##### Table of Contents

---

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



---

FORM 10-Q



---

(Mark One)

|x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- | ---------------------------------------------------------------------------------------

For the quarterly period ended June 30, 2007, or



| ̈ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- | ----------------------------------------------------------------------------------------

For the transition period from
 to
.

000-21669

(Commission File Number)



---

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)                          

(727) 442-6677

(Registrants telephone number, including area code)

Not Applicable

(Former name, former address, and former fiscal year, if changed since last report)



---

Indicate by check mark whether the
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 period that the Registrant was required to file such report(s)),
and (2) has been subject to such filing requirements for the past 90 days.    YES  x    NO ̈

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

Large Accelerated Filer ̈Accelerated Filer ̈Non-Accelerated Filer  x

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

The number of shares outstanding of the Registrants Common Stock as of July 20, 2007, was 255,467,346.



---



---

##### Table of Contents

DIGITAL LIGHTWAVE, INC.

QUARTERLY REPORT ON FORM 10-Q

For the Period Ended June 30, 2007

INDEX



|                              |  |                                                                                                                  |  |     
|----------------------------- |  | ---------------------------------------------------------------------------------------------------------------- |  | ----
|                              |  |                                                                                                                  |  | Page
|PART I. FINANCIAL INFORMATION
|                              |  |                                                                                                                 
|Item 1.                       |  | Financial Statements:                                                                                            |  |     
|                              |  |                                                                                                                 
|                              |  | Consolidated Condensed Balance Sheets  June 30, 2007 (Unaudited) and December 31, 2006                          |  | 1   
|                              |  |                                                                                                                 
|                              |  | Consolidated Condensed Statements of Operations (Unaudited)  Three Months Ended June 30, 2007 and June 30, 2006 |  | 2   
|                              |  |                                                                                                                 
|                              |  | Consolidated Condensed Statements of Operations (Unaudited)  Six Months Ended June 30, 2007 and June 30, 2006   |  | 3   
|                              |  |                                                                                                                 
|                              |  | Consolidated Condensed Statements of Cash Flows (Unaudited)  Six Months Ended June 30, 2007 and June 30, 2006   |  | 4   
|                              |  |                                                                                                                 
|                              |  | Notes to Consolidated Condensed Financial Statements (Unaudited)                                                 |  | 5   
|                              |  |                                                                                                                 
|Item 2.                       |  | Managements Discussion and Analysis of Financial Condition and Results of Operations                            |  | 10  
|                              |  |                                                                                                                 
|Item 3.                       |  | Quantitative and Qualitative Disclosures About Market Risk                                                       |  | 16  
|                              |  |                                                                                                                 
|Item 4.                       |  | Controls and Procedures                                                                                          |  | 16  
|                             
|PART II. OTHER INFORMATION   
|                              |  |                                                                                                                 
|Item 1.                       |  | Legal Proceedings                                                                                                |  | 17  
|                              |  |                                                                                                                 
|Item 1A.                      |  | Risk Factors                                                                                                     |  | 17  
|                              |  |                                                                                                                 
|Item 2.                       |  | Unregistered Sales of Equity Securities and Use of Proceeds                                                      |  | 17  
|                              |  |                                                                                                                 
|Item 3.                       |  | Defaults Upon Senior Securities                                                                                  |  | 17  
|                              |  |                                                                                                                 
|Item 4.                       |  | Submission of Matters to a Vote of Security Holders                                                              |  | 17  
|                              |  |                                                                                                                 
|Item 5.                       |  | Other Information                                                                                                |  | 17  
|                              |  |                                                                                                                 
|Item 6.                       |  | Exhibits                                                                                                         |  | 17  
|                              | 
|SIGNATURES                    |  | 18                                                                                                              
|                              | 
|EXHIBIT INDEX                 |  | 19                                                                                                              



---

##### Table of Contents

PART I

FINANCIAL INFORMATION



|Item 1. | Financial Statements
|------- | --------------------

DIGITAL LIGHTWAVE, INC.

CONSOLIDATED CONDENSED BALANCE SHEETS

(In thousands, except share data)



|                                                                                                                                                       |  |               |          |   |                  |   |          |  
|------------------------------------------------------------------------------------------------------------------------------------------------------ |  | ------------- | -------- | - | ---------------- | - | -------- | -
|                                                                                                                                                       |  | June 30, 2007 |          |   | December 31,2006 |  
|                                                                                                                                                       |  | (Unaudited)   |          |   |                  |  
|ASSETS                                                                                                                                                 |  |               |          |   |                  |   |          |  
|Current assets:                                                                                                                                        |  |               |          |   |                  |   |          |  
|Cash and cash equivalents                                                                                                                              |  | $             | 24       |   |                  | $ | 425      |  
|Accounts receivable, less allowance of $84 in 2007 and 2006                                                                                            |  |               | 2,847    |   |                  |   | 2,385    |  
|Inventories, net                                                                                                                                       |  |               | 3,284    |   |                  |   | 2,729    |  
|Prepaid expenses and other current assets                                                                                                              |  |               | 366      |   |                  |   | 274      |  
|                                                                                                                                                       |  |               |          |   |                  |   |          |  
|Total current assets                                                                                                                                   |  |               | 6,521    |   |                  |   | 5,813    |  
|Other assets, net                                                                                                                                      |  |               | 221      |   |                  |   | 218      |  
|                                                                                                                                                       |  |               |          |   |                  |   |          |  
|Total assets                                                                                                                                           |  | $             | 6,742    |   |                  | $ | 6,031    |  
|                                                                                                                                                       |  |               |          |   |                  |   |          |  
|                                                                                                                                                       |  |              
|LIABILITIES AND STOCKHOLDERS DEFICIT                                                                                                                  |  |               |          |   |                  |   |          |  
|Current liabilities:                                                                                                                                   |  |               |          |   |                  |   |          |  
|Accounts payable and accrued liabilities                                                                                                               |  | $             | 2,051    |   |                  | $ | 2,232    |  
|Accrued interest payable to related party                                                                                                              |  |               | 5,222    |   |                  |   | 11,743   |  
|Notes payable to related party                                                                                                                         |  |               | 28,100   |   |                  |   | 54,645   |  
|Notes payable                                                                                                                                          |  |               |         |   |                  |   | 50       |  
|                                                                                                                                                       |  |               |          |   |                  |   |          |  
|Total current liabilities                                                                                                                              |  |               | 35,373   |   |                  |   | 68,670   |  
|Other long-term liabilities                                                                                                                            |  |               | 269      |   |                  |   | 239      |  
|                                                                                                                                                       |  |               |          |   |                  |   |          |  
|Total liabilities                                                                                                                                      |  |               | 35,642   |   |                  |   | 68,909   |  
|                                                                                                                                                       |  |               |          |   |                  |   |          |  
|Stockholders equity (deficit):                                                                                                                        |  |               |          |   |                  |   |          |  
|Preferred stock, $.0001 par value; authorized 20,000,000 shares; no shares issued or outstanding                                                       |  |               |         |   |                  |   |         |  
|Common stock, $.0001 par value; authorized 300,000,000 shares; issued and outstanding 255,467,346 and 35,240,331 shares in 2007 and 2006,
respectively |  |               | 26       |   |                  |   | 3        |  
|Additional paid-in capital                                                                                                                             |  |               | 122,997  |   |                  |   | 87,982   |  
|Accumulated deficit                                                                                                                                    |  |               | (151,923 | ) |                  |   | (150,863 | )
|                                                                                                                                                       |  |               |          |   |                  |   |          |  
|Total stockholders deficit                                                                                                                            |  |               | (28,900  | ) |                  |   | (62,878  | )
|                                                                                                                                                       |  |               |          |   |                  |   |          |  
|Total liabilities and stockholders deficit                                                                                                            |  | $             | 6,742    |   |                  | $ | 6,031    |  
|                                                                                                                                                       |  |               |          |   |                  |   |          |  

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



1



---

##### Table of Contents

DIGITAL LIGHTWAVE, INC.

CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS

(Unaudited)

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



|                                                                 |  |                             |             |   |      |   |            |  
|---------------------------------------------------------------- |  | --------------------------- | ----------- | - | ---- | - | ---------- | -
|                                                                 |  | Three Months Ended June 30, |            
|                                                                 |  | 2007                        |             |   | 2006 |  
|Net sales                                                        |  | $                           | 3,385       |   |      | $ | 1,992      |  
|Cost of goods sold                                               |  |                             | 1,638       |   |      |   | 1,698      |  
|                                                                 |  |                             |             |   |      |   |            |  
|Gross profit                                                     |  |                             | 1,747       |   |      |   | 294        |  
|                                                                 |  |                             |             |   |      |   |            |  
|Operating expenses:                                              |  |                             |             |   |      |   |            |  
|Engineering and development                                      |  |                             | 456         |   |      |   | 1,228      |  
|Sales and marketing                                              |  |                             | 647         |   |      |   | 525        |  
|General and administrative                                       |  |                             | 295         |   |      |   | 2,080      |  
|Gain on sale of property and equipment                           |  |                             |            |   |      |   |           |  
|Impairment of long lived assets                                  |  |                             | 19          |   |      |   |           |  
|                                                                 |  |                             |             |   |      |   |            |  
|Total operating expenses                                         |  |                             | 1,417       |   |      |   | 3,833      |  
|                                                                 |  |                             |             |   |      |   |            |  
|Operating profit (loss)                                          |  |                             | 330         |   |      |   | (3,539     | )
|Other expense, net                                               |  |                             | (787        | ) |      |   | (1,323     | )
|                                                                 |  |                             |             |   |      |   |            |  
|Loss before income taxes                                         |  |                             | (457        | ) |      |   | (4,862     | )
|Provision for income taxes                                       |  |                             |            |   |      |   |           |  
|                                                                 |  |                             |             |   |      |   |            |  
|Net loss                                                         |  | $                           | (457        | ) |      | $ | (4,862     | )
|                                                                 |  |                             |             |   |      |   |            |  
|Per share of common stock:                                       |  |                             |             |   |      |   |            |  
|Basic net loss per share                                         |  | $                           | (0.00       | ) |      | $ | (0.14      | )
|                                                                 |  |                             |             |   |      |   |            |  
|Diluted net loss per share                                       |  | $                           | (0.00       | ) |      | $ | (0.14      | )
|                                                                 |  |                             |             |   |      |   |            |  
|Weighted average common shares outstanding                       |  |                             | 255,467,346 |   |      |   | 35,226,400 |  
|                                                                 |  |                             |             |   |      |   |            |  
|Weighted average common and common equivalent shares outstanding |  |                             | 255,467,346 |   |      |   | 35,226,400 |  
|                                                                 |  |                             |             |   |      |   |            |  

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



2



---

##### Table of Contents

DIGITAL LIGHTWAVE, INC.

CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS

(Unaudited)

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



|                                                                 |  |                           |             |   |      |   |            |  
|---------------------------------------------------------------- |  | ------------------------- | ----------- | - | ---- | - | ---------- | -
|                                                                 |  | Six Months Ended June 30, |            
|                                                                 |  | 2007                      |             |   | 2006 |  
|Net sales                                                        |  | $                         | 5,876       |   |      | $ | 4,224      |  
|Cost of goods sold                                               |  |                           | 2,768       |   |      |   | 3,614      |  
|                                                                 |  |                           |             |   |      |   |            |  
|Gross profit                                                     |  |                           | 3,108       |   |      |   | 610        |  
|                                                                 |  |                           |             |   |      |   |            |  
|Operating expenses:                                              |  |                           |             |   |      |   |            |  
|Engineering and development                                      |  |                           | 975         |   |      |   | 2,883      |  
|Sales and marketing                                              |  |                           | 1,252       |   |      |   | 1,763      |  
|General and administrative                                       |  |                           | 600         |   |      |   | 2,884      |  
|Impairment of long-lived assets                                  |  |                           | 19          |   |      |   |           |  
|Gain on sale of property and equipment                           |  |                           | (265        | ) |      |   |           |  
|                                                                 |  |                           |             |   |      |   |            |  
|Total operating expenses                                         |  |                           | 2,581       |   |      |   | 7,530      |  
|                                                                 |  |                           |             |   |      |   |            |  
|Operating profit (loss)                                          |  |                           | 527         |   |      |   | (6,920     | )
|Other expense, net                                               |  |                           | (1,587      | ) |      |   | (2,703     | )
|                                                                 |  |                           |             |   |      |   |            |  
|Loss before income taxes                                         |  |                           | (1,060      | ) |      |   | (9,623     | )
|Provision for income taxes                                       |  |                           |            |   |      |   |           |  
|                                                                 |  |                           |             |   |      |   |            |  
|Net loss                                                         |  | $                         | (1,060      | ) |      | $ | (9,623     | )
|                                                                 |  |                           |             |   |      |   |            |  
|Per share of common stock:                                       |  |                           |             |   |      |   |            |  
|Basic net loss per share                                         |  | $                         | (0.00       | ) |      | $ | (0.27      | )
|                                                                 |  |                           |             |   |      |   |            |  
|Diluted net loss per share                                       |  | $                         | (0.00       | ) |      | $ | (0.27      | )
|                                                                 |  |                           |             |   |      |   |            |  
|Weighted average common shares outstanding                       |  |                           | 251,816,321 |   |      |   | 35,216,147 |  
|                                                                 |  |                           |             |   |      |   |            |  
|Weighted average common and common equivalent shares outstanding |  |                           | 251,816,321 |   |      |   | 35,216,147 |  
|                                                                 |  |                           |             |   |      |   |            |  

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



3



---

##### Table of Contents

DIGITAL LIGHTWAVE, INC.

CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS

(Unaudited)

(In thousands)



|                                                                        |  |                          |         |   |      |   |        |  
|----------------------------------------------------------------------- |  | ------------------------ | ------- | - | ---- | - | ------ | -
|                                                                        |  | Six Months EndedJune 30, |        
|                                                                        |  | 2007                     |         |   | 2006 |  
|Cash flows from operating activities:                                   |  |                          |         |   |      |   |        |  
|Net loss                                                                |  | $                        | (1,060  | ) |      | $ | (9,623 | )
|Adjustments to reconcile net loss to cash used in operating activities: |  |                          |         |   |      |   |        |  
|Compensation expense for stock option grants                            |  |                          | 66      |   |      |   | 305    |  
|Contributed services from related party                                 |  |                          | 143     |   |      |   |       |  
|Provision for excess and obsolete inventory                             |  |                          |        |   |      |   | 700    |  
|Impairment of long lived assets                                         |  |                          | 19      |   |      |   |       |  
|Gain on sale of property and equipment                                  |  |                          | (265    | ) |      |   |       |  
|Changes in operating assets and liabilities:                            |  |                          |         |   |      |   |        |  
|(Increase) decrease in accounts receivable                              |  |                          | (462    | ) |      |   | 1,413  |  
|(Increase) decrease in inventories                                      |  |                          | (555    | ) |      |   | (229   | )
|(Increase) decrease in prepaid expenses and other assets                |  |                          | (95     | ) |      |   | (188   | )
|Increase (decrease) in accounts payable and accrued expenses            |  |                          | 1,157   |   |      |   | 1,001  |  
|                                                                        |  |                          |         |   |      |   |        |  
|Net cash used in operating activities                                   |  |                          | (1,052  | ) |      |   | (6,621 | )
|                                                                        |  |                          |         |   |      |   |        |  
|Cash flows from investing activities:                                   |  |                          |         |   |      |   |        |  
|Purchase of property, plant & equipment                                 |  |                          | (19     | ) |      |   |       |  
|Proceeds from sale of property and equipment                            |  |                          | 265     |   |      |   |       |  
|                                                                        |  |                          |         |   |      |   |        |  
|Net cash provided by investing activities                               |  |                          | 246     |   |      |   |       |  
|                                                                        |  |                          |         |   |      |   |        |  
|Cash flows from financing activities:                                   |  |                          |         |   |      |   |        |  
|Proceeds from notes payable - related party                             |  |                          | 455     |   |      |   | 6,448  |  
|Principal payments on notes payable - other                             |  |                          | (50     | ) |      |   | (55    | )
|Proceeds from sale of common stock, net of expense                      |  |                          |        |   |      |   | 4      |  
|                                                                        |  |                          |         |   |      |   |        |  
|Net cash (used in) provided by financing activities                     |  |                          | 405     |   |      |   | 6,397  |  
|                                                                        |  |                          |         |   |      |   |        |  
|Net decrease in cash and cash equivalents                               |  |                          | (401    | ) |      |   | (224   | )
|Cash and cash equivalents at beginning of period                        |  |                          | 425     |   |      |   | 499    |  
|                                                                        |  |                          |         |   |      |   |        |  
|Cash and cash equivalents at end of period                              |  | $                        | 24      |   |      | $ | 275    |  
|                                                                        |  |                          |         |   |      |   |        |  
|Supplemental disclosures of non cash activities  related party:        |  |                          |         |   |      |   |        |  
|Debt and accrued interest converted into common stock                   |  | $                        | (34,774 | ) |      | $ |       |  
|Reduction of interest payable from sale of property and equipment       |  | $                        | (55     | ) |      | $ |       |  
|                                                                        |  |                         
|Supplemental disclosures of cash flow information:                      |  |                          |         |   |      |   |        |  
|Cash paid for interest                                                  |  | $                        | (265    | ) |      | $ |       |  

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



4



---

##### Table of Contents

DIGITAL LIGHTWAVE, INC.

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

(Unaudited)

1. SUMMARY OF SIGNIFICANT ACCOUNTING
POLICIES

Business and Basis of Presentation

Digital Lightwave, Inc. (the Company) 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 provide international sales support, but are currently inactive. All significant intercompany transactions and balances are eliminated in consolidation.

The accompanying unaudited consolidated condensed financial statements of Digital Lightwave, Inc. and its subsidiaries (the Company, Digital
Lightwave, us, we, our, etc.) have been prepared in accordance with United States generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and
Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by United States generally accepted accounting principles for complete financial statements. In the opinion of management, these
statements include all adjustments, consisting of normal and recurring adjustments, considered necessary for a fair presentation of results for such periods. The results of operations for the three- and six-months ended June 30, 2007, are not
necessarily indicative of results, which may be achieved for the full fiscal year or for any future period. The unaudited interim financial statements should be read in conjunction with the financial statements and notes thereto contained in the
Companys Annual Report on Form 10-K for the year ended December 31, 2006.

Operational Matters

The Company continues to have insufficient short-term resources for the payment of its current liabilities. Optel Capital, LLC (Optel), an entity controlled
by the Companys largest stockholder and current chairman of the board of directors, Dr. Bryan J. Zwan, 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. 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, the Companys independent registered public accounting firm has included an explanatory paragraph for a going concern in its report for the
year ended December 31, 2006, that was included in the Companys Annual Report on Form 10-K for the year ended December 31, 2006.

As of
July 20, 2007, the Company owed Optel approximately $28.1 million in principal plus approximately $5.4 million in accrued interest thereon, which debt is secured by a first priority security interest in substantially all of our assets and
accrues interest at a rate of 10% per annum pursuant to short-term notes issued since September 16, 2004 (Short Term Notes). Approximately $27.6 million in principal, plus accrued interest, is currently due and payable on
demand at any time, and $455,000 in principal, plus accrued interest, is due and payable on demand at any time after August 11, 2007.



5



---

##### Table of Contents

Accrued Warranty

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



|                   |  |                          |     |   |      |   |     |  
|------------------ |  | ------------------------ | --- | - | ---- | - | --- | -
|                   |  | Six Months EndedJune 30, |    
|                   |  | 2007                     |     |   | 2006 |  
|                   |  | (In thousands)           |    
|Beginning balance  |  | $                        | 487 |   |      | $ | 813 |  
|Warranty provision |  |                          | 27  |   |      |   | (42 | )
|Warranty costs     |  |                          | (49 | ) |      |   | (92 | )
|                   |  |                          |     |   |      |   |     |  
|Ending balance     |  | $                        | 465 |   |      | $ | 679 |  
|                   |  |                          |     |   |      |   |     |  

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. The Company presents sales net of sales tax and other related taxes.

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

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

For sales made under an original equipment manufacturer (OEM) arrangement, delivery generally occurs when the product is delivered to a common carrier. OEM sales are defined as sales of Company products to
a third party that will market the products under the third partys brand.

For trade-in sales, including both Company and competitor products, that
have a cash component 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 No. 153, Exchanges of
Non-monetary Assets (SFAS 153) and Accounting Principles Board Opinion No. 29, Accounting for Non-monetary Transactions (Opinion 29) 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.

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. The Company does not generally offer extended payment terms.

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



6



---

##### Table of Contents

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

For the six
months ended June 30, 2007, one customer accounted for approximately 14.7% of total net sales. No other single customer accounted for more than 10.0% of net sales.

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 the three- and six-month periods ended June 30, 2007 and 2006, diluted loss per share does not include the effect of incremental shares from common stock equivalents using the treasury stock method,
as the inclusion of such equivalents would be anti-dilutive. The total incremental shares from common stock equivalents were 0 and 120,457,000 at June 30, 2007, and 2006, respectively. The total incremental shares from common stock equivalents
at June 30, 2006, included 34,000 from outstanding stock options and 120,423,000 shares that were issuable pursuant to the conversion feature of the Secured Convertible Promissory Note formerly held by Optel. The table below shows the
calculation of basic weighted average common shares outstanding and the incremental number of shares arising from common stock equivalents under the treasury stock method:



|                                                |  |                             |  |           
|----------------------------------------------- |  | --------------------------- |  | ----------
|                                                |  | Three Months Ended June 30,
|                                                |  | 2007                        |  | 2006      
|Basic:                                          |  |                             |  |           
|Weighted average common shares outstanding      |  | 255,467,346                 |  | 35,226,400
|Total basic                                     |  | 255,467,346                 |  | 35,226,400
|                                                |  |                             |  |           
|Diluted:                                        |  |                             |  |           
|Incremental shares for common stock equivalents |  |                            |  |          
|                                                |  |                             |  |           
|Total dilutive                                  |  | 255,467,346                 |  | 35,226,400
|                                                |  |                             |  |           



|                                                |  |                           |  |           
|----------------------------------------------- |  | ------------------------- |  | ----------
|                                                |  | Six Months Ended June 30,
|                                                |  | 2007                      |  | 2006      
|Basic:                                          |  |                           |  |           
|Weighted average common shares outstanding      |  | 251,816,321               |  | 35,216,147
|Total basic                                     |  | 251,816,321               |  | 35,216,147
|                                                |  |                           |  |           
|Diluted:                                        |  |                           |  |           
|Incremental shares for common stock equivalents |  |                          |  |          
|                                                |  |                           |  |           
|Total dilutive                                  |  | 251,816,321               |  | 35,216,147
|                                                |  |                           |  |           

Stock Based Compensation

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

The Companys compensation cost for stock-based employee compensation for the three- and six-month periods ended June 30, 2007 was $16,000 and $66,000, respectively. No tax benefits were recognized for these costs due to recurring
losses.



7



---

##### Table of Contents

Prior to the adoption of SFAS 123R, the Company presented all tax benefits resulting from the exercise of stock options
as operating cash flows in the Consolidated Statement of Cash Flows. SFAS 123R requires that cash flows from the exercise of stock options resulting from tax benefits in excess of recognized cumulative compensation cost (Excess Tax
Benefits) be classified as financing cash flows. For the three months ended June 30, 2007 and 2006, there were no such Excess Tax Benefits classified as financing cash flows.

The expected term of the options is based on evaluations of historical and expected future employee exercise behavior. The risk-free interest rate is based on the U.S. Treasury rates at the date of grant with maturity
dates approximately equal to the expected life at the grant date. Volatility is based on historical volatility of the Companys stock. The Company has not historically paid any dividends on its common stock and does not expect to in the future.

Stock Option Plans

The Company has one stock option
plan with 7,956,972 shares available for grant as of June 30, 2007. The following summarizes certain terms of the Companys stock option plan:



|                                                                             |  |                 
|---------------------------------------------------------------------------- |  | ----------------
|                                                                             |  | Plan 2001       
|Minimum exercise price as a percentage of fair market value at date of grant |  | 100%            
|Plan termination date                                                        |  | December 31,2007

Options granted under the plan have a term of six years. Option grants generally 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. The Company recognizes compensation costs for these awards on a straight-line basis over the service period.

The following is a summary of the changes in outstanding options for the six months ended June 30, 2007:



|                                 |  |                       |   |  |                               |      |                                        |   |  
|-------------------------------- |  | --------------------- | - |  | ----------------------------- | ---- | -------------------------------------- | - | -
|                                 |  | Shares (In thousands) |   |  | WeightedAverage ExercisePrice |      | AggregateIntrinsic Value(In thousands)
|Outstanding at December 31, 2006 |  | 3,181                 |   |  | $                             | 2.44 |                                        | $ | 0
|Granted                          |  |                      |   |  |                               |     |                                        |   | 
|Exercised                        |  |                      |   |  |                               |     |                                        |   | 
|Forfeited and expired            |  | (402                  | ) |  | $                             | 8.49 |                                        | $ | 0
|                                 |  |                       |   |  |                               |      |                                        |   |  
|Outstanding at June 30, 2007     |  | 2,779                 |   |  | $                             | 1.60 |                                        | $ | 0
|                                 |  |                       |   |  |                               |      |                                        |   |  
|Exercisable at end of period     |  | 2,635                 |   |  | $                             | 1.56 |                                        | $ | 0
|                                 |  |                       |   |  |                               |      |                                        |   |  

There were no stock options exercised during the six month period ended June 30, 2007.

Income Taxes

On January 1, 2007, the Company adopted the
provisions of the Financial Accounting Standards Board Interpretation No. 48, Accounting for Uncertainty in Income Taxes (FIN 48), an interpretation of Financial Accounting Standards Board 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 June 30, 2007.



8



---

##### Table of Contents

The Company is subject to income taxes in the U.S. federal jurisdiction and various states and foreign jurisdictions. Tax
regulations within each jurisdiction are subject to the interpretation of the related tax laws and regulations and require significant judgment to apply. With few exceptions, the Company is no longer subject to U.S. federal, state and local or
non-U.S. income tax examinations by tax authorities for the years before 2004. The Company expects those examinations to be concluded and settled within 12 months.

There is a possibility that a limitation on the Companys net operating loss carryforwards may have come into effect under Section 382 of the Internal Revenue Code as a result of cumulative stock ownership changes. Management
plans to complete an analysis later in the year to determine whether such a limitation is in effect. As of June 30, 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 carryforwards.

The Company recognizes interest accrued related to unrecognized tax benefits in interest expense and penalties in operating expenses for all periods presented. No interest or penalties were required to be recorded as of June 30, 2007.

New Accounting Pronouncements

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

In February 2007, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 159, The Fair Value Option for Financial Assets and Financial Liabilities - Including an Amendment of Statement of Financial Accounting Standards Statement No. 115 (SFAS 159), which
permits entities to choose to measure many financial instruments and certain other items at fair value at specified election dates. A business entity is required to report unrealized gains and losses on items for which the fair value option has been
elected in earnings at each subsequent reporting date. This statement is expected to expand the use of fair value measurement. SFAS 159 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim
periods within those fiscal years. The Company has not determined the impact of SFAS 159 on its financial position.

2. INVENTORIES

Inventories are summarized as follows:



|                    |  |                             |       |                                |   |      
|------------------- |  | --------------------------- | ----- | ------------------------------ | - | -----
|                    |  | June 30, 2007(In thousands) |       | December 31,2006(In thousands)
|Raw materials, net  |  | $                           | 3,132 |                                | $ | 2,397
|Finished goods, net |  |                             | 152   |                                |   | 332  
|                    |  |                             |       |                                |   |      
|                    |  | $                           | 3,284 |                                | $ | 2,729
|                    |  |                             |       |                                |   |      

The Company has established reserves for excess and obsolete inventory based upon current and expected sales
trends, the amount of parts on-hand, the market value of parts on-hand and the viability and technical obsolescence of products and components. Inventory balances are net of estimated reserves for excess and obsolete inventory of $13.9 million and
$15.5 million at June 30, 2007 and December 31, 2006, respectively.



9



---

##### Table of Contents

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 could have a material
adverse effect on the Companys business, financial condition and results of operations.

4. COMMITMENTS

At June 30, 2007, the Company had outstanding non-cancelable purchase order commitments to purchase certain inventory items totaling approximately $778,000 with M.C.
Assembly, Inc.

5. RELATED PARTY TRANSACTIONS

Notes
Payable

As described in Note 1 under the paragraph entitled Operational Matters, as of June 30, 2007, the Company owed Short Term
Notes to Optel of approximately $28.1 million in principal plus approximately $5.2 million in accrued interest thereon, which debt is secured by a first priority security interest in substantially all of our assets and such debt accrues interest at
a rate of 10% per annum. Approximately $27.6 million in principal, plus accrued interest, is currently due and payable on demand at any time, and $455,000 in principal, plus accrued interest, is due and payable on demand at any time after
August 11, 2007.

Services Rendered

During the
three- and six-month periods ended June 30, 2007, Optel provided the Company with approximately $56,000 and $143,000 respectively, in services associated with information technology and accounting. These services are shown as a contribution of
capital and are expensed within general and administration expenses.

Accrued Interest Payment

During the three- and six-month periods ended June 30, 2007, the accrued interest on the Short Term Notes was reduced by $0, and $265,000 respectively. On
February 1, 2007 the Company sold certain assets associated with its Billerica, MA facility to a third party for $265,000. The proceeds from this sale were used to pay accrued interest. In addition, the Company sold $54,625 of assets to Optel,
which reduced accrued interest and credited additional paid-in capital.



|Item 2. | Managements Discussion and Analysis of Financial Condition and Results of Operations
|------- | -------------------------------------------------------------------------------------

FORWARD LOOKING STATEMENTS

The following discussion 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, except as
required by law. 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 report are based on information available to us on the date of filing, and we assume no obligation to update any such forward-looking statements. In evaluating these
statements, you should specifically consider various factors, including the risks outlined under the caption Risk Factors set forth in Item 1A of Part I of our Annual Report on Form 10-K and those contained from time to time in our
other filings with the U.S. Securities and Exchange Commission. We caution you that our business and financial performance are subject to substantial risks and uncertainties.

This information should be read in conjunction with (i) the consolidated condensed financial statements and notes thereto included in Item 1 of Part I of this quarterly report on Form 10-Q, and
(ii) the consolidated financial statements and notes thereto, as well as the accompanying Managements Discussion and Analysis of Results of Operations, for the years ended December 31, 2006 and 2005 included in our Annual Reports on
Form 10-K.



10



---

##### Table of Contents

OVERVIEW

Executive Summary

The Company designs, develops and markets a portfolio of portable and network-based products for installing, maintaining
and monitoring fiber optic circuits and networks. Network operators and telecommunications service providers use fiber optics to provide increased network bandwidth to transmit voice and other non-voice traffic such as internet, data and multimedia
video transmissions. The Company provides telecommunications service providers and equipment manufacturers with product capabilities to cost-effectively deploy and manage fiber optic networks. The Companys product lines include Network
Information Computers (NIC), Network Access Agents (NAA), Optical Test Systems (OTS), and Optical Wavelength Managers (OWM). The Companys products are sold worldwide to leading and emerging
telecommunications service providers, telecommunications equipment manufacturers, equipment leasing companies and international distributors.

The
Companys net sales are generated from sales of its products, less an estimate for customer returns. We expect that the average selling price (ASP) 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 introduction of competitive products. As our cost of goods sold tends to remain relatively stable for any given
product, decreases in the ASP may have a material adverse effect on our business, financial condition and results of operations.

The Company has not
entered into long-term agreements or blanket purchase orders for the sale of its 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. Most of our operating expenses are fixed and cannot be easily reduced in response to decreased revenues. Variations in the timing of revenues could cause significant variations in results of operations from quarter to
quarter and result in continuing quarterly losses. The deferral of any large order from one quarter to another would negatively affect the results of operations for the earlier quarter. The Company must obtain orders during each quarter for shipment
in that quarter to achieve revenue and profit objectives.

For the six months ended June 30, 2007, one customer accounted for approximately 14.7% of
total net sales. No other single customer accounted for more than 10.0% of net sales.

The Company has established channel partners such as independent
sales representatives and distributors to complement our sales force. Additionally, in order to maintain our market share, we are focused on maintaining technological leadership with our product lines. We have evaluated our sales efforts to identify
opportunities where our account presence can be improved and are working to exploit those opportunities. Subject to resolution of our working capital constraints, we are seeking new applications for our installed product base to be realized with use
of new modular add-ons and enhancements to support the telecommunications network evolution of the next generation protocols and services. These plans include the introduction of enhancements that support the convergence of the telecommunications
and data communications networks and enhance our data communications network analysis capabilities to meet growing global high-speed data service requirements.

Critical Accounting Estimates

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



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



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



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



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



| |  |  | uncertain tax positions assessment;
| | - |  | -----------------------------------



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



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



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

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



11



---

##### Table of Contents

We derive our revenues principally from product sales. We recognize revenue from the sale of products when persuasive
evidence of an arrangement exists, the product has been delivered, the price is fixed and determinable and collection of the resulting receivable is reasonably assured. We estimate the amount of potential future product returns related to current
period product revenue. We consider many factors when making our estimates, including analyzing historical returns, current economic trends, changes in customer demand and acceptance of our products to evaluate the adequacy of the sales returns and
other allowances. Our estimate for the provision for sales returns and other allowances as of June 30, 2007 was approximately $54,000.

We also
estimate the collectibility of our accounts receivables. We consider many factors when making our estimates, including accounts receivable and historical bad debts, customer concentrations, customer credit-worthiness and current economic trends. We
also consider changes in our customer payment terms when evaluating the adequacy of the reserve for uncollectible accounts. Our accounts receivable balance as of June 30, 2007, was $2.8 million, net of our estimated reserve for uncollectible
accounts of approximately $84,000.

We estimate the amount of excess and obsolete inventory. When evaluating the reserve for excess and obsolete inventory,
we consider many factors, including 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 $3.3 million as of June 30, 2007, net of our estimated reserve for excess and obsolete inventory of $13.9 million.

The Company recognizes 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 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 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 or liability to recognize in the financial statements.

We estimate the impairment of long-lived assets. We monitor events and changes in circumstances that could indicate whether carrying amounts of long-lived assets may not
be recoverable. These events and circumstances include any decrease in the market price of a long-lived asset, changes 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 circumstances occur, we assess the recoverability of
long-lived assets by determining whether the carrying value of such assets will be recovered through undiscounted expected future cash flows. We recognize impairments 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. As of June 30, 2007 a review of the
carrying value of our long-lived assets and the probability of recovering such value indicated a $19,000 additional 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 June 30, 2007 was approximately $465,000.

We estimate the amount of liability the Company may incur as a result of pending litigation. As of June 30, 2007, the Company was not aware of any pending
litigation, claims or assessments. Accordingly, there is no accrual for pending litigation at June 30, 2007.



12



---

##### Table of Contents

RESULTS OF OPERATIONS

The following is a discussion of significant changes in the results of operations of the Company, which occurred in the three- and six-months ended June 30, 2007, compared to the three- and six-months ended June 30, 2006. The
following sets forth certain financial data as a percentage of net sales:



|                                       |  |                                                         |    |  |                                                      |    |  |      |    |  |      |   
|-------------------------------------- |  | ------------------------------------------------------- | -- |  | ---------------------------------------------------- | -- |  | ---- | -- |  | ---- | --
|                                       |  | Percent of Net Sales for the Three MonthsEnded June 30, |    |  | Percent of Net Salesfor the Six MonthsEnded June 30, |   
|                                       |  | 2007                                                    |    |  | 2006                                                 |    |  | 2007 |    |  | 2006 |   
|Net sales                              |  | 100                                                     | %  |  | 100                                                  | %  |  | 100  | %  |  | 100  | % 
|Cost of goods sold                     |  | 48                                                      |    |  | 85                                                   |    |  | 47   |    |  | 86   |   
|                                       |  |                                                         |    |  |                                                      |    |  |      |    |  |      |   
|Gross profit                           |  | 52                                                      |    |  | 15                                                   |    |  | 53   |    |  | 14   |   
|                                       |  |                                                         |    | 
|Operating expenses:                    |  |                                                         |    |  |                                                      |    |  |      |    |  |      |   
|Engineering and development            |  | 13                                                      |    |  | 62                                                   |    |  | 17   |    |  | 68   |   
|Sales and marketing                    |  | 19                                                      |    |  | 26                                                   |    |  | 21   |    |  | 42   |   
|General and administrative             |  | 9                                                       |    |  | 104                                                  |    |  | 10   |    |  | 68   |   
|Impairment of long-lived assets        |  | 1                                                       |    |  |                                                     |    |  |     |    |  |     |   
|Gain on sale of property and equipment |  |                                                        |    |  |                                                     |    |  | (4   | )  |  |     |   
|                                       |  |                                                         |    |  |                                                      |    |  |      |    |  |      |   
|Total operating expenses               |  | 42                                                      |    |  | 192                                                  |    |  | 44   |    |  | 178  |   
|                                       |  |                                                         |    |  |                                                      |    |  |      |    |  |      |   
|Operating profit (loss)                |  | 10                                                      |    |  | (177                                                 | )  |  | 9    |    |  | (164 | ) 
|                                       |  |                                                         |    | 
|Other loss, net                        |  | (23                                                     | )  |  | (67                                                  | )  |  | (27  | )  |  | (64  | ) 
|                                       |  |                                                         |    |  |                                                      |    |  |      |    |  |      |   
|Loss before income taxes               |  | (13                                                     | )  |  | (244                                                 | )  |  | (18  | )  |  | (228 | ) 
|Provision for income taxes             |  |                                                        |    |  |                                                     |    |  |     |    |  |     |   
|                                       |  |                                                         |    |  |                                                      |    |  |      |    |  |      |   
|Net Loss                               |  | (13                                                     | )% |  | (244                                                 | )% |  | (18  | )% |  | (228 | )%
|                                       |  |                                                         |    |  |                                                      |    |  |      |    |  |      |   

Net Sales

Net
sales for the quarter ended June 30, 2007, increased $1.4 million, or 70%, to $3.4 million from $2.0 million for the quarter ended June 30, 2006. The increase in net sales was primarily a result of the improved acceptance of the NIC
product due to new feature enhancements. International net sales for the quarter ended June 30, 2007, were approximately $1.4 million, or 42% of net sales, as compared to approximately $375,000, or 19% of net sales, for the quarter ended
June 30, 2006.

Net sales for the six months ended June 30, 2007, increased $1.7 million, or 39%, to $5.9 million from $4.2 million for the
quarter ended June 30, 2006. The increase in net sales was primarily a result of the improved acceptance of the NIC product due to new feature enhancements. International net sales for the six months ended June 30, 2007, were approximately
$2.3 million, or 40% of net sales, as compared to approximately $978,000, or 24% of net sales, for the six months ended June 30, 2006.

Cost of
Goods Sold

Cost of goods sold for the quarter ended June 30, 2007, totaled approximately $1.6 million, or 48% of net sales, as compared to $1.7
million, or 85% of net sales, for the quarter ended June 30, 2006. For the quarter ended June 30, 2007, cost of goods sold was lower due to an increase in repair and calibration services and licensed software feature sales, which have
minor parts cost. The lower percentage of cost of goods sold to net sales reflects the enforcement of a higher margin policy for all sales and the sale of licensed features.

Cost of goods sold for the six months ended June 30, 2007, totaled approximately $2.8 million, or 47% of net sales, as compared to $3.6 million, or 86% of net sales, for the quarter ended June 30, 2006. For
the six months ended June 30, 2007, cost of goods sold was lower due to an increase in repair and calibration services and licensed software feature sales, which have minor parts cost. The lower percentage of cost of goods sold to net sales
reflects the enforcement of a higher margin policy for all sales and the sale of licensed features.



13



---

##### Table of Contents

Gross Profit

Gross
profit for the quarter ended June 30, 2007, increased by approximately $1.5 million to approximately $1.7 million, or 52% of net sales, from $294,000, or 15% of net sales, for the quarter ended June 30, 2006. Gross profit percentage
increased from the prior period reflecting the enforcement of a higher margin policy for all sales and the sale of licensed features.

Gross profit for the
six months ended June 30, 2007, increased by approximately $2.5 million to approximately $3.1 million, or 53% of net sales, from $610,000, or 14% of net sales, for the six months ended June 30, 2006. Gross profit percentage increased from
the prior period reflecting the enforcement of a higher margin policy for all sales and the sale of licensed features.

Engineering and Development

Engineering and development expenses principally include salaries for engineering and development personnel, depreciation of production and development
assets, outside consulting fees and other development expenses. Engineering and development expenses for the quarter ended June 30, 2007, decreased by approximately $772,000 to $456,000, or 13% of net sales, from approximately $1.2 million, or
62% of net sales, for the quarter ended June 30, 2006. The decrease is due to a reduction in work force completed in 2006.

Engineering and
development expenses for the six months ended June 30, 2007, decreased by approximately $1.9 million to $975,000, or 17% of net sales, from approximately $2.9 million, or 68% of net sales, for the six months ended June 30, 2006. The
decrease is due to a reduction in workforce completed in 2006.

Sales and Marketing

Sales and marketing expenses principally include salaries, commissions, travel, tradeshows, advertising and promotional materials, depreciation of demonstration units, bad debt and warranty expenses. Sales and
marketing expenses for the quarter ended June 30, 2007, were $647,000, or 19% of net sales, an increase of approximately $122,000 over the spending of $525,000, or 26% of net sales, for the quarter ended June 30, 2006. The increase in
sales and marketing expenses in absolute dollars was primarily attributable to an increase in marketing efforts and travel expenses related to the 70% increase in sales.

Sales and marketing expenses for the six months ended June 30, 2007, were $1.3 million, or 21% net of sales, a decrease of approximately $511,000 over the spending of $1.8 million, or 42% net of sales, for the
six months ended June 30, 2006. The decrease for the six months ended June 30, 2007 as compared to the same period in 2006 was primarily attributable to decreases in sales staff.

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 quarter ended June 30, 2007, decreased by
approximately $1.8 million to $295,000, or 9% net of sales, from approximately $2.1 million, or 104% net of sales, for the quarter ended June 30, 2006. The decrease for the three months ended for June 30, 2007 reflects a 2006 expense of
approximately $2.1 million in termination fees resulting from the Companys execution and delivery of the expiration agreement for the property located at 15550 Lightwave Drive, Clearwater, savings in facility rentals and a reduction in the
general and administrative workforce.

General and administrative expenses for the six months ended June 30, 2007, decreased by approximately $2.3
million to $600,000, or 10% net of sales, from approximately $2.9 million, or 68% net of sales, for the six months ended June 30, 2006. The decrease reflects a 2006 expense of approximately $2.1 million in termination fees resulting from the
Companys execution and delivery of the expiration agreement for the property located at 15550 Lightwave Drive, Clearwater, savings in facility rentals and a reduction in the general and administrative workforce.

Other Income and Expense, net

Other expense, net for the quarter
ended June 30, 2007 was approximately $787,000, a decrease of $536,000 as compared to other expense, net of approximately $1.3 million for the quarter ended June 30, 2006. Other expense, net for the six months ended June 30, 2007 was
approximately $1.6 million, a decrease of $1.1 million, as compared to other expense, net of approximately $2.7 million for the six months ended June 30, 2006. The decrease was primarily attributable to decreased interest expense on the
outstanding debt owed to Optel resulting from the conversion of the Secured Convertible Promissory Note by Optel in January 2007.



14



---

##### Table of Contents

Provision for Income Taxes

No provision for income taxes was made for the three-and six-month periods ending June 30, 2007 and 2006 due to the Companys expected annual net losses. Any tax benefits resulting from the Companys net loss have not been
recognized due to a full valuation allowance for deferred tax assets being recorded as a result of managements belief that it is more likely than not that future tax benefits will not be realized as a result of future income.

Net Loss

Net loss for the quarter ended June 30, 2007 was
approximately $457,000 or $0 per diluted share, compared to net loss of approximately $4.9 million, or $0.14 per diluted share, for the quarter ended June 30, 2006, for the reasons discussed above. Net loss for the six months ended
June 30, 2007 was approximately $1.1 million or $0 per diluted share, compared to net loss of approximately $9.6 million, or $0.27 per diluted share, for the six months ended June 30, 2006, for the reasons discussed above.

LIQUIDITY AND CAPITAL RESOURCES

As of June 30, 2007, the
Companys unrestricted cash and cash equivalents totaled approximately $24,000, a decrease of approximately $401,000 from December 31, 2006. As of June 30, 2007, the Companys working capital deficit was $28.9 million as compared
to a working capital deficit of $62.9 million at December 31, 2006. The Company had an accumulated deficit of approximately $151.9 million at June 30, 2007.

As of July 20, 2007, the Company owed Optel approximately $28.1 million in principal plus approximately $5.4 million in accrued interest thereon, which debt is secured by a first priority security interest in
substantially all of our assets and accrues interest at a rate of 10% per annum. Approximately $27.6 million in principal, plus accrued interest is currently due and payable on demand at any time, and $455,000 in principal plus accrued interest
is due and payable on demand at any time after August 11, 2007.

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

The Company has entered into discussions with Optel to arrange for additional short-term working
capital. If the Company does not reach an agreement to obtain additional financing from Optel, it will be unable to meet the obligations to Optel and our other creditors. Furthermore, in an attempt to collect payment, our creditors, including Optel,
may seek legal remedies, including filing a petition for involuntary bankruptcy, or the Company may elect to seek relief by filing a voluntary bankruptcy petition.

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 in their report for the year ended December 31, 2006 an explanatory paragraph emphasizing the substantial doubt about the Companys ability to continue as a going
concern.

Operating Activities

Net cash used by
operating activities for the six months ended June 30, 2007 was approximately $1.1 million. This was primarily the result of losses from operations of approximately $1.1 million and the increases in inventory of approximately $555,000, accounts
receivable of $462,000 and prepaid expenses of $95,000 offset by an increase in accounts payable of approximately $1.2 million.

Investing Activities

Net cash provided by investing activities was $246,000 for the six months ended June 30, 2007. This reflects $265,000 in proceeds from the sale of
property and equipment, partially offset by leasehold improvements of $19,000.



15



---

##### Table of Contents

Financing Activities

Net cash provided by financing activities for the six months ended June 30, 2007 was approximately $405,000. This was primarily the result of proceeds of $455,000 from borrowings from Optel. The proceeds provided by Optels
financing were used to fund the Companys working capital requirements and operating losses. The Company used $50,000 in net cash for financing activities during the six months ended June 30, 2007.

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 could have a material adverse effect on the Companys business, financial
condition and results of operations.

Other Material Commitments

The Companys contractual cash obligations as of June 30, 2007 are summarized (in thousands) in the table below.



|                                   |  |       |        |          |   |            |  |            |     |           |   |     |  |   |  
|---------------------------------- |  | ----- | ------ | -------- | - | ---------- |  | ---------- | --- | --------- | - | --- |  | - | -
|Contractual Cash Obligations       |  | Total |        | < 1 year |   | 1 - 3years |  | 3 - 5years |     | > 5 years
|Notes Payable - Related Party (1)  |  | $     | 28,100 |          | $ | 28,100     |  | $          |    |           | $ |    |  | $ | 
|Interest Payable  Related Party   |  |       | 5,222  |          |   | 5,222      |  |            |     |           |   |     |  |   |  
|Operating leases                   |  |       | 1,157  |          |   | 267        |  |            | 565 |           |   | 325 |  |   | 
|Non-cancelable purchase orders (2) |  |       | 778    |          |   | 778        |  |            |    |           |   |    |  |   | 
|                                   |  |       |        |          |   |            |  |            |     |           |   |     |  |   |  
|Total contractual cash obligations |  | $     | 35,257 |          | $ | 34,367     |  | $          | 565 |           | $ | 325 |  | $ | 
|                                   |  |       |        |          |   |            |  |            |     |           |   |     |  |   |  

---

|(1) | Notes payable obligations are presented exclusive of accrued interest.
|--- | ----------------------------------------------------------------------

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



|Item 3. | Quantitative and Qualitative Disclosures About Market Risk.
|------- | -----------------------------------------------------------

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



|Item 4. | Controls and Procedures.
|------- | ------------------------

Our principal
executive officer and principal financial officer evaluated the effectiveness of our disclosure controls and procedures pursuant to the Securities Exchange Act of 1934, as amended (the Exchange Act), as defined in Rules 13a-15(e) and
15d-15(e) under the Exchange Act, as of December 31, 2006. Based on this evaluation, our principal executive officer and principal financial officer concluded that, as of June 30, 2007, (1) our disclosure controls and procedures are
not sufficiently effective pursuant to the requirements of the Sarbanes-Oxley Act of 2002 for companies our size, (2) information to be disclosed in reports we file under the Exchange Act is recorded, processed, summarized and reported within
the time periods specified by the rules and forms promulgated under the Exchange Act, and (3) information required to be disclosed in reports filed under the Exchange Act is accumulated and communicated to the principal executive officer and
principal financial officer as appropriate to allow timely decisions regarding required disclosure. There were no changes in the Companys internal control over financial reporting that occurred during the Companys last fiscal quarter
that have materially affected or are reasonably likely to materially affect, the Companys internal control over financial reporting.



16



---

##### Table of Contents

PART II

OTHER INFORMATION



|Item 1. | Legal Proceedings.
|------- | ------------------

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.



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

There have been no material
changes from the risk factors previously disclosed in the Companys Annual Report on Form 10-K for the year ended December 31, 2006 in response to Item 1A to Part 1 of Form 10-K.



|Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds.
|------- | ------------------------------------------------------------

Not applicable.



|Item 3. | Defaults Upon Senior Securities.
|------- | --------------------------------

Not
applicable.



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

The following matters were approved at our Annual Meeting of Stockholders held on May 22, 2007:

Proposal 1  Election of
Directors:



|                  |  |             |  |              
|----------------- |  | ----------- |  | -------------
|Name              |  | Vote For    |  | Vote Withheld
|Dr. Bryan J. Zwan |  | 252,232,291 |  | 310,093      
|                  |  |            
|Peter H. Collins  |  | 252,267,194 |  | 375,190      
|                  |  |            
|Robert F. Hussey  |  | 252,267,134 |  | 275,250      
|                  |  |            
|Gerald A. Fallon  |  | 252,219,942 |  | 322,442      
|                  |  |            
|Robert Moreyra    |  | 252,189,660 |  | 352,724      

Proposal 2  Ratification of Appointment of Independent Auditors:



|                    |  |             |  |              |  |             
|------------------- |  | ----------- |  | ------------ |  | ------------
|Name                |  | Vote For    |  | Vote Against |  | Vote Abstain
|Grant Thornton, LLP |  | 242,489,359 |  | 51,729       |  | 1,296       



|Item 5. | Other Information.
|------- | ------------------

None.



|Item 6. | Exhibits and Reports on Form 8-K.
|------- | ---------------------------------

A list
of exhibits is set forth in the Exhibit Index found on page 18 of this report.



17



---

##### Table of Contents

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report
to be signed on its behalf by the undersigned thereunto duly authorized.



Digital Lightwave, Inc.(Registrant)By:

/s/ KENNETH T. MYERSPresident and Chief Executive Officer(Principal Executive Officer)Date: August 14, 2007By:

/s/ KENNETH T. MYERSInterim Chief Accounting Officer(Principal Financial Officer)Date: August 14, 2007




18



---

##### Table of Contents

EXHIBIT INDEX



|              |  |                                                                                                                                                                                                                                              
|------------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|ExhibitNumber |  | Description                                                                                                                                                                                                                                  
|3.1*          |  | Amended and Restated Certificate of Incorporation (incorporated by reference to Exhibit 3.02 to the Quarterly Report on Form 10-Q filed by the Company on August 14, 2002).                                                                  
|              | 
|3.2*          |  | Certificate of Amendment of Amended and Restated Certificate of Incorporation (incorporated by reference to Exhibit 3.1 to the Current Report on Form 8-K filed by the Company on February 16,
2004).                                        
|              | 
|3.3*          |  | Amended and Restated Bylaws (incorporated by reference to Exhibit 3.03 to the Quarterly Report on Form 10-Q filed by the Company on August 14, 2002).                                                                                        
|              | 
|4.1*          |  | Specimen Certificate for Common Stock (incorporated by reference to Exhibit 4.01 to the Companys Registration Statement on Form S-1 (File No. 333-09457), declared effective by the
Securities and Exchange Commission on February 5, 1997).
|              | 
|10.1*         |  | Secured Promissory Note issued by Digital Lightwave, Inc. to Optel Capital, LLC on May 11, 2007 (incorporated by reference to Exhibit 10.1 to the Current Report on Form 8-K filed by the Company
on May 16, 2007).                          
|              | 
|10.2*         |  | Secured Promissory Note issued by Digital Lightwave, Inc. to Optel Capital, LLC on June 1, 2007 (incorporated by reference to Exhibit 10.1 to the Current Report on Form 8-K filed by the Company
on June 6, 2007).                          
|              | 
|31.1+         |  | Certification by the Chief Executive Officer pursuant to Section 302 of the SarbanesOxley Act of 2002.                                                                                                                                      
|              | 
|31.2+         |  | Certification by the Principal Financial Officer pursuant to Section 302 of the Sarbanes  Oxley Act of 2002.                                                                                                                                
|              | 
|32.1+         |  | Certification by the Chief Executive Officer and Principal Financial Officer pursuant to Section 906 of the SarbanesOxley Act of 2002.                                                                                                      

---

|* | Such exhibits are incorporated by reference.
|- | --------------------------------------------

|+ | Filed herewith.
|- | ---------------



19