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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549





FORM 10-K





(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, 2008

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: 001-31770





Digital Lightwave, Inc.

(Exact name of Registrant as specified in its charter)







|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|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





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(d) 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.  x

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



|                        |  |   |  |                           |  |  
|----------------------- |  | - |  | ------------------------- |  | -
|Large Accelerated Filer |  |  ̈ |  | Accelerated Filer         |  |  ̈
|                        |  |   | 
|Non-Accelerated Filer   |  |  ̈ |  | Smaller Reporting Company |  | 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, 2008, was
approximately $1,698,319 based on the last-sale price of $0.08 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 13, 2009, was 255,489,847.

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, 2008, are incorporated by reference into Part III.









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##### Table of Contents

FORM 10-K

For the Year Ended December 31, 2008

Index



|            |  |                                                                                                              |  |     
|----------- |  | ------------------------------------------------------------------------------------------------------------ |  | ----
|            |  |                                                                                                              |  | Page
|            |  | PART I                                                                                                       |  |     
|            |  |                                                                                                             
|Item 1.     |  | Business                                                                                                     |  | 1   
|            |  |                                                                                                             
|Item 1A.    |  | Risk Factors                                                                                                 |  | 6   
|            |  |                                                                                                             
|Item 1B.    |  | Unresolved Staff Comments                                                                                    |  | 15  
|            |  |                                                                                                             
|Item 2.     |  | Properties                                                                                                   |  | 15  
|            |  |                                                                                                             
|Item 3.     |  | Legal Proceedings                                                                                            |  | 15  
|            |  |                                                                                                             
|Item 4.     |  | Submission of Matters to a Vote of Security Holders                                                          |  | 15  
|            |  |                                                                                                             
|            |  | PART II                                                                                                      |  |     
|            |  |                                                                                                             
|Item 5.     |  | Market for Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities |  | 16  
|            |  |                                                                                                             
|Item 6.     |  | Selected Financial Data                                                                                      |  | 17  
|            |  |                                                                                                             
|Item 7.     |  | Managements Discussion and Analysis of Financial Condition and Results of Operations                        |  | 17  
|            |  |                                                                                                             
|Item 7A.    |  | Quantitative and Qualitative Disclosures About Market Risk                                                   |  | 26  
|            |  |                                                                                                             
|Item 8.     |  | Financial Statements and Supplementary Data                                                                  |  | 26  
|            |  |                                                                                                             
|Item 9.     |  | Changes in and Disagreements with Accountants on Accounting and Financial Disclosure                         |  | 26  
|            |  |                                                                                                             
|Item 9A(T). |  | Controls and Procedures                                                                                      |  | 26  
|            |  |                                                                                                             
|Item 9B.    |  | Other Information                                                                                            |  | 27  
|            |  |                                                                                                             
|            |  | PART III                                                                                                     |  |     
|            |  |                                                                                                             
|Item 10.    |  | Directors, Executive Officers, and Corporate Governance                                                      |  | 28  
|            |  |                                                                                                             
|Item 11.    |  | Executive Compensation                                                                                       |  | 28  
|            |  |                                                                                                             
|Item 12.    |  | Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters               |  | 28  
|            |  |                                                                                                             
|Item 13.    |  | Certain Relationships and Related Transactions and Director Independence                                     |  | 28  
|            |  |                                                                                                             
|Item 14.    |  | Principal Accountant Fees and Services                                                                       |  | 28  
|            |  |                                                                                                             
|            |  | PART IV                                                                                                      |  |     
|            |  |                                                                                                             
|Item 15.    |  | Exhibits and Financial Statement Schedules                                                                   |  | 29  



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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 Events

On April 4, 2008, the Company and Optel Capital, LLC (Optel) entered into a Credit and Restructuring Agreement (the Credit Agreement)
pursuant to which (a) the Companys existing indebtedness owed to Optel, consisting of approximately $28.0 million of principal, which bore interest at 10% per annum, and accrued interest thereon of approximately $7.7 million, all of
which was due and payable upon demand by Optel, was restructured and (b) Optel agreed to make a $2.5 million revolving credit facility available to the Company. Optel is controlled by Dr. Bryan J. Zwan, the Companys largest
stockholder and chairman of the board of directors. The Credit Agreement was approved by the Companys board of directors upon the unanimous recommendation of a special committee of the board comprised solely of independent directors.

Pursuant to the Credit Agreement, the restructured indebtedness is evidenced by a new secured convertible promissory note in the principal amount of
approximately $35.7 million (the Restated Note), and the revolving credit facility is evidenced by an additional secured convertible promissory note in the principal amount of $2.5 million (the New Commitment Note and,
together with the Restated Note, the Notes). As of March 9, 2009, the balance of the Restated Note and New Commitment Note was $35.7 million and $2.5 million, respectively. The Notes bear interest at a rate equal to LIBOR plus
1.0% per annum and are secured by substantially all the Companys assets pursuant to an amended and restated security agreement (the Security Agreement). From April 4, 2008 through March 9, 2009, interest expense related
to the Restated Note was approximately $1.3 million which is recorded in other expense on the Consolidated Statements of Operations. As of December 31, 2008, accrued interest associated with the Notes of $465,000 is recorded in accounts payable
and accrued liabilities on the Consolidated Balance Sheets. Each of the Notes requires quarterly payments of interest commencing on June 30, 2008, and matures on March 31, 2010. Interest payments of approximately $321,000, $353,000 and
$465,000 were made July 1, 2008, October 1, 2008 and January 5, 2009, respectively.

All the indebtedness evidenced by the Notes is
convertible into common stock of the Company at the option of Optel at any time following approval of the conversion feature by the disinterested stockholders at a conversion price equal to the greater of $0.01 or average trading price of the stock
during the five-day period preceding the date of any conversion. The Company and Optel have made it a condition to the indebtedness evidenced by the Notes becoming convertible, that the conversion feature be approved by the holders of a majority of
the outstanding shares of common stock of the Company who are not affiliated with Optel or any of its affiliates at the Companys 2009 annual meeting of stockholders. If such holders do not approve the conversion feature, the outstanding debt
and accrued interest would immediately become due and payable in full upon demand by Optel at any time after the stockholders meeting.

On
March 26, 2009 and March 30, 2009, the Company borrowed $200,000 and $225,000, respectively from Optel to fund its working capital requirements. The loans are evidenced by secured promissory notes that bear interest at 10.0% per annum
and are secured by a security interest in substantially all of the Companys assets. Principal and any accrued but unpaid interest under the secured promissory notes are due and payable upon demand by Optel at any time after May 31, 2009;
provided, however, that the entire unpaid principal amount of the loan, together with accrued but unpaid interest, shall become immediately due and payable upon demand by Optel at any time on or following the occurrence of certain events as defined
by the notes.



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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 additional 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.

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 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.

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 Optical Wavelength Manager (OWM).
The OWM is a monitoring system for Dense-Wavelength Division Multiplexing (DWDM) networks that remotely monitors up to eight optical fibers providing fast and highly accurate analysis of optical wavelengths for troubleshooting and predictive
analysis.

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.

With the emergence of
internet protocol television (IPTV) and the popularity of video on demand services such as YouTube, the demand for bandwidth in the network is accelerating. This demand is pushing carriers to deploy higher bit rate services such as
40Gbps and 100 Gigabit Ethernet. Providing a cost-effective path to increase bandwidth without adding additional fiber, several 40Gbps networks have been deployed throughout the world, and significant new deployments are expected in 2009
and 2010. The 40Gbps market is expected to increase at



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least for the next three to five years at which time reasonably priced 100GigE products will overtake 40Gbps. Virtually all major network equipment vendors
are developing 40Gbps transport equipment. The market for 40Gbps test instruments includes equipment manufacturers (for research and development as well as field implementation), network providers and government.

The current global credit crisis has effected many sectors of the world economy. Telecommunications has been shown to be a key input to economic growth and a critical
utility for economic development. It is expected that federal legislation will contain $30 billion of stimulus for telecommunications, photonics and information technology over the next 24 months, with another $30 billion being spent on related
activities that could further boost these sectors. Other nations are putting forth their own packages, which are also likely to contain telecommunications related investments. It is likely the stimulus packages will not have an immediate effect on
the telecommunications industry due to delays in getting grants and contracts awarded. It is expected some effects will be seen by the end of 2009, with the largest portions of the stimulus being spent in 2010 and 2011.

The Digital Lightwave Solution

Digital Lightwave provides products
and technologies that are designed to support networking technologies used worldwide. 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 rack mountable form factors to serve 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 the time and expense of diagnosis and resolution of network emergencies and repairs.

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 our products in the laboratory environment to confirm network equipment functionality, compatibility and conformance to international
standards. The Companys products are also used to confirm functionality as part of the manufacturing process for network equipment providers throughout the world.

Products and Services

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 with 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:



| |  |  | The NIC 2.5G, NIC 10G, NIC 40G, NIC BP, NIC BP40G, NIC NXG and NIC GigE are small units that
accommodate two modules. They offer lightweight portability and ease of use through a 10.4 color touch-screen. The platforms can provide SONET/SDH, OTN, ATM, Ethernet, Fiber Channel, Optical Spectrum Analyzer and/or Serial Port testing via
hardware and software (license-based) options.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | The NIC Plus®/NIC Plus
NXG® is a larger scalable testing platform that accommodates up to five 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.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | The NIC EP® is an embedded
platform designed for remotely operated embedded testing. It is mounted in a 19 or 23 equipment rack and accommodates up to five test modules.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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Available modules include:



| |  |  | 40/43G Testing Module provides SONET/SDH/OTN test capability at 40Gbps and 43Gbps. The 40/43G Testing Module can be equipped in the small NIC chassis
as a NIC 40G. Combined with other modules in the NIC Plus or NIC EP chassis, a single unit can support testing from 1.5Mbps to 43Gbps including SONET, SDH, OTN, PDH, T-Carrier and Ethernet for an all-in-one telecom and datacom solution.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | 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), GigE, 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.
| | - |  | --------------------------------------------------------------------------------------------------------------------



| |  |  | MSA 2020 Module provides SONET/SDH test capability from 52Mbps 155Mbps, 2.5Gbps or 10Gbps with optional ATM, ODU Multiplexing, Generic Framing
Procedure (GFP), Transport Network (OTN), GigE, 10GigE LAN and WAN and 10GigE with Forward Error Correction (FEC), Ethernet 10GigE, GigE, 10/100/1000BaseT and Fibre Channel.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | MSA 2030 Module provides SONET/SDH test capability from 52Mbps 155Mbps, 2.5Gbps or 10Gbps with optional ATM, ODU Multiplexing, Generic Framing
Procedure (GFP), Virtual Concatenation (VCAT), Link Adjustment Scheme (LCAS), Optical Transport Network (OTN), GigE, 10GigE LAN and WAN and 10GigE with Forward Error Correction (FEC), Ethernet 10GigE, GigE, 10/100/1000BaseT and Fibre Channel.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | ESA 2025 Module provides Ethernet 10GigE, GigE, 10/100/1000BaseT with optional Fibre Channel, SONET/SDH test capability from 52Mbps 155Mbps, 2.5Gbps
or 10Gbps, ODU Multiplexing, Generic Framing Procedure (GFP), Virtual Concatenation (VCAT), Link Adjustment Scheme (LCAS), Optical Transport Network (OTN), GigE, 10GigE LAN and WAN and 10GigE with Forward Error Correction (FEC).
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



| |  |  | 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 69% and 74% of our net sales for the years ended
December 31, 2008 and 2007, respectively.

Network Management Tools

This product category consists of the Companys Optical Wavelength Manager (OWM) product. The OWM is a highly sophisticated Dense Wave Division Multiplexing (DWDM) analysis system that provides functionality
specifically designed for analysis of DWDM networks. Providing an SNMP (Simple Network Management Protocol) interface, it is easily connected to most network management systems. The technology utilized has no moving parts and therefore provides
substantially better reliability and product life than traditional optical spectrum analyzers. 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.



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Customers

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;
| | - |  | ---------------------------------------



| |  |  | 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, 2008, one customer accounted for approximately 14.5% of net sales. For the year ended December 31, 2007, one customer accounted for approximately 11% 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. The Company has 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 sales channels consist of a combination of direct salespeople,
manufacturer representatives and distributors.

Marketing

The Company focuses its marketing efforts on equipment manufacturers and service providers developing and deploying high-speed fiber-optic networks. The Company seeks to build awareness of its products through a variety of marketing
channels and methodologies, including industry trade shows, conferences, advertising in trade publications and internet-based marketing activities to targeted customers and association groups.



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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, Brazil and India. 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 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 products. The Company performs final assembly
and programs the products with our software and firmware. The Company implements strict quality control procedures throughout each stage of the manufacturing process and tests the boards, subassemblies, and units at various stages in the process,
including complete functional, system, environmental, and automation and final tests for qualification of the product. The Company also obtains other equipment manufacturers products for resale to customers.

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 2008 and 2007 the Company spent approximately $2.2 million and $2.0 million, respectively, on engineering and development
activities.

Intellectual Property

As of
March 13, 2009, we had eleven issued patents, including five issued patents in the United States relating to the NIC technology, and six issued patents relating to the DWDM technology.

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 64% and
68%, of our net sales for the years ending 2008 and 2007, respectively. The Companys international sales represented approximately 36% and 32% total net sales for the years ended 2008 and 2007, respectively.

Employees

As of March 13, 2009, we employed a full-time staff
of 39 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.

Beginning in the third quarter of 2001 and continuing through
December 31, 2008, we incurred combined net losses of $170.0 million. For the years ended December 31, 2008 and 2007, we reported net losses of approximately $3.5 million and $2.6 million, respectively, and cash flows used by operations of
$1.0 million and $1.4 million, respectively. We anticipate that our net operating losses may continue in fiscal year 2009.



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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.

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 products are currently produced in Clearwater, Florida. We subcontract the manufacturing of computer systems, boards, plastic molds and metal chassis and certain
subassemblies and components for the NIC 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. We have entered into a letter of 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 products are sourced from a single or a limited number of suppliers. 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 that may become obsolete, as well as 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 that are available from multiple vendors. Nonetheless, we continually monitor end-of-life notices and perform last time buys or redesign as needed.

We formulate a monthly forecast of product sales on a 90 day forward looking 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 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 13, 2009, 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.

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;
| | - |  | ------------------------------------------------------------------------------------------------------------------------



7



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| |  |  | 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.

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.

We have undertaken a number of initiatives to
reduce costs. These measures have included significant reductions in workforce and the relocation of our headquarters to a smaller facility that better meets our needs.

Since transitioning to a reduced cost structure, there are several risks inherent in operating as a smaller organization 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 could be impaired. Our leaner operations 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.



8



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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.

The current global economic environment is one of contraction. Many companies have reduced their capital expenditure budgets and
credit is difficult to obtain. The United States government and other nations are enacting legislation intended to stimulate the economy with aid directed specifically to the telecommunications sector. The extent and the duration of the global
downturn are uncertain, and it is also uncertain how effective the economic stimulus legislation will be. It is likely the economic stimulus legislation will not have an immediate effect on the telecommunications industry due to delays in awarding
government grants and contracts. It is expected some effects will be seen by the end of 2009, with the largest portions of the stimulus being spent in 2010 and 2011.

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 ended December 31, 2008, net sales from international customers
represented approximately 36% 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 United States 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 6,500 units. 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;
| | - |  | ---------------------------------------------------------------------



9



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| |  |  | 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 $3.5 million and $2.6 million for the years ended December 31, 2008 and 2007, respectively. We anticipate that our net losses
may continue in fiscal year 2009 due primarily to interest expense and costs associated with the introduction of new products and technologies.

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.

On
January 1, 2007, the Company adopted the provisions of the Financial Accounting Standards Board (FASB) Interpretation No. 48, Accounting for Uncertainty in Income Taxes (FIN 48), an interpretation of
Statement of Financial Accounting Standards (SFAS) 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. Based on the analysis performed, the Company did not record any unrecognized tax positions as of December 31, 2007 and December 31,
2008. There is a possibility that a limitation on the Companys net operating loss carry-forwards may have come into effect under Section 382 of the Internal Revenue Code as a result of cumulative stock ownership changes. As of
December 31, 2007 and December 31, 2008, the impact of such a limitation has no impact on the accompanying financial statements since all net operating losses have a full valuation allowance; however, such a limitation could impact
substantially the reported gross asset related to the net operating loss carry-forwards.

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. Acquisition transactions are accompanied by a number of risks, including:



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



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



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



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| |  |  | 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.
| | - |  | ------------------------------------------------------------------------------

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 OWM product line, 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;
| | - |  | ---------------------------



11



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| |  |  | 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.
| | - |  | -------------------------------------------

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 Anritsu, EXFO Electro-Optical Engineering, Inc., JDS Uniphase Corp., 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, 2008, one
customer accounted for approximately 14.5% of net sales. For the year ended December 31, 2007, one customer accounted for approximately 11% of net sales. No other customer accounted for sales of 10% or more during those years.



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Our success depends on our ability to broaden our customer base to increase the level of sales. None of our customers
have a written agreement with us that obligate 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 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.

We are
dependent on proprietary technology.

Our success and 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 13, 2009, we had eleven issued patents, including five issued patents in the United States relating to the NIC technology, and six issued patents relating to the DWDM technology.
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 enforce 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;
| | - |  | -------------------------------------------



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| |  |  | 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;
| | - |  | -----------------------------------------------------------



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



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



| |  |  | 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. These 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 13, 2009, 255,489,847 shares of our common stock were outstanding. Of these shares, 27,767,324 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.

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.

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



14



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##### Table of Contents

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
|-------- | -------------------------

None.



|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 believe this facility is 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 2008, no matters were submitted to a vote of stockholders through the solicitation of proxies or otherwise.



15



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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, 2008 and 2007. 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
|2007        |  |              |      |     |   |     
|1st Quarter |  | $            | 0.35 |     | $ | 0.13
|2nd Quarter |  | $            | 0.23 |     | $ | 0.16
|3rd Quarter |  | $            | 0.18 |     | $ | 0.09
|4th Quarter |  | $            | 0.15 |     | $ | 0.07
|            |  |             
|2008        |  |              |      |     |   |     
|1st Quarter |  | $            | 0.12 |     | $ | 0.09
|2nd Quarter |  | $            | 0.12 |     | $ | 0.08
|3rd Quarter |  | $            | 0.10 |     | $ | 0.04
|4th Quarter |  | $            | 0.07 |     | $ | 0.01

On March 10, 2009, the last sale price of the Companys Common Stock was $0.05 per share. As of
March 10, 2009, there were approximately 625 holders of record of the Companys Common Stock.

2008 Equity Compensation Table

The following table provides information as of December 31, 2008 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     |  | 2,100,000                                                                               |  | $                                                                        | 1.56 |                                                                                                                             | 10,037,214
|Equity compensation plans not approved by security holders |  |                                                                                        |  | $                                                                        |     |                                                                                                                             |          
|Total                                                      |  | 2,100,000                                                                               |  | $                                                                        | 1.56 |                                                                                                                             | 10,037,214



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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, 2008 and 2007, 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.



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

None



|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.



17



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##### Table of Contents

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 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 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. Sales returns have historically been minimal and recognized on a specific identification basis.

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, 2008, one customer accounted for approximately 14.5% of net sales. For the
year ended December 31, 2007, one customer accounted for approximately 11% 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. Warranties are provided on products with varying terms. Based upon historical claims experience and tracking of open warranty units, 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 2007 and 2008, we expanded our



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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 2007 and 2008, we broadened our product offering and capabilities with the following important new products and enhancements:

2007



| |  |  | Introduction of Gigabit Ethernet Test Option to NGMR, enabling Ethernet testing at 1Gbps in the same module that supports SONET/SDH/OTN.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Introduction of GFP into OTN Test Option to NGMR, enabling NextGen GFP mapping direct to Optical Transport Network (OTN) rates.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------



| |  |  | Began development of 40/43Gbps testing module for NIC platform.
| | - |  | ---------------------------------------------------------------



| |  |  | Introduction of Fiber Channel Test Option on High-Density Ethernet Module, enabling Fiber Channel testing application for Storage Area Network (SAN)
applications.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Introduced NXG Series (NIC NXG and NIC Plus NXG), to highlight the capabilities of the Next Generation Multi-Rate (NGMR) module.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------

2008



| |  |  | Announced first demonstration of NIC Platform 40/43G features, in Italy and in the USA.
| | - |  | ---------------------------------------------------------------------------------------



| |  |  | Introduced ESA (Ethernet Services Analyzer) 2025 Module, for Ethernet testing up to 10G with test options for SONET/SDH/OTN.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------



| |  |  | Introduced MSA 2020 (Multi-Services Analyzer) Module, for SONET/SDH testing with test options for OTN, GFP and Ethernet.
| | - |  | ------------------------------------------------------------------------------------------------------------------------



| |  |  | Introduced MSA 2030 (Multi-Services Analyzer) Module, for SONET/SDH testing with test options for OTN, GFP, VCAT, LCAS and Ethernet.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Introduced the Battery Option for the NIC Platform, enabling the instrument to be used in environments without power and ensuring accurate results in the
event of power failure.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Introduced enhancements to the NIC Platforms Ethernet testing feature set, enabling more thorough testing, quicker turn-up time and cost savings for
customers.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------

We believe that these product enhancements 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 asset 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:



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



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



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



| |  |  | assessments of uncertain tax positions;
| | - |  | ---------------------------------------



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



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



| |  |  | warranty reserve.
| | - |  | -----------------

We make significant judgments and
estimates and assumptions in connection with establishing the above-mentioned asset valuation allowances and accrued liabilities. 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. During the year ended December 31, 2008, a review of the amount of potential future product returns indicated no allowance was required.

We also estimate the collectability 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, 2008 was $1.7 million, net of our estimated reserve for uncollectible accounts of approximately $76,000.

We estimate the amount of
excess and obsolete inventory and lower of cost or market adjustments. 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 $3.6 million as of December 31, 2008, net of our estimated reserve for excess and obsolete
inventory and lower of cost or market adjustments of approximately $14.1 million. Annually, we assess the utility of our inventory and determine the potential disposition of any obsolete items.

On January 1, 2007, the Company adopted the provisions of the Financial Accounting Standards Board (FASB) Interpretation No. 48, Accounting for
Uncertainty in Income Taxes (FIN 48), an interpretation of Statement of Financial Accounting Standards (SFAS) 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. Based on the analysis performed, the Company did not record any
unrecognized tax positions as of December 31, 2007 and December 31, 2008. There is a possibility that a limitation on the Companys net operating loss carry-forwards (NOLS) may have come into effect under Section 382
of the Internal Revenue Code as a result of cumulative stock ownership changes. As of December 31, 2007 and December 31, 2008, the impact of such a limitation has no impact on the accompanying financial statements since all net
operating losses have a full valuation allowance; however, such a limitation could impact substantially the reported gross asset related to the net operating loss carry-forwards.

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 we conclude that it is more likely than not that the deferred tax assets will not be realized. We review projected taxable income, reversal of taxable timing differences and tax planning ideas in order to
assess recoverability. Based upon recurring taxable losses and the possibility of the use of the NOLs being limited, a full valuation allowance has been provided.

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.



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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, 2008, a review of the carrying value of our long-lived
assets and the probability of recovering such value indicated no impairment charge was required.

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, 2008 was approximately $338,000.



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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.



|                                       |  |                  |    |  |                  |   
|-------------------------------------- |  | ---------------- | -- |  | ---------------- | --
|                                       |  | December 31,2008 |    |  | December 31,2007 |   
|Net sales                              |  | 100              | %  |  | 100              | % 
|Cost of goods sold                     |  | 58               |    |  | 51               |   
|                                       |  |                  |    |  |                  |   
|Gross profit                           |  | 42               |    |  | 49               |   
|                                       |  |                 
|Operating expenses:                    |  |                  |    |  |                  |   
|Engineering and development            |  | 20               |    |  | 17               |   
|Sales and marketing                    |  | 26               |    |  | 19               |   
|General and administrative             |  | 10               |    |  | 9                |   
|Gain on sale of property and equipment |  |                 |    |  | (2               | ) 
|                                       |  |                  |    |  |                  |   
|Total operating expenses               |  | 56               |    |  | 43               |   
|                                       |  |                  |    |  |                  |   
|Operating income (loss)                |  | (14              | )  |  | 6                |   
|Interest income                        |  |                 |    |  |                 |   
|                                       |  |                 
|Interest expense                       |  | (19              | )  |  | (26              | ) 
|Other income (expense),net             |  |                 |    |  | (1               | ) 
|                                       |  |                  |    |  |                  |   
|Loss before income taxes               |  | (33              | )  |  | (21              | ) 
|                                       |  |                  |    |  |                  |   
|Net income (loss)                      |  | (33              | )% |  | (21              | )%
|                                       |  |                  |    |  |                  |   



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

Year Ended December 31,
2008 Compared With Year Ended December 31, 2007

Net Sales

Net sales for the year ended December 31, 2008, decreased by $1.3 million, or 11%, to $10.8 million from $12.1 million for the year ended December 31, 2007. Sales to repeat customers for the year represented
approximately 87% of sales, or $9.4 million, as compared to approximately 96% of sales, or $11.6 million for 2007. In 2007 the Company experienced a 50% increase in demand for repair and calibration services as the telecom industry experienced an
increase in demand. In 2008 revenue from repair and calibration returned to more traditional levels thus decreasing net sales. During 2008, the Company shipped 228 NIC units as compared to 300 units for the year ended December 31, 2007. The
remainder of the decrease in net sales was primarily a result of the slowdown of the global economy during the forth quarter of 2008.

International sales
for the year ended December 31, 2008, as a percentage of net sales, increased from 32% to 36% of net sales. For the year ended December 31, 2008, international sales decreased by $160,000 or 0.5% to $3.84 million from $3.9 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, 2008 increased by $98,000, or 2%, to
$6.2 million as compared to $6.1 million for the year ended December 31, 2007. The increased percentage of cost of goods sold relative to net sales is due to an additional $642,000 inventory reserve related to slow-moving or obsolete inventory,
an increase in the allocated expenses of $124,000 and the allocations of fixed overhead costs to cost of goods with lower sales.

Gross Profit

Gross profit for the year ended December 31, 2008, declined to $4.6 million from $5.9 million for the year ended December 31, 2007. Gross
margins for the years ended December 31, 2008 and 2007 were approximately 42% and 49%, respectively. The decrease in gross profit as a percentage of net sales is attributable to a relatively fixed overhead allocation applied against lower sales
and the increase in the inventory reserves in 2008.



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##### Table of Contents

Engineering and Development

Engineering and development expenses principally include salaries for engineering, development and certain operations personnel, outside consulting fees and other development expenses. Engineering and development expenses for the year ended
December 31, 2008, increased by $159,000 to $2.2 million, or 20% of net sales, from $2.0 million, or 17% of net sales, for the year ended December 31, 2007. The increase reflects an increase in staff during 2008. Increased expenditures
were related to the development and verification of the MSA 2020/2030 modules and the NIC BP.

Sales and Marketing

Sales and marketing expenses principally include salaries for sales, commissions, travel, tradeshows, promotional materials and warranty expenses. Sales and marketing
expenses for the year ended December 31, 2008, increased by $462,000 to $2.8 million, or 26% of net sales, from $2.3 million, or 19% of net sales, for the year ended December 31, 2007. The increase was primarily attributable to the
increases in sales staff and associated travel expenses and commissions for sales made through representatives.

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, 2008, decreased by $62,000 to $1.1 million, or 10% of net sales, from $1.1 million, or 9% of net sales, for the year ended
December 31, 2007. General and administrative expenses decreased due to lower facility rentals.

Impairment of Property and Equipment

During the year ended December 31, 2008, the Company did not incur any impairment charges. During the year ended December 31, 2007, the
Company incurred a non-cash impairment charge of $19,000. The Company expects to recover property and equipment comprised of rental and demonstration units.

Other Income (Expense)

Other expense for the year ended December 31, 2008, decreased by $1.2 million to $2.0 million from $3.3 million
of other expense in the year ended December 31, 2007. The decrease was primarily attributable to lower interest expense on the Notes owed to Optel resulting from the loan restructuring that occurred in April 2008.

Provision for Income Taxes

No provision for income taxes was made
for the years ended December 31, 2008 and 2007 because any tax benefits resulting from the Companys net losses have not been recognized due to a full valuation allowance being recognized against deferred tax assets. Management believes it
is more likely than not that future tax benefits will not be realized as a result of expected future taxable losses.

Net Loss

For the reasons discussed above, net loss for the year ended December 31, 2008, was $3.5 million, or $0.01 per basic and diluted share, an increase of approximately
$966,000, from a net loss of $2.6 million, or $0.01 per basic and diluted share, for the year ended December 31, 2007.

Liquidity and Capital
Resources

On April 4, 2008, the Company and Optel Capital, LLC (Optel) entered into a Credit and Restructuring Agreement (the
Credit Agreement) pursuant to which (a) the Companys existing indebtedness owed to Optel, consisting of approximately $28.0 million of principal, which bore interest at 10% per annum, and accrued interest thereon of
approximately $7.7 million, all of which was due and payable upon demand by Optel, was restructured and (b) Optel agreed to make a $2.5 million revolving credit facility available to the Company. The Credit Agreement was approved by the
Companys board of directors upon the unanimous recommendation of a special committee of the board comprised solely of independent directors.



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##### Table of Contents

Pursuant to the Credit Agreement, the restructured indebtedness is evidenced by a new secured convertible promissory note
in the principal amount of approximately $35.7 million (the Restated Note), and the revolving credit facility is evidenced by an additional secured convertible promissory note in the principal amount of $2.5 million (the New
Commitment Note and, together with the Restated Note, the Notes). As of March 9, 2009, the balance of the Restated Note and New Commitment Note was $35.7 million and $2.5 million, respectively. The Notes bear interest at a
rate equal to LIBOR plus 1.0% per annum and are secured by substantially all the Companys assets pursuant to an amended and restated security agreement (the Security Agreement). From April 4, 2008 through March 9,
2009, interest expense related to the Notes was approximately $1.3 million and recorded in other expense on the Consolidated Statements of Operations. As of December 31, 2008, accrued interest associated with the Notes of $465,000, is
recorded in accounts payable and accrued liabilities on the Consolidated Balance Sheets. Each of the Notes requires quarterly payments of interest commencing on June 30, 2008, and matures on March 31, 2010. Interest payments of
approximately $321,000, $353,000 and $465,000 were made July 1, 2008, October 1, 2008 and January 5, 2009, respectively.

All the
indebtedness evidenced by the Notes is convertible into common stock of the Company at the option of Optel at any time following approval of the conversion feature by the disinterested stockholders at a conversion price based on the average trading
price of the stock during the five-day period preceding the date of any conversion. The Company and Optel have made it a condition to the indebtedness evidenced by the Notes becoming convertible, that the conversion feature be approved by the
holders of a majority of the outstanding shares of common stock of the Company who are not affiliated with Optel or any of its affiliates at the Companys 2009 annual meeting of stockholders. If such holders do not approve the conversion
feature, the outstanding debt and accrued interest would immediately become due and payable in full upon demand by Optel at any time after the stockholders meeting.

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 registered public accounting firm has included an explanatory paragraph for a going concern in their report for the year ended
December 31, 2008.

On March 26, 2009 and March 30, 2009, the Company borrowed $200,000 and $225,000, respectively from Optel to fund its
working capital requirements. The loans are evidenced by secured promissory notes that bear interest at 10.0% per annum and are secured by a security interest in substantially all of the Companys assets. Principal and any accrued but
unpaid interest under the secured promissory notes are due and payable upon demand by Optel at any time after May 31, 2009; provided, however, that the entire unpaid principal amount of the loan, together with accrued but unpaid interest, shall
become immediately due and payable upon demand by Optel at any time on or following the occurrence of certain events as defined by the notes.

As of
December 31, 2008, the Companys unrestricted cash and cash equivalents were approximately $15,000, an increase of $3,000 from December 31, 2007. As of December 31, 2008, the Companys working capital was approximately $2.6
million as compared to a working capital of $4.6 million as of December 31, 2007. Our operating cash flow is impacted by the reduction in accounts receivable due to reduced fourth quarter sales. Accounts payable has also grown due to inventory
purchases in anticipation of stronger fourth quarter sales than what actually occurred.

Beginning in the third quarter of 2001 and continuing through
December 31, 2008, the Company has incurred combined net losses of $170.0 million. The Company expects to continue to incur net losses in 2009. Management has taken actions to reduce operating expenses and capital expenditures. These actions
include restructuring operations to more closely align operating costs with revenues.

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 the Companys landlord, currently Bay Vista TIC, as beneficiary. The letter of credit expires July 31, 2011.



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Operating Activities

Net cash used in operating activities for the year ended December 31, 2008, was $1.0 million. This was primarily attributable to the net loss in 2008 of $3.5 million. The increase in accounts payable and accrued expenses totaled
approximately $1.2 million. The Company added $1.0 million of demo and rental units. This increase resulted primarily from accrued but unpaid interest expenses of $465,000 and an increase in unpaid trade accounts payable of $737,000. The increase of
on-hand inventory used operating cash of $1.2 million. An increase in prepaid expenses and other assets used operating cash of $22,000. Accounts receivable provided operating cash of approximately $2.1 million on net sales of approximately $10.8
million, as cash collections outpaced new customer billings during the fourth quarter.

Net cash used in operating activities for the year ended
December 31, 2007, was $1.4 million. This was primarily attributable to the net loss in 2007 of $2.6 million. The decrease in accounts payable and accrued expenses totaled approximately $5.4 million. This decrease resulted primarily from the
net of the conversion of $7.75 million of accrued interest to stock, payback of accrued interest of $325,000, accrued but unpaid interest expenses of $3.2 million and a decrease in unpaid trade accounts payable of $447,000. The increase of on-hand
inventory used operating cash of $111,000. A decrease in prepaid expenses and other assets provided operating cash of $104,000. Accounts receivable used operating cash of approximately $1.5 million on net sales of approximately $12.1 million, as
cash collections outpaced new customer billings.

Investing Activities

Investing activities provided cash flows of $246,000 during the year ended December 31, 2007 due to sales of property and equipment.

Financing Activities

Net cash provided by financing activities for the year ended December 31, 2008 of $1.0
million reflects $780,000 used to repay related-party notes payable and $1.8 million provided by related party borrowings. As of December 31, 2008 there remains $950,000 in available funds from the secured convertible promissory note.

Net cash provided by financing activities for the year ended December 31, 2007 of $783,000 was a result of $1.0 million additional financing provided
by Optel, LLC and Optel Capital, LLC (see Note 9 to the Consolidated Financial Statements  Related Party Transactions). On February 5, 2008 the Company paid one note in full totaling $230,000 plus interest and on February 19, 2008
made partial payment on a second note of $300,000 plus interest.

New Accounting Pronouncements

In December 2007, the FASB issued SFAS No. 141 (revised 2007), Business Combinations (SFAS 141 (R)). SFAS 141 (R) provides revised guidance
for recognizing and measuring identifiable assets and goodwill acquired, liabilities assumed and any noncontrolling interest in the acquiree. It also provides disclosure requirements to enable users of the financial statements to evaluate the nature
and financial effects of the business combination. SFAS 141 (R) is effective for financial statements issued for fiscal years beginning after December 15, 2008. The Company does not expect the adoption of SFAS 141 (R) will have a
material effect on the Companys future financial position or results of operations.

In December 2007, the FASB issued SFAS No. 160,
Noncontrolling Interests in Consolidated Financial StatementsAn Amendment of Accounting Research Bulletin No. 51 (SFAS 160). The standard changes the accounting for noncontrolling (minority) interests in Consolidated
Financial Statements including the requirements to classify noncontrolling interests as a component of consolidated stockholders equity, and the elimination of minority interest accounting in results of operations with earnings
attributable to noncontrolling interests reported as part of consolidated earnings. The provisions of SFAS 160 are effective for fiscal years beginning after December 15, 2008, with early adoption prohibited. The Company does not expect the
adoption of SFAS 160 will have a material impact on its financial statements.



25



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##### Table of Contents

In March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative Instruments and Hedging
Activitiesan amendment to FASB Statement No. 133, (SFAS 161).SFAS 161 is intended to improve financial standards for derivative instruments and hedging activities by requiring enhanced disclosures to enable
investors to better understand their effects on an entitys financial position, financial performance, and cash flows. Entities are required to provide enhanced disclosures about: (a) how and why an entity uses derivative instruments;
(b) how derivative instruments and related hedged items are accounted for under Statement 133 and its related interpretations; and (c) how derivative instruments and related hedged items affect an entitys financial position,
financial performance, and cash flows. It is effective for financial statements issued for fiscal years beginning after November 15, 2008. The Company does not expect the adoption of SFAS 161 will have a material impact on its financial
statements.



Off-Balance Sheet Arrangements

During the fiscal year ended December 31, 2008, the Company did not engage in any off-balance sheet arrangements as defined in Item 303(a)(4) of Regulation S-K.

Trends and Uncertainties

During 2008, the
telecommunications industry continued to experience modest growth. This recovery follows a period from 2001 to 2005 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
|-------- | ----------------------------------------------------------

None.



|Item 8. | 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(T). | Controls and Procedures
|----------- | -----------------------

Disclosure
Controls and Procedures

Our management, with the participation of 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 the end of the period
covered by this annual report on Form 10-K. Based on this evaluation, our principal executive officer and principal financial officer concluded that, (1) our disclosure controls and procedures are not 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.

Changes in Internal Control Over Financial Reporting

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.



26



---

##### Table of Contents

Managements Report on Internal Control Over Financial Reporting

Our management is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is a
process designed by, or under the supervision of, our principal executive officer and principal financial officer and effected by our Board of Directors, management and other personnel, to provide reasonable assurance regarding the reliability of
our financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America. Internal control over financial reporting includes policies and
procedures that (i) pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the Companys transactions; (ii) provide reasonable assurance that transactions are recorded as necessary for
preparation of our financial statements and that receipts and expenditures of the Companys assets are made in accordance with authorizations of our management and directors; and (iii) provide reasonable assurance regarding prevention or
timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting is not intended to provide
absolute assurance that a misstatement of the Companys financial statements would be prevented or detected.

Our management conducted an evaluation
of the effectiveness of our internal control over financial reporting as of December 31, 2008 using the criteria set forth in the Internal Control over Financial Reporting  Guidance for Smaller Public Companies issued by the Committee of
Sponsoring Organizations of the Treadway Commission. Based upon the evaluation, our management concluded that our internal control over financial reporting was not effective as of December 31, 2008 because of material weaknesses in our internal
control over financial reporting. A material weakness is a control deficiency that results in a more than remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected on a timely
basis by employees in the normal course of their assigned functions. Our management concluded that we have several material weaknesses in our internal control over financial reporting because of inadequate segregation of duties over
authorization, review and recording of transactions as well as the financial reporting of such transactions. The Company has developed a plan and is in process of executing the plan to mitigate these material weaknesses. Despite the existence
of these material weaknesses, we believe the financial information presented herein is materially correct and in accordance with generally accepted accounting principles.

This annual report does not include an attestation report of our registered public accounting firm regarding internal control over financial reporting. Managements report was not subject to attestation by our
registered public accounting firm pursuant to temporary rules of the SEC that permit the Company to provide only managements report in this annual report.



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

None.



27



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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 for the Companys annual meeting of stockholders to be held on May 14, 2009, (the Proxy Statement), which information is hereby
incorporated herein by reference.



|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.



28



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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         |  | (4)  |  | - |  | 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)* |  | - |  | Amended and Restated 2001 Stock Option Plan.                                                                                                              
|            |  |      | 
|10.5        |  | (5)  |  | - |  | Credit and Restructuring Agreement, between the Digital Lightwave, Inc. and Optel Capital, LLC. dated April 4, 2008                                       
|            |  |      | 
|10.6        |  | (5)  |  | - |  | Secured Convertible Promissory Noted (Restated Noted), issued by Digital Lightwave, Inc. to Optel Capital, LLC dated April 4, 2008                        
|            |  |      | 
|10.7        |  | (5)  |  | - |  | Secured Convertible Promissory Noted (New Commitment Loans) issued by Digital Lightwave, Inc. to Optel Capital, LLC dated April 4, 2008,                  
|            |  |      | 
|10.8        |  | (5)  |  | - |  | Amended and Restated Security Agreement, between Digital Lightwave, Inc. and Optel Capital, LLC dated April 4, 2008.                                      
|            |  |      | 
|10.9        |  | (5)  |  | - |  | Registration Rights Agreement, between Digital Lightwave, Inc. and Optel Capital, LLC. dated April 4, 2008                                                
|            |  |      | 
|10.10       |  | +    |  | - |  | Secured Convertible Promissory Note issued by Digital Lightwave, Inc. to Optel Capital, LLC dated March 26, 2009,                                         
|            |  |      | 
|10.11       |  | +    |  | - |  | Secured Convertible Promissory Note issued by Digital Lightwave, Inc. to Optel Capital, LLC dated March 30, 2009,                                         
|            |  |      | 
|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.



|* | 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 Appendix A to the registrants Proxy Statement filed January 4, 2005, for a Special Meeting of Stockholders held on February 10, 2005.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(5) | Incorporated by reference to the similarly described exhibits filed in connection with the Registrants Form 8-K on April 10, 2008.
|--- | -----------------------------------------------------------------------------------------------------------------------------------



| | (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.
| | --- | -------------------------------------------------------



29



---

##### 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: March 31, 2009

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 |  |  |  | March 31, 2009
|Kenneth T. Myers      |  |  |  | (Principal Executive Officer)         |  |  |  |               
|                      |  |  |  |                                      
|/s/ KENNETH T. MYERS  |  |  |  | Interim Chief Accounting Officer      |  |  |  | March 31, 2009
|Kenneth T. Myers      |  |  |  | (Principal Accounting Officer)        |  |  |  |               
|                      |  |  |  |                                      
|/s/ DR. BRYAN J. ZWAN |  |  |  | Chairman of the Board                 |  |  |  | March 31, 2009
|Dr. Bryan J. Zwan     |  |  |  |                                       |  |  |  |               
|                      |  |  |  |                                      
|/s/ PETER H. COLLINS  |  |  |  | Director                              |  |  |  | March 31, 2009
|Peter H. Collins      |  |  |  |                                       |  |  |  |               
|                      |  |  |  |                                      
|/s/ GERALD A. FALLON  |  |  |  | Director                              |  |  |  | March 31, 2009
|Gerald A. Fallon      |  |  |  |                                       |  |  |  |               
|                      |  |  |  |                                      
|/s/ ROBERT F. HUSSEY  |  |  |  | Director                              |  |  |  | March 31, 2009
|Robert F. Hussey      |  |  |  |                                       |  |  |  |               
|                      |  |  |  |                                      
|/s/ ROBERT MOREYRA    |  |  |  | Director                              |  |  |  | March 31, 2009
|Robert Moreyra        |  |  |  |                                       |  |  |  |               



30



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##### 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) and Comprehensive Loss |  | F-5 
|                                                                                 | 
|Consolidated Statements of Cash Flows                                            |  | F-6 
|                                                                                 | 
|Notes to Consolidated Financial Statements                                       |  | F-7 



---

##### Table of Contents

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders of

Digital Lightwave, Inc.

We have audited the accompanying consolidated balance sheets of Digital Lightwave, Inc. (a Delaware corporation) and subsidiaries as of December 31,
2008 and 2007, and the related consolidated statements of operations, stockholders equity (deficit) and comprehensive loss, and cash flows for each of the two years in the period ended December 31, 2008. These financial statements
are the responsibility of the Companys management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with 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 respects, the financial position of Digital Lightwave, Inc. and subsidiaries as of December 31, 2008, and 2007, and the results of
their operations and their cash flows for each of the two years in the period ended December 31, 2008, in conformity with accounting principles generally accepted in the United States of America.

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 $3.5 million in 2008 and $2.6 million in 2007 and as of December 31, 2008, has a stockholders deficit of $33.7 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.



|                      
|----------------------
|/s/ GRANT THORNTON LLP
|                      
|Tampa, Florida        
|March 31, 2009        



F-2



---

##### Table of Contents

DIGITAL LIGHTWAVE, INC.

CONSOLIDATED BALANCE SHEETS

(In
thousands, except share data)



|                                                                                                                                                        |  |                  |          |   |                  |   |          |  
|------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ---------------- | -------- | - | ---------------- | - | -------- | -
|                                                                                                                                                        |  | December 31,2008 |          |   | December 31,2007 |  
|ASSETS                                                                                                                                                  |  |                  |          |   |                  |   |          |  
|Current assets:                                                                                                                                         |  |                  |          |   |                  |   |          |  
|Cash                                                                                                                                                    |  | $                | 15       |   |                  | $ | 12       |  
|Accounts receivable, less reserve for uncollectible accounts of $76 and $77 in 2008 and 2007, respectively                                              |  |                  | 1,730    |   |                  |   | 3,871    |  
|Inventories, net                                                                                                                                        |  |                  | 3,576    |   |                  |   | 2,840    |  
|Prepaid expenses and other current assets                                                                                                               |  |                  | 196      |   |                  |   | 184      |  
|                                                                                                                                                        |  |                  |          |   |                  |   |          |  
|Total current assets                                                                                                                                    |  |                  | 5,517    |   |                  |   | 6,907    |  
|                                                                                                                                                        |  |                 
|Property and equipment, net                                                                                                                             |  |                  | 950      |   |                  |   |         |  
|Other assets, net                                                                                                                                       |  |                  | 214      |   |                  |   | 204      |  
|                                                                                                                                                        |  |                  |          |   |                  |   |          |  
|Total assets                                                                                                                                            |  | $                | 6,681    |   |                  | $ | 7,111    |  
|                                                                                                                                                        |  |                  |          |   |                  |   |          |  
|                                                                                                                                                        |  |                 
|LIABILITIES AND STOCKHOLDERS DEFICIT                                                                                                                   |  |                  |          |   |                  |   |          |  
|Current liabilities:                                                                                                                                    |  |                  |          |   |                  |   |          |  
|Accounts payable and accrued liabilities                                                                                                                |  | $                | 2,896    |   |                  | $ | 1,729    |  
|Current portion of notes payable to related party                                                                                                       |  |                  |         |   |                  |   | 530      |  
|                                                                                                                                                        |  |                  |          |   |                  |   |          |  
|Total current liabilities                                                                                                                               |  |                  | 2,896    |   |                  |   | 2,259    |  
|Other long-term liabilities                                                                                                                             |  |                  | 319      |   |                  |   | 355      |  
|Notes payable to related party                                                                                                                          |  |                  | 37,204   |   |                  |   | 34,797   |  
|                                                                                                                                                        |  |                  |          |   |                  |   |          |  
|Total liabilities                                                                                                                                       |  |                  | 40,419   |   |                  |   | 37,411   |  
|                                                                                                                                                        |  |                  |          |   |                  |   |          |  
|Commitments and Contingencies (Notes 8 and 12)                                                                                                          |  |                  |         |   |                  |   |         |  
|Stockholders 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 255,489,847 and 255,480,847 shares in 2008 and 2007,
respectively |  |                  | 26       |   |                  |   | 26       |  
|Additional paid-in capital                                                                                                                              |  |                  | 123,167  |   |                  |   | 123,088  |  
|Accumulated deficit                                                                                                                                     |  |                  | (156,931 | ) |                  |   | (153,414 | )
|                                                                                                                                                        |  |                  |          |   |                  |   |          |  
|Total stockholders deficit                                                                                                                             |  |                  | (33,738  | ) |                  |   | (30,300  | )
|                                                                                                                                                        |  |                  |          |   |                  |   |          |  
|Total liabilities and stockholders deficit                                                                                                             |  | $                | 6,681    |   |                  | $ | 7,111    |  
|                                                                                                                                                        |  |                  |          |   |                  |   |          |  

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



F-3



---

##### Table of Contents

DIGITAL LIGHTWAVE, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

For The Years Ended December 31, 2008 and 2007

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



|                                                                 |  |      |             |   |      |   |             |  
|---------------------------------------------------------------- |  | ---- | ----------- | - | ---- | - | ----------- | -
|                                                                 |  | 2008 |             |   | 2007 |  
|Net sales                                                        |  | $    | 10,776      |   |      | $ | 12,058      |  
|Cost of goods sold                                               |  |      | 6,216       |   |      |   | 6,118       |  
|                                                                 |  |      |             |   |      |   |             |  
|Gross profit                                                     |  |      | 4,560       |   |      |   | 5,940       |  
|                                                                 |  |      |             |   |      |   |             |  
|Operating expenses:                                              |  |      |             |   |      |   |             |  
|Engineering and development                                      |  |      | 2,183       |   |      |   | 2,024       |  
|Sales and marketing                                              |  |      | 2,800       |   |      |   | 2,338       |  
|General and administrative                                       |  |      | 1,059       |   |      |   | 1,121       |  
|Gain on sale of property and equipment                           |  |      |            |   |      |   | (265        | )
|Impairment of long-lived assets                                  |  |      |            |   |      |   | 19          |  
|                                                                 |  |      |             |   |      |   |             |  
|Total operating expenses                                         |  |      | 6,042       |   |      |   | 5,237       |  
|                                                                 |  |      |             |   |      |   |             |  
|Operating income (loss)                                          |  |      | (1,482      | ) |      |   | 703         |  
|                                                                 |  |      |             |   |      |   |             |  
|Other expenses:                                                  |  |      |             |   |      |   |             |  
|Interest expense                                                 |  |      | (2,018      | ) |      |   | (3,186      | )
|Other expense                                                    |  |      | (17         | ) |      |   | (68         | )
|                                                                 |  |      |             |   |      |   |             |  
|Total other expense                                              |  |      | (2,035      | ) |      |   | (3,254      | )
|                                                                 |  |      |             |   |      |   |             |  
|Loss before income taxes                                         |  |      | (3,517      | ) |      |   | (2,551      | )
|Provision for income taxes                                       |  |      |            |   |      |   |            |  
|                                                                 |  |      |             |   |      |   |             |  
|Net loss                                                         |  | $    | (3,517      | ) |      | $ | (2,551      | )
|                                                                 |  |      |             |   |      |   |             |  
|                                                                 |  |     
|Basic and diluted net loss per share                             |  | $    | (0.01       | ) |      | $ | (0.01       | )
|                                                                 |  |      |             |   |      |   |             |  
|Weighted average common and common equivalent shares outstanding |  |      | 255,488,224 |   |      |   | 253,661,021 |  
|                                                                 |  |      |             |   |      |   |             |  

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



F-4



---

##### Table of Contents

DIGITAL LIGHTWAVE, INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY (DEFICIT) AND COMPREHENSIVE LOSS

For The Years Ended December 31, 2008 and 2007

(In thousands, except
share data)



|                                                                                  |  |              |  |                          |    |                    |   |         |                   |   |          |       |  |   |        |   |  |   |         |  
|--------------------------------------------------------------------------------- |  | ------------ |  | ------------------------ | -- | ------------------ | - | ------- | ----------------- | - | -------- | ----- |  | - | ------ | - |  | - | ------- | -
|                                                                                  |  | Common Stock |  | AdditionalPaid-InCapital |    | AccumulatedDeficit |   |         | ComprehensiveLoss |   |          | Total | 
|                                                                                  |  | Shares       |  | Amount                   |    |                    |   |        
|Balance December 31, 2006                                                         |  | 35,241,831   |  | $                        | 3  |                    | $ | 87,982  |                   | $ | (150,863 | )     |  |   |        |   |  | $ | (62,878 | )
|Comprehensive loss:                                                               |  |              |  |                          |    |                    |   |         |                   |   |          |       |  |   |        |   |  |   |         |  
|                                                                                  |  |              |  |                          |    |                   
|Net loss                                                                          |  |             |  |                          |   |                    |   |        |                   |   | (2,551   | )     |  |   | (2,551 | ) |  |   | (2,551  | )
|                                                                                  |  |              |  |                          |    |                    |   |         |                   |   |          |       |  |   |        |   |  |   |         |  
|Comprehensive loss                                                                |  |              |  |                          |    |                    |   |         |                   |   |          |       |  | $ | (2,551 | ) |  |   |         |  
|                                                                                  |  |              |  |                          |    |                    |   |         |                   |   |          |       |  |   |        |   |  |   |         |  
|                                                                                  |  |              |  |                          |    |                   
|Non cash sale from related party                                                  |  |             |  |                          |   |                    |   | 55      |                   |   |         |       |  |   |        |   |  |   | 55      |  
|Contributed services from related party                                           |  |             |  |                          |   |                    |   | 211     |                   |   |         |       |  |   |        |   |  |   | 211     |  
|Issuance of common stock                                                          |  | 16,501       |  |                          |   |                    |   | 3       |                   |   |         |       |  |   |        |   |  |   | 3       |  
|Conversion of notes payable to related party and accrued interest to common stock |  | 220,222,515  |  |                          | 23 |                    |   | 34,751  |                   |   |         |       |  |   |        |   |  |   | 34,774  |  
|                                                                                  |  |              |  |                          |    |                   
|Stock compensation expense                                                        |  |             |  |                          |   |                    |   | 86      |                   |   |         |       |  |   |        |   |  |   | 86      |  
|                                                                                  |  |              |  |                          |    |                    |   |         |                   |   |          |       |  |   |        |   |  |   |         |  
|Balance December 31, 2007                                                         |  | 255,480,847  |  | $                        | 26 |                    | $ | 123,088 |                   | $ | (153,414 | )     |  |   |        |   |  | $ | (30,300 | )
|                                                                                  |  |              |  |                          |    |                    |   |         |                   |   |          |       |  |   |        |   |  |   |         |  
|Comprehensive loss:                                                               |  |              |  |                          |    |                    |   |         |                   |   |          |       |  |   |        |   |  |   |         |  
|Net loss                                                                          |  |              |  |                          |    |                    |   |         |                   |   | (3,517   | )     |  |   | (3,517 | ) |  |   | (3,517  | )
|                                                                                  |  |              |  |                          |    |                    |   |         |                   |   |          |       |  |   |        |   |  |   |         |  
|Comprehensive loss                                                                |  |              |  |                          |    |                    |   |         |                   |   |          |       |  | $ | (3,517 | ) |  |   |         |  
|                                                                                  |  |              |  |                          |    |                    |   |         |                   |   |          |       |  |   |        |   |  |   |         |  
|Contributed services from related party                                           |  |              |  |                          |    |                    |   | 76      |                   |   |          |       |  |   |        |   |  |   | 76      |  
|Issuance of common stock                                                          |  | 9,000        |  |                          |   |                    |   | 1       |                   |   |          |       |  |   |        |   |  |   | 1       |  
|Stock compensation expense                                                        |  |              |  |                          |    |                    |   | 2       |                   |   |          |       |  |   |        |   |  |   | 2       |  
|                                                                                  |  |              |  |                          |    |                    |   |         |                   |   |          |       |  |   |        |   |  |   |         |  
|Balance December 31, 2008                                                         |  | 255,489,847  |  | $                        | 26 |                    | $ | 123,167 |                   | $ | (156,931 | )     |  |   |        |   |  | $ | (33,738 | )
|                                                                                  |  |              |  |                          |    |                    |   |         |                   |   |          |       |  |   |        |   |  |   |         |  

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

For The Years Ended December 31, 2008 and 2007

(In thousands)



|                                                                                       |  |      |        |   |      |   |        |  
|-------------------------------------------------------------------------------------- |  | ---- | ------ | - | ---- | - | ------ | -
|                                                                                       |  | 2008 |        |   | 2007 |  
|Cash flows from operating activities:                                                  |  |      |        |   |      |   |        |  
|Net loss                                                                               |  | $    | (3,517 | ) |      | $ | (2,551 | )
|Adjustments to reconcile net loss to cash used in operating activities:                |  |      |        |   |      |   |        |  
|Gain on sale of property and equipment                                                 |  |      |       |   |      |   | (265   | )
|Deprecation and amortization                                                           |  |      | 54     |   |      |   |       |  
|Provision for excess and obsolete inventory                                            |  |      | 642    |   |      |   |       |  
|Impairment of long-lived assets                                                        |  |      |       |   |      |   | 19     |  
|Contributed services from related party                                                |  |      | 76     |   |      |   | 211    |  
|Stock compensation expense                                                             |  |      | 2      |   |      |   | 86     |  
|Changes in operating assets and liabilities:                                           |  |      |        |   |      |   |        |  
|Accounts receivable                                                                    |  |      | 2,141  |   |      |   | (1,486 | )
|Inventories                                                                            |  |      | (2,382 | ) |      |   | (111   | )
|Prepaid expenses and other assets                                                      |  |      | (22    | ) |      |   | 104    |  
|Accounts payable, accrued expenses and other liabilities                               |  |      | 1,988  |   |      |   | 2,551  |  
|                                                                                       |  |      |        |   |      |   |        |  
|Net cash used in operating activities                                                  |  |      | (1,018 | ) |      |   | (1,442 | )
|                                                                                       |  |      |        |   |      |   |        |  
|Cash flows from investing activities:                                                  |  |      |        |   |      |   |        |  
|Proceeds from sale of property and equipment                                           |  |      |       |   |      |   | 265    |  
|Purchases of property and equipment                                                    |  |      |       |   |      |   | (19    | )
|                                                                                       |  |      |        |   |      |   |        |  
|Net cash provided by (used in) investing activities                                    |  |      |       |   |      |   | 246    |  
|                                                                                       |  |      |        |   |      |   |        |  
|Cash flows from financing activities:                                                  |  |      |        |   |      |   |        |  
|Proceeds from notes payablerelated party                                              |  |      | 1,800  |   |      |   | 1,055  |  
|Principal payments on notes payableother                                              |  |      |       |   |      |   | (50    | )
|Principal payments on notes payablerelated party                                      |  |      | (780   | ) |      |   | (225   | )
|Proceeds from sale of common stock, net of expense                                     |  |      | 1      |   |      |   | 3      |  
|                                                                                       |  |      |        |   |      |   |        |  
|Net cash provided by financing activities                                              |  |      | 1,021  |   |      |   | 783    |  
|                                                                                       |  |      |        |   |      |   |        |  
|Net increase (decrease) in cash and cash equivalents                                   |  |      | 3      |   |      |   | (413   | )
|Cash and cash equivalents at beginning of period                                       |  |      | 12     |   |      |   | 425    |  
|                                                                                       |  |      |        |   |      |   |        |  
|Cash and cash equivalents at end of period                                             |  | $    | 15     |   |      | $ | 12     |  
|                                                                                       |  |      |        |   |      |   |        |  
|                                                                                       |  |     
|Supplemental disclosures of non cash activities:                                       |  |      |        |   |      |   |        |  
|Accrued interest transferred to notes payable to related party                         |  | $    | 857    |   |      |   |       |  
|Debt and accrued interest converted into common stock                                  |  | $    |       |   |      | $ | 34,774 |  
|Reduction of interest payable from sale of property and equipment                      |  | $    |       |   |      | $ | 265    |  
|Inventory used as demonstration and rental units transferred to property and equipment |  | $    | 1,004  |   |      | $ |       |  
|                                                                                       |  |     
|Supplemental disclosures of cash flow information:                                     |  |      |        |   |      |   |        |  
|Cash paid for interest                                                                 |  | $    | 696    |   |      | $ | 55     |  

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



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##### Table of Contents

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

On April 4, 2008, the Company and Optel
Capital, LLC (Optel) entered into a Credit and Restructuring Agreement (the Credit Agreement) pursuant to which (a) the Companys existing indebtedness owed to Optel, consisting of approximately $28.0 million of
principal, which bore interest at 10% per annum, and accrued interest thereon of approximately $7.7 million, all of which was due and payable upon demand by Optel, was restructured and (b) Optel agreed to make a $2.5 million revolving
credit facility available to the Company. The Credit Agreement was approved by the Companys board of directors upon the unanimous recommendation of a special committee of the board comprised solely of independent directors.

Pursuant to the Credit Agreement, the restructured indebtedness is evidenced by a new secured convertible promissory note in the principal amount of approximately $35.7
million (the Restated Note), and the revolving credit facility is evidenced by an additional secured convertible promissory note in the principal amount of $2.5 million (the New Commitment Note and, together with the Restated
Note, the Notes). As of March 9, 2009, the balance of the Restated Note and New Commitment Note was $35.7 million and $2.5 million, respectively. The Notes bear interest at a rate equal to LIBOR plus 1.0% per annum and are
secured by substantially all the Companys assets pursuant to an amended and restated security agreement (the Security Agreement). Each of the Notes requires quarterly payments of interest commencing on June 30, 2008, and
matures on March 31, 2010.

All the indebtedness evidenced by the Notes is convertible into common stock of the Company at the option of Optel at any
time following approval of the conversion feature by the disinterested stockholders at a conversion price based on the average trading price of the stock during the five-day period preceding the date of any conversion. The Company and Optel have
made it a condition to the indebtedness evidenced by the Notes becoming convertible, that the conversion feature be approved by the holders of a majority of the outstanding shares of common stock of the Company who are not affiliated with Optel or
any of its affiliates at the Companys 2009 annual meeting of stockholders. If such holders do not approve the conversion feature, the outstanding debt and accrued interest would immediately become due and payable in full upon demand by Optel
at any time after the stockholders meeting.

On March 26, 2009 and March 30, 2009, the Company borrowed $200,000 and $225,000, respectively
from Optel to fund its working capital requirements. The loans are evidenced by a secured promissory notes that bears interest at 10.0% per annum and are secured by a security interest in substantially all of the Companys assets.
Principal and any accrued but unpaid interest under the secured promissory notes are due and payable upon demand by Optel at any time after May 31, 2009; provided, however, that the entire unpaid principal amount of the loan, together with
accrued but unpaid interest, shall become immediately due and payable upon demand by Optel at any time on or following the occurrence of certain events as defined by the notes.

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. The accompanying financial
statements do not reflect any adjustments that might result from the outcome of this uncertainty.



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##### Table of Contents

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 leased 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.

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, 2007, the Company incurred a $19,000 impairment charge. During the year ended December 31, 2008, the Company incurred no impairment charges.

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 for the years ended
December 31, 2008 and 2007 are summarized as follows:



|                   |  |                |      |   |      |   |      |  
|------------------ |  | -------------- | ---- | - | ---- | - | ---- | -
|                   |  | 2008           |      |   | 2007 |  
|                   |  | (In thousands) |     
|Beginning balance  |  | $              | 471  |   |      | $ | 487  |  
|Warranty provision |  |                | 157  |   |      |   | 147  |  
|Warranty costs     |  |                | (290 | ) |      |   | (163 | )
|                   |  |                |      |   |      |   |      |  
|Ending balance     |  | $              | 338  |   |      | $ | 471  |  
|                   |  |                |      |   |      |   |      |  

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.



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##### Table of Contents

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.

The Company sells extended warranty contracts. Revenue is recognized over the period of the extended warranty after the
expiration of the initial warranty. In 2007 the Company began selling software maintenance agreements for its NIC product line. These agreements extend the software maintenance period two or three years from the expiration of the initial software
maintenance period provided with each unit sold. Revenue from these contracts is recognized on a monthly basis beginning after the initial period has expired.

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 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 Statement of Financial Accounting Standards (SFAS) No. 153 Exchanges of Non- monetary Assetsand Accounting Principles Board (APB) 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, 2008 and 2007, the Company recorded approximately
$518,000 and $1.3 million, of 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 collectability 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 collectability 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.

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.

Reserve For Uncollectible Accounts

The Company estimates the collectability 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.



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##### Table of Contents

Reserve for uncollectible accounts for the year ended December 31, 2008 and 2007 are summarized as follows:



|                               |  |                |    |   |      |   |    |  
|------------------------------ |  | -------------- | -- | - | ---- | - | -- | -
|                               |  | 2008           |    |   | 2007 |  
|                               |  | (In Thousands) |   
|Balance at Beginning of Period |  | $              | 77 |   |      | $ | 84 |  
|Write-offs                     |  |                | (1 | ) |      |   | (7 | )
|                               |  |                |    |   |      |   |    |  
|Balance at End of Period       |  | $              | 76 |   |      | $ | 77 |  
|                               |  |                |    |   |      |   |    |  

Engineering 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.

The Company follows the provisions of the Financial Accounting Standards Board (FASB) Interpretation No. 48, Accounting for Uncertainty in Income
Taxes (FIN 48), an interpretation of SFAS No. 109, Accounting for Income Taxes (SFAS 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 SFAS 109.

Shipping and Handling Costs

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

Computation of Net Loss Per Share

Basic net loss per share is based on the weighted average number of common shares outstanding during the periods presented. For all the years presented,
diluted net 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. There were no incremental shares from common
stock equivalents during the years ended December 31, 2008 and 2007. Total outstanding stock options of 2,100,000, and 2,509,000, shares for the years ended December 31, 2008 and 2007, 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:



|                                                |  |                  |  |                 
|----------------------------------------------- |  | ---------------- |  | ----------------
|                                                |  | December 31,2008 |  | December 31,2007
|Basic:                                          |  |                  |  |                 
|Weighted average common shares outstanding      |  | 255,488,224      |  | 253,661,021     
|                                                |  |                  |  |                 
|Total basic                                     |  | 255,488,224      |  | 253,661,021     
|Diluted:                                        |  |                  |  |                 
|Incremental shares for common stock equivalents |  |                 |  |                
|                                                |  |                  |  |                 
|Total dilutive                                  |  | 255,488,224      |  | 253,661,021     
|                                                |  |                  |  |                 



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##### Table of Contents

Concentrations of Credit Risk

Financial instruments that potentially subject the Company to concentrations of credit risk consist principally of cash and accounts receivable. As of December 31, 2008 and 2007, 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, 2008 one customer accounted for 14.5% of net sales. For the year ended December 31, 2007, one
customer accounted for approximately 11% 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. The Companys international sales represented approximately 36% and 32% of total net sales for the years ended 2008 and 2007, respectively.

Fair Value of Financial Instruments

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

Stock Based Compensation

The Company applies the provisions of SFAS No.123 (revised 2004), Share-Based
Payment, (SFAS 123R) which requires the Company to recognize expense related to the fair value of stock-based compensation awards, including employee stock options.

The Company consistently used the Black-Scholes option pricing model for estimating the fair value of options granted. 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 Company had $2,000 and $86,000 of
compensation cost for stock-based employee compensation for the years ended December 31, 2008 and 2007, respectively. No tax benefits were recognized for these costs due to recurring losses.

Segment Reporting

As of December 31, 2008, 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 December 2007, the FASB issued SFAS No. 141 (revised 2007), Business Combinations (SFAS
141 (R)). SFAS 141 (R) provides revised guidance for recognizing and measuring identifiable assets and goodwill acquired, liabilities assumed and any noncontrolling interest in the acquiree. It also provides disclosure requirements to
enable users of the financial statements to evaluate the nature and financial effects of the business combination. SFAS 141 (R) is effective for financial statements issued for fiscal years beginning after December 15, 2008. The Company
does not expect the adoption of SFAS 141 (R) will have a material effect on the Companys future financial position or results of operations.

In
December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated Financial StatementsAn Amendment of Accounting Research Bulletin No. 51 (SFAS 160). The standard changes the accounting for
noncontrolling (minority) interests in Consolidated Financial Statements including the requirements to classify noncontrolling interests as a component of consolidated stockholders equity, and the elimination of minority interest
accounting in results of operations with earnings attributable to noncontrolling interests reported as part of consolidated earnings. The provisions of SFAS 160 are effective for fiscal years beginning after December 15, 2008, with early
adoption prohibited. The Company does not expect the adoption of SFAS 160 will have a material impact on its financial statements.



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In March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities
 an amendment to FASB Statement No. 133, (SFAS 161). SFAS 161 is intended to improve financial standards for derivative instruments and hedging activities by requiring enhanced disclosures to enable investors to better
understand their effects on an entitys financial position, financial performance, and cash flows. Entities are required to provide enhanced disclosures about: (a) how and why an entity uses derivative instruments; (b) how derivative
instruments and related hedged items are accounted for under Statement 133 and its related interpretations; and (c) how derivative instruments and related hedged items affect an entitys financial position, financial performance, and cash
flows. It is effective for financial statements issued for fiscal years beginning after November 15, 2008. The Company does not expect the adoption of SFAS 161 will have a material impact on its financial statements.

2. INVENTORIES

Net inventories at December 31, 2008 and 2007
are summarized as follows:



|               |  |                |       |      |   |      
|-------------- |  | -------------- | ----- | ---- | - | -----
|               |  | 2008           |       | 2007
|               |  | (In thousands)
|Raw materials  |  | $              | 3,425 |      | $ | 2,706
|Finished goods |  |                | 151   |      |   | 134  
|               |  |                |       |      |   |      
|               |  | $              | 3,576 |      | $ | 2,840
|               |  |                |       |      |   |      

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 products are sourced from a single or a limited number of suppliers. The loss of a
supplier for any of these key components could seriously disrupt our operations.

The total reserve balance for inventory at December 31, 2008 and
2007 approximated $14.1 million and $13.9 million, respectively. When evaluating the adequacy of the reserve for excess and obsolete inventory and lower cost or market, 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, 2008 and 2007, is adequate.

As of December 31, 2008 and 2007, inventories included approximately $896,000 and $940,000, respectively of trade-in products, which are fully reserved.

Reserves activity for excess and obsolete inventory for the years ended December 31, 2008 and 2007 are summarized as follows:



|                               |  |                |        |   |      |   |        |  
|------------------------------ |  | -------------- | ------ | - | ---- | - | ------ | -
|                               |  | 2008           |        |   | 2007 |  
|                               |  | (In Thousands) |       
|Balance at beginning of period |  | $              | 13,912 |   |      | $ | 15,468 |  
|Charged to costs and expenses  |  |                | 642    |   |      |   |       |  
|Write-offs or disposals        |  |                | (462   | ) |      |   | (1,556 | )
|                               |  |                |        |   |      |   |        |  
|Balance at end of period       |  | $              | 14,092 |   |      | $ | 13,912 |  
|                               |  |                |        |   |      |   |        |  



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##### Table of Contents

3. PROPERTY AND EQUIPMENT

Property and equipment at December 31, 2008 and 2007 are summarized as follows:



|                                                                        |  |                |         |   |      |   |         |  
|----------------------------------------------------------------------- |  | -------------- | ------- | - | ---- | - | ------- | -
|                                                                        |  | 2008           |         |   | 2007 |  
|                                                                        |  | (in thousands) |        
|Test equipment                                                          |  | $              | 6,188   |   |      | $ | 6,272   |  
|Demonstration and loaner units                                          |  |                | 4,428   |   |      |   | 3,244   |  
|Computer equipment and software                                         |  |                | 4,705   |   |      |   | 4,716   |  
|Office furniture, fixtures and equipment                                |  |                | 936     |   |      |   | 2,264   |  
|Leasehold improvements                                                  |  |                | 19      |   |      |   | 19      |  
|Tooling                                                                 |  |                | 1,028   |   |      |   | 1,028   |  
|Tradeshow fixtures and equipment                                        |  |                | 359     |   |      |   | 359     |  
|                                                                        |  |                |         |   |      |   |         |  
|                                                                        |  |                | 17,663  |   |      |   | 17,902  |  
|                                                                        |  |               
|Less: accumulated depreciation and impairment of property and equipment |  |                | (16,713 | ) |      |   | (17,902 | )
|                                                                        |  |                |         |   |      |   |         |  
|                                                                        |  | $              | 950     |   |      | $ |        |  
|                                                                        |  |                |         |   |      |   |         |  

4. ACCOUNTS PAYABLE AND ACCRUED LIABILITIES

Accounts payable and accrued liabilities at December 31, 2008 and 2007 are summarized as follows:



|                                    |  |                |       |      |   |      
|----------------------------------- |  | -------------- | ----- | ---- | - | -----
|                                    |  | 2008           |       | 2007
|                                    |  | (in thousands)
|Accounts payable                    |  | $              | 1,394 |      | $ | 657  
|Interest payable                    |  |                | 465   |      |   |     
|Current portion of accrued warranty |  |                | 179   |      |   | 243  
|Employee related accruals           |  |                | 213   |      |   | 160  
|Accrued returns and allowances      |  |                |      |      |   | 54   
|Sales tax accruals                  |  |                | 203   |      |   | 219  
|Accrued expenses and other          |  |                | 94    |      |   | 73   
|Deferred revenue                    |  |                | 272   |      |   | 217  
|Accrued sales commissions           |  |                | 76    |      |   | 106  
|                                    |  |                |       |      |   |      
|                                    |  | $              | 2,896 |      | $ | 1,729
|                                    |  |                |       |      |   |      



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5. INCOME TAXES

For
the years ended December 31, 2008 and 2007, 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, 2008 and 2007 are summarized as follows:



|                                      |  |                |          |   |      |   |          |  
|------------------------------------- |  | -------------- | -------- | - | ---- | - | -------- | -
|                                      |  | 2008           |          |   | 2007 |  
|                                      |  | (in thousands) |         
|Current:                              |  |                |          |   |      |   |          |  
|Deferred tax assets:                  |  |                |          |   |      |   |          |  
|Accrued liabilities                   |  | $              | 3,630    |   |      | $ | 3,177    |  
|Other assets                          |  |                | 5,365    |   |      |   | 5,264    |  
|Valuation allowance                   |  |                | (8,995   | ) |      |   | (8,441   | )
|                                      |  |                |          |   |      |   |          |  
|Total current deferred tax assets     |  | $              |         |   |      | $ |         |  
|                                      |  |                |          |   |      |   |          |  
|Non-current:                          |  |                |          |   |      |   |          |  
|Deferred tax assets:                  |  |                |          |   |      |   |          |  
|Net operating loss carry forward      |  |                | 142,298  |   |      |   | 141,256  |  
|Fixed assets                          |  |                | 424      |   |      |   | 272      |  
|Research and experimentation credit   |  |                | 4,140    |   |      |   | 4,140    |  
|Valuation allowance                   |  |                | (146,862 | ) |      |   | (145,668 | )
|                                      |  |                |          |   |      |   |          |  
|Total non-current deferred tax assets |  | $              |         |   |      | $ |         |  
|                                      |  |                |          |   |      |   |          |  

A full valuation allowance has been recorded at December 31, 2008 and 2007 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. 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 attain long-term profitability.

The Company had a valuation allowance of approximately
$155.9 million and $154.1 million as of December 31, 2008, and 2007, 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, 2008, the Company had net operating loss carry-forwards of approximately $378 million for tax purposes. The Company has recorded taxable deductions for the exercise of stock options and for certain
securities litigation costs for which the benefit of approximately $90 million has 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 and if the tax benefit is realized. Loss
carry-forwards will expire between the years 2008 and 2024.As of December 31, 2008, the Company also had general business credit carry-forwards of approximately $4.1 million that expire between the years 2008 and 2021.

The Company has not recorded any unrecognized tax positions as of December 31, 2008 and 2007. There is a possibility that a limitation on the
Companys net operating loss carry-forwards may have come into effect under Section 382 of the Internal Revenue Code as a result of cumulative stock ownership changes. As of December 31, 2008 and 2007, the impact of such a
limitation has no impact on the accompanying financial statements since all net operating losses have a full valuation allowance; however, such a limitation could impact substantially the reported gross asset related to the net operating loss
carry-forwards.



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The 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.



|                                              |  |                  |        |   |                  |   |       |  
|--------------------------------------------- |  | ---------------- | ------ | - | ---------------- | - | ----- | -
|                                              |  | December 31,2008 |        |   | December 31,2007 |  
|                                              |  | ( in thousands)  |       
|Tax provision at U.S. federal income tax rate |  | $                | (1,196 | ) |                  | $ | (867  | )
|State income tax provision net of federal     |  |                  | (128   | ) |                  |   | (93   | )
|Adjustment to net operating loss carryforward |  |                  | (650   | ) |                  |   | 1,339 |  
|Net operating losses expiring in current year |  |                  | 188    |   |                  |   |      |  
|Other, net                                    |  |                  | 36     |   |                  |   | 10    |  
|Valuation allowance increase (decrease)       |  |                  | 1,750  |   |                  |   | (389  | )
|                                              |  |                  |        |   |                  |   |       |  
|Provision for income taxes                    |  | $                |       |   |                  | $ |      |  
|                                              |  |                  |        |   |                  |   |       |  

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

Through April 2008, the Company funded operations and other working capital requirements with short-term notes payable. The principal lender is Optel, an entity
controlled by the Companys largest stockholder and current chairman of the board of directors, Dr. Bryan J. Zwan.

On April 4, 2008,
the Company and Optel Capital, LLC (Optel) entered into a Credit and Restructuring Agreement (the Credit Agreement) pursuant to which (a) the Companys existing indebtedness owed to Optel, consisting of
approximately $28.0 million of principal, which bore interest at 10% per annum, and accrued interest thereon of approximately $7.7 million, all of which was due and payable upon demand by Optel, was restructured and (b) Optel agreed to
make a $2.5 million revolving credit facility available to the Company. Optel is controlled by Dr. Bryan J. Zwan, the Companys largest stockholder and chairman of the board of directors. The Credit Agreement was approved by the Companys
board of directors upon the unanimous recommendation of a special committee of the board comprised solely of independent directors.

Pursuant to the Credit
Agreement, the restructured indebtedness is evidenced by a new secured convertible promissory note in the principal amount of approximately $35.7 million (the Restated Note), and the revolving credit facility is evidenced by an
additional secured convertible promissory note in the principal amount of $2.5 million (the New Commitment Note and, together with the Restated Note, the Notes). As of March 9, 2009, the balance of the Restated Note and
New Commitment Note was $35.7 million and $2.5 million, respectively. The Notes bear interest at a rate equal to LIBOR plus 1.0% per annum and are secured by substantially all the Companys assets pursuant to an amended and restated
security agreement (the Security Agreement). During the year ended December 31, 2008 and 2007, interest expense related to the Notes was approximately $2.0 and $3.2 million, respectively and recorded in other expense on the
Consolidated Statements of Operations. As of December 31, 2008, accrued interest associated with the Notes of $465,000 is recorded in accounts payable and accrued liabilities on the Consolidated Balance Sheets. Each of the Notes requires
quarterly payments of interest commencing on June 30, 2008, and matures on March 31, 2010. Interest payments of approximately $321,000, $353,000 and $465,000 were made July 1, 2008, October 1, 2008 and January 5, 2009,
respectively.

All the indebtedness evidenced by the Notes is convertible into common stock of the Company at the option of Optel at any time following
approval of the conversion feature by the disinterested stockholders at a conversion price equal to the greater of $0.01 or the average trading price of the stock during the five-day period preceding the date of any conversion. The Company and Optel
have made it a condition to the indebtedness evidenced by the Notes becoming convertible, that the conversion feature be approved by the holders of a majority of the outstanding shares of common stock of the Company who are not affiliated with Optel
or any of its affiliates at the Companys 2009 annual meeting of stockholders. If such holders do not approve the conversion feature, the outstanding debt and accrued interest shall immediately become due and payable in full upon demand by
Optel at any time after the stockholders meeting.

Pursuant to a Registration Rights Agreement entered into in connection with the Credit Agreement,
the Company has agreed to file, upon written demand by Optel, a registration statement covering the resale by Optel of the shares of common stock issuable upon conversion of the Notes.

Optel maintains an irrevocable letter of credit in the amount of approximately $278,339 on the Companys behalf and naming Bay Vista TIC, the Companys landlord, as beneficiary. The letter of credit expires
July 31, 2011.



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7. LEASES

The
Company is obligated under various non-cancelable leases primarily for office space. Total rent expense was approximately $299,000 and $349,000 for the years ended December 31, 2008 and 2007, respectively. Future minimum lease commitments under
operating leases were as follows:



|            |  |                    |    
|----------- |  | ------------------ | ---
|Year Ending |  | December 31,Amount
|            |  | (in thousands)    
|2009        |  |                    | 283
|2010        |  |                    | 294
|2011        |  |                    | 175
|Thereafter  |  |                    |   
|            |  |                    |    
|            |  | $                  | 752
|            |  |                    |    

8. COMMITMENTS

At December 31, 2008, the Company had outstanding non-cancelable purchase order commitments to purchase certain inventory items totaling approximately $685,000. 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, 2008 and 2007, the Company has not recorded a liability for any obligations arising as a result of these indemnifications.

9. RELATED
PARTY TRANSACTIONS

During 2008 and 2007, Optel provided the Company with approximately $76,000 and $211,000, respectively, in services associated with
information technology and administrative services. These services are shown as a contribution of capital and are expensed, within general and administration expense.

10. COMMON STOCK AND STOCK OPTIONS

Stock Option Plans

The Company has one stock 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 former 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) as stated above not to exceed 2,735,872 shares). The 2001 Option Plan superseded
the 1996 Option Plan with respect to future grants.

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 to a total of 8,000,000 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.

Options granted under the plan have a term of six years. Generally, option grants 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 on each anniversary of the grant date,
commencing with the first anniversary. 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.



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##### Table of Contents

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



|                        |  |           |   |  |                               |     
|----------------------- |  | --------- | - |  | ----------------------------- | ----
|                        |  | Shares    |   |  | WeightedAverageExercise Price
|Outstanding at 12/31/06 |  | 3,180,539 |   |  | $                             | 2.44
|Granted                 |  |          |   |  | $                             |    
|Exercised               |  |          |   |  | $                             |    
|Forfeited               |  | (671,539  | ) |  | $                             | 5.78
|                        |  |           |   |  |                               |     
|Outstanding at 12/31/07 |  | 2,509,000 |   |  | $                             | 1.54
|                        |  |           |   |  |                               |     
|Granted                 |  |          |   |  | $                             |    
|Exercised               |  |          |   |  | $                             |    
|Forfeited               |  | (409,000  | ) |  | $                             | 1.44
|                        |  |           |   |  |                               |     
|Outstanding at 12/31/08 |  | 2,100,000 |   |  | $                             | 1.56
|                        |  |           |   |  |                               |     

The following table summarizes information about stock options outstanding at December 31, 2008:



|                        |  |                                     |  |                                         |  |                                         |      |                                     |           |                                         |   |     
|----------------------- |  | ----------------------------------- |  | --------------------------------------- |  | --------------------------------------- | ---- | ----------------------------------- | --------- | --------------------------------------- | - | ----
|Range of Exercise Price |  | NumberOutstandingAtDecember 31,2008 |  | OutstandingWeightedAverageRemainingLife |  | OutstandingWeightedAverageExercisePrice |      | NumberExercisableAtDecember 31,2008 |           | ExercisableWeightedAverageExercisePrice
|$ 0.22 - $ 1.40         |  | 1,145,000                           |  | 1.70                                    |  | $                                       | 1.01 |                                     | 1,145,000 |                                         | $ | 1.01
|$ 1.60 - $ 2.26         |  | 955,000                             |  | 1.19                                    |  | $                                       | 2.23 |                                     | 955,000   |                                         | $ | 2.23
|                        |  |                                     |  |                                         |  |                                         |      |                                     |           |                                         |   |     
|                        |  | 2,100,000                           |  |                                         |  |                                         |      |                                     | 2,100,000 |                                         | $ | 1.56
|                        |  |                                     |  |                                         |  |                                         |      |                                     |           |                                         |   |     

There was no intrinsic value of options exercised for the years ended December 31, 2008 and 2007. As of
December 31, 2008, there was no unrecognized compensation cost related to non-vested options that is expected to be recognized in 2009. There was no intrinsic value of options fully vested or expected to vest at December 31, 2008.

Employee Stock Purchase Plan

The Companys 1997
Employee Stock Purchase Plan provided 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, 2008 a total
of 455,607 shares had been purchased by employees participating in the plan at a weighted-average price per share of $4.06. The plan expired on June 30, 2007.



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##### Table of Contents

11. 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, 2008 and 2007, total company contributions to the plan were approximately $58,000 and $66,000, respectively.

12.
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. 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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13. 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 31,2008                                   |             |   | June 30,2008 |   |             | September 30,2008 |  |   | December 31,2008 |  
|                                                                                   |  | (in thousands, except share and per-share data) |            
|Net sales                                                                          |  | $                                               | 2,596       |   |              | $ | 2,204       |                   |  | $ | 4,115            |   |  | $ | 1,861       |  
|Gross profit (1)                                                                   |  |                                                 | 1,105       |   |              |   | 903         |                   |  |   | 2,206            |   |  |   | 346         |  
|Operating profit (loss)                                                            |  |                                                 | (259        | ) |              |   | (591        | )                 |  |   | 730              |   |  |   | (1,362      | )
|Net loss                                                                           |  |                                                 | (1,104      | ) |              |   | (952        | )                 |  |   | 370              |   |  |   | (1,831      | )
|                                                                                   |  |                                                 |             |  
|Basic and diluted loss per share (2)                                               |  | $                                               | (0.00       | ) |              | $ | (0.00       | )                 |  | $ | 0.00             |   |  | $ | (0.01       | )
|                                                                                   |  |                                                 |             |  
|Weighted average shares outstanding and average shares and equivalents outstanding |  |                                                 | 255,484,160 |   |              |   | 255,489,006 |                   |  |   | 255,489,847      |   |  |   | 255,488,224 |  
|                                                                                   | 
|                                                                                   |  | Quarter Ended                                   |            
|                                                                                   |  | March 31,2007                                   |             |   | June 30,2007 |   |             | September 30,2007 |  |   | December 31,2007 |  
|                                                                                   |  | (in thousands, except share and per-share data) |            
|Net sales                                                                          |  | $                                               | 2,491       |   |              | $ | 3,385       |                   |  | $ | 2,305            |   |  | $ | 3,877       |  
|Gross profit                                                                       |  |                                                 | 1,361       |   |              |   | 1,747       |                   |  |   | 1,189            |   |  |   | 1,643       |  
|Operating loss                                                                     |  |                                                 | 197         |   |              |   | 330         |                   |  |   | (149             | ) |  |   | 325         |  
|Net loss                                                                           |  |                                                 | (603        | ) |              |   | (457        | )                 |  |   | (982             | ) |  |   | (509        | )
|                                                                                   |  |                                                 |             |  
|Basic and diluted loss per share (2)                                               |  | $                                               | (0.00       | ) |              | $ | (0.00       | )                 |  | $ | (0.00            | ) |  | $ | (0.00       | )
|                                                                                   |  |                                                 |             |  
|Weighted average shares outstanding and average shares and equivalents outstanding |  |                                                 | 248,124,730 |   |              |   | 255,467,346 |                   |  |   | 255,470,433      |   |  |   | 253,661,021 |  



|(1) | Gross profit for the fourth quarter of 2008 included a charge of $250,000 for an increase in inventory reserves.
|--- | ----------------------------------------------------------------------------------------------------------------

|(2) | Loss per share was calculated for each three-month period on a stand-alone basis.
|--- | ---------------------------------------------------------------------------------

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

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.



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