |                   | $ | 499      |  
|Accounts receivable, less reserve for uncollectible accounts of $84 and $145 in 2006 and 2005, respectively                                           |  |                   | 2,385    |   |                   |   | 2,672    |  
|Inventories, net                                                                                                                                      |  |                   | 2,729    |   |                   |   | 4,765    |  
|Prepaid expenses and other current assets                                                                                                             |  |                   | 274      |   |                   |   | 341      |  
|                                                                                                                                                      |  |                   |          |   |                   |   |          |  
|Total current assets                                                                                                                                  |  |                   | 5,813    |   |                   |   | 8,277    |  
|Property and equipment, net                                                                                                                           |  |                   |         |   |                   |   |         |  
|Other assets, net                                                                                                                                     |  |                   | 218      |   |                   |   | 37       |  
|                                                                                                                                                      |  |                   |          |   |                   |   |          |  
|Total assets                                                                                                                                          |  | $                 | 6,031    |   |                   | $ | 8,314    |  
|                                                                                                                                                      |  |                   |          |   |                   |   |          |  
|                                                                                                                                                      |  |                  
|LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)                                                                                                        |  |                   |          |   |                   |   |          |  
|Current liabilities:                                                                                                                                  |  |                   |          |   |                   |   |          |  
|Accounts payable and accrued liabilities                                                                                                              |  | $                 | 13,975   |   |                   | $ | 10,181   |  
|Notes payable to related party                                                                                                                        |  |                   | 54,645   |   |                   |   | 46,830   |  
|Notes payable                                                                                                                                         |  |                   | 50       |   |                   |   | 55       |  
|                                                                                                                                                      |  |                   |          |   |                   |   |          |  
|Total current liabilities                                                                                                                             |  |                   | 68,670   |   |                   |   | 57,066   |  
|Other long-term liabilities                                                                                                                           |  |                   | 239      |   |                   |   | 438      |  
|                                                                                                                                                      |  |                   |          |   |                   |   |          |  
|Total liabilities                                                                                                                                     |  |                   | 68,909   |   |                   |   | 57,504   |  
|                                                                                                                                                      |  |                   |          |   |                   |   |          |  
|Commitments and Contingencies (Notes 10 and 15)                                                                                                       |  |                   |         |   |                   |   |         |  
|Stockholders' equity (deficit):                                                                                                                       |  |                   |          |   |                   |   |          |  
|Preferred stock, $.0001 par value; authorized 20,000,000 shares; no shares issued or outstanding                                                      |  |                   |         |   |                   |   |         |  
|Common stock, $.0001 par value; authorized 300,000,000 shares; issued and outstanding 35,241,831 and 35,204,425 shares in 2006 and 2005,
respectively |  |                   | 3        |   |                   |   | 3        |  
|Additional paid-in capital                                                                                                                            |  |                   | 87,982   |   |                   |   | 87,182   |  
|Accumulated deficit                                                                                                                                   |  |                   | (150,863 | ) |                   |   | (136,375 | )
|                                                                                                                                                      |  |                   |          |   |                   |   |          |  
|Total stockholders' equity (deficit)                                                                                                                  |  |                   | (62,878  | ) |                   |   | (49,190  | )
|                                                                                                                                                      |  |                   |          |   |                   |   |          |  
|Total liabilities and stockholders' equity (deficit)                                                                                                  |  | $                 | 6,031    |   |                   | $ | 8,314    |  
|                                                                                                                                                      |  |                   |          |   |                   |   |          |  

The accompanying notes are an integral part of these consolidated financial statements.



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DIGITAL LIGHTWAVE, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except share and per-share data)



|                                                                 |  |                                  |            |   |      |   |            |      |  |   |            |  
|---------------------------------------------------------------- |  | -------------------------------- | ---------- | - | ---- | - | ---------- | ---- |  | - | ---------- | -
|                                                                 |  | For the Years Ended December 31, |           
|                                                                 |  | 2006                             |            |   | 2005 |   |            | 2004 | 
|Net sales                                                        |  | $                                | 10,481     |   |      | $ | 12,882     |      |  | $ | 13,739     |  
|Cost of goods sold                                               |  |                                  | 8,155      |   |      |   | 11,010     |      |  |   | 12,642     |  
|                                                                 |  |                                  |            |   |      |   |            |      |  |   |            |  
|Gross profit                                                     |  |                                  | 2,326      |   |      |   | 1,872      |      |  |   | 1,097      |  
|                                                                 |  |                                  |            |   |      |   |            |      |  |   |            |  
|                                                                 |  |                                  |           
|Operating expenses:                                              |  |                                  |            |   |      |   |            |      |  |   |            |  
|Engineering and development                                      |  |                                  | 4,509      |   |      |   | 7,752      |      |  |   | 5,133      |  
|Sales and marketing                                              |  |                                  | 3,011      |   |      |   | 5,774      |      |  |   | 6,113      |  
|General and administrative                                       |  |                                  | 3,510      |   |      |   | 3,461      |      |  |   | 3,932      |  
|Restructuring charge                                             |  |                                  |           |   |      |   |           |      |  |   | 40         |  
|Impairment of long-lived assets                                  |  |                                  |           |   |      |   | 3,369      |      |  |   | 322        |  
|                                                                 |  |                                  |            |   |      |   |            |      |  |   |            |  
|Total operating expenses                                         |  |                                  | 11,030     |   |      |   | 20,356     |      |  |   | 15,540     |  
|                                                                 |  |                                  |            |   |      |   |            |      |  |   |            |  
|Operating loss                                                   |  |                                  | (8,704     | ) |      |   | (18,484    | )    |  |   | (14,443    | )
|                                                                 |  |                                  |            |   |      |   |            |      |  |   |            |  
|                                                                 |  |                                  |           
|Other income (expense):                                          |  |                                  |            |   |      |   |            |      |  |   |            |  
|Interest income                                                  |  |                                  |           |   |      |   | 4          |      |  |   | 46         |  
|Interest expense                                                 |  |                                  | (5,773     | ) |      |   | (4,062     | )    |  |   | (2,433     | )
|Other income (expense)                                           |  |                                  | (11        | ) |      |   | 1,449      |      |  |   | 3,952      |  
|                                                                 |  |                                  |            |   |      |   |            |      |  |   |            |  
|Total other income (expense)                                     |  |                                  | (5,784     | ) |      |   | (2,609     | )    |  |   | 1,565      |  
|                                                                 |  |                                  |            |   |      |   |            |      |  |   |            |  
|Loss before income taxes                                         |  |                                  | (14,488    | ) |      |   | (21,093    | )    |  |   | (12,878    | )
|Provision for income taxes                                       |  |                                  |           |   |      |   |           |      |  |   |           |  
|                                                                 |  |                                  |            |   |      |   |            |      |  |   |            |  
|Net loss                                                         |  | $                                | (14,488    | ) |      | $ | (21,093    | )    |  | $ | (12,878    | )
|                                                                 |  |                                  |            |   |      |   |            |      |  |   |            |  
|                                                                 |  |                                  |           
|Per share of common stock:                                       |  |                                  |            |   |      |   |            |      |  |   |            |  
|Basic and diluted net loss net loss per share                    |  | $                                | (0.41      | ) |      | $ | (0.60      | )    |  | $ | (0.39      | )
|                                                                 |  |                                  |            |   |      |   |            |      |  |   |            |  
|Weighted average common and common equivalent shares outstanding |  |                                  | 35,228,948 |   |      |   | 35,094,986 |      |  |   | 33,065,582 |  
|                                                                 |  |                                  |            |   |      |   |            |      |  |   |            |  

The accompanying notes are an integral part of these consolidated financial statements.



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DIGITAL LIGHTWAVE, INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (Deficit)

For The Years Ended December 31, 2006, 2005,
and 2004

(In thousands, except share data)



|                                        |  |              |  |                            |   |                     |   |        |                             |   |          |       |  |   |         |   |  |   |         |  
|--------------------------------------- |  | ------------ |  | -------------------------- | - | ------------------- | - | ------ | --------------------------- | - | -------- | ----- |  | - | ------- | - |  | - | ------- | -
|                                        |  | Common Stock |  | Additional Paid-In Capital |   | Accumulated Deficit |   |        | Comprehensive Income (Loss) |   |          | Total | 
|                                        |  | Shares       |  | Amount                     |   |                     |   |       
|Balance December 31, 2003               |  | 31,591,890   |  | $                          | 3 |                     | $ | 81,261 |                             | $ | (102,404 | )     |  |   |         |   |  | $ | (21,140 | )
|Comprehensive loss:                     |  |              |  |                            |   |                     |   |        |                             |   |          |       |  |   |         |   |  |   |         |  
|Net loss                                |  |             |  |                            |  |                     |   |       |                             |   | (12,878  | )     |  |   | (12,878 | ) |  |   | (12,878 | )
|                                        |  |              |  |                            |   |                     |   |        |                             |   |          |       |  |   |         |   |  |   |         |  
|Comprehensive loss                      |  |              |  |                            |   |                     |   |        |                             |   |          |       |  | $ | (12,878 | ) |  |   |         |  
|                                        |  |              |  |                            |   |                     |   |        |                             |   |          |       |  |   |         |   |  |   |         |  
|Issuance of common stock                |  | 2,591,314    |  |                            |  |                     |   | 4,799  |                             |   |         |       |  |   |         |   |  |   | 4 ,799  |  
|Issuance of stock options for services  |  |             |  |                            |  |                     |   | 73     |                             |   |         |       |  |   |         |   |  |   | 73      |  
|                                        |  |              |  |                            |   |                     |   |        |                             |   |          |       |  |   |         |   |  |   |         |  
|Balance December 31, 2004               |  | 34,183,204   |  |                            | 3 |                     |   | 86,133 |                             |   | (115,282 | )     |  |   |         |   |  |   | (29,146 | )
|Comprehensive loss:                     |  |              |  |                            |   |                     |   |        |                             |   |          |       |  |   |         |   |  |   |         |  
|Net loss                                |  |             |  |                            |  |                     |   |       |                             |   | (21,093  | )     |  |   | (21,093 | ) |  |   | (21,093 | )
|                                        |  |              |  |                            |   |                     |   |        |                             |   |          |       |  |   |         |   |  |   |         |  
|Comprehensive loss                      |  |              |  |                            |   |                     |   |        |                             |   |          |       |  | $ | (21,093 | ) |  |   |         |  
|                                        |  |              |  |                            |   |                     |   |        |                             |   |          |       |  |   |         |   |  |   |         |  
|Issuance of common stock                |  | 1,021,221    |  |                            |  |                     |   | 1,026  |                             |   |         |       |  |   |         |   |  |   | 1,026   |  
|Issuance of stock options for services  |  |             |  |                            |  |                     |   | 23     |                             |   |         |       |  |   |         |   |  |   | 23      |  
|                                        |  |              |  |                            |   |                     |   |        |                             |   |          |       |  |   |         |   |  |   |         |  
|Balance December 31, 2005               |  | 35,204,425   |  |                            | 3 |                     |   | 87,182 |                             |   | (136,375 | )     |  |   |         |   |  |   | (49,190 | )
|Comprehensive loss:                     |  |              |  |                            |   |                     |   |        |                             |   |          |       |  |   |         |   |  |   |         |  
|Net loss                                |  |             |  |                            |  |                     |   |       |                             |   | (14,488  | )     |  |   | (14,488 | ) |  |   | (14,488 | )
|                                        |  |              |  |                            |   |                     |   |        |                             |   |          |       |  |   |         |   |  |   |         |  
|Comprehensive loss                      |  |              |  |                            |   |                     |   |        |                             |   |          |       |  | $ | (14,488 | ) |  |   |         |  
|                                        |  |              |  |                            |   |                     |   |        |                             |   |          |       |  |   |         |   |  |   |         |  
|Contributed services from related party |  |             |  |                            |  |                     |   | 400    |                             |   |         |       |  |   |         |   |  |   | 400     |  
|Issuance of common stock                |  | 37,406       |  |                            |  |                     |   | 11     |                             |   |         |       |  |   |         |   |  |   | 11      |  
|Stock compensation expense              |  |             |  |                            |  |                     |   | 389    |                             |   |         |       |  |   |         |   |  |   | 389     |  
|                                        |  |              |  |                            |   |                     |   |        |                             |   |          |       |  |   |         |   |  |   |         |  
|Balance December 31, 2006               |  | 35,241,831   |  | $                          | 3 |                     | $ | 87,982 |                             | $ | (150,863 | )     |  |   |         |   |  | $ | (62,878 | )
|                                        |  |              |  |                            |   |                     |   |        |                             |   |          |       |  |   |         |   |  |   |         |  

The accompanying notes are an integral part of these consolidated financial statements.



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##### Table of Contents

DIGITAL LIGHTWAVE, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)



|                                                                        |  |                                  |          |   |      |   |         |      |  |   |         |  
|----------------------------------------------------------------------- |  | -------------------------------- | -------- | - | ---- | - | ------- | ---- |  | - | ------- | -
|                                                                        |  | For the Years Ended December 31, |         
|                                                                        |  | 2006                             |          |   | 2005 |   |         | 2004 | 
|Cash flows from operating activities:                                   |  |                                  |          |   |      |   |         |      |  |   |         |  
|Net loss                                                                |  |                                  | ($14,488 | ) |      | $ | (21,093 | )    |  | $ | (12,878 | )
|Adjustments to reconcile net loss to cash used in operating activities: |  |                                  |          |   |      |   |         |      |  |   |         |  
|Depreciation and amortization                                           |  |                                  |         |   |      |   | 879     |      |  |   | 2,277   |  
|Loss on disposal of property                                            |  |                                  |         |   |      |   | 2       |      |  |   | 159     |  
|Provision for uncollectible accounts                                    |  |                                  |         |   |      |   |        |      |  |   | 98      |  
|Provision for excess and obsolete inventory                             |  |                                  | 983      |   |      |   | (539    | )    |  |   | (160    | )
|Impairment of long-lived assets                                         |  |                                  |         |   |      |   | 3,369   |      |  |   | 322     |  
|Restructuring charge                                                    |  |                                  |         |   |      |   |        |      |  |   | 40      |  
|Contributed services from related party                                 |  |                                  | 400      |   |      |   |        |      |  |   |        |  
|Note receivable forgiven                                                |  |                                  |         |   |      |   | 374     |      |  |   |        |  
|Settlement of accounts payable and accrued litigation                   |  |                                  |         |   |      |   | (1,666  | )    |  |   | (4,401  | )
|Compensation expense for stock option grants                            |  |                                  | 389      |   |      |   | 23      |      |  |   | 73      |  
|Changes in operating assets and liabilities:                            |  |                                  |          |   |      |   |         |      |  |   |         |  
|(Increase) decrease in accounts receivable                              |  |                                  | 287      |   |      |   | (603    | )    |  |   | (963    | )
|Decrease in inventories                                                 |  |                                  | 1,053    |   |      |   | 276     |      |  |   | 2,639   |  
|(Increase) decrease in prepaid expenses and other assets                |  |                                  | (114     | ) |      |   | 326     |      |  |   | (364    | )
|Increase in accounts payable and accrued expenses                       |  |                                  | 3,546    |   |      |   | 5,097   |      |  |   | 1,537   |  
|Decrease in accrued litigation charge                                   |  |                                  |         |   |      |   |        |      |  |   | (5,802  | )
|                                                                        |  |                                  |          |   |      |   |         |      |  |   |         |  
|Net cash used in operating activities                                   |  |                                  | (7,944   | ) |      |   | (13,555 | )    |  |   | (17,423 | )
|                                                                        |  |                                  |          |   |      |   |         |      |  |   |         |  
|Cash flows from investing activities:                                   |  |                                  |          |   |      |   |         |      |  |   |         |  
|Decrease in restricted cash and cash equivalents                        |  |                                  |         |   |      |   |        |      |  |   | 1,993   |  
|Purchases of property and equipment                                     |  |                                  |         |   |      |   | (262    | )    |  |   | (133    | )
|                                                                        |  |                                  |          |   |      |   |         |      |  |   |         |  
|Net cash provided by (used in) investing activities                     |  |                                  |         |   |      |   | (262    | )    |  |   | 1,860   |  
|                                                                        |  |                                  |          |   |      |   |         |      |  |   |         |  
|Cash flows from financing activities:                                   |  |                                  |          |   |      |   |         |      |  |   |         |  
|Proceeds from notes payablerelated party                               |  |                                  | 7,865    |   |      |   | 15,395  |      |  |   | 17,800  |  
|Principal payments on notes payableother                               |  |                                  | (6       | ) |      |   | (1,914  | )    |  |   | (1,840  | )
|Proceeds from sale of common stock, net of expense                      |  |                                  | 11       |   |      |   | 26      |      |  |   | 100     |  
|                                                                        |  |                                  |          |   |      |   |         |      |  |   |         |  
|Net cash provided by financing activities                               |  |                                  | 7,870    |   |      |   | 13,507  |      |  |   | 16,060  |  
|                                                                        |  |                                  |          |   |      |   |         |      |  |   |         |  
|Net increase (decrease) in cash and cash equivalents                    |  |                                  | (74      | ) |      |   | (310    | )    |  |   | 497     |  
|Cash and cash equivalents at beginning of period                        |  |                                  | 499      |   |      |   | 809     |      |  |   | 312     |  
|                                                                        |  |                                  |          |   |      |   |         |      |  |   |         |  
|Cash and cash equivalents at end of period                              |  | $                                | 425      |   |      | $ | 499     |      |  | $ | 809     |  
|                                                                        |  |                                  |          |   |      |   |         |      |  |   |         |  
|Other supplemental disclosures:                                         |  |                                  |          |   |      |   |         |      |  |   |         |  
|Inventory used as demonstration units transferred to fixed assets       |  | $                                |         |   |      | $ | 604     |      |  | $ | 302     |  
|                                                                        |  |                                  |         
|Non-Cash Transactions:                                                  |  |                                  |          |   |      |   |         |      |  |   |         |  
|See Note 18Non-Cash Transactions                                       |  |                                  |          |   |      |   |         |      |  |   |         |  

The accompanying notes are an integral part of these consolidated financial statements.



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DIGITAL LIGHTWAVE, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

General

Digital Lightwave, Inc. provides the global fiber-optic
communications industry with products and technology used to develop, install, maintain, monitor and manage fiber-optic communication networks. Telecommunications service providers, owners of private networks (utilities, government and large
enterprises) and equipment manufacturers deploy the Companys products to provide quality assurance and ensure optimum performance of advanced optical communications networks and network equipment. The Companys products are sold worldwide
to telecommunications service providers, owners of private networks (utilities, government and large enterprises), telecommunications equipment manufacturers, equipment leasing companies and international distributors. The Company's wholly-owned
subsidiaries are Digital Lightwave (UK) Limited (DLL), Digital Lightwave Asia Pacific Pty, Ltd. (DLAP), and Digital Lightwave Latino Americana Ltda. (DLLA). DLL, DLAP, and DLLA provided international sales
support, but are currently inactive. All significant intercompany transactions and balances are eliminated in consolidation.

Operational Matters

As of December 31, 2006, the Companys unrestricted cash and cash equivalents were $425,000, a decrease of $74,000 from December 31,
2005. As of December 31, 2006, the Companys working capital deficit was approximately $62.9 million as compared to a working capital deficit of $48.8 million at December 31, 2005. During 2006, the Company incurred a net loss of $14.5
million and cash flows used by operations were $7.9 million. In 2005, the Company incurred a net loss of $21.1 million and cash flows used in operations were $13.6 million. The Company had an accumulated deficit of $150.9 million at
December 31, 2006.

Beginning in the third quarter of 2001 and continuing through December 31, 2006, the Company experienced significant net
losses. The Company expects to continue to incur operating losses in 2007. Management has taken actions to reduce operating expenses and capital expenditures. These actions include restructuring operations to more closely align operating costs with
revenues. As further discussed below, the Companys ability to meet cash and future liquidity requirements is dependent on its ability to raise additional capital, successfully negotiate extended payment terms with certain creditors, attain
certain business objectives, maintain tight controls over spending and release new products and product upgrades on a timely basis.

The Company continues
to have insufficient short-term resources for the payment of current liabilities. During the twelve months ended December 31, 2006, the Company addressed this shortfall by obtaining financing from Optel Capital, LLC (Optel), an
entity controlled by the Companys largest stockholder and current chairman of the board of directors, Dr. Bryan J. Zwan. The Companys ability to meet cash requirements and maintain sufficient liquidity over the next 12 months
is dependent on the Companys ability to obtain additional financing from funding sources which may include, but may not be limited to, Optel. If the Company is not able to obtain financing, it will not have sufficient cash to fund its working
capital and capital expenditure requirements for the near term and will not have the resources required for the payment of our current liabilities when they become due. Optel currently continues to be the principal source of financing. The Company
has not identified any funding source other than Optel that would be prepared to provide current or future financing to the Company.

As of
September 16, 2004, the Company had borrowed $27.0 million from Optel pursuant to a secured convertible promissory note (the Secured Convertible Promissory Note) that bore interest at 10% per annum and was secured by a first
priority security interest in substantially all of our assets. The conversion feature of the Secured Convertible Promissory Note was approved by the Companys disinterested stockholders at a special meeting of stockholders on February 10,
2005. On March 11, 2005, Optel converted $1.0 million of the indebtedness outstanding under the Secured Convertible Promissory Note into 981,258 shares of common stock. On January 4, 2007, Optel converted the remaining indebtedness, or
$34.8 million, outstanding under the Secured Convertible Promissory Note into 220,222,515 shares of common stock. As a result, the Companys obligations of repayment of debt under the Secured Convertible Promissory Note were satisfied as of
January 4, 2007. As a result of the conversion, the amount outstanding under the Secured Convertible Promissory Note, Optel and other entities controlled by Dr. Zwan control, in the aggregate, approximately 91.1% of the issued outstanding
shares of the Companys common stock.

As of March 19, 2007, the Company owed Optel approximately $27.6 million in principal plus approximately
$4.4 million in accrued interest thereon, which debt is secured by a first priority security interest in substantially all of the Companys assets and such debt accrues interest at a rate of 10% per annum (Short Term Notes).
The $27.6 million in principal plus accrued interest is now



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currently due and payable on demand at any time. The indebtedness evidenced by the Short Term Notes is in addition to the indebtedness formerly evidenced by
the Secured Convertible Promissory Note and therefore it was not affected by Optels conversion of the indebtedness evidenced by the Secured Convertible Promissory Note into common stock in March 2005 and January 2007.

The financial statements have been prepared assuming the Company will continue as a going concern. While the Company has been exploring alternative financing to raise
additional funding, it has not identified a funding source other than Optel that would be willing to provide current or future financing. In the future, if the Company issues additional equity securities to raise funds, the ownership percentage of
the existing stockholders would be diluted, and the new investors may demand rights, preferences or privileges senior to those of existing holders of common stock. Additional debt incurred by the Company would be senior to equity with respect to the
ability of the debt holders to make claims on the assets. In addition, the terms of any debt issued could impose restrictions on the Companys operations. If adequate funds are not available to satisfy either short- or long-term capital
requirements, the Company may be required to curtail operations significantly or to seek funds through arrangements with strategic partners or other parties that may require the Company to relinquish material rights to certain of its products,
technologies or potential markets, or may be forced to seek protection under bankruptcy laws. The Company cannot assure that it will be able to obtain adequate financing which raises substantial doubt about the Companys ability to continue as
a going concern.

Cash Equivalents

The Company
considers all highly liquid investments with an initial maturity of three months or less to be cash equivalents.

Inventories

Inventories include the cost of material, direct labor and overhead and are stated at the lower of cost (first-in, first-out) or market. The Company records a provision
for excess and obsolete inventory when conditions warrant.

Property and Equipment

The Company's property and equipment are stated at cost, less accumulated depreciation and amortization. Depreciation and amortization are provided using the straight-line method over estimated useful lives of 3 to 7
years or over the lesser of the term of the lease or the estimated useful life of assets under capital lease or improvements made to lease property. Maintenance and repairs are expensed as incurred while renewals and improvements are capitalized.
The accounts are relieved of the cost and the related accumulated depreciation and amortization upon the sale or retirement of property and equipment and any resulting gain or loss is included in the results of operations.

Capitalized Software

The Company capitalizes certain internal and
external costs incurred to acquire or create internal use software in accordance with AICPA Statement of Position 98-1, Accounting for the Costs of Computer Software Developed or Obtained for Internal Use. Capitalized software is
included in property and equipment under computer equipment and software and is amortized over its useful life when development is complete.

Intangible
Assets

Included in other assets are certain intangible assets including trademarks, patents, and acquired intangible assets. Intangible assets are
amortized over their estimated useful lives ranging from 5 to 10 years. (See Note 5  Other Assets).



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Impairment of Long-Lived Assets

Long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. During the year ended December 31, 2004, the
Company recorded a non-cash impairment charge of $322,000 for the intangible assets supporting the OTS product line. For the year ended December 31, 2005, the Company recorded a non-cash impairment charge for the remaining balance of its
long-lived assets which included $3.2 million and $200,000 related to its property and equipment and other assets, respectively. During the fiscal year ended December 31, 2006, the Companys incurred no additional impairment charge.

Accrued Warranty

The Company provides the customer a
warranty with each product sold. The Companys policy for product warranties is to review the warranty reserve on a quarterly basis for specifically identified or new matters and review the reserve for estimated future costs associated with any
open warranty years. The reserve is an estimate based on historical trends, the number of products under warranty, the costs of replacement parts and the expected reliability of the Companys products. A change in these factors could result in
a change in the reserve balance. Warranty costs are charged against the accrual when incurred.

The reconciliation of the warranty reserve is as follows:



|                   |  |                                 |      |   |      |   |      |      |  |   |      |  
|------------------ |  | ------------------------------- | ---- | - | ---- | - | ---- | ---- |  | - | ---- | -
|                   |  | For the year ended December 31, |     
|                   |  | 2006                            |      |   | 2005 |   |      | 2004 | 
|                   |  | (In thousands)                  |     
|Beginning balance  |  | $                               | 813  |   |      | $ | 546  |      |  | $ | 678  |  
|Warranty provision |  |                                 | (201 | ) |      |   | 840  |      |  |   | 491  |  
|Warranty costs     |  |                                 | (125 | ) |      |   | (573 | )    |  |   | (623 | )
|                   |  |                                 |      |   |      |   |      |      |  |   |      |  
|Ending balance     |  | $                               | 487  |   |      | $ | 813  |      |  | $ | 546  |  
|                   |  |                                 |      |   |      |   |      |      |  |   |      |  

Revenue Recognition

The Company derives its revenue from product sales. The Company recognizes revenue from the sale of products when persuasive evidence of an arrangement exists, the product has been delivered, the price is fixed and determinable and
collection of the resulting receivable is reasonably assured.

For all sales, the Company uses a binding purchase order as evidence that a sales
arrangement exists. Sales through international distributors are evidenced by a master agreement governing the relationship with the distributor. The Company either obtains an end-user purchase order documenting the order placed with the distributor
or proof of delivery to the end user as evidence that a sales arrangement exists. For demonstration units sold to distributors, the distributors binding purchase order is evidence of a sales arrangement.

For domestic sales, delivery generally occurs when product is delivered to a common carrier. Demonstration units sold to international distributors are considered
delivered when the units are delivered to a common carrier. An allowance is provided for sales returns based on historical experience.

For sales made
under an OEM arrangement, delivery generally occurs when the product is delivered to a common carrier. OEM sales are defined as sales of the Company products to a third party that will market the products under their brand.

For trade-in sales, including both Company and competitor products, that have a cash component of greater than 25% of the fair value of the sale, the Company recognizes
revenue based upon the fair value of what is sold or received, whichever is more readily



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##### Table of Contents

determinable, if the Company has demonstrated the ability to sell its trade-in inventory for that particular product class. Otherwise, the Company accounts
for the trade-in sale as a non-monetary transaction and follows the guidance of SFAS 153 Exchanges of Non- monetary Assets and Accounting Principles Board Opinion No. 29, Accounting for Non-monetary Transactions and
related interpretations. Revenue and cost of sales are recorded based upon the cash portion of the transaction. The remaining costs associated with the new units are assigned to the units received on trade. When the trade-in units are resold,
revenue is recorded based upon the sales price and cost of goods sold is charged with the value assigned to trade-in units from the original transaction. For the years ended December 31, 2006, 2005 and 2004, the Company recorded approximately
$296,000, $543,000 and $1.1 million revenue from transactions that included a trade-in component.

At the time of the transaction, the Company assesses
whether the price associated with its revenue transactions is fixed and determinable and whether or not collection is reasonably assured. The Company assesses whether the price is fixed and determinable based on the payment terms associated with the
transaction. Standard payment terms for domestic customers are 30 days from the invoice date. Distributor contracts provide standard payment terms of 60 days from the invoice date. Generally, the Company does not offer extended payment terms.

The Company assesses collection based on a number of factors, including past transaction history with the customer and the credit-worthiness of the
customer. Collateral is not requested from customers. If it is determined that collection of an account receivable is not reasonably assured at the time of the sale, revenue is recognized at the time collection becomes reasonably assured.

Most sales arrangements do not include acceptance clauses. However, if a sales arrangement includes an acceptance provision, acceptance occurs upon the
earlier of receipt of a written customer acceptance or expiration of the acceptance period.

Reserve For Uncollectible Accounts

The Company estimates the collectibility of its accounts receivable. The Company considers many factors when making its estimates, including analyzing accounts receivable
and historical bad debts, customer concentrations, customer credit-worthiness, current economic trends and changes in its customer payment terms when evaluating the adequacy of the reserve for uncollectible accounts. When a specific account is
deemed uncollectible, the account is written off against the reserve for uncollectible accounts.

Research and Development

Software and product development costs are included in engineering and development and are expensed as incurred. Capitalization of certain software development costs
occurs during the period following the time that technological feasibility is established until general release of the product to customers. The capitalized cost is then amortized over the estimated product life. To date, the period between
achieving technological feasibility and the general release to customers has been short and software development costs qualifying for capitalization have been insignificant.

Income Taxes

The Company recognizes deferred tax liabilities and assets for the expected future tax consequences of
events that have been included in the consolidated financial statements or tax returns. Deferred tax liabilities and assets are determined based on the difference between the consolidated financial statement and the tax basis of assets and
liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. The Company provides for a valuation allowance for the deferred tax assets when it concludes that it is more likely than not that the
deferred tax assets will not be realized.

Shipping and Handling Costs

Shipping and handling costs associated with inbound freight are included in cost of goods sold. Shipping and handling costs associated with outbound freight are generally billed to the customer and are recorded as
revenue.



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Computation of Net Income Per Share

Basic net income per share is based on the weighted average number of common shares outstanding during the periods presented. For all the years presented, diluted loss per share does not include the effect of
incremental shares from common stock equivalents using the treasury stock method, as the inclusion of such equivalents would be anti-dilutive. The total incremental shares from common stock equivalents were 220,303,410, 140,179,472 and 802,008 for
the twelve months ended December 31, 2006, 2005 and 2004, respectively. The total incremental shares from common stock equivalents for the twelve months ended December 31, 2006 included 223,481 from outstanding stock options and
220,079,929 shares that were issuable pursuant to the conversion feature of the Secured Convertible Promissory Note held by Optel Capital, LLC. Total outstanding stock options of 3,180,539, 7,005,785, and 7,654,520 shares for the twelve months ended
December 31, 2006, 2005 and 2004, respectively, were excluded from the computation, as the inclusion of such would be anti-dilutive. The table below presents the basic weighted average common shares outstanding and the incremental number of
shares arising from common stock equivalents under the treasury stock method:



|                                                |  |                                 |  |            |  |           
|----------------------------------------------- |  | ------------------------------- |  | ---------- |  | ----------
|                                                |  | For The Year Ended December 31,
|                                                |  | 2006                            |  | 2005       |  | 2004      
|Basic:                                          |  |                                 |  |            |  |           
|Weighted average common shares outstanding      |  | 35,228,948                      |  | 35,094,986 |  | 33,065,582
|                                                |  |                                 |  |            |  |           
|Total basic                                     |  | 35,228,948                      |  | 35,094,986 |  | 33,065,582
|Diluted:                                        |  |                                 |  |            |  |           
|Incremental shares for common stock equivalents |  |                                |  |           |  |          
|                                                |  |                                 |  |            |  |           
|Total dilutive                                  |  | 35,228,948                      |  | 35,094,986 |  | 33,065,582
|                                                |  |                                 |  |            |  |           

Concentrations of Credit Risk

Financial instruments that potentially subject the Company to concentrations of credit risk consist principally of cash and cash equivalents and accounts receivable. As of December 31, 2006, and 2005,
substantially all of the Company's cash balances were deposited with high quality financial institutions. During the normal course of business, the Company extends credit to customers conducting business primarily in the telecommunications industry
both within the United States and internationally.

For the year ended December 31, 2006, two customers combined to account for approximately 27% of
net sales (40% of accounts receivable at December 31, 2006). For the year ended December 31, 2005, three customers combined to account for approximately 32% of net sales. For the year ended December 31, 2004, one customer accounted for
approximately 21% of net sales. No other customer accounted for sales of 10% or more during those years.

The Company sells its products in domestic and
international markets. Domestic sales represented approximately 72% 64%, and 73% and of net sales for the years ending 2006, 2005, and 2004, respectively. The Companys international sales represented approximately 28%, 36% and 27% of total net
sales for the years ended 2006, 2005, and 2004, respectively.

Fair Value of Financial Instruments

The carrying value of certain financial instruments, including cash and cash equivalents, accounts receivable, accounts payable, accrued liabilities, and other long-term
liabilities approximate fair market value based on their short-term nature.

Use of Estimates

The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to
make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements. Estimates for sales returns and other allowances, the reserve for
uncollectible accounts, the reserve for excess and obsolete inventory, the impairment of long-lived assets, the warranty accrual and the assessment of the probability of litigation are significant estimates to the Company. Actual results could
differ from these estimates.



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##### Table of Contents

Stock Based Compensation

On January 1, 2006, the Company adopted the provisions of Statement of Financial Accounting Standards No.123 (revised 2004) (SFAS 123R), Share-Based Payment, which revises Statement of Financial Accounting Standards
No. 123, Accounting for Stock-Based Compensation,(SFAS 123) and supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees(Opinion 25). SFAS 123R requires the Company to recognize
expense related to the fair value of stock-based compensation awards, including employee stock options.

Prior to the adoption of SFAS 123R, the Company
accounted for stock-based compensation awards using the intrinsic value method of Opinion 25. Accordingly, the Company did not recognize compensation expense in the statement of operations for options granted that had an exercise price equal to the
market value of the underlying common stock on the date of grant. As required by SFAS 123, the Company also provided certain pro forma disclosures for stock-based awards as if the fair-value-based approach of SFAS 123 had been applied.

The Company elected to use the modified prospective transition method as permitted by SFAS 123R and therefore did not restate financial results for prior periods.
Under this transition method, the Company applied the provisions of SFAS 123R to new awards and to awards modified, repurchased, or cancelled after January 1, 2006. Additionally, the Company recognized compensation cost for the portion of
awards for which the requisite service has not been rendered (unvested awards) that are outstanding as of January 1, 2006, as the remaining service is rendered. The compensation cost the Company records for the unvested awards is based on their
grant-date fair value as calculated for the pro forma disclosures required by SFAS 123. The Company has also utilized a forfeiture rate which reflects the historic rates of forfeitures of unvested shares in its determination of compensation expense.

The Company had $389,000 of compensation cost for stock-based employee compensation for the year ended December 31, 2006. No tax benefits were
recognized for these costs due to recurring losses. As a result of the adoption of SFAS 123R, the Companys financial results of operations were lower than under the previous accounting method for share-based compensation by the amount of the
2006 stock compensation.

At December 31, 2006, the Company has two stock-based employee compensation plans, which are described more fully in Note 12
 Common Stock and Stock Options. Until January 1, 2006 Company accounted for the plans under the recognition and measurement principles of APB Opinion No. 25, Accounting for Stock Issued to Employees, and related
Interpretations. For the years ended December 31, 2005 and 2004 approximately $23,000 and $73,000 of stock-based employee compensation cost is reflected in operating expenses, respectively. The following table illustrates the effect on net
income and earnings per share if the company had applied the fair value recognition provisions of FASB Statement No. 123, Accounting for Stock-Based Compensation, to stock-based employee compensation.



|                                                                                                                                      |  |                        |         |   |      |   |         |  
|------------------------------------------------------------------------------------------------------------------------------------- |  | ---------------------- | ------- | - | ---- | - | ------- | -
|                                                                                                                                      |  | Year EndedDecember 31, |        
|                                                                                                                                      |  | 2005                   |         |   | 2004 |  
|                                                                                                                                      |  | (in thousands)         |        
|Net loss, as reported                                                                                                                 |  | $                      | (21,093 | ) |      | $ | (12,878 | )
|Add: Stock-based compensation included in reported net loss, net of related tax effects                                               |  |                        | 23      |   |      |   | 73      |  
|Deduct: Stock-based employee compensation expense determined under fair value based method for all awards, net of related tax
effects |  |                        | (2,973  | ) |      |   | (3,485  | )
|                                                                                                                                      |  |                        |         |   |      |   |         |  
|Pro forma net loss                                                                                                                    |  | $                      | (24,043 | ) |      | $ | (16,290 | )
|                                                                                                                                      |  |                        |         |   |      |   |         |  
|                                                                                                                                      |  |                       
|Loss per share                                                                                                                        |  |                        |         |   |      |   |         |  
|                                                                                                                                      |  |                       
|Basic and dilutedas reported                                                                                                         |  | $                      | (0.60   | ) |      | $ | (0.39   | )
|                                                                                                                                      |  |                        |         |   |      |   |         |  
|Basic and dilutedpro forma                                                                                                           |  | $                      | (0.69   | ) |      | $ | (0.49   | )
|                                                                                                                                      |  |                        |         |   |      |   |         |  



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##### Table of Contents

Segment Reporting

As
of December 31, 2006, the Company was not organized by multiple operating segments for the purpose of making operating decisions or assessing performance. Accordingly, the Company operated in one segment.

New Accounting Pronouncements

In June 2006, the Emerging Issues Task
Force (EITF) ratified Issue No. 06-3, How Taxes Collected From Customers and Remitted to Governmental Authorities Should be Presented in the Income Statement (i.e., Gross versus Net Presentation), which applies to financial
reports for interim and annual reporting periods beginning after December 15, 2006. Under the EITF guidance, the Company may elect to present sales in the Statements of Operations on either a gross (that is, include tax collections within
revenue) or a net (that is, excluded from revenue) basis. The Company does not plan to change its reporting as a result of this EITF guidance. Our practice has been to report such items on a net basis.

In July 2006, the FASB issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes ("FIN 48"), an interpretation of FASB No. 109,
Accounting for Income Taxes ("FASB 109"). FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken in a tax return. The Company must
determine whether it is more-likely-than-not that a tax position will be sustained upon examination, including resolution of any related appeals or litigation processes, based on the technical merits of the position. Once it is
determined that a position meets the more-likely-than-not recognition threshold, the position is measured to determine the amount of benefit to recognize in the financial statements. FIN 48 applies to all tax positions related to income taxes
subject to FASB 109. The Company anticipates adopting the provisions of FIN 48 beginning in the first quarter of fiscal 2007. The Company is currently assessing the impact of this Interpretation on its consolidated financial
statements.

In September 2006, the FASB issued SFAS No. 157 (SFAS 157), Fair Value Measurements. SFAS 157 defines fair value,
establishes a framework for measuring fair value and requires enhanced disclosures about fair value measurements. SFAS 157 creates a fair value hierarchy, which prioritizes the inputs that should be used in determining fair value. Under this
pronouncement, companies must provide disclosures containing relevant information in the financial statements, allowing users to assess inputs used to measure fair value, as well as the effect of those measurements on earnings for the periods
presented, including a reconciliation of the beginning and ending balances separately for each major category of assets and liabilities. SFAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007,
and interim periods within those fiscal years. The Company has not determined the impact of adopting SFAS 157 on their financial position.

In September
2006, the SEC released Staff Accounting Bulletin 108, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements (SAB 108). SAB 108 provides guidance on how the effects of the
carryover or reversal of prior year misstatements should be considered in quantifying a current year misstatement. In some situations, companies will be required to record errors that occurred in prior years even though those errors were immaterial
for each year in which they arose. Companies may choose to either restate all previously presented financial statements or record the cumulative effect of such errors as an adjustment to retained earnings at the beginning of the period in which SAB
108 is applied. SAB 108 is effective for fiscal years ending after November 15, 2006, and was adopted by the Company on December 31, 2006. The adoption of SAB 108 had no effect on the Companys financial statements.

2. INVENTORIES

Net inventories at December 31, 2006 and 2005
are summarized as follows:



|               |  |                |       |      |   |      
|-------------- |  | -------------- | ----- | ---- | - | -----
|               |  | 2006           |       | 2005
|               |  | (In thousands)
|Raw materials  |  | $              | 2,397 |      | $ | 3,745
|Finished goods |  |                | 332   |      |   | 1,020
|               |  |                |       |      |   |      
|               |  | $              | 2,729 |      | $ | 4,765
|               |  |                |       |      |   |      



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##### Table of Contents

In December 2001, the Company signed a manufacturing service agreement with Jabil Circuit, Inc. (Jabil), a
leading provider of technology manufacturing services with a customer base of industry-leading companies. Under the terms of the agreement, Jabil purchased the Companys existing inventory to fulfill orders until the Companys inventory
was depleted to safety stock levels. Under the terms of the agreement, Jabil served as the Companys primary contract manufacturer for the Companys circuit board and product assembly and provided engineering design services.

On February 27, 2003 Jabil terminated the manufacturing service agreement and on March 19, 2003 commenced an arbitration proceeding seeking damages in
excess of $6.8 million. (See Note 15  Legal Proceedings) On December 5, 2003, the Company entered into a manufacturing services letter agreement with Jabil specifying the terms under which Jabil would provide the Company with certain
manufacturing services. The manufacturing services letter agreement expired on December 30, 2003, and the term of such letter agreement was extended through December 31, 2004. Jabil continued to provide manufacturing services to the
Company while Jabil and we discussed the renewal of a manufacturing services agreement. On August 31, 2005, the Company and Jabil amicably ended their manufacturing service relationship and all monies and inventories were exchanged.

Effective as of January 31, 2005, we entered into a letter agreement with MC Test Service, Inc. (MC) to provide outsourced manufacturing services. On
March 15, 2005, Optel established an irrevocable letter of credit (LC) in the amount of $6.0 million on behalf of the Company and naming MC Test Service, Inc. as beneficiary. On December 16, 2005, Optel renewed the LC for $2.0
million and extended the expiration date to December 30, 2006. On July 18, 2006, August 4, 2006 and October 4, 2006 MC drew down on the letter of credit in the amount of $420,404, $234,965, and $269,931 respectively,
(recorded as notes payable to Optel) thus reducing availability under irrevocable letter of credit to $1.1 million. The letter of credit expired on December 30, 2006 (See Note 8 to the Consolidated Financial Statements  Notes Payable,
Line of Credit and Letter of Credit). As of March 19, 2007, MC continues to extend to the Company regular payment terms to pay for purchased production material.

The total reserve balance for excess and obsolete inventory at December 31, 2006 and 2005 approximated $15.5 million and $15.7 million, respectively. When evaluating the adequacy of the reserve for excess and
obsolete inventory the Company analyzes current and expected sales trends, the amount of current parts on hand, the current market value of parts on hand and the viability and technical obsolescence of products. The Company believes the reserve for
excess and obsolete inventory as of December 31, 2006 and 2005, is adequate

As of December 31, 2006 and 2005 inventories included approximately
$951,000 trade-in products. At December 31, 2006, the Company allocated approximately $951,000 of the total excess and obsolete inventory reserve to trade-in products.

3. PREPAID EXPENSES AND OTHER CURRENT ASSETS

Prepaid expenses and other current assets at December 31, 2006 and
2005 are summarized as follows:



|                    |  |                |     |      |   |    
|------------------- |  | -------------- | --- | ---- | - | ---
|                    |  | 2006           |     | 2005
|                    |  | (In thousands)
|Deposits            |  | $              | 165 |      | $ | 165
|Prepaid maintenance |  |                | 19  |      |   | 56 
|Prepaid insurance   |  |                | 34  |      |   | 54 
|Interest receivable |  |                | 5   |      |   | 5  
|Prepaid other       |  |                | 51  |      |   | 61 
|                    |  |                |     |      |   |    
|                    |  | $              | 274 |      | $ | 341
|                    |  |                |     |      |   |    

The deposits represent funds placed with vendors to ensure the availability of future inventory purchases. Prepaid
expenses and other current assets represent various marketing and administration needs of the Company that require cash payments up front.



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##### Table of Contents

4. PROPERTY AND EQUIPMENT

Property and equipment at December 31, 2006 and 2005 are summarized as follows:



|                                                                        |  |                |         |   |      |   |         |  
|----------------------------------------------------------------------- |  | -------------- | ------- | - | ---- | - | ------- | -
|                                                                        |  | 2006           |         |   | 2005 |  
|                                                                        |  | (in thousands) |        
|Test equipment                                                          |  | $              | 8,206   |   |      | $ | 8,246   |  
|Demonstration and loaner units                                          |  |                | 5,242   |   |      |   | 5,242   |  
|Computer equipment and software                                         |  |                | 4,778   |   |      |   | 4,778   |  
|Office furniture, fixtures and equipment                                |  |                | 2,369   |   |      |   | 2,369   |  
|Leasehold improvements                                                  |  |                |        |   |      |   | 2,383   |  
|Tooling                                                                 |  |                | 1,028   |   |      |   | 1,028   |  
|Tradeshow fixtures and equipment                                        |  |                | 359     |   |      |   | 359     |  
|                                                                        |  |                |         |   |      |   |         |  
|                                                                        |  |                | 21,982  |   |      |   | 24,405  |  
|Less: accumulated depreciation and impairment of property and equipment |  |                | (21,982 | ) |      |   | (24,405 | )
|                                                                        |  |                |         |   |      |   |         |  
|                                                                        |  | $              |        |   |      | $ |        |  
|                                                                        |  |                |         |   |      |   |         |  

Depreciation and amortization expense was approximately $737,000 and $1.9 million for the years ended
December 31, 2005 and 2004, respectively. No depreciation expense was recorded in 2006 as a result of the 2005 impairment of all assets.

The Company
recorded charges for the impairment of property and equipment of $3.2 million during 2005. (See Note 1  Summary of Significant Accounting Policies) During 2007 the Company will assess the utility of its property and equipment and will
determine the potential disposition of any obsolete items.

5. OTHER ASSETS

Other assets at December 31, 2006 and 2005 are summarized as follows:



|                                                             |  |                |        |   |      |   |        |  
|------------------------------------------------------------ |  | -------------- | ------ | - | ---- | - | ------ | -
|                                                             |  | 2006           |        |   | 2005 |  
|                                                             |  | (In thousands) |       
|Acquired intangible assets                                   |  | $              | 2,411  |   |      | $ | 2,411  |  
|Trademarks                                                   |  |                | 75     |   |      |   | 75     |  
|Patents                                                      |  |                | 120    |   |      |   | 120    |  
|Deposits                                                     |  |                | 218    |   |      |   | 37     |  
|Accumulated amortization and impairment of intangible assets |  |                | (2,606 | ) |      |   | (2,606 | )
|                                                             |  |                |        |   |      |   |        |  
|                                                             |  | $              | 218    |   |      | $ | 37     |  
|                                                             |  |                |        |   |      |   |        |  

Amortization expense for the years ended December 31, 2005 and 2004 totaled approximately $142,000 and
$345,000, respectively. The Company acquired certain intangible assets in connection with its purchase from Tektronix during 2002. The Company recorded charges for the impairment of the remainder of the acquired intangible assets totaling $200,000
and $322,000 in 2005 and 2004, respectively. (See Note 1  Summary of Significant Accounting Policies)



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##### Table of Contents

6. ACCOUNTS PAYABLE AND ACCRUED LIABILITIES

Accounts payable and accrued liabilities at December 31, 2006 and 2005 are summarized as follows:



|                                    |  |                |        |      |   |       
|----------------------------------- |  | -------------- | ------ | ---- | - | ------
|                                    |  | 2006           |        | 2005
|                                    |  | (in thousands)
|Accounts payable                    |  | $              | 1,104  |      | $ | 2,344 
|Interest payable                    |  |                | 11,743 |      |   | 5,936 
|Current portion of accrued warranty |  |                | 283    |      |   | 441   
|Employee related accruals           |  |                | 155    |      |   | 385   
|Accrued returns and allowances      |  |                | 54     |      |   | 284   
|Sales tax accruals                  |  |                | 204    |      |   | 236   
|Accrued expenses and other          |  |                | 265    |      |   | 468   
|Deferred revenue                    |  |                | 56     |      |   | 37    
|Sales commissions                   |  |                | 111    |      |   | 50    
|                                    |  |                |        |      |   |       
|                                    |  | $              | 13,975 |      | $ | 10,181
|                                    |  |                |        |      |   |       

7. INCOME TAXES

For the years ended December 31, 2006, 2005 and 2004, the Company has not recorded federal or state income tax provisions on a current or deferred basis due to the operating losses experienced during those periods. The tax effected
amounts of temporary differences at December 31, 2006 and 2005 are summarized as follows:



|                                      |  |                |          |   |      |   |          |  
|------------------------------------- |  | -------------- | -------- | - | ---- | - | -------- | -
|                                      |  | 2006           |          |   | 2005 |  
|                                      |  | (in thousands) |         
|Current:                              |  |                |          |   |      |   |          |  
|Deferred tax assets:                  |  |                |          |   |      |   |          |  
|Accrued liabilities                   |  | $              | 4,949    |   |      | $ | 2,887    |  
|Other assets                          |  |                | 6,004    |   |      |   | 6,119    |  
|Valuation allowance                   |  |                | (10,953  | ) |      |   | (9,006   | )
|                                      |  |                |          |   |      |   |          |  
|Total current deferred tax assets     |  |                |         |   |      |   |         |  
|                                      |  |                |          |   |      |   |          |  
|Non-current:                          |  |                |          |   |      |   |          |  
|Deferred tax assets:                  |  |                |          |   |      |   |          |  
|Net operating loss carry forward      |  |                | 138,576  |   |      |   | 138,396  |  
|Fixed assets                          |  |                | 830      |   |      |   | 1,843    |  
|Research and experimentation credit   |  |                | 4,140    |   |      |   | 4,140    |  
|Valuation allowance                   |  |                | (143,546 | ) |      |   | (144,379 | )
|                                      |  |                |          |   |      |   |          |  
|Total non-current deferred tax assets |  | $              |         |   |      | $ |         |  
|                                      |  |                |          |   |      |   |          |  

A full valuation allowance has been recorded at December 31, 2006 and 2005 with respect to the deferred tax
assets since the Company believes that it is more likely than not that future tax benefits will not be realized as a result of current and future income. Factors considered in determining that a full valuation allowance was necessary include the
Companys history of large operating losses and uncertainty as to whether the Company would be able to sustain long-term profitability.



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##### Table of Contents

The Company had a valuation allowance of approximately $154.5 million and $153.4 million as of December 31, 2006,
and 2005, respectively. The increase in the valuation allowance represents the non-recognition of the current year net deferred tax asset because of the uncertainty as to their future use or realization. As of December 31, 2006, the Company had
net operating loss carry forwards of approximately $368 million for tax purposes. The Company has recorded taxable deductions for the exercise of stock options and for certain securities litigation costs which benefit of approximately $90 million
would have been allocated to additional paid-in capital. The tax benefit of this additional net operating loss has not been realized due to the 100% valuation allowance against the deferred tax assets. This deduction will be reported directly as an
increase in additional paid-in capital and will not be recorded in the Companys Consolidated Statement of Operations when the tax benefit is realized. Loss carry forwards will expire between the years 2007 and 2024.As of
December 31, 2006, the Company also had general business credit carry forwards of approximately $4.1 million that expire between the years 2008 and 2021.

Following is a reconciliation of the applicable federal income tax as computed at the federal statutory tax rate to the actual income taxes reflected in the consolidated statement of operations.



|                                              |  |                                 |       |   |      |   |        |      |  |   |        |  
|--------------------------------------------- |  | ------------------------------- | ----- | - | ---- | - | ------ | ---- |  | - | ------ | -
|                                              |  | For The Year Ended December 31, |      
|                                              |  | 2006                            |       |   | 2005 |   |        | 2004 | 
|                                              |  | ( in thousands)                 |      
|Tax provision at U.S. federal income tax rate |  | ($                              | 4,926 | ) |      | $ | (7,171 | )    |  | $ | (4,379 | )
|State income tax provision net of federal     |  |                                 | (495  | ) |      |   | (766   | )    |  |   | (469   | )
|Adjustment to net operating loss carryforward |  |                                 | 1,563 |   |      |   |       |      |  |   |       |  
|Other, net                                    |  |                                 | 285   |   |      |   | 22     |      |  |   | 28     |  
|Valuation allowance increase                  |  |                                 | 3,573 |   |      |   | 7,915  |      |  |   | 4,820  |  
|                                              |  |                                 |       |   |      |   |        |      |  |   |        |  
|Provision for income taxes                    |  | $                               |      |   |      | $ |       |      |  | $ |       |  
|                                              |  |                                 |       |   |      |   |        |      |  |   |        |  

8. NOTES PAYABLE, LINE OF CREDIT AND LETTER OF CREDIT

During the past two years, the Company has funded operations and other working capital requirements with short-term notes payable financing. The principal lender is Optel
Capital, LLC, which is referred to as Optel, an entity controlled by the Companys largest stockholder and current chairman of the board of directors, Dr. Bryan J. Zwan. The following is a summary of these liabilities for the years
ended December 31, 2006 and 2005.



|                    |  |                                 |        |      |   |       
|------------------- |  | ------------------------------- | ------ | ---- | - | ------
|                    |  | For The Year Ended December 31,
|                    |  | 2006                            |        | 2005
|                    |  | ( in thousands)                
|Optel               |  | $                               | 54,645 |      | $ | 46,830
|Other               |  |                                 | 50     |      | $ | 55    
|                    |  |                                 |        |      |   |       
|Notes Payable Total |  | $                               | 54,695 |      | $ | 46,855
|                    |  |                                 |        |      |   |       

Optel

As of
September 16, 2004, the Company had borrowed $27.0 million from Optel pursuant to a secured convertible promissory note (the Secured Convertible Promissory Note) that bore interest at 10% per annum and was secured by a first
priority security interest in substantially all of the Companys assets. The conversion feature of the Secured Convertible Promissory Note was approved by the disinterested stockholders at a special meeting of our stockholders on
February 10, 2005. On March 11, 2005, Optel converted $1.0 million of the indebtedness outstanding under the Secured Convertible Promissory Note into 981,258 shares of common stock. On January 4, 2007, Optel converted the remaining
indebtedness, or $34.8 million, outstanding under the Secured Convertible Promissory Note into 220,222,515 shares of common stock. The conversion price was based on the average of the daily volume weighted-average trading price of the Companys
common stock during the period of five consecutive trading days prior to the conversion date. As a result of the conversion, the obligations of debt repayment under the Secured Convertible Promissory Note were satisfied as of January 4, 2007.
As a result of the conversion of the amount outstanding under the Secured Convertible Promissory Note, Optel and other entities controlled by Dr. Zwan control, in the aggregate, approximately 91.1% of the issued outstanding shares of the
Companys common stock.



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##### Table of Contents

As of March 19, 2007, the Company owed Optel approximately $27.6 million in principal plus approximately $4.4
million in accrued interest thereon, which debt is secured by a first priority security interest in substantially all of our assets and such debt accrues interest at a rate of 10% per annum (Short Term Notes). The $27.6 million in
principal plus accrued interest is now currently due and payable on demand at any time. The indebtedness evidenced by the Short Term Notes is in addition to the indebtedness formerly evidenced by the Secured Convertible Promissory Note and therefore
it was not affected by Optels conversion of the indebtedness evidenced by the Secured Convertible Promissory Note into common stock in March 2005 and January 2007.

All of the foregoing transactions with Optel were approved by the Companys board of directors, upon the recommendation of a special committee of the board. The special committee is composed solely of independent
directors.

On May 15, 2006, Optel established an irrevocable letter of credit in the amount of approximately $278,339 on the Companys behalf
and naming Highwoods/Florida Holdings, L.P., the Companys landlord, as beneficiary. The letter of credit expires July 31, 2011.



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##### Table of Contents

9. LEASES

The
Company is obligated under various non-cancelable leases primarily for office space. Future minimum lease commitments under operating leases were as follows as of December 31, 2006:



|           |  |                             |      
|---------- |  | --------------------------- | -----
|           |  | Operating Lease Commitments
|           |  | ( in thousands)            
|2007       |  | $                           | 276  
|2008       |  |                             | 251  
|2009       |  |                             | 258  
|2010       |  |                             | 266  
|2011       |  |                             | 158  
|Thereafter |  |                             |     
|           |  |                             |      
|           |  | $                           | 1,209
|           |  |                             |      

Total rent expense was approximately $3.2 million, $2.4 million and $2.0 million for the years ended
December 31, 2006, 2005 and 2004, respectively. Rent expense for 2006 includes $2.1 million for the buyout of the lease for the Companys former corporate headquarters. The lease was terminated effective June 2006.

10. COMMITMENTS

At December 31, 2006, the Company had
outstanding non-cancelable purchase order commitments to purchase certain inventory items totaling approximately $840,000. The majority of the quantities under order are deliverable upon demand by the Company.

The Company indemnifies its officers and directors against costs and expenses related to shareholder and other claims which are not covered by the Companys
directors and officers insurance policy. This indemnification is ongoing and does not include a limit on the minimum potential future payments, nor are there any resource provisions or collateral that may offset the cost. As of December 31,
2006, the Company has not recorded a liability for any obligations arising as a result of these indemnifications.

11. RELATED PARTY TRANSACTIONS

Note Receivable

On February 15, 2005, in
conjunction with a severance agreement between the Company and James R. Green, the Companys former Chief Executive Officer, the Company agreed to forgive the entire amount of a note receivable from Mr. Green of approximately $374,000,
including approximately $7,700 of accrued interest. Further, the Company agreed to release all collateral held as security against such note, including a second lien on Mr. Greens residence. The costs associated with the forgiveness of
the note and the severance agreement were reported as general and administrative expenses during the fiscal year ended December 31, 2005.

Services
Rendered

During 2006 Optel provided the Company with approximately $400,000 in services associated with information technology and accounting. These
services are shown as a contribution of capital and are expensed, within general and administration expense.

Related Party Financing

As of December 31, 2006, the outstanding balance owed to Optel Capital, LLC (Optel), an entity controlled by the Companys largest stockholder and
current chairman of the board of directors, Dr. Bryan J. Zwan, was approximately $54.6 million, exclusive of accrued interestof approximately $11.7 million. (See Note 8 to the Consolidated Financial Statements - Notes Payable, Line of Credit
and Letter of Credit)



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##### Table of Contents

12. COMMON STOCK AND STOCK OPTIONS

Stock Option Plans

The Company has two stock option plans. The 1996 Stock Option Plan (the "1996 Option Plan")
became effective on March 5, 1996. A reserve of 5,000,000 shares of the Company's Common Stock was established for issuance under the 1996 Option Plan. The stockholders of the Company approved the 2001 Stock Option Plan (the 2001 Option
Plan) at a special meeting held February 27, 2001. Under the 2001 Option Plan, 3,000,000 shares, plus (i) the number of shares available for grant under the 1996 Option Plan and (ii) the number of shares subject to options
outstanding under the 1996 Option Plan to the extent that such options expire or terminate for any reason prior to exercise in full, were reserved for issuance (with the sum of (i) and (ii) not to exceed 2,735,872 shares). The 2001 Option
Plan superseded the 1996 Option Plan with respect to future grants.

On May 20, 2002, the stockholders of the Company approved an amendment to the
2001 Option Plan, increasing the number of shares of Common Stock authorized for issuance thereunder by an additional 3,000,000 shares.

On
February 10, 2005, the stockholders of the Company approved an amendment to the 2001 Option Plan, increasing the number of shares of Common Stock authorized for issuance thereunder by an additional 5,000,000 shares. The stockholders also
approved amendments to the 2001 Option Plan to increase the aggregate number of shares that can be granted to an individual in a single fiscal year by 500,000 to 750,000, and to modify the circumstances in which vesting of certain options granted
under such plan may be accelerated.

Generally, options issued vest in one-third annual increments or quarterly over a three-year period, with the
exception of certain option agreements that provide for various vesting schedules throughout the same three-year vesting period or options allowing vesting acceleration based on certain performance milestones. Where performance milestones are not
met, the options will generally vest ratably over a five-and-one-half-year period. Option agreements generally expire six years from date of issue if not exercised. Unvested options are generally forfeited upon termination of employment with the
Company. Generally, vested shares must be exercised within sixty days of termination or be forfeited. Total shares exercisable were 4,294,447 and 3,121,959 at a weighted average exercise price of $4.421 and $9.328 as of December 31, 2005, and
2004, respectively.

Transactions related to the 2001 and 1996 Option Plans are summarized as follows:



|                        |  |            |   |  |                               |     
|----------------------- |  | ---------- | - |  | ----------------------------- | ----
|                        |  | Shares     |   |  | Weighted Average Option Price
|Outstanding at 1/1/04   |  | 3,982,485  |   |  | $                             | 9.30
|Granted                 |  | 4,891,000  |   |  | $                             | 1.87
|Exercised               |  | (64,982    | ) |  | $                             | 1.29
|Forfeited               |  | (1,153,983 | ) |  | $                             | 6.62
|                        |  |            |   |  |                               |     
|Outstanding at 12/31/04 |  | 7,654,520  |   |  | $                             | 5.04
|Granted                 |  | 1,167,500  |   |  | $                             | 0.64
|Exercised               |  |           |   |  | $                             |    
|Forfeited               |  | (1,816,235 | ) |  | $                             | 8.79
|                        |  |            |   |  |                               |     
|Outstanding at 12/31/05 |  | 7,005,785  |   |  | $                             | 3.40
|Granted                 |  |           |   |  | $                             |    
|Exercised               |  | (25,000    | ) |  | $                             | 0.26
|Forfeited               |  | (3,800,246 | ) |  | $                             | 4.51
|                        |  |            |   |  |                               |     
|Outstanding at 12/31/06 |  | 3,180,539  |   |  | $                             | 2.44
|                        |  |            |   |  |                               |     



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##### Table of Contents

The following table summarizes information about stock options outstanding at December 31, 2006:



|                        |  |                                     |  |                                         |  |                                         |        |                                     |           |                                         |   |       
|----------------------- |  | ----------------------------------- |  | --------------------------------------- |  | --------------------------------------- | ------ | ----------------------------------- | --------- | --------------------------------------- | - | ------
|Range of Exercise Price |  | NumberOutstandingAtDecember 31,2006 |  | OutstandingWeightedAverageRemainingLife |  | OutstandingWeightedAverageExercisePrice |        | NumberExercisableAtDecember 31,2006 |           | ExercisableWeightedAverageExercisePrice
|$ 0.2200  $ 1.4200     |  | 1,759,226                           |  | 3.05                                    |  | $                                       | 1.121  |                                     | 1,492,970 |                                         | $ | 1.166 
|$ 1.6000  $ 2.4200     |  | 1,305,413                           |  | 3.08                                    |  | $                                       | 2.185  |                                     | 1,214,151 |                                         | $ | 2.184 
|$ 9.2200  $ 9.2200     |  | 2,400                               |  | 0.75                                    |  | $                                       | 9.220  |                                     | 2,400     |                                         | $ | 9.220 
|$ 15.6719  $ 15.6719   |  | 20,000                              |  | 0.25                                    |  | $                                       | 15.672 |                                     | 20,000    |                                         | $ | 15.672
|$ 27.5000  $ 27.7500   |  | 93,500                              |  | 0.16                                    |  | $                                       | 27.750 |                                     | 93,500    |                                         | $ | 27.750
|                        |  |                                     |  |                                         |  |                                         |        |                                     |           |                                         |   |       
|                        |  | 3,180,539                           |  |                                         |  |                                         |        |                                     | 2,823,021 |                                         | $ | 2.463 
|                        |  |                                     |  |                                         |  |                                         |        |                                     |           |                                         |   |       

The total intrinsic value of options exercised for the years ended December 31, 2006, 2005 and 2004 was $500,
$0 and $66,476 respectively. As of December 31, 2006, there was $99,000 of unrecognized compensation cost related to non-vested options that is expected to be recognized through 2008. The aggregate intrinsic value of options fully vested at
December 31, 2006 was $0. The aggregate intrinsic value of options outstanding at December 31, 2006 and expected to vest was $0.

The Company
consistently used the Black-Scholes valuation model for estimating the fair value of options granted in the years ended December 31, 2005 and 2004. The Company used historical data to estimate the option exercise and employee departure behavior
used in the valuation model. Forfeitures are estimated on the date of grant and shares vest on a graded schedule, with shares being earned per day under the accrual method. The expected term of options granted is derived from the output of the
option pricing model and represents the period of time that options granted are expected to be outstanding. The risk-free rates for periods within the contractual term of the options are based on the U.S. Treasury stripped coupon interest in effect
at the end of the quarter. The volatility factor is based upon averaging the week ending prices for Digital Lightwave and other comparable public companies for periods matching the terms of the options granted.

The following are the key assumptions used in the Black-Scholes valuation model: (i) a discount rate of 3.93% and 4.0% for the years ending December 31, 2005
and 2004, respectively; (ii) a volatility factor of 269% for 2005 and 2004; (iii) an average expected option life of 4 years for all years; (iv) no payment of dividends.

Employee Stock Purchase Plan

The Company's 1997 Employee Stock Purchase Plan provides employees with the opportunity to
purchase shares of the Company's Common Stock. An aggregate of 300,000 shares of the Company's Common Stock were reserved for issuance under the Plan. On May 20, 2002 the shareholders of the Company approved an amendment to the Employee Stock
Purchase Plan that increased the number of shares of Common Stock authorized for issuance thereunder by an additional 300,000 shares. At December 31, 2006 a total of 430,107 shares had been purchased by employees participating in the plan at a
weighted-average price per share of $4.29.

13. DEFINED CONTRIBUTION PLAN

The Company offers a defined contribution plan that qualifies under IRC section 401(k). All full-time employees are eligible to participate in the plan after three months of service with the Company. Employees may
contribute up to 15% of their salary to the plan, subject to certain Internal Revenue Service limitations. The Company matches the first 6% of such voluntary contributions at 50% of the amount contributed by the employee. The Company has not made
unmatched contributions. For the years ended December 31, 2006, 2005 and 2004, total company contributions to the plan were approximately $83,000, $130,000 and $96,000, respectively.



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14. RESTRUCTURING

During 2004 and 2003, the board of directors approved business restructuring and cost reduction activities in response to the downturn in the economy and specifically, the telecommunications industry. These activities included multiple
reductions in the work force and the closing of the Companys sales offices in Brazil, Singapore, India and Australia. The Company recorded net restructuring charges of $40,000 in the year ending December 31, 2004. At December 31,
2004, all outstanding liabilities relating to these restructuring efforts have been fully satisfied.

15. LEGAL PROCEEDINGS

As of the date of this report, the Company is not aware of any pending litigation, claims or assessments that would have a material adverse effect on the Company's
business, financial condition and results of operations. During the year ending December 31, 2006, the Company was not aware of any pending litigation, claims or assessments that would have a material adverse effect on the Company's business,
financial condition and results of operations. The following is a summary of settled, dismissed, or otherwise resolved litigation, claims or assessments during the years ending December 31, 2004 and 2005.

CIT Technologies Corporation

As described below, litigation between
CIT Technologies Corporation (CIT) and the Company has been dismissed.

On June 8, 2004, the Company entered into a settlement agreement
(the Mediation Settlement Agreement) with CIT, which resolved and settled certain disputes between the Company and CIT. Under the Mediation Settlement Agreement, and in full satisfaction of all claims by CIT against the Company, CIT
received $5.2 million in cash, 2,500,000 shares of common stock of the Company and certain equipment subject to the original lease agreements between the Company and CIT. Further, CIT dismissed the lawsuit it filed in April 2003. As a result of the
Mediation Settlement Agreement, the Company realized a gain of $3.7 million from debt forgiveness, which is recorded as part of other income (expense) on the 2004 statement of operations.

Jabil Circuit, Inc.

As described below, litigation between Jabil
Circuit, Inc. (Jabil) and the Company has been dismissed.

On May 11, 2004, Jabil and the Company entered into a settlement agreement (the
2004 Settlement), which resolved and settled certain and all previous disputes between Jabil and the Company. Pursuant to the Settlement Agreement, the Company executed promissory notes (the Jabil Notes) totaling
approximately $5.2 million in favor of Jabil for unpaid accounts, notes and certain inventory for which the Company had not paid. Further, the Company also placed additional purchase orders with Jabil approximating $1.1 million and made cash
payments to Jabil approximating $1.4 million in conjunction with new purchase orders and as initial payments under the Jabil Notes. Under the Settlement Agreement, the Company and Jabil agreed to dismiss the two lawsuits filed by Jabil in 2003, and
Jabil agreed to continue to provide manufacturing services to the Company through December 31, 2004.

On October 7, 2003, Jabil filed two
complaints in the Circuit Court of the Thirteenth Judicial Circuit for Hillsborough County, Florida, for certain unpaid accounts receivable and inventory for which the Company had not paid of approximately $5.6 million. Prior to filing the
complaints, in March 2003, Jabil commenced an arbitration proceeding against the Company and sought damages in excess of $6.8 million related to non-payment by the Company for amounts due under a manufacturing services agreement and costs
originating as a result of the termination of that agreement due to non-payment. On December 5, 2003, the Company entered into a manufacturing services letter agreement with Jabil for certain manufacturing services, at which time the Company
wrote off approximately $4.0 million in inventory claims for inventory held at Jabil.



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##### Table of Contents

On August 23, 2004, Optel entered into a guarantee agreement with Jabil, pursuant to which Optel guaranteed certain
obligations of the Company owing to Jabil relating to purchase orders for production material issued by the Company to Jabil after June 30, 2004. Optels maximum obligation under the guarantee agreement was $1.88 million. Prior to the
completion of the guarantee agreement, the Company was required to prepay Jabil for all orders of production material. With the guarantee agreement in place, the Company was able to pay for production material purchased from Jabil upon receipt of
that material.

On August 31, 2005, the Company and Jabil entered into a Settlement Agreement and Mutual Release (the Settlement
Agreement) relating to the 2004 Settlement. In connection with the Settlement Agreement, and in view of the fact that the Companys current manufacturing needs have changed, Jabil and the Company have agreed to amicably settle all
outstanding principal and interest financial obligations between them relating to the 2004 Settlement. Under the terms of the Settlement Agreement, Jabil returned to the Company approximately $810,000 in parts inventory and work-in-progress
materials that had been purchased by the Company and warehoused at Jabil for Jabils use in the on-going manufacturing of the Companys finished goods and the Company paid Jabil $1.9 million (the Settlement Payment) on
August 31, 2005. The Company and Jabil exchanged mutual releases subject to specified exclusions and the Company obtained the remaining parts inventory and work-in-progress materials in Jabils possession on September 9, 2005.

Other Employee Matters

The Company was not involved
in any disputes with employees for the years ending December 31, 2005 and 2006. Described below, is a summary of the resolved disputes between certain former employees and the Company during the year ended December 31, 2004.

During fiscal year 2004, the Company entered into settlement agreements with two former officers, George Matz and Dr. Glenn Dunlap. The settlements related to
outstanding obligations for previously negotiated severance agreements approximating $155,000 and $32,000 for Mr. Matz and Dr. Dunlap, respectively.

On April 30, 2004, Mr. Matz and the Company entered into a settlement agreement, pursuant to which the Company agreed to engage Mr. Matz as a consultant through March 31, 2006, for a consulting fee of $50,000, of which
$15,000 was paid on May 6, 2004. The remaining $35,000 in fees was paid monthly on a scheduled basis through March 2006. Further, the Company granted Mr. Matz options to purchase 60,000 shares of the Companys common stock at an
exercise price of $0.92 per share, which vest quarterly over three years. The Company also agreed to provide Mr. Matz medical insurance coverage through April 2006 at the Companys expense. The settlement agreement also contained mutual
releases.

On May 6, 2004, Dr. Dunlap and the Company entered into a settlement agreement whereby all claims and liabilities and all previous
agreements between Dr. Dunlap and the Company were settled for a lump sum payment of $25,000, which was paid upon execution of the settlement agreement. Pursuant to the settlement agreement, Dr. Dunlap retained the right to exercise an
option to purchase 66,666 shares of the Companys common stock at an exercise price of $1.42 per share, which expired on August 16, 2004. The settlement agreement also contained mutual releases.

Other Legal Matters

During 2004, the Company was engaged in a number
of other less significant legal actions and disputes, all of which have been resolved or dismissed. These disputes were brought about as result of the significant economic downturn, which occurred during that period and the corresponding decline in
the Companys business and the constraints on the Companys working capital. The majority of these disputes resulted from vendor actions over nonpayment by the Company for goods and services provided to the Company during that period.
Payments during fiscal year 2004 in settlement of vendor disputes approximated $371,000 and $210,000 to Arrow Electronics Inc. and Plaut Sigma Solutions, Inc., respectively.

Other

The Company from time to time may be involved in various other lawsuits and actions by third parties arising
in the ordinary course of business. The Company is not aware of any additional pending litigation, claims or assessments that could have a material adverse effect on the Company's business, financial condition and results of operations.



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##### Table of Contents

16. QUARTERLY OPERATING RESULTS (UNAUDITED)

The following table presents unaudited quarterly operating results for each of the last eight quarters. This information has been prepared by the Company on a basis consistent with the Company's consolidated financial
statements and includes all adjustments, consisting only of normal recurring accruals in accordance with generally accepted accounting principles. Such quarterly results are not necessarily indicative of future operating results.



|                                                                                   |  |                                                 |            |   |               |   |            |                   |  |   |                  |   |  |   |            |  
|---------------------------------------------------------------------------------- |  | ----------------------------------------------- | ---------- | - | ------------- | - | ---------- | ----------------- |  | - | ---------------- | - |  | - | ---------- | -
|                                                                                   |  | Quarter Ended                                   |           
|                                                                                   |  | March 31,2006                                   |            |   | June 30, 2006 |   |            | September 30,2006 |  |   | December 31,2006 |  
|                                                                                   |  | (in thousands, except share and per-share data) |           
|Net sales                                                                          |  | $                                               | 2,232      |   |               | $ | 1,992      |                   |  | $ | 2,587            |   |  | $ | 3,670      |  
|Gross profit                                                                       |  |                                                 | 316        |   |               |   | 294        |                   |  |   | 1,170            |   |  |   | 546        |  
|Operating loss                                                                     |  |                                                 | (3,381     | ) |               |   | (3,539     | )                 |  |   | (624             | ) |  |   | 1,160      |  
|Net loss                                                                           |  |                                                 | (4,761     | ) |               |   | (4,862     | )                 |  |   | (2,095           | ) |  |   | 2,770      |  
|                                                                                   |  |                                                 |            |  
|Basic and diluted loss per share (1)                                               |  | $                                               | (0.14      | ) |               | $ | (0.14      | )                 |  | $ | (0.06            | ) |  | $ | (0.08      | )
|                                                                                   |  |                                                 |            |  
|Weighted average shares outstanding and average shares and equivalents outstanding |  |                                                 | 34,214,906 |   |               |   | 35,226,400 |                   |  |   | 35,240,820       |   |  |   | 35,241,831 |  
|                                                                                   | 
|                                                                                   |  | Quarter Ended                                   |           
|                                                                                   |  | March 31,2005                                   |            |   | June 30, 2005 |   |            | September 30,2005 |  |   | December 31,2005 |  
|                                                                                   |  | (in thousands, except share and per-share data) |           
|Net sales                                                                          |  | $                                               | 2,865      |   |               | $ | 2,670      |                   |  | $ | 4,898            |   |  | $ | 2,449      |  
|Gross profit (loss)                                                                |  |                                                 | (104       | ) |               |   | 343        |                   |  |   | 1,369            |   |  |   | 264        |  
|Operating loss                                                                     |  |                                                 | (5,577     | ) |               |   | (7,150     | )                 |  |   | (2,603           | ) |  |   | (3,154     | )
|Net loss                                                                           |  |                                                 | (6,423     | ) |               |   | (8,090     | )                 |  |   | (2,083           | ) |  |   | (4,497     | )
|                                                                                   |  |                                                 |            |  
|Basic and diluted loss per share (1)                                               |  | $                                               | (0.19      | ) |               | $ | (0.23      | )                 |  | $ | (0.06            | ) |  | $ | (0.13      | )
|                                                                                   |  |                                                 |            |  
|Weighted average shares outstanding and average shares and equivalents outstanding |  |                                                 | 34,419,148 |   |               |   | 35,179,118 |                   |  |   | 35,191,317       |   |  |   | 35,204,003 |  

---

|(1) | Earnings per share were calculated for each three-month periods on a stand-alone basis. Earnings per share for each of the quarters ended from March 31, 2004 through
December 31, 2005 do not include the impact of common stock equivalents as inclusion would be anti-dilutive.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

The Company's sales and
operating results may fluctuate from quarter-to-quarter and from year-to-year due to the following factors: (i) the ability to obtain funding for working capital needs to allow the Company to procure inventory in sufficient supplies to meet
customer demand (ii) announced capital expenditure cutbacks by customers within the telecommunications industry, (iii) limited number of major customers, (iv) the product mix, volume, timing and number of orders received from
customers, (v) the long sales cycle for obtaining new orders, (vi) the timing of introduction and market acceptance of new products, (vii) success in developing, introducing and shipping product enhancements and new products,
(viii) pricing changes by our competitors, (ix) the ability to enter into long term agreements or blanket purchase orders with customers, (x) the ability to obtain sufficient supplies of sole or limited source components for products,
(xi) the ability to attain and maintain production volumes and quality levels for current and future products, and (xii) changes in costs of materials, labor and overhead. Any unfavorable changes in these or other factors could have a
material adverse effect on the Company's business, financial condition and results of operations. The Company does not anticipate that its backlog at the beginning of each quarter will be sufficient to achieve expected revenue for that quarter. To
achieve its revenue objectives, the Company expects that it will have to obtain orders during a quarter for shipment in that quarter.



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##### Table of Contents

17. SUBSEQUENT EVENTS

Conversion of Secured Convertible Promissory Note

On September 16, 2004, we borrowed $27.0 million from Optel pursuant to a secured
convertible promissory note (the Secured Convertible Promissory Note) that bore interest at 10% per annum and was secured by a first priority security interest in substantially all of our assets. The conversion feature of the
Secured Convertible Promissory Note was approved by our disinterested stockholders at a special meeting of our stockholders on February 10, 2005. On March 11, 2005, Optel converted $1.0 million of the indebtedness outstanding under the
Secured Convertible Promissory Note into 981,258 shares of our common stock. On January 4, 2007, Optel converted the remaining indebtedness, or $34.8 million, outstanding under the Secured Convertible Promissory Note into 220,222,515 shares of
our common stock. As a result, our obligations of repayment of debt under the Secured Convertible Promissory Note were satisfied as of January 4, 2007. As a result of the conversion of the amount outstanding under the Secured Convertible
Promissory Note, Optel and other entities controlled by Dr. Zwan control, in the aggregate, approximately 91.1% of the issued outstanding shares of the Companys common stock.

18. NON-CASH TRANSACTIONS

During the year ended December 31, 2005, Optel elected to convert a total of $1.0
million of the Secured Convertible Promissory Note into 981,258 shares of common stock of the Company, reducing accrued interest payable by $1.0 million and increasing additional paid-in capital by the same amount. The number of shares issued
increased common stock by 981,258.

In 2005, the Company forgave the notes receivable outstanding balance of $374,000 from Mr. James R. Green,
the Companys former Chief Executive Officer, as part of his severance arrangements (see Note 11  Related Party Transactions).

Also during the
year ended December 31, 2005, pursuant to the Settlement Agreement, the Company paid Jabil $1.9 million on the remaining notes which consisted of $3.1 million of principal and $300,000 of accrued interest. The Company realized a total non-cash
gain of $1.7 million, which included a $1.5 million of debt settlement gain on the current notes as well as $200,000 remaining deferred gain on settlement of the restructured Jabil Notes (see Note 15  Legal Proceedings).

During the year ended December 31, 2004, the Company completed litigation settlements representing $14.2 million of accrued litigation liabilities reported at
December 31, 2003. In connection with the CIT Technologies Corporation (CIT) settlement in fiscal year 2004, the Company paid $5.2 million in cash and recognized non-cash other income of $3.7 million and an increase of $4.7 million
to additional paid-in capital related to the issuance of 2,500,000 shares of common stock to CIT. The Company paid approximately $400,000 in cash related to certain other litigation settlements.

Further, the Jabil settlement, also completed during the year ended December 31, 2004, resulted in a reduction of approximately $276,000 in accounts payable and
accrued expenses and a net increase of approximately $69,000 to notes payable. During fiscal year 2004, the settlement completed with Jabil resulted in a $1.1 million increase to prepaid assets for future inventory purchases, a reduction of $4.5
million in accounts payable, and a $5.6 million increase in notes payable.



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##### Table of Contents

DIGITAL LIGHTWAVE, INC.

SCHEDULE II  VALUATION AND QUALIFYING ACCOUNTS

(Dollars in thousands)



|                                          |  |                                |        |                                   |   |        |                               |  |            |   |  |                          |       |       |  |   |       
|----------------------------------------- |  | ------------------------------ | ------ | --------------------------------- | - | ------ | ----------------------------- |  | ---------- | - |  | ------------------------ | ----- | ----- |  | - | ------
|COL. A                                    |  | COL. B                         |        | COL. C                            |   | COL. D |                               |  | COL. E    
|                                          |  |                                |        | Additions                         |   |        |                               |  |           
|Description                               |  | Balance at Beginning Of
Period |        | (1) Charged to Costs and Expenses |   |        | (2) Charged to Other Accounts |  | Deductions |   |  | Balance at End of Period
|Year 2006                                 |  |                                |        |                                   |   |        |                               |  |            |   |  |                          |       |       |  |   |       
|Reserve for uncollectible accounts        |  | $                              | 145    |                                   | $ |       |                               |  | $          |  |  | $                        | 61    | (a)   |  | $ | 84    
|Reserve for excess and obsolete inventory |  |                                | 15,711 |                                   |   | 983    |                               |  |            |  |  |                          | 1,226 | (b)   |  |   | 15,468
|Year 2005                                 |  |                                |        |                                   |   |        |                               |  |            |   |  |                          |       |       |  |   |       
|Reserve for uncollectible accounts        |  |                                | 690    |                                   |   |       |                               |  |            |  |  |                          | 545   | (a)   |  |   | 145   
|Reserve for excess and obsolete inventory |  |                                | 16,249 |                                   |   | (1     | )                             |  |            |  |  |                          | 537   | (b)   |  |   | 15,711
|Year 2004                                 |  |                                |        |                                   |   |        |                               |  |            |   |  |                          |       |       |  |   |       
|Reserve for uncollectible accounts        |  |                                | 531    |                                   |   | 98     |                               |  |            |  |  |                          | (61   | ) (a) |  |   | 690   
|Reserve for excess and obsolete inventory |  |                                | 14,555 |                                   |   | 1,315  |                               |  |            |  |  |                          | (379  | ) (b) |  |   | 16,249

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|(a) | Amounts written off as uncollectible, payments or recoveries.
|--- | -------------------------------------------------------------

|(b) | Amounts written off upon disposal or return of inventory.
|--- | ---------------------------------------------------------



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##### Table of Contents

Exhibit Index



|            |  |      |  |   |  |                                                                                                                                                           
|----------- |  | ---- |  | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |  | Ref. |  |   |  | Description                                                                                                                                               
|23.1        |  | +    |  |  |  | Consent of Grant Thornton LLP.                                                                                                                            
|            |  |      | 
|24.1        |  | +    |  |  |  | Power of Attorney (included as part of signature page)                                                                                                    
|            |  |      | 
|31.1        |  | +    |  |  |  | Certification of the Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                   
|            |  |      | 
|31.2        |  | +    |  |  |  | Certification of the Principal Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                               
|            |  |      | 
|32.1        |  | +    |  |  |  | Certification by the Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.    
|            |  |      | 
|32.2        |  | +    |  |  |  | Certification by the Principal Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

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|+ | Filed with this report.
|- | -----------------------