##### 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, 2008
 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: 000-27234
 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
  o þ




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##### 



INDEX
 PagePART I FINANCIAL INFORMATIONItem 1
    
    Financial Statements (unaudited)
    
    
    3Condensed Consolidated Balance Sheets as of March 31, 2008 and September 30, 2007
    
    
    3Condensed Consolidated Statements of Operations for the Three and Six Months Ended March 31, 2008 and 2007
    
    
    4Condensed Consolidated Statements of Cash Flows for the Six Months Ended March 31, 2008 and 2007
    
    
    5Notes to Condensed Consolidated Financial Statements
    
    
    6Item 2
    
    Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    21Item 3
    
    Quantitative and Qualitative Disclosures About Market Risk
    
    
    38Item 4
    
    Controls and Procedures
    
    
    39PART II OTHER INFORMATIONItem 1
    
    Legal Proceedings
    
    
    41Item 1A
    
    Risk Factors
    
    
    41Item 2
    
    Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    41Item 3
    
    Defaults Upon Senior Securities
    
    
    41Item 4
    
    Submission of Matters to a Vote of Security Holders
    
    
    42Item 5
    
    Other Information
    
    
    42Item 6
    
    Exhibits
    
    
    42Signatures
    
    
    
    
    43EXHIBIT 10.57EXHIBIT 10.58EXHIBIT 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 30,2008
    
    
    2007(in thousands)ASSETSCurrent assets:Cash and cash equivalents
    
    $
    44,344
    
    
    $
    41,170Short-term investments
    
    
    19,321
    
    
    
    42,640Accounts receivable, net of allowance for doubtful accounts of $54 and
$239 at March 31, 2008 and September 30, 2007, respectively
    
    
    30,210
    
    
    
    11,934Inventories
    
    
    18,081
    
    
    
    13,292Refundable customs obligations
    
    
    676
    
    
    
    560Other current assets
    
    
    4,870
    
    
    
    3,661Total current assets
    
    
    117,502
    
    
    
    113,257Long-term investments
    
    
    1,525
    
    
    
    1,176Land, property and equipment, net
    
    
    8,637
    
    
    
    10,583Other assets
    
    
    5,952
    
    
    
    5,365Intangible assets, net
    
    
    9,240
    
    
    
    11,023Goodwill
    
    
    6,857
    
    
    
    6,857Total assets
    
    $
    149,713
    
    
    $
    148,261LIABILITIES AND SHAREHOLDERS EQUITYCurrent liabilities:Accounts payable
    
    $
    14,637
    
    
    $
    4,217Warranty
    
    
    3,583
    
    
    
    3,217Employee note payable
    
    
    2,733
    
    
    
    Customs obligations
    
    
    690
    
    
    
    4,114Other current liabilities
    
    
    10,084
    
    
    
    9,874Deferred gross margin
    
    
    773
    
    
    
    3,236Total current liabilities
    
    
    32,500
    
    
    
    24,658Non-current liabilities:Long-term employee note payable
    
    
    2,667
    
    
    
    5,381Other non-current liabilities
    
    
    
    
    
    
    38Total non-current liabilities
    
    
    2,667
    
    
    
    5,419Commitments and contingenciesShareholders equity:Common stock, no par value
    
    
    301,222
    
    
    
    300,290Accumulated deficit
    
    
    (186,238
    )
    
    
    (181,503
    )Accumulated other comprehensive loss
    
    
    (438
    )
    
    
    (603
    )Total shareholders equity
    
    
    114,546
    
    
    
    118,184Total liabilities and shareholders equity
    
    $
    149,713
    
    
    $
    148,261
  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 31,2008
    
    
    2007
    
    
    2008
    
    
    2007(in thousands, except per share data)Product revenue
    
    $
    40,832
    
    
    $
    10,473
    
    
    $
    53,497
    
    
    $
    28,106Customer support and spare parts revenue
    
    
    4,261
    
    
    
    3,455
    
    
    
    7,772
    
    
    
    7,257Total revenue
    
    
    45,093
    
    
    
    13,928
    
    
    
    61,269
    
    
    
    35,363Product cost of revenue
    
    
    25,378
    
    
    
    11,945
    
    
    
    35,281
    
    
    
    26,245Customer support and spare parts cost of revenue
    
    
    1,732
    
    
    
    1,659
    
    
    
    3,554
    
    
    
    3,309Total cost of revenue
    
    
    27,110
    
    
    
    13,604
    
    
    
    38,835
    
    
    
    29,554Gross margin
    
    
    17,983
    
    
    
    324
    
    
    
    22,434
    
    
    
    5,809Operating expenses:Research and development
    
    
    6,156
    
    
    
    7,194
    
    
    
    11,372
    
    
    
    15,130Selling, general and administrative
    
    
    7,535
    
    
    
    6,484
    
    
    
    14,856
    
    
    
    11,366Restructuring charge
    
    
    
    
    
    
    1,017
    
    
    
    
    
    
    
    1,463Impairment of property and equipment
    
    
    
    
    
    
    2,834
    
    
    
    
    
    
    
    2,834Loss (gain) on sale of property and equipment
    
    
    1
    
    
    
    
    
    
    
    (49
    )
    
    
    Amortization of intangible assets
    
    
    892
    
    
    
    372
    
    
    
    1,783
    
    
    
    745Total operating expenses
    
    
    14,584
    
    
    
    17,901
    
    
    
    27,962
    
    
    
    31,538Income (loss) from operations
    
    
    3,399
    
    
    
    (17,577
    )
    
    
    (5,528
    )
    
    
    (25,729
    )Interest income and other, net
    
    
    618
    
    
    
    1,996
    
    
    
    1,463
    
    
    
    3,010Income (loss) before income taxes
    
    
    4,017
    
    
    
    (15,581
    )
    
    
    (4,065
    )
    
    
    (22,719
    )Provision for income taxes
    
    
    163
    
    
    
    105
    
    
    
    304
    
    
    
    206Net income (loss)
    
    $
    3,854
    
    
    $
    (15,686
    )
    
    $
    (4,369
    )
    
    $
    (22,925
    )Net income (loss) per share:Basic
    
    $
    0.22
    
    
    $
    (0.95
    )
    
    $
    (0.25
    )
    
    $
    (1.38
    )Diluted
    
    $
    0.21
    
    
    $
    (0.95
    )
    
    $
    (0.25
    )
    
    $
    (1.38
    )Weighted average number of shares:Basic
    
    
    17,749
    
    
    
    16,591
    
    
    
    17,745
    
    
    
    16,590Diluted
    
    
    18,561
    
    
    
    16,591
    
    
    
    17,745
    
    
    
    16,590
  4




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##### Table of Contents



PHOTON DYNAMICS, INC.
 
 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
 Six Months EndedMarch 31,2008
    
    
    2007(in thousands)Cash flows from operating activities:Net loss
    
    $
    (4,369
    )
    
    $
    (22,925
    )Adjustments to reconcile net loss to net cash used in operating activities:Depreciation
    
    
    1,587
    
    
    
    2,541Amortization of intangible assets
    
    
    1,783
    
    
    
    745Stock-based compensation
    
    
    853
    
    
    
    1,006Restructuring charge
    
    
    
    
    
    
    273Impairment of property and equipment
    
    
    
    
    
    
    2,834Foreign currency translation adjustment gain recognized upon liquidation of a subsidiary
    
    
    
    
    
    
    (928
    )Gain on sale of property and equipment
    
    
    (49
    )
    
    
    Accretion of non-interest bearing notes payable
    
    
    
    
    
    
    15Changes in operating assets and liabilities:Accounts receivable
    
    
    (18,276
    )
    
    
    15,086Inventories
    
    
    (3,423
    )
    
    
    (7,663
    )Other current assets
    
    
    (1,325
    )
    
    
    (111
    )Other assets
    
    
    (788
    )
    
    
    (251
    )Accounts payable
    
    
    10,420
    
    
    
    (685
    )Other current liabilities
    
    
    (3,141
    )
    
    
    1,762Deferred gross margin
    
    
    (2,463
    )
    
    
    (4,469
    )Other liabilities
    
    
    (38
    )
    
    
    (12
    )Net cash used in operating activities
    
    
    (19,229
    )
    
    
    (12,782
    )Cash flows from investing activities:Purchase of property and equipment
    
    
    (970
    )
    
    
    (923
    )Proceeds from sale of property and equipment
    
    
    250
    
    
    
    Purchase of short-term investments
    
    
    (13,621
    )
    
    
    (63,815
    )Maturities and sales of short-term investments
    
    
    36,568
    
    
    
    54,228Net cash provided by (used in) investing activities
    
    
    22,227
    
    
    
    (10,510
    )Cash flows from financing activities:Issuance of common stock
    
    
    10
    
    
    
    724Capital lease payments
    
    
    (54
    )
    
    
    (41
    )Net cash provided by (used in) financing activities
    
    
    (44
    )
    
    
    683Effect of exchange rate changes on cash and cash equivalents
    
    
    220
    
    
    
    (73
    )Net increase (decrease) in cash and cash equivalents
    
    
    3,174
    
    
    
    (22,682
    )Cash and cash equivalents at beginning of period
    
    
    41,170
    
    
    
    47,935Cash and cash equivalents at end of period
    
    $
    44,344
    
    
    $
    25,253
  5




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##### Table of Contents



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.
 Revenue Recognition.
  6




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PHOTON DYNAMICS, INC.
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
       Accounting Changes
 Recent Accounting Pronouncements.
  7




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##### Table of Contents



PHOTON DYNAMICS, INC.
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 .
 .
 NOTE 2  FINANCIAL STATEMENT COMPONENTS
 March 31,
    
    
    September 30,2008
    
    
    2007(in thousands)Inventories:Raw materials
    
    $
    14,676
    
    
    $
    7,465Work-in-process
    
    
    2,790
    
    
    
    4,491Finished goods
    
    
    615
    
    
    
    1,336Total
    
    $
    18,081
    
    
    $
    13,292Other current liabilities:Compensation
    
    $
    4,067
    
    
    $
    4,897Professional fees
    
    
    1,924
    
    
    
    2,441Customer deposits
    
    
    765
    
    
    
    Other accrued expenses
    
    
    3,328
    
    
    
    2,536Total
    
    $
    10,084
    
    
    $
    9,874Deferred gross margin:Deferred system revenue
    
    $
    7,527
    
    
    $
    10,269Deferred cost of revenue
    
    
    (6,754
    )
    
    
    (7,033
    )Total
    
    $
    773
    
    
    $
    3,236Accumulated other comprehensive loss:Foreign currency translation adjustments
    
    $
    (355
    )
    
    $
    (543
    )Unrealized losses on availablefor-sale securities
    
    
    (83
    )
    
    
    (60
    )Total
    
    $
    (438
    )
    
    $
    (603
    )
 NOTE 3  GOODWILL AND OTHER PURCHASED INTANGIBLE ASSETS
 Goodwill
   Intangible Assets
  8




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##### Table of Contents



PHOTON DYNAMICS, INC.
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 NonDeveloped
    
    
    Core
    
    
    Compete
    
    
    Customer
    
    
    TradeTechnology
    
    
    Technology
    
    
    Contract
    
    
    Relations
    
    
    Name
    
    
    Backlog
    
    
    Total(in thousands)Gross carrying amount at March 31, 2008
    
    $
    7,346
    
    
    $
    3,988
    
    
    $
    2,348
    
    
    $
    910
    
    
    $
    640
    
    
    $
    110
    
    
    $
    15,342Accumulated amortization
    
    
    (2,011
    )
    
    
    (2,539
    )
    
    
    (1,259
    )
    
    
    (152
    )
    
    
    (107
    )
    
    
    (34
    )
    
    
    (6,102
    )Net carrying amount at March 31, 2008
    
    $
    5,335
    
    
    $
    1,449
    
    
    $
    1,089
    
    
    $
    758
    
    
    $
    533
    
    
    $
    76
    
    
    $
    9,240
  NonDeveloped
    
    
    Core
    
    
    Compete
    
    
    Customer
    
    
    TradeTechnology
    
    
    Technology
    
    
    Contract
    
    
    Relations
    
    
    Name
    
    
    Backlog
    
    
    Total(in thousands)Gross carrying amount at September 30, 2007
    
    $
    7,346
    
    
    $
    3,988
    
    
    $
    2,348
    
    
    $
    910
    
    
    $
    640
    
    
    $
    110
    
    
    $
    15,342Accumulated amortization
    
    
    (1,094
    )
    
    
    (2,111
    )
    
    
    (1,041
    )
    
    
    (38
    )
    
    
    (27
    )
    
    
    (8
    )
    
    
    (4,319
    )Net carrying amount at September 30, 2007
    
    $
    6,252
    
    
    $
    1,877
    
    
    $
    1,307
    
    
    $
    872
    
    
    $
    613
    
    
    $
    102
    
    
    $
    11,023
  NonDeveloped
    
    
    Core
    
    
    Compete
    
    
    Customer
    
    
    TradeTechnology
    
    
    Technology
    
    
    Contract
    
    
    Relations
    
    
    Name
    
    
    Backlog
    
    
    Total(in thousands)Balance as of September 30, 2007
    
    $
    6,252
    
    
    $
    1,877
    
    
    $
    1,307
    
    
    $
    872
    
    
    $
    613
    
    
    $
    102
    
    
    $
    11,023Amortization during the period
    
    
    (917
    )
    
    
    (428
    )
    
    
    (218
    )
    
    
    (114
    )
    
    
    (80
    )
    
    
    (26
    )
    
    
    (1,783
    )Balance as of March 31, 2008
    
    $
    5,335
    
    
    $
    1,449
    
    
    $
    1,089
    
    
    $
    758
    
    
    $
    533
    
    
    $
    76
    
    
    $
    9,240
   NOTE 4  RESTRUCTURING AND OTHER CHARGES
 March 2007 Impairment of Property and Equipment
   February 2007 Restructure
  9




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PHOTON DYNAMICS, INC.
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
    November 2006 Restructure
 TM
 NOTE 5  COMPREHENSIVE INCOME (LOSS)
  Three Months Ended
    
    
    Six Months EndedMarch 31,
    
    
    March 31,2008
    
    
    2007
    
    
    2008
    
    
    2007(in thousands)Net income (loss)
    
    $
    3,854
    
    
    $
    (15,686
    )
    
    $
    (4,369
    )
    
    $
    (22,925
    )Other comprehensive income (loss):Net change in unrealized gain (loss) on investments
    
    
    (13
    )
    
    
    30
    
    
    
    (23
    )
    
    
    (3
    )Change in foreign currency translation
    
    
    175
    
    
    
    (958
    )(1)
    
    
    188
    
    
    
    (968
    )(1)Other comprehensive income (loss)
    
    
    162
    
    
    
    (928
    )
    
    
    165
    
    
    
    (971
    )Total comprehensive income (loss)
    
    $
    4,016
    
    
    $
    (16,614
    )
    
    $
    (4,204
    )
    
    $
    (23,896
    )
 
 (1)
    
    In the quarter ended March 31, 2007, the Company substantially liquidated its net investment
in its Canadian subsidiary, Photon Dynamics Canada, Inc., for financial statement purposes. In
accordance with the provisions of Statement of Financial Accounting Standards No. 52, Foreign
Currency Translation the Company recorded a gain on its net investment in this subsidiary of
approximately $928,000, composed of translation adjustment gains that had accumulated in
Accumulated other comprehensive income (loss) on the Consolidated Balance Sheet. NOTE 6  STOCK-BASED COMPENSATION PLANS
   10




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PHOTON DYNAMICS, INC.
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 Three Months Ended
    
    
    Six Months EndedMarch 31
    
    
    March 312008
    
    
    2007
    
    
    2008
    
    
    2007(in thousands, except per share data)Stock-based compensation expense included in continuing
operations: :Cost of revenue
    
    $
    39
    
    
    $
    25
    
    
    $
    102
    
    
    $
    106Research and development
    
    
    117
    
    
    
    109
    
    
    
    169
    
    
    
    198Selling, general and administrative
    
    
    353
    
    
    
    459
    
    
    
    582
    
    
    
    702Total stock-based compensation expense after income taxes (1)
    
    $
    509
    
    
    $
    593
    
    
    $
    853
    
    
    $
    1,006Stock-based compensation expense by type of award: :Employee stock options
    
    $
    91
    
    
    $
    551
    
    
    $
    153
    
    
    $
    855Employee stock purchase plan
    
    
    
    
    
    
    104
    
    
    
    
    
    
    
    208Restricted stock awards
    
    
    488
    
    
    
    20
    
    
    
    770
    
    
    
    25Amounts capitalized as inventory and deferred gross margin
    
    
    (70
    )
    
    
    (82
    )
    
    
    (70
    )
    
    
    (82
    )Total stock-based compensation expense after income taxes (1)
    
    $
    509
    
    
    $
    593
    
    
    $
    853
    
    
    $
    1,006
 
  Equity Incentive and Other Programs
  The 2005 Equity Incentive Plan
 2006 Non-Employee Directors Stock Incentive Plan
  11




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##### Table of Contents



PHOTON DYNAMICS, INC.
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
  Valuation and Other Assumption
  Expected Volatility
 Expected Term
 Risk-Free Interest Rate
 Expected Dividends
 Forfeitures
  Three Months Ended
    
    Six Months EndedMarch 31,
    
    March 31,2008
    
    2007
    
    2008
    
    2007Stock option plan:Expected volatility
    
    
    50
    %
    
    
    40
    %
    
    
    50
    %
    
    
    44
    %Risk free rate
    
    
    2.47
    %
    
    
    4.87
    %
    
    
    2.47
    %
    
    
    4.67
    %Expected term (in years)
    
    
    4.0
    
    
    
    2.9
    
    
    
    4.0
    
    
    
    3.35Expected dividends
    
    

    None
    

    
    

    None
    


   

    
    None

    

   

    
    None
  12




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PHOTON DYNAMICS, INC.
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
  Three Months Ended
    
    Six Months EndedMarch 31, 2007
    
    March 31, 2007Stock purchase plan:Expected volatility
    
    
    44
    %
    
    
    44
    %Risk free rate
    
    
    4.66
    %
    
    
    4.66
    %Expected term (years)
    
    
    0.6
    
    
    
    0.6Expected dividends
    
    

    None
    


    
    

    None
   Equity Incentive Plan
  Awards
    
    
    
    
    
    
    Weighted-
    
    
    Weighted-Average
    
    
    AggregateAvailable
    
    
    Options
    
    
    Average
    
    
    Remaining Contract
    
    
    Intrinsic Valuefor Grant
    
    
    Outstanding
    
    
    Exercise Price
    
    
    Term (in years)
    
    
    (in thousands)Balances at September 30, 2007
    
    
    1,739,630
    
    
    
    1,245,582
    
    
    $
    19.29Plan shares expired (1)
    
    
    (95,139
    )
    
    
    
    
    
    
    Restricted stock units granted (2)
    
    
    (596,300
    )
    
    
    
    
    
    
    Restricted stock units canceled or
withheld for taxes (2)
    
    
    66,481
    
    
    
    
    
    
    
    Options granted
    
    
    (137,250
    )
    
    
    137,250
    
    
    
    9.43Options canceled
    
    
    174,303
    
    
    
    (174,303
    )
    
    
    19.36Options exercised
    
    
    
    
    
    
    (3,080
    )
    
    
    3.08Balances at March 31, 2008
    
    
    1,151,725
    
    
    
    1,205,449
    
    
    $
    18.20
    
    
    
    5.8
    
    
    $
    249Vested and expected to vest at March 31, 2008
    
    
    
    
    
    
    1,029,595
    
    
    $
    19.26
    
    
    
    5.7
    
    
    $
    205Exercisable at March 31, 2008
    
    
    
    
    
    
    783,557
    
    
    $
    21.65
    
    
    
    5.4
    
    
    $
    98
 
 (1)
    
    The Companys 1995 Amended and Restated Stock Option Plan expired in November 2005. Option
shares that were available for grant at the time of cancellation and all outstanding option
shares that subsequently are cancelled or expire are no longer available for grant.(2)
    
    Any restricted stock units granted under the 2005 Equity Incentive Plan or 2006 Non-Employee
Directors Stock Incentive Plan shall be counted against the total number of shares issuable
under the Plans. Additional detail of issued restricted stock units are shown below.  13




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##### Table of Contents



PHOTON DYNAMICS, INC.
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
    Restricted Stock Units
  Weighted-AverageNumber
    
    
    Grant Dateof Shares
    
    
    Fair ValueUnvested restricted stock units at September 30, 2007
    
    
    284,196
    
    
    $
    10.44Restricted stock units granted
    
    
    596,300
    
    
    $
    9.82Restricted stock units released
    
    
    (14,374
    )
    
    $
    10.94Unvested restricted stock units cancelled
    
    
    (62,424
    )
    
    $
    10.29Unvested restricted stock units at March 31, 2008
    
    
    803,698
    
    
    $
    9.98
  Employee Stock Purchase Plan
   NOTE 7  EARNINGS (LOSS) PER SHARE
   14




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##### Table of Contents



PHOTON DYNAMICS, INC.
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 Three Months Ended
    
    
    Six Months EndedMarch 31,
    
    
    March 31,2008
    
    
    2007
    
    
    2008
    
    
    2007(in thousands, except per share data)Numerator:Net income (loss)
    
    $
    3,854
    
    
    $
    (15,686
    )
    
    $
    (4,369
    )
    
    $
    (22,925
    )Denominator:Weighted average shares
outstanding, excluding unvested
restricted stock, for basic net
income (loss) per share
    
    
    17,749
    
    
    
    16,591
    
    
    
    17,745
    
    
    
    16,590Effect of dilutive securities:Employee stock options and
restricted stock
    
    
    812
    
    
    
    
    (1)
    
    
    
    (1)
    
    
    
    (1)Weighted average shares for
diluted net income (loss) per
share
    
    
    18,561
    
    
    
    16,591
    
    
    
    17,745
    
    
    
    16,590Earnings (loss) per share:Basic
    
    $
    0.22
    
    
    $
    (0.95
    )
    
    $
    (0.25
    )
    
    $
    (1.38
    )Diluted
    
    $
    0.21
    
    
    $
    (0.95
    )
    
    $
    (0.25
    )
    
    $
    (1.38
    )Potentially anti-dilutive securities
    
    
    1,147
    (2)
    
    
    2,049
    (2)
    
    
    1,159
    (2)
    
    
    2,016
    (2)
 
 (1)
    
    The effect of potentially dilutive securities to purchase approximately 814,000 shares of
common stock in the six months ended March 31, 2008, and 81,000 shares of common stock for
both the three and six months ended March 31, 2007 were not included in the computation of
diluted net loss per share as the effect is anti-dilutive.(2)
    
    These securities are excluded from the computation of diluted earnings per share because the
exercise price, including unamortized stock-based compensation net of tax benefits, was
greater than the average market price of common shares for the periods presented. As a result,
their effect would have been anti-dilutive. NOTE 8  COMMITMENTS AND CONTINGENCIES
 Purchase Agreements
   Warranty Obligations
   Six Months EndedMarch 31,2008
    
    
    2007(in thousands)Beginning balance
    
    $
    3,217
    
    
    $
    8,058Estimated warranty cost of new shipments during the period
    
    
    2,687
    
    
    
    2,126Warranty costs during the period
    
    
    (2,579
    )
    
    
    (3,243
    )Changes in liability for pre-existing warranties, including expirations
    
    
    258
    
    
    
    477Ending balance
    
    $
    3,583
    
    
    $
    7,418
 15




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##### Table of Contents



PHOTON DYNAMICS, INC.
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 TM
 Legal Proceedings
     NOTE 9  SEGMENT REPORTING AND GEOGRAPHIC INFORMATION
  16




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##### Table of Contents



PHOTON DYNAMICS, INC.
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
  
    
    Flat Panel Display Segment. Includes test and repair equipment used in the flat panel
display industry to collect and analyze data from the liquid crystal display production
lines and to diagnose and repair defects in the production line.
    
    High-Performance Digital Imaging Segment. Includes high-performance digital cameras used
in the defense, industrial and scientific/medical industries for a variety of applications.
In the defense industry, high-performance digital camera applications include targeting,
unmanned vehicle guidance, discrimination of decoy versus real targets and daytime and
nighttime surveillance. Industrial customers use high-performance digital cameras for
inspection, metrology and machine guidance. Scientific and medical industry applications
include X-ray, fluoroscopy, mammography, veterinary x-ray and semiconductor process
monitoring and non-destructive testing.
     Three Months
    
    
    Six MonthsEnded
    
    
    EndedMarch 31,
    
    
    March 31,2008
    
    
    2007
    
    
    2008
    
    
    2007(in thousands)Revenue:Flat panel display segment
    
    $
    44,242
    
    
    $
    13,928
    
    
    $
    59,068
    
    
    $
    35,363High-performance digital imaging segment
    
    
    851
    
    
    
    
    
    
    
    2,201
    
    
    
    Consolidated revenue
    
    $
    45,093
    
    
    $
    13,928
    
    
    $
    61,269
    
    
    $
    35,363Operating income (loss):Flat panel display segment
    
    $
    5,816
    
    
    $
    (13,133
    )
    
    $
    (1,813
    )
    
    $
    (20,426
    )High-performance digital imaging segment.
    
    
    (1,907
    )
    
    
    
    
    
    
    (2,911
    )
    
    
    Total segment operating income (loss)
    
    $
    3,909
    
    
    $
    (13,133
    )
    
    $
    (4,724
    )
    
    $
    (20,426
    )
  17




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##### Table of Contents



PHOTON DYNAMICS, INC.
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
  Three Months
    
    
    Six MonthsEnded
    
    
    EndedMarch 31,
    
    
    March 31,2008
    
    
    2007
    
    
    2008
    
    
    2007(in thousands)Operating loss:Total segment operating income (loss)
    
    $
    3,909
    
    
    $
    (13,133
    )
    
    $
    (4,724
    )
    
    $
    (20,426
    )Unallocated costs
    
    
    (509
    )
    
    
    (593
    )
    
    
    (853
    )
    
    
    (1,006
    )Restructuring costs
    
    
    
    
    
    
    (1,017
    )
    
    
    
    
    
    
    (1,463
    )Impairment of property and equipment
    
    
    
    
    
    
    (2,834
    )
    
    
    
    
    
    
    (2,834
    )Gain (loss) on sale of property and equipment
    
    
    (1
    )
    
    
    
    
    
    
    49
    
    
    
    Consolidated income (loss) from operations
    
    $
    3,399
    
    
    $
    (17,577
    )
    
    $
    (5,528
    )
    
    $
    (25,729
    )
  Three Months
    
    
    Six MonthsEnded
    
    
    EndedMarch 31,
    
    

March 31,2008
    
    
    2007
    
    
    2008
    
    
    2007(in thousands)Revenue:South Korea
    
    $
    20,896
    
    
    $
    4,054
    
    
    $
    24,874
    
    
    $
    10,073Taiwan
    
    
    19,119
    
    
    
    7,468
    
    
    
    23,751
    
    
    
    13,630Japan
    
    
    3,823
    
    
    
    1,505
    
    
    
    9,695
    
    
    
    10,540United States
    
    
    845
    
    
    
    
    
    
    
    2,195
    
    
    
    China
    
    
    410
    
    
    
    901
    
    
    
    754
    
    
    
    1,120Total
    
    $
    45,093
    
    
    $
    13,928
    
    
    $
    61,269
    
    
    $
    35,363
  Three Months
    
    Six MonthsEnded
    
    EndedMarch 31,
    
    March 31,2008
    
    2007
    
    2008
    
    2007Customer A
    
    
    36
    %
    
    
    13
    %
    
    
    29
    %
    
    
    16
    %Customer B
    
    
    35
    %
    
    
    27
    %
    
    
    27
    %
    
    
    19
    %Customer C
    
    
    *
    
    
    
    *
    
    
    
    12
    %
    
    
    28
    %Customer D
    
    
    *
    
    
    
    *
    
    
    
    11
    %
    
    
    *Customer E
    
    
    *
    
    
    
    *
    
    
    
    *
    
    
    
    20
    %Customer F
    
    
    *
    
    
    
    24
    %
    
    
    *
    
    
    
    *
 
 *
    
    Customer accounted for less than 10% of total revenue for the period.   March 31,
    
    September 30,2008
    
    2007Customer A
    
    
    39
    %
    
    
    *Customer B
    
    
    20
    %
    
    
    26
    %Customer C
    
    
    14
    %
    
    
    *Customer D
    
    
    *
    
    
    
    19
    %Customer E
    
    
    *
    
    
    
    28
    %
 
 *
    
    Customer accounted for less than 10% of total accounts receivable.  18




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PHOTON DYNAMICS, INC.
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
  March 31,
    
    
    September 30,2008
    
    
    2007(In thousands)United States
    
    $
    24,121
    
    
    $
    27,518South Korea
    
    
    448
    
    
    
    756Other
    
    
    165
    
    
    
    189Total
    
    $
    24,734
    
    
    $
    28,463
 NOTE 10  FINANCIAL INSTRUMENTS
     NOTE 11  NOTES PAYABLE
  19




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##### Table of Contents



PHOTON DYNAMICS, INC.
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
  NOTE 12  INCOME TAXES
 Tax Provision
  Adoption of FIN 48
    20




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##### 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: our ability to remediate material
weaknesses in our internal controls; our ability to attract and retain qualified employees;
possible further changes in our customs duty liability; possible civil and criminal liability in
connection with customs duty issues; the adoption of new technology by our existing and potential
customers; our customers response to prevailing economic and market conditions; the changing
customer investment climate, which could lead to the impairment of our assets; our ability to
successfully migrate our manufacturing operations offshore; our ability to maintain competitive
pricing; the introduction of competing products having technological and/or pricing advantages,
which would reduce the demand for our products; our ability to operate and integrate our newly
acquired subsidiary; and failure to comply with a variety of Untied States and foreign federal,
state and local laws and regulation, which could lead to the Company incurring additional
penalties, interest and other expenses. 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 I Item 1A. Risk Factors in our Annual Report on Form 10-K for
our fiscal year ended September 30, 2007. 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, 2007, contained in our Annual Report
on Form 10-K , as filed with the SEC on January 24, 2008.
 BUSINESS AND COMPANY OVERVIEW
 Our Company
  Flat Panel Display Segment
 Flat Panel Display Market
  21




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TM TM TM TM
    Flat Panel Display Industry Trends
  22




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##### Table of Contents



High-Performance Digital Imaging Segment
 High-Performance Digital Imaging Market
      High-Performance Digital Imaging Industry Trends
  23




---



##### Table of Contents



Backlog
  CRITICAL ACCOUNTING POLICIES AND ESTIMATES
     Revenue Recognition
   24




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##### Table of Contents



Allowance for Doubtful Account
   Fair value of financial instruments
    Inventories
  25




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##### Table of Contents



Warranty
  Goodwill and Intangible Assets
   Stock-Based Compensation
    26




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##### Table of Contents



Contingencies and Litigation
   RESULTS OF OPERATIONS
 Selected Financial Data
  Three Months Ended
    
    Six Months EndedMarch 31,
    
    March 31,2008
    
    2007
    
    2008
    
    2007Product revenue
    
    
    90.6
    %
    
    
    75.2
    %
    
    
    87.3
    %
    
    
    79.5
    %Customer support and spare parts revenue
    
    
    9.4
    
    
    
    24.8
    
    
    
    12.7
    
    
    
    20.5Total revenue
    
    
    100.0
    
    
    
    100.0
    
    
    
    100.0
    
    
    
    100.0Product cost of revenue
    
    
    56.3
    
    
    
    85.8
    
    
    
    57.6
    
    
    
    74.2Customer support and spare parts cost of revenue
    
    
    3.8
    
    
    
    11.9
    
    
    
    5.8
    
    
    
    9.4Total cost of revenue
    
    
    60.1
    
    
    
    97.7
    
    
    
    63.4
    
    
    
    83.6Gross Margin
    
    
    39.9
    
    
    
    2.3
    
    
    
    36.6
    
    
    
    16.4Operating expenses:Research and development
    
    
    13.7
    
    
    
    51.7
    
    
    
    18.6
    
    
    
    42.8Selling, general and administrative
    
    
    16.7
    
    
    
    46.6
    
    
    
    24.2
    
    
    
    32.1Restructuring charge
    
    
    
    
    
    
    7.3
    
    
    
    
    
    
    
    4.1Impairment of property and equipment
    
    
    
    
    
    
    20.3
    
    
    
    
    
    
    
    8.0Loss (gain) on sale of property and equipment
    
    
    
    
    
    
    
    
    
    
    (0.1
    )
    
    
    Amortization of intangible assets
    
    
    2.0
    
    
    
    2.7
    
    
    
    2.9
    
    
    
    2.1Total operating expenses
    
    
    32.4
    
    
    
    128.5
    
    
    
    45.7
    
    
    
    89.2Income (loss) from operations
    
    
    7.5
    
    
    
    (126.2
    )
    
    
    (9.0
    )
    
    
    (72.8
    )Interest income and other, net
    
    
    1.4
    
    
    
    14.3
    
    
    
    2.4
    
    
    
    8.5Income (loss) from continuing operations before income taxes
    
    
    8.9
    
    
    
    (111.9
    )
    
    
    (6.6
    )
    
    
    (64.2
    )Provision for income taxes
    
    
    0.4
    
    
    
    0.8
    
    
    
    0.5
    
    
    
    0.6Net income (loss)
    
    
    8.5
    %
    
    
    (112.6
    )%
    
    
    (7.1
    )%
    
    
    (64.8
    )%
  27




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##### Table of Contents



Three Months Ended
    
    
    Six Months EndedMarch 31,
    
    
    March 31,2008
    
    
    Change
    
    
    2007
    
    
    2008
    
    
    Change
    
    
    2007(dollars in millions)Korea
    
    $
    20.9
    
    
    
    415
    %
    
    $
    4.0
    
    
    $
    24.9
    
    
    
    147
    %
    
    $
    10.1Taiwan
    
    
    19.1
    
    
    
    156
    %
    
    
    7.4
    
    
    
    23.8
    
    
    
    74
    %
    
    
    13.6Japan
    
    
    3.8
    
    
    
    154
    %
    
    
    1.5
    
    
    
    9.7
    
    
    
    (8
    )%
    
    
    10.6United States
    
    
    0.9
    
    
    
    100
    %
    
    
    
    
    
    
    2.2
    
    
    
    100
    %
    
    
    China
    
    
    0.4
    
    
    
    (54
    )%
    
    
    1.0
    
    
    
    0.8
    
    
    
    (33
    )%
    
    
    1.1Total Revenue
    
    $
    45.1
    
    
    
    224
    %
    
    $
    13.9
    
    
    $
    61.3
    
    
    
    73
    %
    
    $
    35.4
  Operating Segments
   Flat Panel Display Segment
 TM TM
  Three Months Ended
    
    Six Months EndedMarch 31,
    
    March 31,2008
    
    Change
    
    2007
    
    2008
    
    Change
    
    2007(dollars in millions)Revenues:Product
    
    $
    40.0
    
    
    
    282
    %
    
    $
    10.5
    
    
    $
    51.3
    
    
    
    83
    %
    
    $
    28.1Customer support and spare parts
    
    $
    4.3
    
    
    
    23
    %
    
    $
    3.5
    
    
    $
    7.8
    
    
    
    7
    %
    
    $
    7.3Gross margin:Product
    
    $
    15.5
    
    
    
    1,217
    %
    
    $
    (1.4
    )
    
    $
    17.8
    
    
    
    704
    %
    
    $
    2.2Customer support and spare parts
    
    $
    2.5
    
    
    
    41
    %
    
    $
    1.8
    
    
    $
    4.2
    
    
    
    14
    %
    
    $
    3.7
 28




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##### Table of Contents



Three Months Ended
    
    Six Months EndedMarch 31,
    
    March 31,2008
    
    Change
    
    2007
    
    2008
    
    Change
    
    2007(dollars in millions)Operating expenses:Research and development
    
    $
    5.7
    
    
    
    (19
    )%
    
    $
    7.1
    
    
    $
    10.8
    
    
    
    (28
    )%
    
    $
    14.9Selling, general and administrative
    
    $
    6.2
    
    
    
    4
    %
    
    $
    6.0
    
    
    $
    12.7
    
    
    
    19
    %
    
    $
    10.7Amortization of intangible assets
    
    $
    0.2
    
    
    
    (54
    )%
    
    $
    0.4
    
    
    $
    0.4
    
    
    
    (53
    )%
    
    $
    0.7Operating income (loss)
    
    $
    5.8
    
    
    
    145
    %
    
    $
    (13.1
    )
    
    $
    (1.9
    )
    
    
    91
    %
    
    $
    (20.4
    )
 Revenue
  ArrayChecker TM and ArraySaver TM Product Revenue. TM TM
 Three Months Ended March 31,
    
    Six Months Ended March 31,2008
    
    2007
    
    2008
    
    2007Revenue by generation:Generation 6 and earlier
    
    
    40
    %
    
    
    28
    %
    
    
    36
    %
    
    
    16
    %Generation 7 and 8
    
    
    50
    %
    
    
    31
    %
    
    
    50
    %
    
    
    55
    %Revenue by product:ArrayCheckerTM
    
    
    85
    %
    
    
    31
    %
    
    
    82
    %
    
    
    51
    %ArraySaverTM
    
    
    5
    %
    
    
    28
    %
    
    
    5
    %
    
    
    20
    %
 TM TM
 TM TM
 TM TM
 PanelMaster TM Product Revenue. TM TM TM
 TM TM
 29




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##### Table of Contents



TM
 Customer Support and Spare Parts Revenue. TM TM
 Gross Margin
 TM
  Research and Development
   Selling, General and Administrative
   Amortization of Intangible Assets
   30




---



##### Table of Contents



Operating Income/Loss
  
    
    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;
    
    The success of our strategy of using both domestic and offshore manufacturing;
    
    The success of outsourcing certain manufacturing to third-party vendors;
    
    The under-utilization of manufacturing facilities as a consequence of industry slowdown,
order cancellations or changes in delivery schedules by our customers;
    
    The unanticipated need for additional warranty charges;
    
    The level of spending required on developing new Generations of our ArrayCheckerTM
and ArraySaverTM products; and
    
    The inability to reduce our expense levels quickly in the event of market 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.
  High-Performance Digital Imaging Segment
   Three Months Ended
    
    Six Months EndedMarch 31, 2008
    
    March 31, 2008(dollars in millions)Revenue
    
    $
    0.9
    
    
    $
    2.2Gross margin
    
    $
    0.1
    
    
    $
    0.5Operating expenses:Research and development
    
    $
    0.3
    
    
    $
    0.4Selling, general and administrative
    
    $
    0.9
    
    
    $
    1.6Amortization of intangible assets
    
    $
    0.7
    
    
    $
    1.4Operating loss
    
    $
    (1.9
    )
    
    $
    (2.9
    )
  Revenue
 31




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##### Table of Contents



Gross Margin
  Research and Development
   Selling, General and Administrative
   Amortization of Intangible Assets
   Operating Loss
  32




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##### Table of Contents




    
    The costs of increasing marketing and customer service staff to increase market share and
support potential increased demands from new and existing customers;
    
    The additional costs in connection with inefficiencies of manufacturing newly-introduced
products;
    
    The modification, cancellation or termination of contracts and subcontracts by the U.S.
government;
    
    The unanticipated need for additional warranty charges; and
    
    The inability to reduce our expense levels quickly in the event of market 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.
 Restructuring Charge
 Three Months Ended
    
    Six Months EndedMarch 31
    
    March 312008
    
    Change
    
    2007
    
    2008
    
    Change
    
    2007(dollars in millions)Expense
    
    $
    0.0
    
    
    
    (100
    )%
    
    $
    1.0
    
    
    $
    0.0
    
    
    
    (100
    )%
    
    $
    1.5Percent of Revenue
    
    
    0
    %
    
    
    
    
    
    
    7
    %
    
    
    0
    %
    
    
    
    
    
    
    4
    %
  February 2007 Restructure
   November 2006 Restructure
 TM
  Impairment of Property and Equipment
 Three Months Ended
    
    Six Months EndedMarch 31
    
    March 312008
    
    Change
    
    2007
    
    2008
    
    Change
    
    2007(dollars in millions)Expense
    
    $
    0.0
    
    
    
    (100
    )%
    
    $
    2.8
    
    
    $
    0.0
    
    
    
    (100
    )%
    
    $
    2.8Percent of Revenue
    
    
    0
    %
    
    
    
    
    
    
    20
    %
    
    
    0
    %
    
    
    
    
    
    
    8
    %
 33




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##### Table of Contents



Gain on Sale of Property and Equipment
 Three Months Ended
    
    Six Months EndedMarch 31
    
    March 312008
    
    Change
    
    2007
    
    2008
    
    Change
    
    2007(dollars in thousands)Gain (loss)
    
    $
    (1.0
    )
    
    
    100
    %
    
    $
    0.0
    
    
    $
    49.0
    
    
    
    100
    %
    
    $
    0.0Percent of Revenue
    
    
    0
    %
    
    
    
    
    
    
    0
    %
    
    
    0
    %
    
    
    
    
    
    
    0
    %
  Interest Income and Other, Net
 Three Months Ended
    
    Six Months EndedMarch 31
    
    March 312008
    
    Change
    
    2007
    
    2008
    
    Change
    
    2007(dollars in millions)Income
    
    $
    0.6
    
    
    
    (69
    )%
    
    $
    2.0
    
    
    $
    1.5
    
    
    
    (51
    )%
    
    $
    3.0Percent of Revenue
    
    
    1
    %
    
    
    
    
    
    
    14
    %
    
    
    2
    %
    
    
    
    
    
    
    9
    %
   Provision for Income Taxes
 Three Months Ended
    
    Six Months EndedMarch 31
    
    March 312008
    
    Change
    
    2007
    
    2008
    
    Change
    
    2007(dollars in millions)Expense
    
    $
    0.2
    
    
    
    55
    %
    
    $
    0.1
    
    
    $
    0.3
    
    
    
    48
    %
    
    $
    0.2Percent of Revenue
    
    
    0
    %
    
    
    
    
    
    
    1
    %
    
    
    1
    %
    
    
    
    
    
    
    1
    %
  34




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##### Table of Contents



Stock-Based Compensation
   Three Months Ended
    
    
    Six Months EndedMarch 31
    
    
    March 312008
    
    
    2007
    
    
    2008
    
    
    2007(in thousands, except per share data)Stock-based compensation expense included in continuing
operations:Cost of revenue
    
    $
    39
    
    
    $
    25
    
    
    $
    102
    
    
    $
    106Research and development
    
    
    117
    
    
    
    109
    
    
    
    169
    
    
    
    198Selling, general and administrative
    
    
    353
    
    
    
    459
    
    
    
    582
    
    
    
    702Total stock-based compensation expense after income taxes (1)
    
    $
    509
    
    
    $
    593
    
    
    $
    853
    
    
    $
    1,006Stock-based compensation expense by type of award:Employee stock options
    
    $
    91
    
    
    $
    551
    
    
    $
    153
    
    
    $
    855Employee stock purchase plan
    
    
    
    
    
    
    104
    
    
    
    
    
    
    
    208Restricted stock awards
    
    
    488
    
    
    
    20
    
    
    
    770
    
    
    
    25Amounts capitalized as inventory and deferred gross margin
    
    
    (70
    )
    
    
    (82
    )
    
    
    (70
    )
    
    
    (82
    )Total stock-based compensation expense after income taxes (1)
    
    $
    509
    
    
    $
    593
    
    
    $
    853
    
    
    $
    1,006
 
 (1)
    
    The income tax benefit on stock-based compensation for all periods presented was not material.   LIQUIDITY AND CAPITAL RESOURCES
  Operating Activities
  35




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##### Table of Contents



Investing Activities
  Financing Activities
    Contractual Obligations
  Payments Due by Fiscal YearContractual Obligations
    
    Total
    
    
    2008(1)
    
    
    2009
    
    
    2010
    
    
    2011
    
    
    2012
    
    
    Thereafter(In thousands)Purchase obligations
    
    $
    50,207
    
    
    $
    47,200
    
    
    $
    3,007
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    Operating lease obligations
    
    
    8,151
    
    
    
    1,717
    
    
    
    2,881
    
    
    
    2,830
    
    
    
    723
    
    
    
    
    
    
    $
    Notes payable, including interest
    
    
    5,633
    
    
    
    133
    
    
    
    2,800
    
    
    
    2,700
    
    
    
    
    
    
    
    
    
    
    
    Capital lease obligations
    
    
    47
    
    
    
    47
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Total
    
    $
    64,038
    
    
    $
    49,097
    
    
    $
    8,688
    
    
    $
    5,530
    
    
    $
    723
    
    
    $
    
    
    
    $
    
 
 (1)
    
    Remaining six months    36




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##### Table of Contents



Working Capital
  IMPACT OF ACCOUNTING PRONOUNCEMENTS
  .
 .
 37




---



##### Table of Contents



ITEM 3. Quantitative and Qualitative Disclosures About Market Risk
 Foreign Currency Exchange Rate Risk
      Market Risk
   38




---



##### Table of Contents



ITEM 4. Controls and Procedures
   
    
    The absence of adequate processes for detecting noncompliance with applicable laws and
regulations and our employee code of conduct, evaluating the effect of such noncompliance
on our financial statements on a timely and accurate basis, and communicating such
noncompliance and related evaluation to our Audit Committee;
    
    The absence of adequate processes and programs in our control environment to educate
employees on our employee code of conduct and applicable laws and regulations; and
    
    Insufficient accounting and finance personnel with the knowledge and experience required
to ensure an appropriate level of review of financial statement accounts.
  Remediation of the Material Weakness That Existed as of March 31, 2008
  
    
    Review and evaluation of our internal controls, including our internal reporting
processes, to ensure that legal, regulatory and other matters that could have a significant
financial statement effect are identified and evaluated and documented by management and
escalated on a timely basis, where appropriate, to the Audit Committee.
    
    Development, with the assistance of outside advisors, of new valuation and declaration
processes to ensure compliance with all customs regulations of each of the countries into
which we import parts, including replacing manual invoices with an automated customs
commercial invoice process that requires review by legal and finance personnel.
    
    Enhanced compliance and ethics training for employees, including implementation of an
online compliance system in four languages, increasing awareness of the employee code of
conduct through mandatory training for all employees, and reinforcing the ethics policy by
requiring an annual ethics certification for all employees.
 39




---



##### Table of Contents




    
    With respect to personnel who were determined to have known, or who should have known,
that the Companys customs practices were non-compliant, certain of such personnel have
been terminated or have otherwise left the Company, and others, including a former
executive officer, have had their responsibilities and reporting relationships modified.
     Changes in Control Over Financial Reporting in the Second Quarter of Fiscal 2008
  Inherent Limitations of Disclosure Controls and Procedures and Internal Control Over Financial
Reporting.
  40




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##### Table of Contents



PART II. OTHER INFORMATION
 
 ITEM 1. Legal Proceedings
     
 ITEM 1A. Risk Factors
  
 ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds
  
 ITEM 3. Defaults Upon Senior Securities
  41




---



##### Table of Contents



ITEM 4. Submission of Matters to a Vote of Security Holders
   Name
    
    For
    
    WithheldMalcolm J. Thompson
    
    
    10,487,412
    
    
    
    148,074Jeffrey A. Hawthorne
    
    
    10,506,910
    
    
    
    128,576Terry H. Carlitz
    
    
    10,397,385
    
    
    
    238,101Donald C. Fraser
    
    
    10,506,004
    
    
    
    129,482Edward Rogas Jr.
    
    
    10,398,291
    
    
    
    237,195Curtis S. Wozniak
    
    
    10,397,706
    
    
    
    237,780
  For
    
    
    10,501,347Against
    
    
    132,411Abstain
    
    
    1,728
 
 ITEM 5. Other Information
  
 ITEM 6. Exhibits
 Exhibits
  42




---



##### Table of Contents



SIGNATURES
  PHOTON DYNAMICS, INC.By:
    
    /s/ James P. MonizJames P. MonizChief Financial Officer(Duly authorized and principal financial officer)
  43




---



##### Table of Contents



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 3.3.10.57
    
    Manufacturing Agreement between the Registrant and C SUN Manufacturing, Ltd., dated April 11, 2008.10.58
    
    Manufacturing Agreement between the Registrant and Ultra Clean Technology Systems and Service,
Inc., dated February 1, 2008.31.1
    
    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
10-Q 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. 44