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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 March 31, 2009, or



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

For the transition period from              to
            .

001-31770

(Commission File Number)





Digital Lightwave, Inc.

(Exact name of Registrant as specified in its charter)







|                                                              |  |                                    
|------------------------------------------------------------- |  | -----------------------------------
|Delaware                                                      |  | 95-4313013                         
|(State or other jurisdiction ofincorporation or organization) |  | (I.R.S. EmployerIdentification No.)



|                                         |  |           
|---------------------------------------- |  | ----------
|5775 Rio Vista DriveClearwater, 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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of
Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes   ̈    No   ̈

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



|                        |  |                                                |  |                           |  |  
|----------------------- |  | ---------------------------------------------- |  | ------------------------- |  | -
|Large Accelerated Filer |  |  ̈                                              |  | Accelerated Filer         |  |  ̈
|Non-Accelerated Filer   |  |  ̈  (Do not check if smaller reporting company) |  | Smaller Reporting Company |  | x

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

The number of shares outstanding of the Registrants Common Stock as of May 5, 2009, was 255,489,847.









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DIGITAL LIGHTWAVE, INC.

QUARTERLY REPORT ON FORM 10-Q

For the Period Ended March 31, 2009

INDEX



|              |  |                                                                                                          |  |     
|------------- |  | -------------------------------------------------------------------------------------------------------- |  | ----
|              |  |                                                                                                          |  | Page
|              |  | PART I. FINANCIAL INFORMATION                                                                            |  |     
|              |  |                                                                                                         
|Item 1.       |  | Financial Statements:                                                                                    |  |     
|              |  |                                                                                                         
|              |  | Consolidated Balance Sheets  March 31, 2009 (Unaudited) and December 31, 2008                           |  | 1   
|              |  |                                                                                                         
|              |  | Consolidated Statements of Operations (Unaudited)  Three Months Ended March 31, 2009 and March 31, 2008 |  | 2   
|              |  |                                                                                                         
|              |  | Consolidated Statements of Cash Flows (Unaudited)  Three Months Ended March 31, 2009 and March 31, 2008 |  | 3   
|              |  |                                                                                                         
|              |  | Notes to Consolidated Condensed Financial Statements (Unaudited)                                         |  | 4   
|              |  |                                                                                                         
|Item 2.       |  | Managements Discussion and Analysis of Financial Condition and Results of Operations                    |  | 8   
|              |  |                                                                                                         
|Item 3.       |  | Quantitative and Qualitative Disclosures About Market Risk                                               |  | 14  
|              |  |                                                                                                         
|Item 4T.      |  | Controls and Procedures                                                                                  |  | 14  
|              |  |                                                                                                         
|              |  | PART II. OTHER INFORMATION                                                                               |  |     
|              |  |                                                                                                         
|Item 1.       |  | Legal Proceedings                                                                                        |  | 15  
|              |  |                                                                                                         
|Item 1A.      |  | Risk Factors                                                                                             |  | 15  
|              |  |                                                                                                         
|Item 2.       |  | Unregistered Sales of Equity Securities and Use of Proceeds                                              |  | 15  
|              |  |                                                                                                         
|Item 3.       |  | Defaults Upon Senior Securities                                                                          |  | 15  
|              |  |                                                                                                         
|Item 4.       |  | Submission of Matters to a Vote of Security Holders                                                      |  | 15  
|              |  |                                                                                                         
|Item 5.       |  | Other Information                                                                                        |  | 15  
|              |  |                                                                                                         
|Item 6.       |  | Exhibits and Reports on Form 8-K                                                                         |  | 15  
|              | 
|SIGNATURES    |  | 15                                                                                                      
|              | 
|EXHIBIT INDEX |  | 16                                                                                                      



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PART I

FINANCIAL INFORMATION



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

DIGITAL LIGHTWAVE, INC.

CONSOLIDATED BALANCE SHEETS

(In thousands, except share data)



|                                                                                                                                                        |  |               |          |   |                  |   |          |  
|------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------- | -------- | - | ---------------- | - | -------- | -
|                                                                                                                                                        |  | March 31,2009 |          |   | December 31,2008 |  
|                                                                                                                                                        |  | (Unaudited)   |          |   |                  |  
|ASSETS                                                                                                                                                  |  |               |          |   |                  |   |          |  
|Current assets:                                                                                                                                         |  |               |          |   |                  |   |          |  
|Cash                                                                                                                                                    |  | $             | 62       |   |                  | $ | 15       |  
|Accounts receivable, less allowance of $76 in 2009 and 2008                                                                                             |  |               | 1,891    |   |                  |   | 1,730    |  
|Inventories, net                                                                                                                                        |  |               | 3,313    |   |                  |   | 3,576    |  
|Prepaid expenses and other current assets                                                                                                               |  |               | 209      |   |                  |   | 196      |  
|                                                                                                                                                        |  |               |          |   |                  |   |          |  
|Total current assets                                                                                                                                    |  |               | 5,475    |   |                  |   | 5,517    |  
|Property and equipment, net                                                                                                                             |  |               | 953      |   |                  |   | 950      |  
|Other assets, net                                                                                                                                       |  |               | 214      |   |                  |   | 214      |  
|                                                                                                                                                        |  |               |          |   |                  |   |          |  
|Total assets                                                                                                                                            |  | $             | 6,642    |   |                  | $ | 6,681    |  
|                                                                                                                                                        |  |               |          |   |                  |   |          |  
|                                                                                                                                                        |  |              
|LIABILITIES AND STOCKHOLDERS DEFICIT                                                                                                                   |  |               |          |   |                  |   |          |  
|Current liabilities:                                                                                                                                    |  |               |          |   |                  |   |          |  
|Accounts payable and accrued liabilities                                                                                                                |  |               | 2,328    |   |                  | $ | 2,896    |  
|Current portion of notes payable to related party                                                                                                       |  |               | 38,579   |   |                  |   |         |  
|                                                                                                                                                        |  |               |          |   |                  |   |          |  
|Total current liabilities                                                                                                                               |  |               | 40,907   |   |                  |   | 2,896    |  
|Other long-term liabilities                                                                                                                             |  |               | 310      |   |                  |   | 319      |  
|                                                                                                                                                        |  |              
|Notes payable to related party                                                                                                                          |  |               |         |   |                  |   | 37,204   |  
|                                                                                                                                                        |  |               |          |   |                  |   |          |  
|Total liabilities                                                                                                                                       |  |               | 41,217   |   |                  |   | 40,419   |  
|                                                                                                                                                        |  |               |          |   |                  |   |          |  
|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 255,489,847 and 255,489,847 shares in 2009 and 2008,
respectively |  |               | 26       |   |                  |   | 26       |  
|Additional paid-in capital                                                                                                                              |  |               | 123,199  |   |                  |   | 123,167  |  
|Accumulated deficit                                                                                                                                     |  |               | (157,800 | ) |                  |   | (156,931 | )
|                                                                                                                                                        |  |               |          |   |                  |   |          |  
|Total stockholders deficit                                                                                                                             |  |               | (34,575  | ) |                  |   | (33,738  | )
|                                                                                                                                                        |  |               |          |   |                  |   |          |  
|Total liabilities and stockholders deficit                                                                                                             |  | $             | 6,642    |   |                  | $ | 6,681    |  
|                                                                                                                                                        |  |               |          |   |                  |   |          |  

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



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DIGITAL LIGHTWAVE, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

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



|                                                                 |  |                             |             |   |      |   |             |  
|---------------------------------------------------------------- |  | --------------------------- | ----------- | - | ---- | - | ----------- | -
|                                                                 |  | Three Months EndedMarch 31, |            
|                                                                 |  | 2009                        |             |   | 2008 |  
|Net sales                                                        |  | $                           | 2,037       |   |      | $ | 2,596       |  
|Cost of goods sold                                               |  |                             | 1,175       |   |      |   | 1,491       |  
|                                                                 |  |                             |             |   |      |   |             |  
|Gross profit                                                     |  |                             | 862         |   |      |   | 1,105       |  
|                                                                 |  |                             |             |   |      |   |             |  
|Operating expenses:                                              |  |                             |             |   |      |   |             |  
|Engineering and development                                      |  |                             | 499         |   |      |   | 510         |  
|Sales and marketing                                              |  |                             | 682         |   |      |   | 604         |  
|General and administrative                                       |  |                             | 311         |   |      |   | 250         |  
|                                                                 |  |                             |             |   |      |   |             |  
|Total operating expenses                                         |  |                             | 1,492       |   |      |   | 1,364       |  
|                                                                 |  |                             |             |   |      |   |             |  
|Operating loss                                                   |  |                             | (630        | ) |      |   | (259        | )
|Other expense, net                                               |  |                             | (239        | ) |      |   | (845        | )
|                                                                 |  |                             |             |   |      |   |             |  
|Loss before income taxes                                         |  |                             | (869        | ) |      |   | (1,104      | )
|Provision for income taxes                                       |  |                             |            |   |      |   |            |  
|                                                                 |  |                             |             |   |      |   |             |  
|Net loss                                                         |  | $                           | (869        | ) |      | $ | (1,104      | )
|                                                                 |  |                             |             |   |      |   |             |  
|Per share of common stock:                                       |  |                             |             |   |      |   |             |  
|Basic net loss per share                                         |  | $                           | (0.00       | ) |      | $ | (0.00       | )
|                                                                 |  |                             |             |   |      |   |             |  
|Diluted net loss per share                                       |  | $                           | (0.00       | ) |      | $ | (0.00       | )
|                                                                 |  |                             |             |   |      |   |             |  
|Weighted average common shares outstanding                       |  |                             | 255,489,847 |   |      |   | 255,484,160 |  
|                                                                 |  |                             |             |   |      |   |             |  
|Weighted average common and common equivalent shares outstanding |  |                             | 255,489,847 |   |      |   | 255,484,160 |  
|                                                                 |  |                             |             |   |      |   |             |  

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



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DIGITAL LIGHTWAVE, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(In thousands)



|                                                                                       |  |                             |        |   |      |   |        |  
|-------------------------------------------------------------------------------------- |  | --------------------------- | ------ | - | ---- | - | ------ | -
|                                                                                       |  | Three Months EndedMarch 31, |       
|                                                                                       |  | 2009                        |        |   | 2008 |  
|Cash flows from operating activities:                                                  |  |                             |        |   |      |   |        |  
|Net loss                                                                               |  | $                           | (869   | ) |      | $ | (1,104 | )
|Adjustments to reconcile net loss to cash used in operating activities:                |  |                             |        |   |      |   |        |  
|Compensation expense for stock option grants                                           |  |                             |       |   |      |   | 1      |  
|Contributed services from related party                                                |  |                             | 32     |   |      |   | 23     |  
|Depreciation and amortization                                                          |  |                             | 86     |   |      |   |       |  
|Changes in operating assets and liabilities:                                           |  |                             |        |   |      |   |        |  
|Accounts receivable                                                                    |  |                             | (161   | ) |      |   | 1,703  |  
|Inventories                                                                            |  |                             | 174    |   |      |   | (456   | )
|Prepaid expenses and other assets                                                      |  |                             | (13    | ) |      |   | (351   | )
|Accounts payable, accrued expenses and other liabilities                               |  |                             | (577   | ) |      |   | 1,252  |  
|                                                                                       |  |                             |        |   |      |   |        |  
|Net cash provided by (used in) operating activities                                    |  |                             | (1,328 | ) |      |   | 1,068  |  
|                                                                                       |  |                             |        |   |      |   |        |  
|Cash flows from financing activities:                                                  |  |                             |        |   |      |   |        |  
|Proceeds from notes payable - related party                                            |  |                             | 1,375  |   |      |   |       |  
|Principal payments on notes payable - related party                                    |  |                             |       |   |      |   | (530   | )
|Proceeds from sale of common stock, net of expense                                     |  |                             |       |   |      |   | 1      |  
|                                                                                       |  |                             |        |   |      |   |        |  
|Net cash used provided by (used in) financing activities                               |  |                             | 1,375  |   |      |   | (529   | )
|                                                                                       |  |                             |        |   |      |   |        |  
|Net increase in cash and cash equivalents                                              |  |                             | 47     |   |      |   | 539    |  
|Cash and cash equivalents at beginning of period                                       |  |                             | 15     |   |      |   | 12     |  
|                                                                                       |  |                             |        |   |      |   |        |  
|Cash and cash equivalents at end of period                                             |  | $                           | 62     |   |      | $ | 551    |  
|                                                                                       |  |                             |        |   |      |   |        |  
|                                                                                       |  |                            
|Supplemental disclosures of non cash activities:                                       |  |                             |        |   |      |   |        |  
|Inventory used as demonstration and rental units transferred to property and equipment |  | $                           | 89     |   |      | $ |       |  
|                                                                                       |  |                            
|Supplemental disclosures of cash flow information  related party:                     |  |                             |        |   |      |   |        |  
|Cash paid for interest                                                                 |  | $                           | 697    |   |      | $ |       |  

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



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DIGITAL LIGHTWAVE, INC.

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

(Unaudited)

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Business and Basis of Presentation

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

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 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 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 months ended March 31, 2009, is not necessarily indicative of results that 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, 2008.

Operational Matters

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

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

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



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

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

Accrued
Warranty

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



|                   |  |                             |      |   |      |   |     |  
|------------------ |  | --------------------------- | ---- | - | ---- | - | --- | -
|                   |  | Three Months EndedMarch 31, |     
|                   |  | 2009                        |      |   | 2008 |  
|                   |  | (In thousands)              |     
|Beginning balance  |  | $                           | 338  |   |      | $ | 471 |  
|Warranty provision |  |                             | 123  |   |      |   | 50  |  
|Warranty costs     |  |                             | (109 | ) |      |   | (77 | )
|                   |  |                             |      |   |      |   |     |  
|Ending balance     |  | $                           | 352  |   |      | $ | 444 |  
|                   |  |                             |      |   |      |   |     |  

Revenue Recognition

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

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

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

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



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

For trade-in sales, including both Company and competitor products, that have a cash component of greater than 25% of the fair value of the sale, the Company recognizes revenue based upon the fair value of what is sold or received,
whichever is more readily determinable, if the Company has demonstrated the ability to sell its trade-in inventory for that particular product class. Otherwise, the Company accounts for the trade-in sale as a non-monetary transaction and follows the
guidance of Statement of Financial Accounting Standards (SFAS) No. 153 Exchanges of Non- monetary Assetsand Accounting Principles Board (APB) Opinion No. 29, Accounting for Non-monetary Transactions
and related interpretations. Revenue and cost of sales are recorded based upon the cash portion of the transaction. The remaining costs associated with the new units are assigned to the units received on trade. When the trade-in units are resold,
revenue is recorded based upon the sales price and cost of goods sold is charged with the value assigned to trade-in units from the original transaction.

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

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

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

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 months
ended March 31, 2009 and 2008, 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. There were no
incremental shares from common stock equivalents for the three months ended March 31, 2009 and 2008. Total outstanding stock options of 2,100,000 and 2,509,000 shares for the years ended December 31, 2008 and 2007, respectively, were
excluded from the computation, as the inclusion of such would be anti-dilutive. The table below presents the basic weighted average common shares outstanding and the incremental number of shares arising from common stock equivalents under the
treasury stock method:



|                                                |  |                             |  |            
|----------------------------------------------- |  | --------------------------- |  | -----------
|                                                |  | Three Months EndedMarch 31,
|                                                |  | 2009                        |  | 2008       
|Basic:                                          |  |                             |  |            
|Weighted average common shares outstanding      |  | 255,489,847                 |  | 255,484,160
|Diluted:                                        |  |                             |  |            
|Incremental shares for common stock equivalents |  |                            |  |           
|                                                |  |                             |  |            
|Total dilutive                                  |  | 255,489,847                 |  | 255,484,160
|                                                |  |                             |  |            

Stock-Based Compensation

The Companys compensation cost for stock-based employee compensation was $0 and $1,000 for the three months ended March 31, 2009 and 2008, respectively. No tax benefits were recognized for these costs due
to recurring losses.

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.



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Stock Option Plans

The Company has one stock option plan with 10,037,214 shares available for grant as of March 31, 2009 as follows:



|                                                                             |  |                   |  
|---------------------------------------------------------------------------- |  | ----------------- | -
|                                                                             |  | Plan 2001         |  
|Minimum exercise price as a percentage of fair market value at date of grant |  | 100               | %
|Plan termination date                                                        |  | December 31, 2011 |  

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 three months ended March 31, 2009:



|                                 |  |                      |   |  |                              |      |                                        |   |  
|-------------------------------- |  | -------------------- | - |  | ---------------------------- | ---- | -------------------------------------- | - | -
|                                 |  | Shares(In thousands) |   |  | WeightedAverageExercisePrice |      | AggregateIntrinsic Value(In thousands)
|Outstanding at December 31, 2008 |  | 2,100                |   |  | $                            | 1.56 |                                        | $ | 0
|Granted                          |  |                     |   |  |                              |     |                                        |   | 
|Exercised                        |  |                     |   |  |                              |     |                                        |   | 
|Forfeited and expired            |  | (150                 | ) |  | $                            | 1.28 |                                        | $ | 0
|                                 |  |                      |   |  |                              |      |                                        |   |  
|Outstanding at March 31, 2009    |  | 1,950                |   |  | $                            | 1.59 |                                        | $ | 0
|                                 |  |                      |   |  |                              |      |                                        |   |  
|Exercisable at end of period     |  | 1,950                |   |  | $                            | 1.59 |                                        | $ | 0
|                                 |  |                      |   |  |                              |      |                                        |   |  

There were no stock options exercised during the first three months of 2009 and 2008.

Income Taxes

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 have been recognized during the three months ended March 31, 2009 or 2008.

The Company follows the provisions of the Financial Accounting Standards Board (FASB) Interpretation No. 48, Accounting for Uncertainty in Income
Taxes (FIN 48), an interpretation of SFAS No. 109, Accounting for Income Taxes (SFAS 109). FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and
measurement of a tax position taken in a tax return. The Company must determine whether it is more-likely-than-not that a tax position will be sustained upon examination, including resolution of any related appeals or litigation
processes, based on the technical merits of the position. Once it is determined that a position meets the more-likely-than-not recognition threshold, the position is measured to determine the amount of benefit to recognize in the
financial statements. FIN 48 applies to all tax positions related to income taxes subject to SFAS 109.

Based on the analysis performed, the Company
did not record any unrecognized tax positions as of March 31, 2009 and December 31, 2008. There is a possibility that a limitation on the Companys net operating loss carry-forwards may have come into effect under Section 382 of
the Internal Revenue Code as a result of cumulative stock ownership changes. As of March 31, 2009 and December 31, 2008, the impact of such a limitation has no impact on the accompanying financial statements since all net operating losses
have a full valuation allowance; however, such a limitation could impact substantially the reported gross asset related to the net operating loss carry-forwards.



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2. INVENTORIES

Inventories are summarized as follows:



|               |  |                             |       |                                |   |      
|-------------- |  | --------------------------- | ----- | ------------------------------ | - | -----
|               |  | March 31,2009(In thousands) |       | December 31,2008(In thousands)
|Raw materials  |  | $                           | 3,313 |                                | $ | 3,425
|Finished goods |  |                             |      |                                |   | 151  
|               |  |                             |       |                                |   |      
|               |  | $                           | 3,313 |                                | $ | 3,576
|               |  |                             |       |                                |   |      

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. As of March 31, 2009, inventory reserves were approximately $14.0 million.

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 March 31, 2009, the Company had outstanding non-cancelable purchase order commitments to purchase certain inventory items totaling approximately $655,000.

5. RELATED PARTY TRANSACTIONS

Services Rendered

During the three months ended March 31, 2009, Optel provided the Company with approximately $33,000 in services associated with information technology and accounting. These services are shown as a contribution of
capital and are expensed within general and administrative expenses.



|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 SEC. 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, 2008 and 2007 included in our Annual Reports on Form 10-K.



8



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##### Table of Contents

OVERVIEW

Executive Summary

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

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

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

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

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

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 the introduction of competitive products. Because the cost of goods sold tends to
remain relatively stable for any given product, fluctuations in the ASP may have a material adverse effect on our business, financial condition and results of operations.

For the three months ended March 31, 2009, two customers accounted for approximately 31% of total net sales. No other customers accounted for more than 10% of net 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. When selling through a distributor to an end-user customer, we either obtain an end-user purchase order documenting the order placed with the distributor or proof of
delivery to the end-user as evidence that a sales arrangement exists. No revenue is recognized on products shipped on a trial basis. We believe that our accrued warranty reserve is sufficient to meet our responsibilities for potential future
warranty work on products sold.



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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.

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. We also established channel partners such as independent sales representatives and distributors to complement our sales force.

Critical Accounting Estimates

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



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



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



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



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



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



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



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

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

We derive our revenues principally from
product sales. We recognize revenue from the sale of products when persuasive evidence of an arrangement exists, the product has been delivered, the price is fixed and determinable and collection of the resulting receivable is reasonably assured. We
estimate the amount of potential future product returns related to current period product revenue. We consider many factors when making our estimates, including analyzing historical returns, current economic trends, changes in customer demand and
acceptance of our products to evaluate the adequacy of the sales returns and other allowances. As of March 31, 2009, a review of the amount of potential future product returns indicated no allowance was required.

We also estimate the collectability of our accounts receivable. We consider many factors when making our estimates, including analyzing accounts receivable and
historical bad debts, customer concentrations, customer credit-worthiness, current economic trends and changes in our customer payment terms when evaluating the adequacy of the reserve for uncollectible accounts. As of March 31, 2009, our
accounts receivable balance was $1.9 million, net of our estimated reserve for uncollectible accounts of approximately $76,000.

We estimate the amount of
excess and obsolete inventory and lower of cost or market adjustments. We consider many factors when making our estimates, including analyzing current and expected sales trends, the amount of current parts on hand, the current market value of parts
on hand and the viability and technical obsolescence of our products. The assumptions made relative to expected sales trends are subjective in nature and have a material impact on the estimate of the reserve requirement. Should future sales trends,
in total or by product line, fluctuate from that used in our estimates, this reserve could be overstated or understated. Our inventory balance was $3.3 million as of March 31, 2009, net of our estimated reserve for excess and obsolete inventory
and lower of cost or market adjustments of approximately $14.0 million.

We estimate the impairment of long-lived assets. We monitor events and changes in
circumstances that indicate whether carrying amounts of long-lived assets may not be recoverable. These events and circumstances include decrease in market price of a long-lived asset, change in the manner in which a long-lived asset is used,
changes in legal factors and a current-period



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##### Table of Contents

operating loss or cash flow loss combined with a history of operating losses or cash flow losses or a forecast that demonstrates continuing losses associated
with the use of long-lived assets. When such an event or changes in circumstance occur, we assess the recoverability of long-lived assets by determining whether the carrying value of such assets will be recovered through undiscounted expected future
cash flows. We recognize impairment when there is an excess of the assets carrying value over the fair value as estimated using a discounted expected future cash flows model. In estimating undiscounted expected future cash flows, we must make
judgments and estimates related to future sales and profitability. Should future sales trends or profitability be significantly less than that forecasted, our impairment could be understated. We could be required to take an additional impairment
charge in the future should our actual cash flows be less than forecasted.

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

We 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 March 31, 2009 was approximately $352,000.

RESULTS OF OPERATIONS

The following is a discussion of significant changes in the results of operations of the Company, which occurred in the three months ended
March 31, 2009, compared to the three months ended March 31, 2008. The following sets forth certain financial data as a percentage of net sales:



|                            |  |                                                          |    |  |      |   
|--------------------------- |  | -------------------------------------------------------- | -- |  | ---- | --
|                            |  | Percent of Net Sales for theThree Months Ended March 31, |   
|                            |  | 2009                                                     |    |  | 2008 |   
|Net sales                   |  | 100                                                      | %  |  | 100  | % 
|Cost of goods sold          |  | 58                                                       |    |  | 57   |   
|                            |  |                                                          |    |  |      |   
|Gross profit                |  | 42                                                       |    |  | 43   |   
|                            |  |                                                         
|Operating expenses:         |  |                                                          |    |  |      |   
|Engineering and development |  | 25                                                       |    |  | 20   |   
|Sales and marketing         |  | 33                                                       |    |  | 23   |   
|General and administrative  |  | 15                                                       |    |  | 10   |   
|                            |  |                                                          |    |  |      |   
|Total operating expenses    |  | 73                                                       |    |  | 53   |   
|                            |  |                                                          |    |  |      |   
|Operating loss              |  | (31                                                      | )  |  | (10  | ) 
|Other expense, net          |  | (12                                                      | )  |  | (33  | ) 
|                            |  |                                                          |    |  |      |   
|Loss before income taxes    |  | (43                                                      | )  |  | (43  | ) 
|Benefit from income taxes   |  |                                                         |    |  |     |   
|                            |  |                                                          |    |  |      |   
|Net Loss                    |  | (43                                                      | )% |  | (43  | )%
|                            |  |                                                          |    |  |      |   

Net Sales

Net
sales for the quarter ended March 31, 2009, decreased $559,000, or 22%, to $2.0 million from $2.6 million for the quarter ended March 31, 2008. International net sales for the quarter ended March 31, 2009, were approximately $847,000,
or 42% of net sales, as compared to approximately $790,000, or 30% of net sales, for the quarter ended March 31, 2008. The decrease is due to business conditions affecting the telecommunications industry.



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Cost of Goods Sold

Cost of goods sold for the quarter ended March 31, 2009, totaled approximately $1.2 million, or 58% of net sales, as compared to $1.5 million, or 57% of net sales, for the quarter ended March 31, 2008. For the quarter ended
March 31, 2009, cost of goods as a percentage of net sales was relatively unchanged.

Gross Profit

Gross profit for the quarter ended March 31, 2009, decreased by approximately $243,000 to $862,000, or 42% of net sales, from $1.1 million, or 43% of net sales, for
the quarter ended March 31, 2008. The decrease in gross profit was commensurate with the decrease in net sales.

Engineering and Development

Engineering and development expenses principally include salaries for engineering and development personnel, outside consulting fees and other development
expenses. Engineering and development expenses for the quarter ended March 31, 2009, decreased by approximately $11,000 to $499,000 from approximately $510,000 for the quarter ended March 31, 2008.

Sales and Marketing

Sales and marketing expenses principally include
salaries, commissions, travel, tradeshows and promotional materials and warranty expenses. Sales and marketing expenses for the quarter ended March 31, 2009, were $682,000, a increase of approximately $78,000 over the quarter ended
March 31, 2008 of $604,000. The increase is due to the depreciation expense of new demo units that were built throughout 2008 and 2009.

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 March 31, 2009, increased by approximately $61,000 to $311,000 from approximately $250,000 for the quarter ended
March 31, 2008. This increase is primarily due to higher accounting and consulting services.

Other Income and Expense, net

Other expense, net for the quarter ended March 31, 2009 was approximately $239,000, a decrease of $606,000 as compared to other expense, net of approximately
$845,000 for the quarter ended March 31, 2008. The decrease was primarily attributable to lower interest expense on promissory notes owed to Optel in connection with the credit agreement.

Provision for Income Taxes

No provision for income taxes was made
for the three-month periods ending March 31, 2009 and 2008 due to the Companys expected annual net losses. Any tax benefits resulting from the Companys net loss have not been recognized due to a full valuation allowance for deferred
tax assets being recorded as a result of managements belief it is more likely than not that future tax benefits will not be realized as a result of future income.

Net Loss

Net loss for the quarter ended March 31, 2009 was approximately $869,000, or $0.00 per
diluted share, compared with net loss of approximately $1.1 million, or $0.00 per diluted share, for the quarter ended March 31, 2008, for the reasons discussed above.

LIQUIDITY AND CAPITAL RESOURCES

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



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Pursuant to the Credit Agreement, the restructured indebtedness is evidenced by the Restated Note, and the revolving
credit facility is evidenced by the New Commitment Note. As of March 9, 2009, the balance of the Restated Note and New Commitment Note was $35.7 million and $2.5 million, respectively. The Notes bear interest at a rate equal to LIBOR plus
1.0% per annum and are secured by substantially all the Companys assets pursuant the Security Agreement. From April 4, 2008 through March 31, 2009, interest expense related to the Notes was approximately $1.3 million and
recorded in other expense on the Consolidated Statements of Operations. Each of the Notes requires quarterly payments of interest commencing on June 30, 2008, and matures on March 31, 2010. Interest payments of approximately $465,000
and $231,000 were made January 5, 2009 and March 31, 2009, respectively.

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

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

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

Operating Activities

Net cash used by operating activities for the three months ended March 31, 2009 was approximately $1.3 million. This was primarily the result of the decrease in
accounts payable of approximately $568,000 and an operating loss of $869,000.

Off Balance Sheet Arrangements

There were no off balance sheet arrangements for the three months ended March 31, 2009.

Investing Activities

No net cash was provided or used by investing activities for the three months ended
March 31, 2009.

Financing Activities

Net cash
provided by financing activities for the three months ended March 31, 2009 was a result of $1.4 million additional financing provided by Optel, LLC and Optel Capital, LLC.



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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.



|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. As of March 31, 2009, the related party notes have an
interest rate based upon LIBOR. As of March 31, 2009, a 1% change in LIBOR would have a $382,000 impact on interest expense.



|Item 4(T). | Controls and Procedures.
|---------- | ------------------------

Our management, with
the participation of our principal executive officer and principal financial officer evaluated the effectiveness of our disclosure controls and procedures pursuant to the Securities Exchange Act of 1934, as amended (the Exchange Act), as
defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, as of the end of the period covered by this quarterly report on Form 10-Q. Based on this evaluation, our principal executive officer and principal financial officer concluded that,
(1) our disclosure controls and procedures are not effective pursuant to the requirements of the Sarbanes-Oxley Act of 2002 for companies our size, (2) information to be disclosed in reports we file under the Exchange Act is recorded,
processed, summarized and reported within the time periods specified by the rules and forms promulgated under the Exchange Act, and (3) information required to be disclosed in reports filed under the Exchange Act is accumulated and communicated
to the principal executive officer and principal financial officer as appropriate to allow timely decisions regarding required disclosure.

Managements Report on Internal Control Over Financial Reporting

There was no material change in the Companys internal control
over financial reporting that occurred during the quarter ended March 31, 2009 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.



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PART II

OTHER INFORMATION



|Item 1. | 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 or 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, 2008 in response to Item 1A to Part 1 of Form 10-K.



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

None.



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

None.



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

None.



|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 17 of this report.

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: May 15, 2009By:

/s/ KENNETH T. MYERSInterim Chief Accounting Officer(Principal Financial Officer)Date: May 15, 2009




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EXHIBIT INDEX



|               |  |                                                                                                                                                                                                                                                               
|-------------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit Number |  | 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*          |  | Credit and Restructuring Agreement, between the Digital Lightwave, Inc. and Optel Capital, LLC. dated April 4, 2008 (incorporated by reference to Exhibit 10.1 to the Current Report on Form
8-K filed by the Company on April 10, 2008).                     
|               | 
|10.2*          |  | Secured Convertible Promissory Noted (Restated Noted), issued by Digital Lightwave, Inc. to Optel. Capital, LLC dated April 4, 2008 (incorporated by reference to Exhibit 10.2 to the Current
Report on Form 8-K filed by the Company on April 10, 2008).     
|               | 
|10.3*          |  | Secured Convertible Promissory Noted (New Commitment Loans) issued by Digital Lightwave, Inc. to Optel Capital, LLC dated April 4, 2008, (incorporated by reference to Exhibit 10.3 to the
Current Report on Form 8-K filed by the Company on April 10, 2008).
|               | 
|10.4*          |  | Amended and Restated Security Agreement, between Digital Lightwave, Inc. and Optel Capital, LLC dated April 4, 2008 (incorporated by reference to Exhibit 10.4 to the Current Report on Form
8-K filed by the Company on April 10, 2008).                     
|               | 
|10.5*          |  | Registration Rights Agreement, between Digital Lightwave, Inc. and Optel Capital, LLC. dated April 4, 2008 (incorporated by reference to Exhibit 10.5 to the Current Report on Form 8-K filed
by the Company on April 10, 2008).                              
|               | 
|10.6*          |  | Secured Convertible Promissory Note issued by Digital Lightwave, Inc. to Optel Capital, LLC dated March 26, 2009,                                                                                                                                             
|               | 
|10.7*          |  | Secured Convertible Promissory Note issued by Digital Lightwave, Inc. to Optel Capital, LLC dated March 30, 2009,                                                                                                                                             
|               | 
|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 herewithin.
|- | -----------------



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