<PAGE>

              UNITED STATES SECURITIES AND EXCHANGE COMMISSION
                            Washington, D.C. 20549

                                  FORM 10-QSB

   (Mark One)
   [X]  QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
        ACT OF 1934

                 For the quarterly period ended June 30, 1999


                                      OR


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

                       Commission File Number:  0-27234

                             PHOTON DYNAMICS, INC.
            (Exact name of registrant as specified in its charter)


                 California                             94-3007502
       (State or other jurisdiction of       (I.R.S. Employer Identification
       incorporation or organization)        No.)



      6325 SAN IGNACIO AVENUE, SAN JOSE, CA                  95119
      (Address of principal executive offices)             (Zip Code)


                                (408) 226-9900
             (Registrant's telephone number, including area code)

                                      N/A
  (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 reports), and (2) has been subject to such filing
requirements for the past 90 days.  YES  X  NO__
                                         -
As of August 8, 1999, 7,743,466 shares of the Issuer's Common Stock, no par
value, were outstanding.

                                       1
<PAGE>

                               TABLE OF CONTENTS


<TABLE>
<CAPTION>
                          Part I:  Financial Information                                                 Page
                                                                                                         ----
<S>                                                                                                      <C>
 Item 1.  Financial Statements (unaudited)
          Condensed Consolidated Balance Sheets - June 30, 1999 and September 30, 1998...............       3
          Condensed Consolidated Statements of Operations - three and nine months ended June 30,
             1999 and 1998...........................................................................       4
          Condensed Consolidated Statements of Cash Flows - nine months ended June 30, 1999 and
             1998....................................................................................       5
          Notes to Condensed Consolidated Financial Statements.......................................       6

Item 2.   Management's Discussion and Analysis of Financial Condition and Results of Operations......       8

                          Part II:  Other Information

Item 1.   Legal Proceedings..........................................................................      12
Item 2.   Changes in Securities......................................................................      12
Item 3.   Defaults Upon Senior Securities............................................................      12
Item 4.   Submission of Matters to a Vote of Security Holders........................................      12
Item 5.   Other Information..........................................................................      12
Item 6.   Exhibits and Reports on Form 8-K...........................................................      12

          Signatures.................................................................................      13
</TABLE>


                                       2
<PAGE>

                             Photon Dynamics, Inc.

                     Condensed Consolidated Balance Sheets
                                (In thousands)


<TABLE>
<CAPTION>
                                                                     (Unaudited)
                                                                     June 30, 1999         September 30, 1998
                                                                     -------------         ------------------
<S>                                                                  <C>                   <C>
                                    Assets
Current assets:
 Cash and cash equivalents                                                $  5,916                   $  5,562
 Accounts receivable, net                                                   11,067                      6,027
 Inventories, net                                                            4,352                      6,767
 Prepaid expenses and other current assets                                     245                        276
                                                                          --------                   --------
 Total current assets                                                       21,580                     18,632

Property, equipment and leasehold improvements, net                          1,196                      1,798

Other assets                                                                   606                        603
                                                                          --------                   --------
Total assets                                                              $ 23,382                   $ 21,033
                                                                          ========                   ========

                     Liabilities and shareholders' equity
Current liabilities:
 Accounts payable                                                         $  2,122                   $  1,486
 Accrued expenses and other liabilities                                      3,389                      2,936
 Customer deposits and deferred revenue                                        118                        116
 Current obligations under lines of credit                                   1,000                          -
 Current portion of long-term debt                                               3                          4
                                                                          --------                   --------
Total current liabilities                                                    6,632                      4,542

Noncurrent portion of long-term debt                                             -                          2

Shareholders' equity:
 Common stock                                                               39,506                     38,918
 Accumulated deficit                                                       (22,617)                   (22,147)
 Foreign currency translation adjustment and other                             (66)                      (197)
 Notes receivable from shareholders                                            (73)                       (85)
                                                                          --------                   --------
 Total shareholders' equity                                                 16,750                     16,489
                                                                          --------                   --------
 Total liabilities and shareholders' equity                               $ 23,382                   $ 21,033
                                                                          ========                   ========
</TABLE>

See accompanying notes to condensed consolidated financial statements.

Note: The balance sheet at September 30, 1998 has been derived from the audited
consolidated financial statements at that date but does not include all of the
information and footnotes required by generally accepted accounting principles
for complete financial statements.

                                       3
<PAGE>

                             Photon Dynamics, Inc.

                Condensed Consolidated Statements of Operations
                   (In thousands, except per share amounts)

                                  (Unaudited)

<TABLE>
<CAPTION>
                                                           Three Months Ended                Nine Months Ended
                                                                 June 30,                         June 30,
                                                        -----------------------            ----------------------
                                                         1999              1998             1999             1998
                                                        -----------------------            ----------------------
Revenue:
<S>                                                    <C>               <C>              <C>             <C>
 Product revenue                                       $9,391            $5,625           $20,199         $18,362
 Non-product revenue                                        -                 -               500               -
                                                       ------            ------           -------         -------
                                                        9,391             5,625            20,699          18,362

Cost of revenue:
 Product revenue                                        5,263             3,061            12,327          10,103
 Non-product revenue                                        -                 -                 -               -
                                                       ------            ------           -------         -------
                                                        5,263             3,061            12,327          10,103
                                                       ------            ------           -------         -------
Gross margin                                            4,128             2,564             8,372           8,259

Operating expenses:
 Research and development                               1,426             1,386             3,743           4,738
 Selling, general and administrative                    1,700             1,235             5,117           3,728
 Asset recovery related to product line disposal            -                 -                 -            (350)
                                                       ------            ------           -------         -------
Total operating expenses                                3,126             2,621             8,860           8,116
                                                       ------            ------           -------         -------
Operating income (loss)                                 1,002               (57)             (488)            143

Interest income                                            39                46               162             184
Interest expense and other                                 11                60               (92)             11
                                                       ------            ------           -------         -------
Income (loss) before provision for income taxes         1,052                49              (418)            338

Provision for income taxes                                 50                 -                52              21
                                                       ------            ------           -------         -------
Net income (loss)                                      $1,002            $   49           $  (470)         $  317
                                                       ======            ======           =======         =======

Basic net income (loss) per share                      $ 0.13            $ 0.01           $ (0.06)         $ 0.04
                                                       ------            ------           -------         -------
Diluted net income (loss) per share                    $ 0.12            $ 0.01           $ (0.06)         $ 0.04
                                                       ------            ------           -------         -------

Shares used in computing basic
net income (loss) per share                             7,635             7,269             7,495           7,214
                                                       ------            ------           -------         -------
Shares used in computing diluted
net income (loss) per share                             8,275             7,586             7,495           7,513
                                                       ------            ------           -------         -------
</TABLE>

See accompanying notes to condensed consolidated financial statements.

                                       4
<PAGE>

                             Photon Dynamics, Inc.

                Condensed Consolidated Statements of Cash Flows

                                (In thousands)

                                  (Unaudited)

<TABLE>
<CAPTION>
                                                                         Nine Months Ended June 30,
                                                                          1999               1998
                                                                      ------------        ------------
<S>                                                                   <C>                 <C>
Operating activities:
Net income (loss)                                                     $       (470)       $        317
Adjustments to reconcile net income (loss) to net cash provided by
 (used in) operating activities:
 Depreciation and amortization                                                 737                 860
 Changes in operating assets and liabilities:
   Accounts receivable                                                      (5,040)              1,780
   Inventories                                                               2,415                (682)
   Prepaid expenses and other current assets                                    31                 256
   Other assets                                                                 (3)                342
   Accounts payable                                                            636                (925)
   Accrued expenses and other liabilities                                      453                  80
   Customer deposits and deferred revenue                                        2                (165)
                                                                      ------------        ------------
Net cash provided by (used in) operating activities                         (1,239)              1,863

Investing Activities:
Acquisition of property and equipment                                         (180)               (484)
Disposal of property and equipment                                              45                   -
                                                                      ------------        ------------
Net cash used in investing activities                                         (135)               (484)

Financing Activities:
Proceeds from borrowings under lines of credit                               1,000                   -
Principal payments under capital leases                                         (3)                 (3)
Proceeds from issuance of common stock                                         588                 218
Repayment of notes receivable from shareholders                                 12                  16
                                                                      ------------        ------------
Net cash provided by financing activities                                    1,597                 231
                                                                      ------------        ------------
Effect of exchange rate changes                                                131                (226)
                                                                      ------------        ------------
Net increase in cash and cash equivalents                                      354               1,384
Cash and cash equivalents at beginning of period                             5,562               4,831
                                                                      ------------        ------------
Cash and cash equivalents at end of period                            $      5,916        $      6,215
                                                                      ============        ============
</TABLE>

See accompanying notes to condensed consolidated financial statements.

                                       5
<PAGE>

                             PHOTON DYNAMICS, INC.
             NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                  (Unaudited)

1.   Significant Accounting Policies

     Interim Financial Statements

     The accompanying unaudited financial statements have been prepared in
accordance with generally accepted accounting principles for interim financial
information and with the instructions to Form 10-QSB. 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, all adjustments (consisting of normal recurring adjustments)
considered necessary for a fair presentation have been included. Operating
results for the nine months ended June 30, 1999 are not necessarily indicative
of the results that may be expected for the fiscal year ending September 30,
1999. For further information, refer to the audited consolidated financial
statements and footnotes thereto included in the Company's Annual Report on Form
10-KSB for the fiscal year ended September 30, 1998.

2.   Inventories

     Inventories are stated at the lower of cost or market, with cost being
determined on a first-in, first-out basis.

<TABLE>
<CAPTION>
Inventories comprise (in thousands):                     June 30,          September 30,
                                                           1999                1998
                                                       ------------        ------------
<S>                                                    <C>                 <C>
Raw materials                                          $      1,232        $      1,888
Work-in-process                                               2,773               2,144
Finished goods                                                  347               2,735
                                                       ------------        ------------
                                                       $      4,352        $      6,767
                                                       ============        ============
</TABLE>


3.   Net Income (Loss) Per Share

     For the three and nine months ended June 30, 1999, basic and diluted net
income (loss) per share is computed using the weighted average number of shares
of common stock outstanding. As the Company incurred a loss for the nine month
period ended June 30, 1999, the effect of dilutive securities totaling
approximately 410,822 from stock options and warrants has been excluded from the
computation of diluted net income (loss) per share as their effect is
antidilutive. The following table sets forth the computation of basic and
diluted net income (loss) per share:

<TABLE>
<CAPTION>
(In thousands, except per share amounts)                 Three Months Ended June 30,              Nine Months Ended June 30,
                                                       -------------------------------         -------------------------------
                                                          1999                1998                 1999                1998
                                                       -----------         -----------         -----------         -----------
<S>                                                    <C>                 <C>                 <C>                 <C>
Numerator for basic and diluted
net income (loss) per share                            $     1,002         $        49         $      (470)        $       317

Denominator for basic net income (loss) per share            7,635               7,269               7,495               7,214
Effect of dilutive securities:
 Employee stock options                                        593                 207                   -                 191
 Warrants                                                       47                 110                   -                 108
                                                       -----------         -----------         -----------         -----------
Denominator for diluted net income (loss) per share          8,275               7,586               7,495               7,513

Basic net income (loss) per share                      $      0.13         $      0.01         $     (0.06)        $      0.04
Diluted net income (loss) per share                    $      0.12         $      0.01         $     (0.06)        $      0.04
</TABLE>

                                       6
<PAGE>

4.   Comprehensive Income

     Effective October 1, 1998, the Company adopted Statement of Financial
Accounting Standard No. 130, Reporting Comprehensive Income ("SFAS 130"). SFAS
130 establishes new rules for the reporting and display of comprehensive income
and its components. Comprehensive income generally represents all changes in
shareholders' equity except those resulting from investments or contributions by
shareholders. The Company has reclassified earlier financial statements for
comparative purposes. The Company's total comprehensive income was as follows:

<TABLE>
<CAPTION>
                                                         Three Months Ended June 30,              Nine Months Ended June 30,
                                                       -------------------------------         -------------------------------
(In thousands)                                            1999                1998                 1999                1998
                                                       -----------         -----------         -----------         -----------
<S>                                                    <C>                 <C>                 <C>                 <C>
Net income (loss)                                      $     1,002         $        49         $      (470)        $       317

Foreign currency translation income (loss)                     (27)                (26)                131                (226)
                                                       -----------         -----------         -----------         -----------
Total comprehensive income (loss)                      $       975         $        23         $      (339)        $        91
                                                       ===========         ===========         ===========         ===========
</TABLE>


5.   New Accounting Pronouncement

     In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standard No. 133, Accounting for Derivative Instruments and
Hedging Activities ("SFAS 133"). SFAS 133 requires all derivatives to be
recorded on the balance sheet at fair value and establishes special accounting
rules for different types of hedges. Adoption of this statement is required in
the year ending September 30, 2001 and is not expected to have a material impact
on the Company's results of operations or financial condition.

                                       7
<PAGE>

                             PHOTON DYNAMICS, INC.

Management's Discussion and Analysis of Financial Condition and Results of
Operations

     The statements contained in this report on Form 10-QSB that are not purely
historical are 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, including statements regarding the Company's expectations, hopes,
intentions, or strategies regarding the future. All forward looking statements
included in this document are based on information available to the Company on
the date hereof, and the Company assumes no obligation to update any such
forward looking statements. It is important to note that the Company's actual
results could differ materially from those in such forward looking statements.
You should consult the risk factors listed from time to time in the Company's
reports on Form 10-KSB and annual reports to shareholders. Among the factors
that could cause actual results to differ materially are those discussed under
"Other Factors Affecting Company Results" and elsewhere in this Form 10-QSB.

     The following discussion should be read in conjunction with the attached
condensed consolidated financial statements and notes thereto and with the
Company's audited financial statements and notes thereto for the year ended
September 30, 1998.

Results of Operations

     Revenue. Revenue for the third quarter of fiscal 1999 increased 67% to $9.4
million from $5.6 million in the third quarter of fiscal 1998. Revenue for the
first nine months of fiscal 1999 increased 13% to $20.7 million from $18.4
million in the comparable period of fiscal 1998. This increase in revenue for
the third quarter of fiscal 1999 over fiscal 1998 was due to a significant
increase in customer orders, particularly in Taiwan, which reflects growth in
the Flat Panel Display (FPD) industry. This growth is driven primarily by the
strong demand for desktop monitors followed by notebook displays and large
screen televisions. The third quarter of fiscal 1998 saw a decrease in capital
spending by FPD manufacturers located in Asia as a result of the adverse
economic conditions experienced by the region at that time. As of June 30, 1999,
backlog was approximately $17.0 million compared to $4.2 million at June 30,
1998.

     Non-product revenue consisted of a non-recurring $500,000 fee paid by a
Japanese company for development work transferred to it by the Company during
the first nine months of fiscal 1999.

     Gross Margin. Gross margin as a percent of revenue was 44% and 40% for the
three and nine month periods ended June 30, 1999, respectively, compared to 46%
and 45% for the three and nine month periods ended June 30, 1998, respectively.
The decrease in gross margin for the first nine months of fiscal 1999 as
compared to the comparable period in fiscal 1998 was due to the Company's
efforts to expand its customer base in Taiwan as well as the shipment of several
system upgrade orders in the second quarter of fiscal 1999. These system upgrade
orders had gross margins lower than typical shipments sold by the Company.
Overall gross margins will fluctuate on a quarterly basis due to the Company's
production volume and product mix, among other factors.

     Research and Development. Research and development spending was $1.4
million in the third quarter of fiscal 1999 and the third quarter of fiscal
1998, or 15% and 25% of revenue, respectively. Research and development expenses
for the first nine months of fiscal 1999 were $3.7 million, or 18% of revenue,
compared to $4.7 million, or 26% of revenue, in the comparable period in fiscal
1998. The decrease in spending for the first nine months of fiscal 1999 as
compared to the comparable period of fiscal 1998 was primarily due to decreased
spending in the areas of outside consultants and prototype materials. In the
first nine months of fiscal 1998, the Company was working on a number of product
enhancements that it believed would improve its ability to sell into volume
production environments. Because this work is now complete, the Company reduced
its spending on outside consultants and prototype materials during the first
nine months of fiscal 1999 as compared to the comparable period of fiscal 1998.
The Company expects that its investment in research and development will
increase incrementally over fiscal 2000 as a result of new product development
projects.

     Selling, General and Administrative. Selling, general and administrative
expenses in the third quarter of fiscal 1999 increased to $1.7 million, or 18%
of revenue, from $1.2 million, or 22% of revenue, in the third quarter of fiscal
1998. Selling, general and administrative expenses for the first nine months of
fiscal 1999 were $5.1 million, or 25% of revenue,

                                       8
<PAGE>

an increase from $3.7 million, or 20% of revenue, in the comparable period of
fiscal 1998. In the first nine months of fiscal 1998, the Company collected some
older extended receivables that had previously been reserved. Without this cash
collection, total selling, general and administrative costs for the first nine
months of fiscal 1998 would have been $4.0 million. The increase in these
expenses for the first nine months of fiscal 1999 from the comparable period of
fiscal 1998 was due to higher commission and other selling expenses related to
increases in orders and revenue. Expenses related to business development
activities have also contributed to the increase in these expenses. Selling,
general and administrative expenses may increase in absolute dollar amounts in
fiscal 1999 and in future periods depending on factors such as the level of the
Company's revenue and operating expenses. Selling expenses may also fluctuate
based on the Company's product and territorial sales mix, which have different
sales channels and associated cost structures.

     Asset Recovery Related to Product Line Disposal. During the quarter ended
December 31, 1997, the Company received a payment of $350,000 in settlement of a
dispute related to the cancellation of its Defect Monitoring Tool (DMT) product
line. In September 1996, the Company ceased operations of its DMT product line.
The DMT product group worked exclusively on a single customer project not in the
FPD market. As a result of the cancellation of this project, the Company
expensed the associated inventory and assets of this product line which were not
transferred to other products.

     Interest Income. Interest income for the three and nine month periods ended
June 30, 1999 were $39,000 and $162,000, respectively, as compared to $46,000
and $184,000, respectively, for the three and nine month periods ended June 30,
1998. The decreases resulted from a slight decrease in interest rates in fiscal
1999 as compared to fiscal 1998.

     Interest Expense and Other. Interest expense and other consists of interest
expense, foreign exchange gains and losses, and other miscellaneous income and
expenses.

     Provision for Income Tax. The provision for income taxes for the three and
nine month periods ended June 30, 1999 was related to taxes at the Company's
foreign subsidiaries. There were no U.S. taxes during this period due to the
Company's net operating loss for the nine months ended June 30, 1999.

Liquidity and Capital Resources

     The Company has financed its growth primarily by a combination of equity
financings, loans, lines of credit, and cash flows from operations. As of June
30, 1999, the Company had working capital of $14.9 million of which $5.9 million
was cash or cash equivalents.

     Cash used in operating activities was $1.2 million for the nine months
ended June 30, 1999. Working capital items that significantly impacted cash
balances in the period were accounts receivable, inventories and accounts
payable. The Company's accounts receivable balance increased $5.1 million to
$11.1 million in the third quarter of fiscal 1999 from $6.0 million in the
fourth quarter of fiscal 1998 due to higher shipments. This higher level of
shipments resulted in a $2.4 million decrease in inventories from $6.8 million
in the fourth quarter of fiscal 1998 to $4.4 million in the third quarter of
fiscal 1999. Accounts payable increased $0.6 million from $1.5 million in the
fourth quarter of fiscal 1998 to $2.1 million in the third quarter of fiscal
1999 due to the purchase of additional materials required to meet the increased
production requirements.

     Capital expenditures during the first nine months of fiscal 1999 were
$180,000 compared to $484,000 in the first nine months of fiscal 1998.

     The Company has entered into a $3.5 million line of credit with a bank
which expires in March 2000. The line of credit is secured by substantially all
of the Company's assets and contains certain financial and other covenants. The
Company is eligible to borrow against accounts receivable and a portion of
inventories. Borrowings under this line of credit bear interest at the prime
rate plus 1.00% to 1.25% (10.00% to 10.25% as of June 30, 1999). At June 30,
1999, $1.0 million was outstanding under this bank line of credit, and the
Company was in compliance with all bank covenants.

     The Company believes that cash and cash equivalents, borrowings from the
line of credit, and cash flow from operations will be sufficient to satisfy
working capital requirements and capital equipment needs for the next twelve
months. As of June 30, 1999, the Company had no material outstanding commitments
to purchase or lease capital equipment.

                                       9
<PAGE>

     The Company believes that success in its industry requires substantial
capital in order to maintain the flexibility to take advantage of opportunities
as they may arise. The Company may, from time to time, invest in or acquire
complementary businesses, products or technologies and may seek additional
equity or debt financing to fund such activities. There can be no assurance that
such funding will be available to the Company on commercially reasonable terms.
The sale of additional equity or convertible debt could result in dilution to
the Company's shareholders.

Year 2000 Computer System Compliance

     The Year 2000 Issue is the result of computer programs being written using
two digits rather than four to define the applicable year. Any of the Company's
computer programs that have date-sensitive software may recognize a date using
"00" as the year 1900 rather than the year 2000. This could result in a system
failure or miscalculations causing the disruption of operations, including among
other things, a temporary inability to process transactions, send invoices or
engage in similar normal business activities. In addition to the Company's own
systems, the Company relies, directly and indirectly, on external systems of its
customers, creditors, financial organizations, utility providers, and government
entities, both domestic and international (collectively, "Third Parties").
Consequently, the Company could be affected by disruptions in the operations of
Third Parties with which the Company interacts.

     The Company is in the process of addressing internal and external Year 2000
issues and has established a task force with this responsibility. To date, the
Company has made several modifications to its product software, its enterprise
software and its network software to ensure Year 2000 compliance. Although the
Company believes that its products and internal systems are currently Year 2000
compliant, there can be no assurance that the Third Parties with which the
Company interacts are or will be Year 2000 compliant. Failure of Third Party
enterprises to achieve Year 2000 compliance could have a material adverse effect
on the Company's business, financial condition and results of operations. The
Company continues to evaluate the estimated costs associated with the efforts to
prepare for the year 2000 based on actual experience. While the efforts will
involve additional costs, the Company believes, based on available information,
that it will be able to manage its total Year 2000 transition without any
material adverse effect on its business operations, products or financial
prospects. The actual outcome and result could be affected by future factors
including, but not limited to, the continued availability of skilled personnel,
cost control, the ability to locate and correct software code problems, critical
suppliers and subcontractors meeting their commitments to be Year 2000
compliant, and timely actions by customers. The Company anticipates that it will
remediate all Year 2000 risks and be able to conduct normal operations without
having to establish a Year 2000 contingency plan; accordingly, the Company does
not have a contingency plan and does not intend to establish one. There is no
guarantee, however, that all problems will be foreseen and corrected or that no
material disruption of business will occur.


Other Factors Affecting Company Results

     The Company has experienced and expects to continue to experience
significant fluctuations in its quarterly results of operations. The Company
derives substantially all of its revenue from the sale of a relatively small
number of systems, which typically range in price from $0.4 million to $1.5
million. As a result, the timing of the sale of a single system could have a
significant impact on the Company's quarterly revenue and results of operations.
The failure to receive anticipated orders or delays in shipments in a particular
quarter due, for example, to unanticipated shipment reschedulings, cancellations
by customers or unexpected manufacturing difficulties may cause revenue for that
quarter to fall significantly below the Company's expectations. This would have
a material adverse effect on the Company's results of operations for such a
quarter. The Company's backlog at the beginning of each quarter is not
necessarily indicative of actual sales for any succeeding period. All orders are
subject to delay or cancellation with limited or no penalty. The Company's sales
will often reflect orders shipped in the same quarter that they are received.
Other factors which may have an influence on the Company's results of operations
in a particular quarter include the volume, mix and timing of the receipt of
orders from major customers; competitive pricing pressures; costs of components
and subsystems; the Company's ability to design, manufacture and introduce new
products on a cost effective and timely basis; the delay between incurrence of
expenses to further develop marketing and service capabilities and realization
of benefits from such improved capabilities; fluctuations in foreign exchange
rates; the timing of recognition of revenue under development contracts; the
introduction and announcement of new products by the Company's competitors; and
changing conditions in the FPD market. In particular, due to substantial
differences in gross margin for the Company's products, changes in the

                                       10
<PAGE>

mix of products sold could result in substantial fluctuations in the Company's
gross margin. Accordingly, the Company's results of operations are subject to
significant variability from quarter to quarter. For a further discussion of the
Company's business and certain risk factors pertaining to its business, please
refer to the Company's 1998 Annual Report on Form 10-KSB.

                                       11
<PAGE>

                          PART II: OTHER INFORMATION



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

       None.

Item 2.  Changes in Securities
------------------------------

       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)  Exhibits

        27     Financial Data Schedule

  (b)  Reports on Form 8-k

       None.

                                       12
<PAGE>

                                  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.



                                    PHOTON DYNAMICS, INC.
                                        (Registrant)



Date: August 12, 1999               /s/ Vincent Sollitto
                                    ------------------------
                                    Vincent Sollitto
                                    Chief Executive Officer and Director
                                    (Principal Executive Officer)





Date: August 12, 1999               /s/ Richard Dissly
                                    ------------------------
                                    Richard Dissly
                                    Chief Financial Officer and Secretary
                                    (Principal Financial and Accounting Officer)


                                       13