##### Table of Contents



UNITED STATES SECURITIES AND EXCHANGE COMMISSION
 Washington, D.C. 20549
 Form 10-Q
 (Mark One)
 þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
 For the quarterly period ended March 31, 2007
 OR
 o
    
    TRANSITION REPORT PURSUANT TO
SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
 For the transition period from 
to
 Commission file number: 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. Employerincorporation or organization)
    
    Identification No.)
 5970 Optical Court
San Jose, California 95138-1400  (Address of principal executive offices including zip code)
 (408) 226-9900  (Registrants telephone number, including area code)
 þ o
  o þ o
 o þ




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##### Table of Contents



INDEX
 PagePART I FINANCIAL INFORMATIONItem 1
    
    Financial Statements (unaudited)
    
    
    3Condensed Consolidated Balance Sheets as of March 31, 2007 and September 30, 2006
    
    
    3Condensed Consolidated Statements of Operations for the Three and Six Months Ended March 31, 2007 and 2006
    
    
    4Condensed Consolidated Statements of Cash Flows for the Six Months Ended March 31, 2007 and 2006
    
    
    5Notes to Condensed Consolidated Financial Statements
    
    
    6Item 2
    
    Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    20Item 3
    
    Quantitative and Qualitative Disclosures About Market Risk
    
    
    34Item 4
    
    Controls and Procedures
    
    
    35PART II OTHER INFORMATIONItem 1
    
    Legal Proceedings
    
    
    37Item 1A
    
    Risk Factors
    
    
    37Item 2
    
    Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    47Item 3
    
    Defaults Upon Senior Securities
    
    
    47Item 4
    
    Submission of Matters to a Vote of Security Holders
    
    
    47Item 5
    
    Other Information
    
    
    48Item 6
    
    Exhibits
    
    
    48Signatures
    
    
    
    
    49EXHIBIT 31.1EXHIBIT 31.2EXHIBIT 32.1
 2




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##### Table of Contents



PART I. FINANCIAL INFORMATION
 
 ITEM 1. Financial Statements
 PHOTON DYNAMICS, INC.
 
 CONDENSED CONSOLIDATED BALANCE SHEETS
 (Unaudited)
 March 31,
    
    
    September 30,2007
    
    
    2006(in thousands)ASSETSCurrent assets:Cash and cash equivalents
    
    $
    25,253
    
    
    $
    47,935Short-term investments
    
    
    56,815
    
    
    
    54,834Accounts receivable, net of allowance for doubtful accounts of $261
and $406 at March 31, 2007 and September 30, 2006, respectively
    
    
    14,255
    
    
    
    29,341Inventories
    
    
    26,187
    
    
    
    18,442Other current assets
    
    
    3,432
    
    
    
    3,972Total current assets
    
    
    125,942
    
    
    
    154,524Long-term investments
    
    
    8,389
    
    
    
    787Land, property and equipment, net
    
    
    11,200
    
    
    
    15,891Other assets
    
    
    5,489
    
    
    
    4,542Intangible assets, net
    
    
    971
    
    
    
    1,716Goodwill
    
    
    153
    
    
    
    153Total assets
    
    $
    152,144
    
    
    $
    177,613LIABILITIES AND SHAREHOLDERS EQUITYCurrent liabilities:Accounts payable
    
    $
    7,217
    
    
    $
    7,657Warranty
    
    
    7,418
    
    
    
    8,058Other current liabilities
    
    
    11,807
    
    
    
    9,944Deferred gross margin
    
    
    2,985
    
    
    
    7,454Total current liabilities
    
    
    29,427
    
    
    
    33,113Other non-current liabilities
    
    
    107
    
    
    
    119Commitments and contingenciesShareholders equity:Common stock, no par value
    
    
    287,433
    
    
    
    285,510Accumulated deficit
    
    
    (164,132
    )
    
    
    (141,409
    )Accumulated other comprehensive income (loss)
    
    
    (691
    )
    
    
    280Total shareholders equity
    
    
    122,610
    
    
    
    144,381Total liabilities and shareholders equity
    
    $
    152,144
    
    
    $
    177,613
  3




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##### Table of Contents



PHOTON DYNAMICS, INC.
 
 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
 (Unaudited)
 Three Months Ended
    
    
    Six Months EndedMarch 31,
    
    
    March 31,2007
    
    
    2006
    
    
    2007
    
    
    2006(in thousands, except per share data)Revenue
    
    $
    13,928
    
    
    $
    50,322
    
    
    $
    35,363
    
    
    $
    91,955Cost of revenue
    
    
    13,391
    
    
    
    33,069
    
    
    
    29,262
    
    
    
    55,451Gross margin
    
    
    537
    
    
    
    17,253
    
    
    
    6,101
    
    
    
    36,504Operating expenses:Research and development
    
    
    7,197
    
    
    
    8,560
    
    
    
    15,192
    
    
    
    16,631Selling, general and administrative
    
    
    6,550
    
    
    
    6,984
    
    
    
    11,480
    
    
    
    13,835Restructuring charge (benefit)
    
    
    1,017
    
    
    
    (32
    )
    
    
    1,463
    
    
    
    30Impairment of property and equipment
    
    
    2,834
    
    
    
    
    
    
    
    2,834
    
    
    
    Amortization of intangible assets
    
    
    372
    
    
    
    373
    
    
    
    745
    
    
    
    745Total operating expenses
    
    
    17,970
    
    
    
    15,885
    
    
    
    31,714
    
    
    
    31,241Income (loss) from operations
    
    
    (17,433
    )
    
    
    1,368
    
    
    
    (25,613
    )
    
    
    5,263Interest income and other, net
    
    
    2,015
    
    
    
    1,019
    
    
    
    3,096
    
    
    
    1,519Income (loss) from continuing operations before
income taxes and discontinued operations
    
    
    (15,418
    )
    
    
    2,387
    
    
    
    (22,517
    )
    
    
    6,782Provision for income taxes
    
    
    105
    
    
    
    199
    
    
    
    206
    
    
    
    551Income (loss) from continuing operations before
discontinued operations
    
    
    (15,523
    )
    
    
    2,188
    
    
    
    (22,723
    )
    
    
    6,231Loss from discontinued operations
    
    
    
    
    
    
    334
    
    
    
    
    
    
    
    (346
    )Net income (loss)
    
    $
    (15,523
    )
    
    $
    2,522
    
    
    $
    (22,723
    )
    
    $
    5,885Income (loss) per share from continuing operations:Basic
    
    $
    (0.94
    )
    
    $
    0.13
    
    
    $
    (1.37
    )
    
    $
    0.37Diluted
    
    $
    (0.94
    )
    
    $
    0.13
    
    
    $
    (1.37
    )
    
    $
    0.37Income (loss) per share from discontinued operations:Basic
    
    $
    
    
    
    $
    0.02
    
    
    $
    
    
    
    $
    (0.02
    )Diluted
    
    $
    
    
    
    $
    0.02
    
    
    $
    
    
    
    $
    (0.02
    )Net income (loss) per share:Basic
    
    $
    (0.94
    )
    
    $
    0.15
    
    
    $
    (1.37
    )
    
    $
    0.35Diluted
    
    $
    (0.94
    )
    
    $
    0.15
    
    
    $
    (1.37
    )
    
    $
    0.34Weighted average number of shares:Basic
    
    
    16,591
    
    
    
    17,018
    
    
    
    16,590
    
    
    
    17,011Diluted
    
    
    16,591
    
    
    
    17,077
    
    
    
    16,590
    
    
    
    17,062
  4




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PHOTON DYNAMICS, INC.
 
 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
 (Unaudited)
 Six Months EndedMarch 31,2007
    
    
    2006(in thousands)Cash flows from operating activities:Income (loss) from continuing operations
    
    $
    (22,723
    )
    
    $
    6,231Adjustments to reconcile income (loss) from continuing operations to net cash used in
operating activities from continuing operations:Depreciation
    
    
    2,541
    
    
    
    2,959Amortization of intangible assets
    
    
    745
    
    
    
    745Impairment of property and equipment
    
    
    2,834
    
    
    
    Non-cash stock-based compensation
    
    
    1,117
    
    
    
    2,038Foreign currency translation adjustment gain recognized upon liquidation of subsidiary
    
    
    (928
    )
    
    
    Non-employee stock ownership expense
    
    
    
    
    
    
    14Restructuring charge
    
    
    273
    
    
    
    Accretion of non-interest bearing notes payable
    
    
    15
    
    
    
    22Changes in operating assets and liabilities:Accounts receivable
    
    
    15,086
    
    
    
    (11,456
    )Inventories
    
    
    (7,663
    )
    
    
    1,486Other current assets
    
    
    540
    
    
    
    (634
    )Other assets
    
    
    (947
    )
    
    
    48Accounts payable
    
    
    (440
    )
    
    
    243Other current liabilities
    
    
    1,249
    
    
    
    1,789Deferred gross margin
    
    
    (4,469
    )
    
    
    (7,720
    )Other liabilities
    
    
    (12
    )
    
    
    (30
    )Net cash used in operating activities from continuing operations
    
    
    (12,782
    )
    
    
    (4,265
    )Net cash used in operating activities from discontinued operations
    
    
    
    
    
    
    (580
    )Net cash used in operating activities
    
    
    (12,782
    )
    
    
    (4,845
    )Cash flows from investing activities:Purchase of property and equipment
    
    
    (923
    )
    
    
    (1,408
    )Purchase of available-for-sale securities
    
    
    (63,815
    )
    
    
    (43,175
    )Maturities and sales of available-for-sale securities
    
    
    54,228
    
    
    
    47,383Net cash provided by (used in) investing activities from continuing operations
    
    
    (10,510
    )
    
    
    2,800Cash flows from financing activities:Issuance of common stock
    
    
    724
    
    
    
    1,617Capital lease payments
    
    
    (41
    )
    
    
    Net cash provided by financing activities from continuing operations
    
    
    683
    
    
    
    1,617Effect of exchange rate changes on cash and cash equivalents
    
    
    (73
    )
    
    
    (260
    )Net decrease in cash and cash equivalents from continuing operations
    
    
    (22,682
    )
    
    
    (108
    )Net decrease in cash and cash equivalents from discontinued operations
    
    
    
    
    
    
    (580
    )Net decrease in cash and cash equivalents
    
    
    (22,682
    )
    
    
    (688
    )Cash and cash equivalents at beginning of period
    
    
    47,935
    
    
    
    20,288Cash and cash equivalents at end of period
    
    $
    25,253
    
    
    $
    19,600
  5




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PHOTON DYNAMICS, INC.
 
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 (Unaudited)
 NOTE 1  Basis of Presentation
 Basis of Presentation.
   Description of Operations and Principles of Consolidation.
  Management Estimates and Assumptions.
 Recent Accounting Pronouncements.
 6




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.
  NOTE 2  Financial Statement Components
 March 31,
    
    
    September 30,2007
    
    
    2006(in thousands)Inventories:Raw materials
    
    $
    12,935
    
    
    $
    10,740Work-in-process
    
    
    12,992
    
    
    
    7,036Finished goods
    
    
    260
    
    
    
    666Total
    
    $
    26,187
    
    
    $
    18,442Other current liabilities:Compensation
    
    $
    4,534
    
    
    $
    3,460Vendor obligations
    
    
    1,933
    
    
    
    942Professional fees
    
    
    939
    
    
    
    891Employee notes payable
    
    
    992
    
    
    
    977Customer deposits
    
    
    
    
    
    
    1,500Other accrued expenses
    
    
    4,359
    
    
    
    2,174Total
    
    $
    12,757
    
    
    $
    9,944Deferred gross margin:Deferred system sales
    
    $
    6,025
    
    
    $
    12,217Deferred cost of revenue related to system sales
    
    
    (3,040
    )
    
    
    (4,763
    )Total
    
    $
    2,985
    
    
    $
    7,454Accumulated other comprehensive income (loss):Foreign currency translation adjustments
    
    $
    (636
    )
    
    $
    332Unrealized losses on available for sale securities
    
    
    (55
    )
    
    
    (52
    )Total
    
    $
    (691
    )
    
    $
    280
 NOTE 3  Discontinued Operations
 Printed Circuit Board Assembly Inspection Business
   7




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##### Table of Contents



Cathode Ray Tube Display and High Quality Glass Inspection Business
    NOTE 4  Goodwill and Other Purchased Intangible Assets
 Goodwill
   Intangible Assets
  Non-Developed
    
    
    Core
    
    
    License
    
    
    CompeteTechnology
    
    
    Technology
    
    
    Agreement
    
    
    Contract
    
    
    Total(in thousands)Gross carrying amount at March 31, 2007
    
    $
    1,006
    
    
    $
    2,408
    
    
    $
    1,138
    
    
    $
    968
    
    
    $
    5,520Accumulated amortization
    
    
    (704
    )
    
    
    (1,805
    )
    
    
    (1,138
    )
    
    
    (902
    )
    
    
    (4,549
    )Net carrying amount at March 31, 2007
    
    $
    302
    
    
    $
    603
    
    
    $
    0
    
    
    $
    66
    
    
    $
    971
 8




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##### Table of Contents



Non-Developed
    
    
    Core
    
    
    License
    
    
    CompeteTechnology
    
    
    Technology
    
    
    Agreement
    
    
    Contract
    
    
    Total(in thousands)Gross carrying amount at September 30, 2006
    
    $
    1,006
    
    
    $
    2,408
    
    
    $
    1,138
    
    
    $
    968
    
    
    $
    5,520Accumulated amortization
    
    
    (578
    )
    
    
    (1,504
    )
    
    
    (948
    )
    
    
    (774
    )
    
    
    (3,804
    )Net carrying amount at September 30, 2006
    
    $
    428
    
    
    $
    904
    
    
    $
    190
    
    
    $
    194
    
    
    $
    1,716
  Non-Developed
    
    
    Core
    
    
    License
    
    
    CompeteTechnology
    
    
    Technology
    
    
    Agreement
    
    
    Contract
    
    
    Total(in thousands)Net carrying amount at September 30, 2006
    
    $
    428
    
    
    $
    904
    
    
    $
    190
    
    
    $
    194
    
    
    $
    1,716Amortization during the period
    
    
    (126
    )
    
    
    (301
    )
    
    
    (190
    )
    
    
    (128
    )
    
    
    (745
    )Net carrying amount at March 31, 2007
    
    $
    302
    
    
    $
    603
    
    
    $
    0
    
    
    $
    66
    
    
    $
    971
   NOTE 5  Restructuring and Other Charges
 March 2007 Impairment of Property and Equipment
   February 2007 Restructure
   9




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One-TimeTerminationBenefits(in thousands)Inception of liability
    
    $
    1,017Cash payments
    
    
    (689
    )Adjustments to the liability
    
    
    3Balance at March 31, 2007
    
    $
    331
  November 2006 Restructure
 TM
 TM
  April 2005 Restructure
 TM
   10




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NOTE 6  Comprehensive Income
  Three Months Ended
    
    
    Six Months EndedMarch 31,
    
    
    March 31,2007
    
    
    2006
    
    
    2007
    
    
    2006(in thousands)Net income (loss)
    
    $
    (15,523
    )
    
    $
    2,522
    
    
    $
    (22,723
    )
    
    $
    5,885Other comprehensive income (loss):Net change in unrealized gain (loss) on investments
    
    
    30
    
    
    
    109
    
    
    
    (3
    )
    
    
    183Change in foreign currency translation
    
    
    (958
    )
    
    
    (214
    )
    
    
    (968
    )
    
    
    (260
    )Other comprehensive income (loss)
    
    
    (928
    )
    
    
    (105
    )
    
    
    (971
    )
    
    
    (77
    )Total comprehensive income (loss)
    
    $
    (16,451
    )
    
    $
    2,417
    
    
    $
    (23,694
    )
    
    $
    5,808
  NOTE 7  Shareholders Equity
 Stock Option Plans
 Stock Option Exchange Program
 Stock Ownership Expense.
 NOTE 8  Stock-Based Compensation
  11




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Three Months Ended
    
    
    Six Months EndedMarch 31
    
    
    March 312007
    
    
    2006
    
    
    2007
    
    
    2006(in thousands, except per share data)Stock-based compensation expense included in continuing
operations: :Cost of revenue
    
    $
    25
    
    
    $
    24
    
    
    $
    106
    
    
    $
    88Research and development
    
    
    109
    
    
    
    195
    
    
    
    198
    
    
    
    333Selling, general and administrative
    
    
    522
    
    
    
    798
    
    
    
    813
    
    
    
    1,617Total stock-based compensation expense after income taxes (1)
    
    $
    656
    
    
    $
    1,017
    
    
    $
    1,117
    
    
    $
    2,038Stock-based compensation expense by type of award: :Employee stock options
    
    $
    614
    
    
    $
    997
    
    
    $
    966
    
    
    $
    1,923Employee stock purchase plan
    
    
    104
    
    
    
    144
    
    
    
    208
    
    
    
    239Restricted stock awards
    
    
    20
    
    
    
    
    
    
    
    25
    
    
    
    Amounts capitalized as inventory and deferred gross margin
    
    
    (82
    )
    
    
    (124
    )
    
    
    (82
    )
    
    
    (124
    )Total stock-based compensation expense after income taxes (1)
    
    $
    656
    
    
    $
    1,017
    
    
    $
    1,117
    
    
    $
    2,038
 
 (1)
    
    The income tax benefit on stock-based compensation for all periods presented was not
material. Equity Incentive and Other Programs
  2006 Non-Employee Directors Stock Incentive Plan
 The 2005 Equity Incentive Plan
  12




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Valuation and Other Assumption
  Expected Volatility
 Expected Term
 Risk-Free Interest Rate
 Expected Dividends
 Forfeitures
  Three Months Ended
    
    Six Months EndedMarch 31,
    
    March 31,2007
    
    2006
    
    2007
    
    2006Stock option plan:Expected volatility
    
    
    40
    %
    
    
    44
    %
    
    
    44
    %
    
    
    44
    %Risk free rate
    
    
    4.87
    %
    
    
    4.44
    %
    
    
    4.67
    %
    
    
    4.38
    %Expected term (in years)
    
    
    2.9
    
    
    
    3.6
    
    
    
    3.35
    
    
    
    3.7Expected dividends
    
    None
    
    None
    
    None
    
    None
  13




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##### Table of Contents



Three Months Ended
    
    Six Months EndedMarch 31,
    
    March 31,2007
    
    2006
    
    2007
    
    2006Stock purchase plan:Expected volatility
    
    
    44
    %
    
    
    44
    %
    
    
    44
    %
    
    
    44
    %Risk free rate
    
    
    4.66
    %
    
    
    4.21
    %
    
    
    4.66
    %
    
    
    4.21
    %Expected term (in years)
    
    
    0.6
    
    
    
    0.5
    
    
    
    0.6
    
    
    
    0.5Expected dividends
    
    None
    
    None
    
    None
    
    None
   Stock Options
  Weighted-
    
    
    Weighted-Average
    
    
    AggregateAvailable
    
    
    Options
    
    
    Average
    
    
    Remaining Contract
    
    
    Intrinsic Valuefor Grant
    
    
    Outstanding
    
    
    Exercise Price
    
    
    Term (in years)
    
    
    (in thousands)Balances at September 30, 2006
    
    
    798,336
    
    
    
    1,950,695
    
    
    $
    23.28Additional shares reserved
    
    
    1,000,000
    
    
    
    
    
    
    
    Plan shares expired (1)
    
    
    (61,266
    )
    
    
    
    
    
    
    Options granted
    
    
    (316,375
    )
    
    
    316,375
    
    
    
    11.15Restricted stock units granted (2)
    
    
    (63,125
    )
    
    
    
    
    
    
    Options canceled/expired
    
    
    197,656
    
    
    
    (197,656
    )
    
    
    21.02Options exercised
    
    
    
    
    
    
    (3,369
    )
    
    
    5.23Balances at March 31, 2007
    
    
    1,555,226
    
    
    
    2,066,045
    
    
    $
    21.67
    
    
    
    6.5
    
    
    $
    687Vested and expected to vest at March 31, 2007
    
    
    
    
    
    
    1,847,165
    
    
    $
    22.42
    
    
    
    6.5
    
    
    $
    538Exercisable at March 31, 2007
    
    
    
    
    
    
    1,342,731
    
    
    $
    24.93
    
    
    
    6.3
    
    
    $
    239
 
 (1)
    
    The Companys 1995 Amended and Restated Stock Option Plan expired in November 2005. Shares
subject to outstanding options that were cancelled or expired during the period are no longer
available for grant.(2)
    
    Restricted stock units are shown as a reduction to shares available for grant as they reduce
the total shares available for option grants. Restricted stock units outstanding are not
included in the table above, but are shown separately in the table below.     14




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Restricted Stock Units
  Weighted-AverageNumber
    
    Grant Dateof Shares
    
    Fair ValueUnvested restricted stock at September 30, 2006
    
    
    0
    
    
    $
    Granted
    
    
    63,125
    
    
    $
    10.95Vested
    
    
    0
    
    
    $
    Forfeited
    
    
    0
    
    
    $
    Unvested restricted stock at March 31, 2007
    
    
    63,125
    
    
    $
  Employee Stock Purchase Plan
   NOTE 9  Net Income (Loss) Per Share
   Three Months Ended
    
    
    Six Months EndedMarch 31,
    
    
    March 31,2007
    
    
    2006
    
    
    2007
    
    
    2006(in thousands, except per share data)Numerator:Net income (loss) from continuing operations
    
    $
    (15,523
    )
    
    $
    2,188
    
    
    $
    (22,723
    )
    
    $
    6,231Net loss from discontinued operations
    
    
    
    
    
    
    334
    
    
    
    
    
    
    
    (346
    )Net income (loss)
    
    $
    (15,523
    )
    
    $
    2,522
    
    
    $
    (22,723
    )
    
    $
    5,885
 15




---



##### Table of Contents



Three Months Ended
    
    
    Six Months EndedMarch 31,
    
    
    March 31,2007
    
    
    2006
    
    
    2007
    
    
    2006(in thousands, except per share data)Denominator:Weighted average shares outstanding, excluding unvested
restricted stock, for basic net income per share
    
    
    16,591
    
    
    
    17,018
    
    
    
    16,590
    
    
    
    17,011Effect of dilutive securities: Employee stock options and
restricted stock
    
    
    
    (1)
    
    
    59
    
    
    
    
    (1)
    
    
    51Weighted average shares for diluted net income per share
    
    
    16,591
    
    
    
    17,077
    
    
    
    16,590
    
    
    
    17,062Earnings per share:Basic net income (loss) per share:Net income (loss) from continuing operations
    
    $
    (0.94
    )
    
    $
    0.13
    
    
    $
    (1.37
    )
    
    $
    0.37Net loss from discontinued operations
    
    
    
    
    
    
    0.02
    
    
    
    
    
    
    
    (0.02
    )Net income (loss) per share
    
    $
    (0.94
    )
    
    $
    0.15
    
    
    $
    (1.37
    )
    
    $
    0.35Diluted net income (loss) per share:Net income (loss) from continuing operations
    
    $
    (0.94
    )
    
    $
    0.13
    
    
    $
    (1.37
    )
    
    $
    0.37Net loss from discontinued operations
    
    
    
    
    
    
    0.02
    
    
    
    
    
    
    
    (0.02
    )Net income (loss) per share
    
    $
    (0.94
    )
    
    $
    0.15
    
    
    $
    (1.37
    )
    
    $
    0.34
 
 (1)
    
    The effect of potentially dilutive securities to purchase approximately 81,000 shares of
common stock for both the three and six month periods ended March 31, 2007 were not included
in the computation of diluted net loss per share as the effect is anti-dilutive.  Three Months Ended
    
    Six Months EndedMarch 31,
    
    March 31,2007
    
    2006
    
    2007
    
    2006(in thousands)Number of shares
    
    
    2,049
    
    
    
    1,822
    
    
    
    2,016
    
    
    
    1,782
 NOTE 10  Commitments and Contingencies
 Purchase Agreements
   Warranty Obligations
   16




---



##### Table of Contents



Six Months EndedMarch 31,2007
    
    
    2006(in thousands)Beginning balance
    
    $
    8,058
    
    
    $
    5,346Estimated warranty cost of new shipments during the period
    
    
    2,126
    
    
    
    3,037Warranty costs during the period
    
    
    (3,243
    )
    
    
    (1,691
    )Changes in liability for pre-existing warranties, including expirations
    
    
    477
    
    
    
    (1,908
    )Ending balance
    
    $
    7,418
    
    
    $
    4,784
 TM
 Legal Proceedings
   NOTE 11  Geographic Information
   Three Months
    
    
    Six MonthsEnded
    
    
    EndedMarch 31,
    
    
    March 31,2007
    
    
    2006
    
    
    2007
    
    
    2006(in thousands)Revenue:South Korea
    
    $
    4,054
    
    
    $
    31,128
    
    
    $
    10,073
    
    
    $
    66,175Taiwan
    
    
    7,468
    
    
    
    18,429
    
    
    
    13,630
    
    
    
    24,350Japan
    
    
    1,505
    
    
    
    765
    
    
    
    10,540
    
    
    
    1,430China
    
    
    901
    
    
    
    
    
    
    
    1,120
    
    
    
    Total
    
    $
    13,928
    
    
    $
    50,322
    
    
    $
    35,363
    
    
    $
    91,955
  17




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##### Table of Contents



Three Months
    
    Six MonthsEnded
    
    EndedMarch 31,
    
    March 31,2007
    
    2006
    
    2007
    
    2006Revenue:ArrayCheckerTM
    
    
    31
    %
    
    
    56
    %
    
    
    52
    %
    
    
    65
    %ArraySaverTM
    
    
    28
    %
    
    
    31
    %
    
    
    20
    %
    
    
    20
    %PanelMasterTM
    
    
    5
    %
    
    
    6
    %
    
    
    1
    %
    
    
    8
    %Customer spares and other
    
    
    36
    %
    
    
    7
    %
    
    
    27
    %
    
    
    7
    %Total
    
    
    100
    %
    
    
    100
    %
    
    
    100
    %
    
    
    100
    %
  Three Months
    
    Six MonthsEnded
    
    EndedMarch 31,
    
    March 31,2007
    
    2006
    
    2007
    
    2006Customer A
    
    
    *
    
    
    
    *
    
    
    
    28
    %
    
    
    *Customer B
    
    
    *
    
    
    
    38
    %
    
    
    20
    %
    
    
    39
    %Customer C
    
    
    27
    %
    
    
    *
    
    
    
    19
    %
    
    
    *Customer D
    
    
    24
    %
    
    
    *
    
    
    
    16
    %
    
    
    *Customer E
    
    
    13
    %
    
    
    24
    %
    
    
    *
    
    
    
    33
    %Customer F
    
    
    *
    
    
    
    21
    %
    
    
    *
    
    
    
    11
    %
 
 *
    
    Customer accounted for less than 10% of total revenue for the period.  March 31,
    
    September 30,2007
    
    2006Customer A
    
    
    43
    %
    
    
    37
    %Customer B
    
    
    11
    %
    
    
    21
    %Customer C
    
    
    14
    %
    
    
    16
    %Customer D
    
    
    13
    %
    
    
    16
    %
  March 31,
    
    
    September 30,2007
    
    
    2006(In thousands)United States
    
    $
    10,957
    
    
    $
    16,234South Korea
    
    
    1,123
    
    
    
    1,229Other
    
    
    244
    
    
    
    297Total
    
    $
    12,324
    
    
    $
    17,760
 NOTE 12  Related Party Transactions
  NOTE 13  Provision for Income Taxes
  18




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NOTE 14  Subsequent Event
  19




---



##### Table of Contents



ITEM 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
 This Quarterly Report on Form 10-Q contains certain 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. All statements included or incorporated by reference in this Quarterly Report on Form 10-Q
other than statements of historical fact may be forward-looking statements. You can identify these
and other forward-looking statements by the use of words such as may, will, could, would,
should, plans, anticipates, relies, expects, intends, believes, estimates,
predicts, potential, continue or the negative of such terms, or other comparable terminology.
Forward-looking statements also include the assumptions underlying or relating to any such
statements. These forward-looking statements are based on current expectations as of the filing
date of this Quarterly Report on Form 10-Q and involve a number of uncertainties and risks. These
uncertainties and risks include, but are not limited to: the adoption of new technology by our
existing and potential customers; the delay of investments by the Companys customers in response
to current economic factors, which could reduce their purchase of Photon Dynamics products until
the markets become more certain; the migration of our manufacturing operations offshore and the
changing customer investment climate, which could lead to impairments of assets; the current
economic conditions, which may cause an increase in competitive pricing pressures; the risk of the
introduction of competing products having technological and/or pricing advantages, which would
reduce the demand for our products; and failure to comply with a variety of United States and
foreign federal, state and local laws and regulations, which could lead to the Company incurring
additional expenses, interest and penalties.. As a result, our actual results and end user demand
may differ substantially from expectations.
 Our actual results could differ materially from those projected in the forward-looking
statements included herein as a result of a number of factors, risks and uncertainties, including
the risk factors set forth in Part II Item 1A. Risk Factors in this Quarterly Report on Form
10-Q. The information included in this Quarterly Report on Form 10-Q is as of the filing date with
the Securities and Exchange Commission and future events or circumstances could differ
significantly from the forward-looking statements included herein. Accordingly, we caution readers
not to place undue reliance on such statements and we expressly assume no obligation to update the
forward-looking statements included in this report after the date hereof except as required by law.
 The following discussion and analysis should be read in conjunction with the condensed
consolidated financial statements and notes thereto in Item 1 above and with our financial
statements and notes thereto for the year ended September 30, 2006, contained in our Annual Report
on Form 10-K filed with the Securities and Exchange Commission (the SEC) on December 14, 2006.
 Overview
 Our Company
  Flat Panel Display Market
   20




---



##### Table of Contents



TM TM TM TM
  TM
  Flat Panel Display Industry Trends
    21




---



##### Table of Contents



Leveraging Core Technologies
  Backlog
  Critical Accounting Policies and Estimates
     Revenue Recognition.
 22




---



##### Table of Contents



Allowance for Doubtful Accounts.
  Inventories.
  Warranty.
 Stock-Based Compensation.
 23




---



##### Table of Contents



Contingencies and Litigation.
 Results of Operations
 Selected Financial Data
  Three Months Ended
    
    
    Six Months EndedMarch 31,
    
    
    March 31,2007
    
    
    2006
    
    
    2007
    
    
    2006Revenue
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %Cost of revenue
    
    
    96.1
    
    
    
    65.7
    
    
    
    82.7
    
    
    
    60.3Gross margin
    
    
    3.9
    
    
    
    34.3
    
    
    
    17.3
    
    
    
    39.7Operating expenses:Research and development
    
    
    51.7
    
    
    
    17.1
    
    
    
    43.0
    
    
    
    18.2Selling, general and administrative
    
    
    47.0
    
    
    
    13.9
    
    
    
    32.5
    
    
    
    15.0Restructuring charge (benefit)
    
    
    7.3
    
    
    
    (0.1
    )
    
    
    4.1
    
    
    
    0.0Impairment of property and equipment
    
    
    20.3
    
    
    
    
    
    
    
    7.9
    
    
    
    Amortization of intangible assets
    
    
    2.7
    
    
    
    0.7
    
    
    
    2.1
    
    
    
    0.8Total operating expenses
    
    
    129.0
    
    
    
    31.6
    
    
    
    89.6
    
    
    
    34.0Income (loss) from operations
    
    
    (125.2
    )
    
    
    2.7
    
    
    
    (72.4
    )
    
    
    5.7Interest income and other, net
    
    
    14.5
    
    
    
    2.0
    
    
    
    8.8
    
    
    
    1.7Income (loss) from continuing
operations before income taxes and
discontinued operations
    
    
    (110.7
    )
    
    
    4.7
    
    
    
    (63.6
    )
    
    
    7.4Provision for income taxes
    
    
    0.8
    
    
    
    0.4
    
    
    
    0.6
    
    
    
    0.6Income (loss) from continuing operations
    
    
    (111.5
    )
    
    
    4.3
    
    
    
    (64.2
    )
    
    
    6.8Loss from discontinued operations
    
    
    
    
    
    
    0.7
    
    
    
    
    
    
    
    (0.4
    )Net income (loss)
    
    
    (111.5
    )%
    
    
    5.0
    %
    
    
    (64.2
    )%
    
    
    6.4
    %
 Revenue
 Three Months Ended
    
    Six Months EndedMarch 31,
    
    March 31,2007
    
    Change
    
    2006
    
    2007
    
    Change
    
    2006(dollars in millions)Revenue
    
    $
    13.9
    
    
    
    (72
    )%
    
    $
    50.3
    
    
    $
    35.4
    
    
    
    (62
    )%
    
    $
    92.0
  TM TM TM TM
 ArrayChecker TM and ArraySaver TM Product Revenue
 TM TM
 24




---



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TM TM
 TM TM
 TM
 TM TM
 PanelMaster TM Product Revenue
 TM TM
 TM TM TM
 Customer Support and Spare Parts Revenue
 TM TM
 25




---



##### Table of Contents



International Revenue
  Three Months Ended
    
    
    Six Months EndedMarch 31,
    
    
    March 31,2007
    
    
    Change
    
    
    2006
    
    
    2007
    
    
    Change
    
    
    2006(dollars in millions)Korea
    
    $
    4.0
    
    
    
    (87
    )%
    
    $
    31.1
    
    
    $
    10.1
    
    
    
    (84
    )%
    
    $
    66.2Taiwan
    
    
    7.4
    
    
    
    (60
    )%
    
    
    18.4
    
    
    
    13.6
    
    
    
    (44
    )%
    
    
    24.4Japan
    
    
    1.5
    
    
    
    97
    %
    
    
    0.8
    
    
    
    10.6
    
    
    
    637
    %
    
    
    1.4China
    
    
    1.0
    
    
    
    100
    %
    
    
    
    
    
    
    1.1
    
    
    
    100
    %
    
    
    Total Revenue
    
    $
    13.9
    
    
    
    (72
    )%
    
    $
    50.3
    
    
    $
    35.4
    
    
    
    (62
    )%
    
    $
    92.0
   Revenue Outlook
  Gross Margin
 Three Months Ended
    
    Six Months EndedMarch 31,
    
    March 31,2007
    
    Change
    
    2006
    
    2007
    
    Change
    
    2006Gross Margin
    
    $
    537,000
    
    
    
    (97
    )%
    
    $17.3 million
    
    $6.1 million
    
    
    (83
    )%
    
    $36.5 millionGross Margin Percentage
    
    
    4
    %
    
    
    (87
    )%
    
    
    34
    %
    
    
    17
    %
    
    
    (56
    )%
    
    
    40
    %
  
    
    A lower percentage sales of higher-margin ArrayCheckerTM systems:
    
    Additional inventory reserves as a consequence of the industry slowdown; and,
    
    The under-utilization of our San Jose facilities as a consequence of the industry slowdown.
  26




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##### Table of Contents




    
    Our revenue mix between higher margin ArrayCheckerTM systems and lower margin ArraySaverTM systems;
    
    The costs of increasing customer service staff to support potential increased demands from new and existing customers;
    
    The additional costs in connection with inefficiencies of manufacturing newly-introduced products;
    
    Competitive pricing pressures, particularly in the array repair market;
    
    The success of our strategy of using both domestic and offshore manufacturing as we begin
limited manufacturing of certain of our ArraySaverTM systems in South Korea;
    
    Reduced production levels as a consequence of either industry slowdown, order
cancellations or customer-initiated changes in delivery schedules by our customers; and
    
    Fluctuations in the level of revenue due to the cyclical nature of customers capital
expenditures.
 Research and Development
 Three Months Ended
    
    Six Months EndedMarch 31
    
    March 312007
    
    Change
    
    2006
    
    2007
    
    Change
    
    2006(dollars in millions)Expense
    
    $
    7.2
    
    
    
    (16
    )%
    
    $
    8.6
    
    
    $
    15.2
    
    
    
    (9
    )%
    
    $
    16.6Percent of Revenue
    
    
    52
    %
    
    
    
    
    
    
    17
    %
    
    
    43
    %
    
    
    
    
    
    
    18
    %
    
    
    Focus on product enhancements and improving cost of ownership on our Generation 7, 7.5 and 8 products;
    
    Accelerate investments in our Generation 10 product development program; and
    
    Invest funds in reliability and cost reduction initiatives.
  27




---



##### Table of Contents



Selling, General and Administrative
 Three Months Ended
    
    Six Months EndedMarch 31
    
    March 312007
    
    Change
    
    2006
    
    2007
    
    Change
    
    2006(dollars in millions)Expense
    
    $
    6.6
    
    
    
    (6
    )%
    
    $
    7.0
    
    
    $
    11.5
    
    
    
    (17
    )%
    
    $
    13.8Percent of Revenue
    
    
    47
    %
    
    
    
    
    
    
    14
    %
    
    
    33
    %
    
    
    
    
    
    
    15
    %
   Restructuring Charge
 Three Months Ended
    
    Six Months EndedMarch 31
    
    March 312007
    
    Change
    
    2006
    
    2007
    
    Change
    
    2006Expense
    
    $1.0 million
    
    
    3,278
    %
    
    $
    (32,000
    )
    
    $1.5 million
    
    
    4,777
    %
    
    $
    30,000Percent of Revenue
    
    
    7
    %
    
    
    
    
    
    
    0
    %
    
    
    4
    %
    
    
    
    
    
    
    0
    %
  March 2007 Restructuring
   November 2006 Restructuring
 TM
  April 2005 Restructuring
  28




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##### Table of Contents



Impairment of Property and Equipment
 Three Months Ended
    
    Six Months EndedMarch 31
    
    March 312007
    
    Change
    
    2006
    
    2007
    
    Change
    
    2006(dollars in millions)Expense
    
    $
    2.8
    
    
    
    100
    %
    
    $
    0
    
    
    $
    2.8
    
    
    
    100
    %
    
    $
    0Percent of Revenue
    
    
    20
    %
    
    
    
    
    
    
    0
    %
    
    
    8
    %
    
    
    
    
    
    
    0
    %
  Amortization of Intangibles
 Three Months Ended
    
    Six Months EndedMarch 31
    
    March 312007
    
    Change
    
    2006
    
    2007
    
    Change
    
    2006Expense
    
    $
    372,000
    
    
    
    0
    %
    
    $
    373,000
    
    
    $
    745,000
    
    
    
    0
    %
    
    $
    745,000Percent of Revenue
    
    
    3
    %
    
    
    
    
    
    
    1
    %
    
    
    2
    %
    
    
    
    
    
    
    1
    %
   Interest Income and Other, Net
 Three Months Ended
    
    Six Months EndedMarch 31
    
    March 31(dollars in millions)2007
    
    Change
    
    2006
    
    2007
    
    Change
    
    2006Interest Income and Other, Net
    
    $
    2.0
    
    
    
    98
    %
    
    $
    1.0
    
    
    $
    3.1
    
    
    
    104
    %
    
    $
    1.5Percent of Revenue
    
    
    15
    %
    
    
    
    
    
    
    2
    %
    
    
    9
    %
    
    
    
    
    
    
    2
    %
  29




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##### Table of Contents



Provision for Income Taxes
 Three Months Ended
    
    Six Months EndedMarch 31
    
    March 312007
    
    Change
    
    2006
    
    2007
    
    Change
    
    2006Expense
    
    $
    105,000
    
    
    
    (47
    )%
    
    $
    199,000
    
    
    $
    206,000
    
    
    
    (63
    )%
    
    $
    551,000Percent of Revenue
    
    
    1
    %
    
    
    
    
    
    
    0
    %
    
    
    1
    %
    
    
    
    
    
    
    1
    %
   Stock-Based Compensation
   Three Months Ended
    
    
    Six Months EndedMarch 31
    
    
    March 312007
    
    
    2006
    
    
    2007
    
    
    2006(in thousands, except per share data)Stock-based compensation expense included in continuing
operations: :Cost of revenue
    
    $
    25
    
    
    $
    24
    
    
    $
    106
    
    
    $
    88Research and development
    
    
    109
    
    
    
    195
    
    
    
    198
    
    
    
    333Selling, general and administrative
    
    
    522
    
    
    
    798
    
    
    
    813
    
    
    
    1,617Total stock-based compensation expense after income taxes (1)
    
    $
    656
    
    
    $
    1,017
    
    
    $
    1,117
    
    
    $
    2,038Stock-based compensation expense by type of award: :Employee stock options
    
    $
    614
    
    
    $
    997
    
    
    $
    966
    
    
    $
    1,923Employee stock purchase plan
    
    
    104
    
    
    
    144
    
    
    
    208
    
    
    
    239Restricted stock awards
    
    
    20
    
    
    
    
    
    
    
    25
    
    
    
    Amounts capitalized as inventory and deferred gross margin
    
    
    (82
    )
    
    
    (124
    )
    
    
    (82
    )
    
    
    (124
    )Total stock-based compensation expense after income taxes (1)
    
    $
    656
    
    
    $
    1,017
    
    
    $
    1,117
    
    
    $
    2,038
 
 (1)
    
    The income tax benefit on stock-based compensation for all periods presented was not
material.   30




---



##### Table of Contents



Discontinued Operations
 Three Months Ended
    
    Six Months EndedMarch 31
    
    March 312007
    
    Change
    
    2006
    
    2007
    
    Change
    
    2006Income (loss)
    
    $
    0
    
    
    
    (100
    )%
    
    $
    334,000
    
    
    $
    0
    
    
    
    (100
    )%
    
    $
    (346,000
    )
   Liquidity and Capital Resources
  Operating Activities of Continuing Operations
  Investing Activities of Continuing Operations
  Financing Activities of Continuing Operations
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Contractual Obligations
  Payments Due by Fiscal YearContractual Obligations
    
    Total
    
    
    2007(1)
    
    
    2008
    
    
    2009
    
    
    2010
    
    
    2011
    
    
    Thereafter(In thousands)Operating lease obligations
    
    $
    10,721
    
    
    $
    1,675
    
    
    $
    2,833
    
    
    $
    2,727
    
    
    $
    2,785
    
    
    $
    701
    
    
    $
    Capital lease obligations
    
    
    163
    
    
    
    32
    
    
    
    71
    
    
    
    60
    
    
    
    
    
    
    
    
    
    
    
    Purchase obligations
    
    
    16,658
    
    
    
    15,136
    
    
    
    1,522
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Total
    
    $
    27,542
    
    
    $
    16,843
    
    
    $
    4,426
    
    
    $
    2,787
    
    
    $
    2,785
    
    
    $
    701
    
    
    $
    
 
 (1)
    
    Remaining six months   Working Capital
   Impact of Accounting Pronouncements
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.
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ITEM 3. Quantitative and Qualitative Disclosures About Market Risk
 Foreign Currency Exchange Rate Risk
     Market Risk
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ITEM 4. Controls and Procedures
   Remediation of the Material Weakness That Existed as of March 31, 2007
  
    
    We are working with the assistance of outside advisors on developing new valuation and
declaration processes to ensure compliance with all customs regulations of each of the
countries into which we import parts.
    
    We are reviewing and evaluating our internal controls, including our internal reporting
processes, to ensure that legal, regulatory and other matters that could have a significant
financial statement impact are evaluated and documented by management and escalated on a
timely basis, where appropriate, to the Audit Committee.
    Changes in Control Over Financial Reporting in the Second Quarter of Fiscal 2007
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Inherent Limitations of Disclosure Controls and Procedures and Internal Control Over Financial
Reporting.
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PART II. OTHER INFORMATION
 
 ITEM 1. Legal Proceedings
   
 ITEM 1A. Risk Factors
 Our operations and financial results are subject to various risks and uncertainties, including
those described below, that could adversely affect our business, financial condition, results of
operations, cash flows and trading price of our common stock. You should refer also to our Annual
Report on Form 10-K for fiscal year 2006 for additional information concerning these and other
uncertainties that could negatively impact our Company.
 We have sustained losses and we may sustain losses in the future.
   Because none of our customers is obligated to purchase our products, each of our customers may
cancel or defer its purchases at any time and on short notice, which could harm our operating
results.
  
    
    may stop purchasing our products or defer their purchases at any time without penalty;
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
    
    are free to purchase products from our competitors;
    
    are not required to make minimum purchases; and
    
    may cancel orders that they place with us.
  Our operating results are difficult to predict and may vary from investors expectations,
which could cause our stock price to fall.
   
    
    the timing of the receipt of orders from major customers;
    
    the result of sudden, unanticipated changes in customer requirements;
    
    the cancellation, delay or extension of firm orders;
    
    the receipt of final acceptance on new products;
    
    the product mix that makes up our revenue;
    
    our inability to reduce our expense levels quickly in the event of market or demand
downturns, due to the fact that a high percentage of our expenses, including those related
to manufacturing, engineering, research and development, sales and marketing and general and
administrative functions, is fixed in the short term;
    
    the result of competitive pricing pressures;
    
    the ability to obtain components from our single or limited source suppliers in a timely manner;
    
    the ability to effectively implement our strategy of migrating or outsourcing manufacturing offshore;
    
    the effects of global economic uncertainty;
    
    the ability of our offshore manufacturing operations to timely produce and deliver
products in the quantity and of the quality our customers require;
    
    the costs of operations in the global markets in which we do business;
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
    
    the effects of changing international economic conditions;
    
    the effects of currency exchange rate fluctuations;
    
    the outcome of the appeal of litigation with a former executive officer;
    
    the effects of worldwide political instability;
    
    the ability to design, manufacture and introduce new products on a cost-effective and timely basis;
    
    the delay between expenses to further develop marketing and service capabilities and the
realization of benefits from those improved capabilities; and
    
    the introduction of new products by our competitors.
  If our products experience performance, reliability or quality problems, our customers may
reduce their orders.
 TM TM
 
    
    delays in receiving final acceptance, which in turn delays recognition of the associated revenue;
    
    delays in collecting accounts receivable;
    
    reduced orders;
    
    additional warranty and service expenses; and
    
    higher manufacturing costs.
  TM
 Capital investment by manufacturers of flat panel display products can be highly cyclical and
may decline in the future.
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We depend on sales to a few large customers in the flat panel display industry, and if we lose
any of our large customers our revenue could decrease significantly.
  We rely upon sales of a limited range of products, and if demand for one product decreases for
any reason it could cause our revenue to decline significantly.
  TM TM TM TM TM TM TM TM TM TM
 We may not be able to develop and introduce new products that respond to evolving industry
requirements in a timely manner, which could reduce our ability to compete effectively.
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If we are not able to receive sufficient parts to meet our production requirements, we may
experience significant delays in producing our products, which could decrease our revenue for an
extended period of time.
  All of our revenue is derived from sales to companies located outside the United States, which
exposes us to risks that we would not experience with domestic sales.
  
    
    political instability and the possibility of hostilities, terrorist attacks, or war;
    
    imposition of governmental controls;
    
    fluctuations in interest and currency exchange rates;
    
    export license requirements;
    
    restrictions on the export of technology;
    
    limited foreign protection of intellectual property rights;
    
    trade restrictions;
    
    periodic or local international downturns;
    
    decreases in productivity, temporary plant shutdowns or infrastructure service
disruptions resulting from widespread health alerts including Severe Acute Respiratory
Syndrome (SARS) and warnings of an Avian Flu pandemic;
    
    changes in tariffs; and
    
    difficulties in staffing and managing international operations.
  Our lengthy and varying-duration customer qualification and customer sales cycle requires us
to incur substantial costs to make a sale, and if the sale does not occur then we will have
incurred these expenses without obtaining increased sales.
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Our ability to efficiently and effectively implement our strategy of using both domestic and
offshore manufacturing may impact our profitability.
   
    
    political instability and the possibility of hostilities, terrorist attacks, or war;
    
    imposition of governmental controls;
    
    fluctuations in interest and currency exchange rates;
    
    limited foreign protection of intellectual property rights;
    
    trade restrictions;
    
    periodic or local international downturns;
    
    decreases in productivity, temporary plant shutdowns or infrastructure service
disruptions resulting from widespread health alerts including SARS and warnings of an Avian
Flu pandemic; and
    
    difficulties in staffing and managing international manufacturing.
  Any failure of, or other problems at or with, our third party manufacturers could delay
shipments of our flat panel display products, harm our relationships with our customers or
otherwise negatively impact our business.
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If we do not compete effectively in our target markets, we will lose market share.
  Our success depends in large part on the strength of the active matrix liquid crystal display
in the flat panel display industry.
  We may have difficulty integrating businesses or assets that we have acquired or developed in
new ventures and may acquire or develop in the future, and we may not realize the benefits that we
expect from these acquisitions and new vetnures.
   
    
    difficulty in the assimilation of the technologies and products;
    
    entering markets in which we have no or limited direct prior experience;
    
    loss of key customers;
    
    diversion of management resources;
    
    incompatibility of business cultures or practices;
    
    loss of key employees;
    
    costs and delays in implementing common systems and procedures;
    
    potential inefficiencies in delivering services to customers; and
    
    assumption of unknown or undisclosed liabilities.
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Compliance with new reporting requirements may strain our resources and we may be unable to
implement in a timely manner additional finance and accounting systems, procedures and controls in
the future to satisfy new reporting requirements, which could cause our stock price to fall.
   Our business could be harmed if we fail to properly protect our intellectual property.
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Litigation may be necessary to enforce or defend against claims of intellectual property
infringement, which could be expensive and, if we lose, could prevent us from selling our products.
   Our failure to comply with governmental regulations related to international activities could
subject us to liability and additional expense.
    We must attract and retain key employees and our management team and employees must work
effectively together to maintain and grow our business.
  Terrorism and international political instability may negatively affect our operations.
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Our manufacturing facilities and our customers manufacturing facilities may be subject to
disruption from natural disasters.
   We have exposure to various risks related to the regulatory environment.
  Computer viruses may disrupt our operations.
  Additional Risks in Owning our Common Stock
 Our stock price may fluctuate significantly.
  
    
    announcements of technological innovations or new products by us or by our competitors;
    
    government regulations;
    
    developments in patent or other property rights; and
    
    developments in our relationships with our customers.
  Some anti-takeover provisions may affect the price of our common stock.
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We do not anticipate paying cash dividends.
  
 ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds
  
 ITEM 3. Defaults Upon Senior Securities
  
 ITEM 4. Submission of Matters to a Vote of Security Holders
   Name
    
    For
    
    WithheldMalcolm J. Thompson
    
    
    14,840,679
    
    
    
    661,602Jeffrey A. Hawthorne
    
    
    14,844,890
    
    
    
    657,391Nicholas E. Brathwaite
    
    
    14,623,211
    
    
    
    879,070Michael J. Kim
    
    
    14,592,331
    
    
    
    909,950Terry H. Carlitz
    
    
    14,879,297
    
    
    
    622,984Curtis S. Wozniak
    
    
    14,646,835
    
    
    
    855,446Ed Rogas Jr.
    
    
    14,883,300
    
    
    
    618,981
  For
    
    
    10,772,389Against
    
    
    1,508,216Abstain
    
    
    23,949No Vote
    
    
    3,197,727
  For
    
    
    10,341,942Against
    
    
    1,935,301Abstain
    
    
    27,311No Vote
    
    
    3,197,727
  For
    
    
    10,458,552Against
    
    
    1,821,015Abstain
    
    
    24,987No Vote
    
    
    3,197,727
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For
    
    
    15,375,017Against
    
    
    108,933Abstain
    
    
    18,331
 
 ITEM 5. Other Information
  
 ITEM 6. Exhibits
 Exhibits
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SIGNATURES
  PHOTON DYNAMICS, INC.By:
    
    /s/ Michael SchradleMichael SchradleChief Financial Officer(Duly authorized and principal financial officer)
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Exhibit Index
 Number
    
    Exhibit3.1(1)
    
    Amended and Restated Articles of Incorporation of the Registrant.3.2(1)
    
    Certificate of Amendment to Articles of Incorporation of the Registrant.3.3(2)
    
    Bylaws of the Registrant.4.1
    
    Reference is made to Exhibits 3.1, 3.2 and 3.3.31.1
    
    Certification required by Rule 13a-14(a) or Rule 15d-14(a).31.2
    
    Certification required by Rule 13a-14(a) or Rule 15d-14(a).32.1**
    
    Certifications required by Rule 13a-14(b) or Rule 15d-14(b) and Section
1350 of Chapter 63 of Title 18 of the United States Code (18 U.S.C.
§1350).
 Key to Exhibits:
 
 (1)
    
    Previously filed as the like-numbered exhibit to the Registrants Registration Statement on
Form S-1 (Commission File No. 333-76650) as filed with the Securities and Exchange Commission
on January 14, 2002, as amended, and incorporated herein by reference.(2)
    
    Previously filed as the like-described exhibit to the Registrants Quarterly Report on Form
10Q for the quarter ended December 31, 2005 as filed with the Securities and Exchange
Commission on February 9, 2006, and incorporated herein by reference.**
    
    The certification attached as Exhibit 32.1 accompanies the Quarterly Report on Form 10-Q
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 and shall not be deemed filed by
the Company for purposes of Section 18 of the Securities Exchange Act of 1934, as amended. 50