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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 June 30, 2009, or



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

For the transition period from              to
            .

000-31770

(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 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 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 a 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 August 13, 2009, was 255,489,847









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DIGITAL LIGHTWAVE, INC.

QUARTERLY REPORT ON FORM 10-Q

For the Period Ended June 30, 2009

INDEX



|              |  |                                                                                                        |  |     
|------------- |  | ------------------------------------------------------------------------------------------------------ |  | ----
|              |  |                                                                                                        |  | Page
|              |  | PART I. FINANCIAL INFORMATION                                                                          |  |     
|              |  |                                                                                                       
|Item 1.       |  | Financial Statements:                                                                                  |  |     
|              |  |                                                                                                       
|              |  | Consolidated Balance Sheets  June 30, 2009 (Unaudited) and December 31, 2008                          |  | 1   
|              |  |                                                                                                       
|              |  | Consolidated Statements of Operations (Unaudited)  Three Months Ended June 30, 2009 and June 30, 2008 |  | 2   
|              |  |                                                                                                       
|              |  | Consolidated Statements of Operations (Unaudited)  Six Months Ended June 30, 2009 and June 30, 2008   |  | 3   
|              |  |                                                                                                       
|              |  | Consolidated Statements of Cash Flows (Unaudited)  Six Months Ended June 30, 2009 and June 30, 2008   |  | 4   
|              |  |                                                                                                       
|              |  | Notes to Consolidated 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                                             |  | 17  
|              |  |                                                                                                       
|Item 4(T)     |  | Controls and Procedures                                                                                |  | 17  
|              |  |                                                                                                       
|              |  | PART II. OTHER INFORMATION                                                                             |  |     
|              |  |                                                                                                       
|Item 1.       |  | Legal Proceedings                                                                                      |  | 18  
|              |  |                                                                                                       
|Item 1A.      |  | Risk Factors                                                                                           |  | 18  
|              |  |                                                                                                       
|Item 2.       |  | Unregistered Sales of Equity Securities and Use of Proceeds                                            |  | 18  
|              |  |                                                                                                       
|Item 3.       |  | Defaults Upon Senior Securities                                                                        |  | 18  
|              |  |                                                                                                       
|Item 4.       |  | Submission of Matters to a Vote of Security Holders                                                    |  | 18  
|              |  |                                                                                                       
|Item 5.       |  | Other Information                                                                                      |  | 18  
|              |  |                                                                                                       
|Item 6.       |  | Exhibits and Reports on Form 8-K                                                                       |  | 18  
|              | 
|SIGNATURES    |  | 19                                                                                                    
|              | 
|EXHIBIT INDEX |  | 20                                                                                                    



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##### Table of Contents

PART I

FINANCIAL INFORMATION



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

DIGITAL LIGHTWAVE, INC.

CONSOLIDATED BALANCE SHEETS

(In thousands, except share data)



|                                                                                                                          |  |              |          |   |                  |   |          |  
|------------------------------------------------------------------------------------------------------------------------- |  | ------------ | -------- | - | ---------------- | - | -------- | -
|                                                                                                                          |  | June 30,2009 |          |   | December 31,2008 |  
|                                                                                                                          |  | (Unaudited)  |          |   |                  |  
|ASSETS                                                                                                                    |  |              |          |   |                  |   |          |  
|Current assets:                                                                                                           |  |              |          |   |                  |   |          |  
|Cash                                                                                                                      |  | $            | 84       |   |                  | $ | 15       |  
|Accounts receivable, less allowance of $76 in 2009 and 2008                                                               |  |              | 1,170    |   |                  |   | 1,730    |  
|Inventories, net                                                                                                          |  |              | 3,253    |   |                  |   | 3,576    |  
|Prepaid expenses and other current assets                                                                                 |  |              | 146      |   |                  |   | 196      |  
|                                                                                                                          |  |              |          |   |                  |   |          |  
|Total current assets                                                                                                      |  |              | 4,653    |   |                  |   | 5,517    |  
|Property and Equipment, net                                                                                               |  |              | 1,044    |   |                  |   | 950      |  
|Other assets, net                                                                                                         |  |              | 214      |   |                  |   | 214      |  
|                                                                                                                          |  |              |          |   |                  |   |          |  
|Total assets                                                                                                              |  | $            | 5,911    |   |                  | $ | 6,681    |  
|                                                                                                                          |  |              |          |   |                  |   |          |  
|                                                                                                                          |  |             
|LIABILITIES AND STOCKHOLDERS DEFICIT                                                                                     |  |              |          |   |                  |   |          |  
|Current liabilities:                                                                                                      |  |              |          |   |                  |   |          |  
|Accounts payable and accrued liabilities                                                                                  |  | $            | 2,104    |   |                  | $ | 2,896    |  
|Current portion of notes payable to related party                                                                         |  |              | 38,856   |   |                  |   |         |  
|                                                                                                                          |  |              |          |   |                  |   |          |  
|Total current liabilities                                                                                                 |  |              | 40,960   |   |                  |   | 2,896    |  
|Other long-term liabilities                                                                                               |  |              | 293      |   |                  |   | 319      |  
|Notes payable to related party                                                                                            |  |              |         |   |                  |   | 37,204   |  
|                                                                                                                          |  |              |          |   |                  |   |          |  
|Total liabilities                                                                                                         |  |              | 41,253   |   |                  |   | 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 shares in 2009 and 2008 |  |              | 26       |   |                  |   | 26       |  
|Additional paid-in capital                                                                                                |  |              | 123,225  |   |                  |   | 123,167  |  
|Accumulated deficit                                                                                                       |  |              | (158,593 | ) |                  |   | (156,931 | )
|                                                                                                                          |  |              |          |   |                  |   |          |  
|Total stockholders deficit                                                                                               |  |              | (35,342  | ) |                  |   | (33,738  | )
|                                                                                                                          |  |              |          |   |                  |   |          |  
|Total liabilities and stockholders deficit                                                                               |  | $            | 5,911    |   |                  | $ | 6,681    |  
|                                                                                                                          |  |              |          |   |                  |   |          |  

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



1



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DIGITAL LIGHTWAVE, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

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



|                                                                 |  |                            |             |   |      |   |             |  
|---------------------------------------------------------------- |  | -------------------------- | ----------- | - | ---- | - | ----------- | -
|                                                                 |  | Three Months EndedJune 30, |            
|                                                                 |  | 2009                       |             |   | 2008 |  
|Net sales                                                        |  | $                          | 1,632       |   |      | $ | 2,204       |  
|Cost of goods sold                                               |  |                            | 946         |   |      |   | 1,301       |  
|                                                                 |  |                            |             |   |      |   |             |  
|Gross profit                                                     |  |                            | 686         |   |      |   | 903         |  
|                                                                 |  |                            |             |   |      |   |             |  
|Operating expenses:                                              |  |                            |             |   |      |   |             |  
|Engineering and development                                      |  |                            | 497         |   |      |   | 543         |  
|Sales and marketing                                              |  |                            | 587         |   |      |   | 637         |  
|General and administrative                                       |  |                            | 179         |   |      |   | 314         |  
|Gain on sale of property and equipment                           |  |                            | (12         | ) |      |   |            |  
|                                                                 |  |                            |             |   |      |   |             |  
|Total operating expenses                                         |  | $                          | 1,251       |   |      | $ | 1,494       |  
|                                                                 |  |                            |             |   |      |   |             |  
|Operating loss                                                   |  |                            | (565        | ) |      |   | (591        | )
|Other expense, net                                               |  |                            | (228        | ) |      |   | (361        | )
|                                                                 |  |                            |             |   |      |   |             |  
|Net loss                                                         |  | $                          | (793        | ) |      | $ | (952        | )
|                                                                 |  |                            |             |   |      |   |             |  
|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 |   |      |   | 255,489,006 |  
|                                                                 |  |                            |             |   |      |   |             |  
|Weighted average common and common equivalent shares outstanding |  |                            | 255,489,847 |   |      |   | 255,489,006 |  
|                                                                 |  |                            |             |   |      |   |             |  

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



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DIGITAL LIGHTWAVE, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

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



|                                                                 |  |                          |             |   |      |   |             |  
|---------------------------------------------------------------- |  | ------------------------ | ----------- | - | ---- | - | ----------- | -
|                                                                 |  | Six Months EndedJune 30, |            
|                                                                 |  | 2009                     |             |   | 2008 |  
|Net sales                                                        |  | $                        | 3,669       |   |      | $ | 4,800       |  
|Cost of goods sold                                               |  |                          | 2,121       |   |      |   | 2,792       |  
|                                                                 |  |                          |             |   |      |   |             |  
|Gross profit                                                     |  |                          | 1,548       |   |      |   | 2,008       |  
|                                                                 |  |                          |             |   |      |   |             |  
|Operating expenses:                                              |  |                          |             |   |      |   |             |  
|Engineering and development                                      |  |                          | 996         |   |      |   | 1,053       |  
|Sales and marketing                                              |  |                          | 1,269       |   |      |   | 1,241       |  
|General and administrative                                       |  |                          | 490         |   |      |   | 564         |  
|Gain on sale of property and equipment                           |  |                          | (12         | ) |      |   |            |  
|                                                                 |  |                          |             |   |      |   |             |  
|Total operating expenses                                         |  |                          | 2,743       |   |      |   | 2,858       |  
|                                                                 |  |                          |             |   |      |   |             |  
|Operating loss                                                   |  |                          | (1,195      | ) |      |   | (850        | )
|Other expense, net                                               |  |                          | (467        | ) |      |   | (1,206      | )
|                                                                 |  |                          |             |   |      |   |             |  
|Net loss                                                         |  | $                        | (1,662      | ) |      | $ | (2,056      | )
|                                                                 |  |                          |             |   |      |   |             |  
|Per share of common stock:                                       |  |                          |             |   |      |   |             |  
|Basic net loss per share                                         |  | $                        | (0.01       | ) |      | $ | (0.01       | )
|                                                                 |  |                          |             |   |      |   |             |  
|Diluted net loss per share                                       |  | $                        | (0.01       | ) |      | $ | (0.01       | )
|                                                                 |  |                          |             |   |      |   |             |  
|Weighted average common shares outstanding                       |  |                          | 255,489,847 |   |      |   | 255,486,584 |  
|                                                                 |  |                          |             |   |      |   |             |  
|Weighted average common and common equivalent shares outstanding |  |                          | 255,489,847 |   |      |   | 255,486,584 |  
|                                                                 |  |                          |             |   |      |   |             |  

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



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DIGITAL LIGHTWAVE, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(In thousands)



|                                                                                       |  |                          |        |   |      |   |        |  
|-------------------------------------------------------------------------------------- |  | ------------------------ | ------ | - | ---- | - | ------ | -
|                                                                                       |  | Six Months EndedJune 30, |       
|                                                                                       |  | 2009                     |        |   | 2008 |  
|Cash flows from operating activities:                                                  |  |                          |        |   |      |   |        |  
|Net loss                                                                               |  | $                        | (1,662 | ) |      | $ | (2,056 | )
|Adjustments to reconcile net loss to cash used in operating activities:                |  |                          |        |   |      |   |        |  
|Compensation expense for stock option grants                                           |  |                          |       |   |      |   | 2      |  
|Contributed services from related party                                                |  |                          | 58     |   |      |   | 41     |  
|Depreciation and amortization                                                          |  |                          | 182    |   |      |   |       |  
|Gain on sale of property and equipment                                                 |  |                          | (12    | ) |      |   |       |  
|Changes in operating assets and liabilities:                                           |  |                          |        |   |      |   |        |  
|Accounts receivable                                                                    |  |                          | 560    |   |      |   | 2,334  |  
|Inventories                                                                            |  |                          | 47     |   |      |   | (1,127 | )
|Prepaid expenses and other assets                                                      |  |                          | 50     |   |      |   | (105   | )
|Accounts payable, accrued expenses and other liabilities                               |  |                          | (818   | ) |      |   | 1,471  |  
|                                                                                       |  |                          |        |   |      |   |        |  
|Net cash (used in) provided by operating activities                                    |  |                          | (1,595 | ) |      |   | 560    |  
|                                                                                       |  |                          |        |   |      |   |        |  
|Cash flows from investing activities:                                                  |  |                          |        |   |      |   |        |  
|Proceeds from sale of property and equipment                                           |  |                          | 12     |   |      |   |       |  
|                                                                                       |  |                          |        |   |      |   |        |  
|Net cash provided by investing activities                                              |  |                          | 12     |   |      |   |       |  
|                                                                                       |  |                          |        |   |      |   |        |  
|Cash flows from financing activities:                                                  |  |                          |        |   |      |   |        |  
|Proceeds from notes payable  related party                                            |  |                          | 1,663  |   |      |   |       |  
|Principal payments on notes payable  related party                                    |  |                          | (11    | ) |      |   | (530   | )
|Proceeds from sale of common stock, net of expense                                     |  |                          |       |   |      |   | 1      |  
|                                                                                       |  |                          |        |   |      |   |        |  
|Net cash provided by (used in) financing activities                                    |  |                          | 1,652  |   |      |   | (529   | )
|                                                                                       |  |                          |        |   |      |   |        |  
|Net increase in cash and cash equivalents                                              |  |                          | 69     |   |      |   | 31     |  
|Cash and cash equivalents at beginning of period                                       |  |                          | 15     |   |      |   | 12     |  
|                                                                                       |  |                          |        |   |      |   |        |  
|Cash and cash equivalents at end of period                                             |  | $                        | 84     |   |      | $ | 43     |  
|                                                                                       |  |                          |        |   |      |   |        |  
|                                                                                       |  |                         
|Supplemental disclosures of non cash activities  related party:                       |  |                          |        |   |      |   |        |  
|Inventory used as demonstration and rental units transferred to property and equipment |  | $                        | 276    |   |      | $ |       |  
|Accrued interest converted to related party note payable                               |  | $                        |       |   |      | $ | 857    |  
|                                                                                       |  |                         
|Supplemental disclosures of cash flow information:                                     |  |                          |        |   |      |   |        |  
|Cash paid for interest                                                                 |  | $                        | 910    |   |      | $ |       |  

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



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DIGITAL LIGHTWAVE, INC.

NOTES TO CONSOLIDATED 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
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- and six -months ended June 30, 2009, are 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. Optel is
controlled by Dr. Bryan J. Zwan, the Companys largest stockholder and chairman of the board of directors. The Credit Agreement was approved by the Companys board of directors upon the unanimous recommendation of a special
committee of the board comprised solely of independent directors.

Pursuant to the Credit Agreement, the restructured indebtedness is evidenced by a new
secured convertible promissory note in the principal amount of approximately $35.7 million (the Restated Note), and the revolving credit facility is evidenced by an additional secured convertible promissory note in the principal amount
of $2.5 million (the New Commitment Note and, together with the Restated Note, the Notes). As of June 30, 2009, the principal balances of the Restated Note and New Commitment Note were $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. The Company has not yet held its 2009 annual meeting of stockholders.



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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.

On June 25, 2009, June 29, 2009 and July 22, 2009, the Company borrowed $75,000, $213,000 and $350,000, 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 August 30, 2009 for the June Notes and September 30, 2009 for the July Note; 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 EndedJune 30, |     
|                   |  | 2009                       |      |   | 2008 |  
|                   |  | (In thousands)             |     
|Beginning balance  |  | $                          | 352  |   |      | $ | 444  |  
|Warranty provision |  |                            | 32   |   |      |   | 33   |  
|Warranty costs     |  |                            | (51  | ) |      |   | (62  | )
|                   |  |                            |      |   |      |   |      |  
|Ending balance     |  | $                          | 333  |   |      | $ | 415  |  
|                   |  |                            |      |   |      |   |      |  
|                   | 
|                   |  | Six Months EndedJune 30,   |     
|                   |  | 2009                       |      |   | 2008 |  
|                   |  | (In thousands)             |     
|Beginning balance  |  | $                          | 338  |   |      | $ | 471  |  
|Warranty provision |  |                            | 155  |   |      |   | 83   |  
|Warranty costs     |  |                            | (160 | ) |      |   | (139 | )
|                   |  |                            |      |   |      |   |      |  
|Ending balance     |  | $                          | 333  |   |      | $ | 415  |  
|                   |  |                            |      |   |      |   |      |  



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##### Table of Contents

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s products to a third party that will market the products under their brand.

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

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.



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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, 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- and six-month periods ended June 20, 2009 and 2008. Total outstanding stock options of 1,950,000 shares for the three- and six-month periods ended June 30, 2009 were excluded from the computation, as the inclusion of such would
be anti-dilutive. Total outstanding stock options of 2,506,000 shares for the three-and six-month periods ended June 30, 2008 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 EndedJune 30,
|                                                |  | 2009                       |  | 2008       
|Basic:                                          |  |                            |  |            
|Weighted average common shares outstanding      |  | 255,489,847                |  | 255,489,006
|Diluted:                                        |  |                            |  |            
|Incremental shares for common stock equivalents |  |                           |  |           
|                                                |  |                            |  |            
|Total dilutive                                  |  | 255,489,847                |  | 255,489,006
|                                                |  |                            |  |            
|                                                | 
|                                                |  | Six Months EndedJune 30,  
|                                                |  | 2009                       |  | 2008       
|Basic:                                          |  |                            |  |            
|Weighted average common shares outstanding      |  | 255,489,847                |  | 255,486,584
|Diluted:                                        |  |                            |  |            
|Incremental shares for common stock equivalents |  |                           |  |           
|                                                |  |                            |  |            
|Total dilutive                                  |  | 255,489,847                |  | 255,486,584
|                                                |  |                            |  |            

Stock-Based Compensation

The Companys compensation cost for stock-based employee compensation was $0 for the three- and six-month periods ended June 30, 2009. The Companys cost for stock based employee compensation was $600
and $1,600 for the three- and six-month periods ended June 30, 2008.

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 10,037,214 shares available for grant as of June 30, 2009 as follows:



|                                                                             |  |                   |  
|---------------------------------------------------------------------------- |  | ----------------- | -
|                                                                             |  | Plan2001          |  
|Minimum exercise price as a percentage of fair market value at date of grant |  | 100               | %
|Plan termination date                                                        |  | December 31, 2011 |  



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##### Table of Contents

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, 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 June 30, 2009     |  | 1,950                |   |  | $                            | 1.59 |                                        | $ | 0
|                                 |  |                      |   |  |                              |      |                                        |   |  
|                                 |  |                      |  
|Exercisable at end of period     |  | 1,950                |   |  | $                            | 1.59 |                                        | $ | 0
|                                 |  |                      |   |  |                              |      |                                        |   |  

There were no stock options exercised during the six months ended June 30, 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 six months ended June 30, 2009.

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 June 30, 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 June 30, 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.

New Accounting Pronouncements

In May 2009, FASB issued SFAS No. 165, Subsequent Events (SFAS 165). SFAS 165
establishes general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. Specifically, SFAS165 provides the period after the balance
sheet date during which management of a reporting entity or disclosure in the financial statements; the circumstances under which an entity should recognize events or transactions occurring after the balance sheet date in its financial statements;
and the disclosures that an entity should make about events or transactions that occurred after the balance sheet date. SFAS 165 was effective for interim or annual financial periods ended after June 15, 2009, and is to be applied
prospectively. The Companys adoption of this statement was not significant to the Companys consolidated financial statements. Management has evaluated subsequent events through August 13, 2009.



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In June 2009, FASB issued SFAS No. 168, The FASB Accounting Standards Codification and the Hierarchy of Generally
Accepted Accounting Principles, a replacement of FASB Statement No. 162 (SFAS 162). The FASB Accounting Standards Codification (Codification) will become the source of authoritative U.S. generally accepted accounting
principles (GAAP) recognized by the FASB to be applied by nongovernmental entities. Rules and interpretive releases of the SEC under authority of federal securities laws are also sources of authoritative GAAP for SEC registrants. On the
effective date of this standard, the Codification will supersede all existing non-SEC accounting and reporting standards. All other non-grandfathered non-SEC accounting literature not included in the Codification will become non-authoritative. The
Company does not expect the adoption of this statement to be significant to its consolidated financial statements.

2. INVENTORIES

Inventories are summarized as follows:



|               |  |                            |       |                                |   |      
|-------------- |  | -------------------------- | ----- | ------------------------------ | - | -----
|               |  | June 30,2009(In thousands) |       | December 31,2008(In thousands)
|Raw materials  |  | $                          | 3,242 |                                | $ | 3,425
|Finished goods |  |                            | 11    |                                |   | 151  
|               |  |                            |       |                                |   |      
|               |  | $                          | 3,253 |                                | $ | 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 June 30, 2009, inventory reserves were approximately $13.9 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 June 30, 2009, the Company had outstanding non-cancelable purchase order commitments to purchase certain inventory items totaling approximately $400,000.

5. RELATED PARTY TRANSACTIONS

Services Rendered

During the three- and six-month periods ended June 30, 2009, Optel provided the Company with approximately $26,000 and $58,000 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.



|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, except as required by law, we assume no obligation to update any such forward-looking statements. In
evaluating these statements, you should specifically consider various factors, including the



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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.

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. Optel is controlled by Dr. Bryan J. Zwan, the Companys largest
stockholder and chairman of the board of directors. The Credit Agreement was approved by the Companys board of directors upon the unanimous recommendation of a special committee of the board comprised solely of independent directors.

Pursuant to the Credit Agreement, the restructured indebtedness is evidenced by a new secured convertible promissory note in the principal amount of
approximately $35.7 million (the Restated Note), and the revolving credit facility is evidenced by an additional secured convertible promissory note in the principal amount of $2.5 million (the New Commitment Note and,
together with the Restated Note, the Notes). As of June 30, 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.

On June 25, 2009, June 29, 2009 and July 22, 2009, the Company borrowed $75,000, $213,000 and $350,000, 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 August 30, 2009 on the June Notes and September 30, 2009 for the July Note; 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



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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 six months ended
June 30, 2009, two customers accounted for, in the aggregate, approximately 23% 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.

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 result 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 June 30, 2009, a review of the amount of potential future product returns indicated no allowance was required.



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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 June 30, 2009, our accounts receivable balance was $1.2 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 June 30, 2009, net of
our estimated reserve for excess and obsolete inventory and lower of cost or market adjustments of approximately $13.9 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 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 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 June 30, 2009 was approximately $333,000.



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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, 2009, compared to the three- and six- months ended June 30, 2008. The
following sets forth certain financial data as a percentage of net sales:



|                                       |  |                                                         |    |  |                                                       |    |  |      |    |  |      |   
|-------------------------------------- |  | ------------------------------------------------------- | -- |  | ----------------------------------------------------- | -- |  | ---- | -- |  | ---- | --
|                                       |  | Percent of Net Sales for theThree Months Ended June 30, |    |  | Percent of Net Sales for theSix Months Ended June 30, |   
|                                       |  | 2009                                                    |    |  | 2008                                                  |    |  | 2009 |    |  | 2008 |   
|                                       |  |                                                         |    | 
|Net sales                              |  | 100                                                     | %  |  | 100                                                   | %  |  | 100  | %  |  | 100  | % 
|Cost of goods sold                     |  | 58                                                      |    |  | 59                                                    |    |  | 58   |    |  | 58   |   
|                                       |  |                                                         |    |  |                                                       |    |  |      |    |  |      |   
|                                       |  |                                                         |    | 
|Gross profit                           |  | 42                                                      |    |  | 41                                                    |    |  | 42   |    |  | 42   |   
|                                       |  |                                                         |    | 
|Operating expenses:                    |  |                                                         |    |  |                                                       |    |  |      |    |  |      |   
|Engineering and development            |  | 31                                                      |    |  | 25                                                    |    |  | 27   |    |  | 22   |   
|Sales and marketing                    |  | 36                                                      |    |  | 29                                                    |    |  | 34   |    |  | 26   |   
|General and administrative             |  | 11                                                      |    |  | 14                                                    |    |  | 13   |    |  | 12   |   
|Gain on sale of property and equipment |  | (1                                                      | )  |  |                                                      |    |  |     |    |  |     |   
|                                       |  |                                                         |    |  |                                                       |    |  |      |    |  |      |   
|Total operating expenses               |  | 77                                                      |    |  | 68                                                    |    |  | 74   |    |  | 60   |   
|                                       |  |                                                         |    |  |                                                       |    |  |      |    |  |      |   
|Operating profit (loss)                |  | (35                                                     | )  |  | (27                                                   | )  |  | (32  | )  |  | (18  | ) 
|Other loss, net                        |  | (14                                                     | )  |  | (16                                                   | )  |  | (13  | )  |  | (25  | ) 
|                                       |  |                                                         |    |  |                                                       |    |  |      |    |  |      |   
|Loss before income taxes               |  | (49                                                     | )  |  | (43                                                   | )  |  | (45  | )  |  | (43  | ) 
|Provision for income taxes             |  |                                                        |    |  |                                                      |    |  |     |    |  |     |   
|                                       |  |                                                         |    |  |                                                       |    |  |      |    |  |      |   
|Net Loss                               |  | (49                                                     | )% |  | (43                                                   | )% |  | (45  | )% |  | (43  | )%
|                                       |  |                                                         |    |  |                                                       |    |  |      |    |  |      |   

Net Sales

Net
sales for the quarter ended June 30, 2009, decreased $572,000, or 26%, to $1.6 million from $2.2 million for the quarter ended June 30, 2008. International net sales for the quarter ended June 30, 2009, were approximately $585,000, or
36% of net sales, as compared to approximately $488,000, or 38% of net sales, for the quarter ended June 30, 2008. The decrease was primarily due to business conditions affecting the telecommunications industry.

Net sales for the six months ended June 30, 2009, decreased $1.1 million, or 24%, to $3.7 million from $4.8 million for the six months ended June 30, 2008. The
decrease in net sales was primarily due to business conditions affecting the telecommunications industry. International net sales for the six months ended June 30, 2009, were approximately $1.5 million, or 40% of net sales, as compared to
approximately $1.6 million, or 34% of net sales, for the six months ended June 30, 2008.

Cost of Goods Sold

Cost of goods sold for the quarter ended June 30, 2009, totaled approximately $946,000, or 58% of net sales, as compared to $1.3 million, or 59% of net sales, for
the quarter ended June 30, 2008. For the quarter ended June 30, 2009, cost of goods as a percentage of net sales was relatively unchanged.

Cost
of goods sold for the six months ended June 30, 2009, totaled approximately $2.1 million, or 58% of net sales, as compared to $2.8 million, or 58% of net sales, for the quarter ended June 30, 2008. For the six months ended June 30,
2009, cost of goods as a percentage of net sales was relatively unchanged.

Gross Profit

Gross profit for the quarter ended June 30, 2009, decreased by approximately $217,000 to approximately $686,000, or 42% of net sales, from $903,000, or 41% of net
sales, for the quarter ended June 30, 2008. The decrease in gross profit was commensurate with the decrease in net sales.



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Gross profit for the six months ended June 30, 2009, decreased by approximately $460,000 to approximately $1.5
million, or 41% of net sales, from $2.0 million, or 42% of net sales, for the six months ended June 30, 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 June 30, 2009, decreased by approximately $46,000 to
$497,000, or 31% of net sales, from approximately $543,000, or 25% of net sales, for the quarter ended June 30, 2008.

Engineering and development
expenses for the six months ended June 30, 2009, decreased by approximately $57,000 to $1.0 million, or 27% of net sales, from approximately $1.1 million, or 22% of net sales, for the six months ended June 30, 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 June 30, 2009, were approximately $587,000 or 36% of net sales, a decrease of approximately $50,000
over the quarter ended June 30, 2008 of $637,000, or 29% of net sales. The decrease in sales and marketing expenses was primarily attributable to a decrease in travel expenses.

Sales and marketing expenses, which remained relatively flat for the six months ended June 30, 2009, were $1.3 million, or 34% net of sales, an increase of approximately $28,000 compared with $1.2 million, or 26%
net of sales, for the six months ended June 30, 2008.

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, 2009, decreased by approximately $135,000 to $179,000, or 11% of net sales, from approximately $314,000, or 14% of net sales, for the quarter ended June 30, 2008. The decrease reflects a reduction in
accounting fees and insurance costs.

General and administrative expenses for the six months ended June 30, 2009, decreased by approximately $74,000
to $490,000, or 13% net of sales, from approximately $564,000, or 12% net of sales, for the six months ended June 30, 2008. The decrease reflects a reduction in accounting fees and insurance costs.

Other Expense, net

Other expense, net for the quarter ended
June 30, 2009 was approximately $228,000, a decrease of $133,000 as compared to other expense, net of approximately $361,000 for the quarter ended June 30, 2008. Other expense, net, for the six months ended June 30, 2009 was
approximately $467,000, a decrease of approximately $739,000 as compared to other expense, net, of approximately $1.2 million for the quarter ended June 30, 2008. The decrease was primarily attributable to reduced interest expense due to the
Optel loan restructuring and low LIBOR rates.

Net Loss

Net loss for the quarter ended June 30, 2009 was $793,000, or $0.00 per diluted share, compared with net loss of approximately $952,000, or $0.00 per diluted share, for the quarter ended June 30, 2008, for the
reasons discussed above. Net loss for the six months ended June 30, 2009 was approximately $1.7 million or $0.01 per diluted share, compared to a net loss of approximately $2.1 million, or $0.01 per diluted share, for the six months ended
June 30, 2008, for the reasons discussed above.



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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. Optel is controlled by Dr. Bryan J. Zwan, the Companys largest stockholder and chairman of the board of directors. The Credit Agreement was approved by the Companys board of directors upon the
unanimous recommendation of a special committee of the board comprised solely of independent directors.

Pursuant to the Credit Agreement, the restructured
indebtedness is evidenced by 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 to 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, and $213,000 were made January 5, 2009, March 31, 2009 and June 29, 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 has not yet held its 2009
annual meeting of stockholders.

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 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.

On June 25, 2009, June 29, 2009 and
July 22, 2009, the Company borrowed $75,000, $213,000 and $350,000, 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 August 30, 2009 on the June Notes and September 30, 2009 for the July Note; 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.



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Operating Activities

Net cash used by operating activities for the six months ended June 30, 2009 was approximately $1.6 million. This was primarily the result of a decrease in accounts receivable of $560,000, a decrease in accounts payable of $818,000 and
an operating loss of $1.7 million.

Off Balance Sheet Arrangements

There were no off balance sheet arrangements for the six months ended June 30, 2009.

Investing Activities

Investing activities for the six months ended June 30, 2009 due to sales of trade show fixed assets provided net cash of $12,000.

Financing Activities

Net cash provided by financing activities for
the six-months ended June 30, 2009 was $1.7 million for additional financing provided by Optel, LLC and Optel Capital, LLC.



|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 June 30, 2009, the related party notes have an interest
rate based upon LIBOR. As of June 30, 2009, a 1% change in LIBOR would have a $382,000 impact on interest expense annually.



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

Disclosure
Controls and Procedures

Our management, with the participation of our principal executive officer and principal financial officer, evaluated the
effectiveness of our disclosure controls and procedures pursuant to the Securities Exchange Act of 1934, as amended (the Exchange Act), as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, as of the end of the period
covered by this 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.

Changes in 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 June 30, 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 20 of this report.



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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, 2009By:

/s/ KENNETH T. MYERSInterim Chief Accounting Officer(Principal Financial Officer)Date: August 14, 2009




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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*         |  | 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 June 25, 2009,                                                                                                                                              
|              | 
|10.7*         |  | Secured Convertible Promissory Note issued by Digital Lightwave, Inc. to Optel Capital, LLC dated June 29, 2009,                                                                                                                                              
|              | 
|10.7*         |  | Secured Convertible Promissory Note issued by Digital Lightwave, Inc. to Optel Capital, LLC dated July 22, 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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