|UNITED
STATES SECURITIES AND EXCHANGE COMMISSIONWashington,
D.C. 20549


FORM 10-QSB


(Mark One)
|-------------------------------------------------------------------------------------------------

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

|For the quarterly period ended March 31, 2000



OR
|---------------------------------------------------

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

|Commission File Number: 0-27234


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

|California | 94-3007502
|---------- | ----------

|(State or other jurisdiction ofincorporation or organization) | (I.R.S. Employer Identification No.)
|------------------------------------------------------------- | ------------------------------------

|6325 San Ignacio Avenue, San Jose, CA | 95119
|------------------------------------- | -----

|(Address of principal executive offices) | (Zip Code)
|---------------------------------------- | ----------

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


N/A (Former name, former address, and former
fiscal year, if changed since last report.)


Indicate by check mark whether the registrant (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. YES _X_  NO ___


As of May 3, 2000, 11,547,801 shares of the Issuers Common
Stock, no par value, were outstanding.
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|INDEX



Photon Dynamics, Inc.
|------------------------------

|Part I.    |  | Financial Information                                                         |  |  | 
|---------- |  | ----------------------------------------------------------------------------- |  |  | 
|Item 1.    |  | Financial Statements (Unaudited)                                              |  |  | 
|           |  | Condensed Consolidated Balance Sheets - March 31, 2000 and September 30, 1999 |  |  | 
|           |  | Condensed Consolidated Statements of Operations - Three and six month periods | 
|           |  | ended March 31, 2000 and 1999                                                 |  |  | 
|           |  | Condensed Consolidated Statements of Cash Flows - Three and six month periods | 
|           |  | ended March 31, 2000 and 1999                                                 |  |  | 
|           |  | Notes to Condensed Consolidated Financial Statements - March 31, 2000         |  |  | 
|Item 2.    |  | Managements Discussion and Analysis of Financial Condition and Results of    | 
|           |  | Operations                                                                    |  |  | 
|Part II    |  | Other Information                                                             | 
|Item 1.    |  | Legal Proceedings                                                             |  |  | 
|Item 2.    |  | Changes in Securities                                                         |  |  | 
|Item 3.    |  | Defaults Upon Senior Securities                                               |  |  | 
|Item 4.    |  | Submission of Matters to a Vote of Security Holders                           |  |  | 
|Item 5.    |  | Other Information                                                             |  |  | 
|Item 6.    |  | Exhibits and Reports on Form 8-K                                              |  |  | 
|Signatures |  |                                                                               |  |  | 

|Part I. FINANCIAL INFORMATION




Photon Dynamics, Inc.Condensed Consolidated Balance Sheets
|--------------------------------------------------------------------------------------------

|                                                                 | March 31,2000 | September 30,1999
|---------------------------------------------------------------- | ------------- | -----------------
|
|
|Assets                                                           |               |                  
|Current assets:                                                  |              
|Cash and cash equivalents                                        |               | $58,318          
|Short-term investments                                           |               | 40,482           
|Accounts receivable, net of allowance of $1,520 and $1,301 as of |              
|March 31, 2000 and September 30, 1999, respectively              |               | 14,463           
|Inventories                                                      |               | 8,651            
|Prepaid expenses and other current assets                        |               | 322              
|                                                                
|Total current assets                                             |               | 122,236          
|Property, equipment and leasehold improvements, net              |               | 1,964            
|Other assets                                                     |               | 757              
|                                                                
|Total assets                                                     |               | $124,957         
|                                                                
|Liabilities and Shareholders Equity                             |              
|Current liabilities:                                             |              
|Accounts payable                                                 |               | $4,531           
|Accrued expenses and other current liabilities                   |               | 7,845            
|Deferred revenue and customer deposits                           |               | 72               
|                                                                
|Total current liabilities                                        |               | 12,448           
|Commitments and contingencies                                    |              
|Shareholders equity:                                            |              
|Preferred stock, no par value                                    |               |                 
|Common stock, no par value                                       |               | 130,508          
|Accumulated deficit                                              |               | (18,031          
|Accumulated other comprehensive income                           |               | 32               
|                                                                
|Total shareholders equity                                       |               | 112,509          
|                                                                
|Total liabilities and shareholders equity                       |               | $124,957         
|                                                                
|                                                                 |              

|Note: The balance sheet at September 30, 1999 has been derived
from the audited supplemental consolidated financial statements at that date but
does not include all of the information and footnotes required by generally
accepted accounting principles for complete financial statements.
See accompanying notes to condensed consolidated financial
statements.
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|Photon Dynamics, Inc.Condensed
Consolidated Statements of Operations
|--------------------------------------------------------------------

|                                    | Three Months EndedMarch 31, | Six Months EndedMarch 31,
|----------------------------------- | --------------------------- | -------------------------
|
|
|
|Revenue                             |                             | $ 19,172                 
|Cost of revenue                     |                             | 10,112                   
|                                   
|Gross margin                        |                             | 9,060                    
|                                   
|Operating expenses:                 |                            
|Research and development            |                             | 2,663                    
|Selling, general and administrative |                             | 3,163                    
|Non-recurring acquisition charges   |                             |                         
|                                   
|Total operating expenses            |                             | 5,826                    
|                                   
|Operating income (loss)             |                             | 3,234                    
|Interest income                     |                             | 918                      
|Interest expense and other          |                             | (46                      
|                                   
|Income (loss) before income taxes   |                             | 4,106                    
|Provision for income taxes          |                             | 730                      
|                                   
|Net income (loss)                   |                             | $   3,376                
|                                   
|Earnings (loss) per share:          |                            
|Basic                               |                             | $     0.31               
|                                   
|Diluted                             |                             | $     0.28               
|                                   
|Weighted average number of shares:  |                            
|Basic                               |                             | 10,733                   
|                                   
|Diluted                             |                             | 11,900                   
|                                   

|See accompanying notes to condensed consolidated financial statements.
|----------------------------------------------------------------------

|Photon Dynamics, Inc.Condensed Consolidated
Statements of Cash Flows
|--------------------------------------------------------------------

|                                                             | Six Months EndedMarch 31, |          
|------------------------------------------------------------ | ------------------------- | ---------
|
|
|
|Operating activities:                                        |                           |          
|Net income (loss)                                            |                           | $   4,898
|Adjustments to reconcile net income (loss) to net cash       |                          
|provided by operating activities:                            |                          
|Depreciation and amortization                                |                           | 551      
|Stock compensation expense                                   |                           | 350      
|Changes in assets and liabilities:                           |                          
|Accounts receivable, net                                     |                           | (833     
|Inventories                                                  |                           | (1,539   
|Deferred income taxes                                        |                           |         
|Prepaid expenses and other current assets                    |                           | 392      
|Other assets                                                 |                           | 11       
|Accounts payable                                             |                           | 1,700    
|Accrued expenses and other current liabilities               |                           | 2,310    
|Deferred revenue and customer deposits                       |                           | (583     
|                                                            
|Net cash provided by (used in) operating activities          |                           | 7,257    
|Investing activities:                                        |                          
|Purchases of property and equipment                          |                           | (698     
|Sales of short-term investments                              |                           |         
|Purchases of short-term investments                          |                           | (38,904  
|                                                            
|Net cash used in investing activities                        |                           | (39,602  
|Financing activities:                                        |                          
|Principle payments on capital lease obligations              |                           |         
|Issuance of notes receivable to employees                    |                           |         
|Proceeds from borrowings under line of credit                |                           |         
|Proceeds from issuance of common stock                       |                           | 84,186   
|Proceeds from notes receivable to shareholders               |                           |         
|                                                            
|Net cash provided by financing activities                    |                           | 84,186   
|Adjustment to conform to fiscal year of CR Technology, Inc.  |                           |         
|Effect of exchange rate changes on cash and cash equivalents |                           | 56       
|                                                            
|                                                             |                           | 56       
|Net increase in cash and cash equivalents                    |                           | 51,897   
|Cash and cash equivalents at beginning of period             |                           | 6,421    
|                                                            
|Cash and cash equivalents at end of period                   |                           | $ 58,318 
|                                                            

|See accompanying notes to condensed consolidated financial statements.
|----------------------------------------------------------------------

|NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS (Unaudited) March 31, 2000




NOTE 1  Basis of Presentation


The accompanying unaudited
condensed consolidated financial statements have been prepared in accordance
with generally accepted accounting principles for interim financial information
and with the instructions to Form 10-QSB and Article 10 of Regulation S-B.
Accordingly, they do not include all of the information and footnotes required
by generally accepted accounting principles for complete financial statements.
In the opinion of management, all adjustments (consisting of normal recurring
accruals) considered necessary for a fair presentation have been included.
Operating results for the six-month period ended March 31, 2000 are not
necessarily indicative of the results that may be expected for the year ending
September 30, 2000. For further information, refer to the supplemental
consolidated financial statements and footnotes thereto for the year ended
September 30, 1999 included in the Companys Registration Statement on Form
S-3 (No. 333-92937), declared effective on January 31, 2000.


On November 30, 1999, the Company
acquired CR Technology, Inc. (CR Technology) in a transaction that
was accounted for as a pooling of interests. The consolidated financial
statements at September 30, 1999 and for the three and six month periods ended
March 31, 2000 and 1999 have been restated to include the financial position,
results of operations and cash flows of CR Technology. Financial information for
Photon Dynamics, Inc.s fiscal years ended September 30, 1999 and 1998 have
been combined with CR Technologys financial information for the fiscal
year ended December 31, 1998 and the twelve months ended September 30, 1999,
respectively. Therefore, CR Technologys results of operations for the
three months ended December 31, 1998 have been included in both years. The
unaudited results of operations of CR Technology are summarized as follows:
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                 | Three Months EndedDecember 31, 1998
|---------------- | -----------------------------------
|
|Revenue          |                                    
|Operating income |                                    
|Net income       |                                    

|NOTE 2  New Accounting Pronouncement


In December 1999, the Securities and Exchange Commission
(SEC) issued Staff Accounting Bulletin No. 101, Revenue Recognition
in Financial Statements (SAB 101). SAB 101 summarizes certain views
of the SEC in applying generally accepted accounting principles to revenue
recognition in financial statements. Changes in the Companys revenue
recognition policy resulting from the interpretation of SAB 101 would be
reported as a change in accounting principle in the quarter ending December 31,
2000. The change in the revenue recognition policy would result in a cumulative
adjustment in the first quarter of fiscal 2001 to reflect the deferral of
revenue for shipments previously reported as revenue that do not meet SAB 101
revenue recognition guidance as of October 1, 2000. Although the Company
believes its revenue recognition policy is in accordance with generally accepted
accounting principles, the Company is currently studying SAB 101 and has not
determined its impact on the Companys financial statements.
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|NOTE 3Inventories


The components of inventories
consist of the following:
|----------------------------------------------------------------------------

|                  | March 31,2000 | September 30,1999
|----------------- | ------------- | -----------------
|
|Raw materials     |               | $3,188           
|Work in process   |               | 5,114            
|Finished products |               | 349              
|                 
|                  |               | $8,651           
|                 
|                  |              

|NOTE 4 Public Offering of Common Stock


On February 4, 2000, the Company
completed an underwritten public offering of shares of common stock. The
offering related to 2,000,000 shares of common stock at a price of $55.00 per
share of which approximately 1,321,000 shares were sold by the Company and
approximately 679,000 shares were sold by a stockholder of the Company. The net
proceeds to the Company were approximately $68.6 million. On March 4, 2000, the
Company received additional proceeds of approximately $15.6 million from the
sale of an additional 300,000 shares of common stock as a result of the
underwriters exercising their over-allotment option in the public offering.



NOTE 5  Business Combination


On November 30, 1999, the Company
acquired CR Technology in exchange for approximately 1,835,000 shares of the
Companys common stock. The acquisition was accounted for as a pooling of
interests. The Company incurred a one-time charge of $860,000. The charge
consisted of costs associated with the acquisition primarily related to legal,
investment banking and accounting fees.



NOTE 6  Comprehensive Income


The components of comprehensive
income are as follows:
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                                             | Three Months EndedMarch 31, | Six Months EndedMarch 31,
|-------------------------------------------- | --------------------------- | -------------------------
|
|
|Net income (loss)                            |                             | $ 3,376                  
|Net foreign currency translation adjustments |                             |                         
|Net unrealized losses on investments         |                             | (30                      
|                                            
|Total comprehensive income (loss)            |                             | $ 3,346                  
|                                            

|NOTE 7  Operations by Industry Segment


The Company conducts business in
two operating segments: flat panel display (FPD) products and
printed circuit board (PCB) assembly and advanced semiconductor
packaging inspection products (collectively, semiconductor inspection
products). The Companys FPD products include test, repair and
inspection equipment. The Companys FPD test and inspection equipment
identifies and characterizes defects at early stages of the manufacturing
process so that the panels may be repaired before the next stage, or, if
necessary, discarded, minimizing the loss of time and materials. The
Companys FPD products gather comprehensive data that enable FPD
manufacturers to control and refine their manufacturing processes. The
Companys semiconductor inspection products enable PCB assembly and
advanced semiconductor packaging manufacturers to detect and identify defects
thereby increasing yields and quality and reducing costs.
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|Prior to the acquisition of CR
Technology on November 30, 1999, the Company only operated in the FPD products
segment. The Companys management has determined the operating segments
based upon the manner in which the business is managed and operated. There are
no significant intersegment sales or transfers, and substantially all of the
Companys long-lived assets are located in the U.S. The Companys
principal customers are primarily Asian-based FPD manufacturers and North
American-based PCB assembly and advanced semiconductor packaging manufacturers.


The Companys operating
segments consisted of the following:
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                                             | Three Months EndedMarch 31, | Six Months EndedMarch 31,
|-------------------------------------------- | --------------------------- | -------------------------
|
|
|Net sales to external customers:             |                             |                          
|FPD products                                 |                             | $15,058                  
|Semiconductor inspection products            |                             | 4,114                    
|                                            
|Consolidated net sales to external customers |                             | $19,172                  
|                                            
|Operating income (loss):                     |                            
|FPD products                                 |                             | $  2,822                 
|Semiconductor inspection products            |                             | 412                      
|                                            
|Consolidated operating income (loss)         |                             | $  3,234                 
|                                            

|NOTE 8  Earnings Per Share


For the three and six month
periods ended March 31, 2000 and 1999, basic earnings (loss) per share is
calculated using the weighted average number of shares of common stock
outstanding. Diluted earnings (loss) per share is computed in the same manner
and also gives effect to all dilutive common equivalent shares outstanding
during the period. Dilutive common equivalent shares consist of employee stock
options and warrants. As the Company incurred a loss for the six month period
ended March 31, 1999, the effect of dilutive common equivalent shares totaling
approximately 467,000 shares from employee stock options and warrants were
excluded from the computation of diluted loss per share as its effect would be
anti-dilutive. The following table sets forth the computation of basic and
diluted earnings (loss) per share:
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                                                          | Three Months EndedMarch 31, | Six Months EndedMarch 31,
|--------------------------------------------------------- | --------------------------- | -------------------------
|
|
|Numerator for basic and diluted earnings per share - net  |                             |                          
|income (loss)                                             |                             | $  3,376                 
|                                                         
|Denominator for basic earnings per share - weighted       |                            
|average shares                                            |                             | 10,733                   
|Effect of dilutive securities:                            |                            
|Employee stock options                                    |                             | 1,156                    
|Warrants                                                  |                             | 11                       
|                                                         
|Denominator for diluted earnings per share - adjusted for |                            
|weighted average shares from options and warrants         |                             | 11,900                   
|                                                         
|Basic earnings (loss) per share                           |                             | $    0.31                
|Diluted earnings (loss) per share                         |                             | $    0.28                

|NOTE 9  Income Taxes


The provision for income taxes was
$730,000 and $1.1 million for the three and six month periods ended March 31,
2000 and was based on income before non-recurring acquisition expenses and no
tax benefit on non-deductible acquisition expenses. The effective tax rate was
18% and 16% for the respective periods and is lower than the statutory U.S. tax
rate of 35% for fiscal 2000 due to the realization of net operating loss
carryforwards. The effective tax rate for the three and six month periods ended
March 31, 1999 was 28% and (6%) due to a different relative benefit of net
operating loss carryforwards realization.
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|Managements Discussion and Analysis of Financial
Condition and Results of Operations


The statements contained in this
report on Form 10-QSB that are not purely historical are forward-looking
statements within the meaning of Section 27A of the Securities Act of 1933 and
Section 21E of the Securities Exchange Act of 1934, including statements
regarding the Companys expectations, hopes, intentions, or strategies
regarding the future. All forward-looking statements included in this document
are based on information available to the Company on the date hereof, and the
Company assumes no obligation to update any such forward-looking statements. It
is important to note that the Companys actual results could differ
materially from those in such forward-looking statements. You should consult the
risk factors listed from time to time in the Companys reports and other
filings with the Securities and Exchange Commission. Among the factors that
could cause actual results to differ materially are those discussed under
Other Factors Affecting Company Results and elsewhere in this Form
10-QSB.


The following discussion should be
read in conjunction with the attached consolidated financial statements and
notes thereto and with the Companys supplemental audited financial
statements and notes thereto for the year ended September 30, 1999.



Overview


The Company is a leading provider
of yield management solutions to the flat panel display (FPD)
industry. The Company also offers yield management solutions for the printed
circuit board (PCB) assembly and advanced semiconductor packaging
industries. In fiscal 1999, the Companys products for the FPD industry
accounted for 69% of revenue.


Revenue is derived primarily from
sales in Japan, Korea and Taiwan, where FPD production is concentrated. However,
with the recent acquisition of CR Technology, which derives the majority of its
revenue from sales in North America, the Company has diversified its geographic
mix of product sales. In fiscal 1999, the Company derived 76% of its revenue
from customers outside North America. Substantially all of the Companys
sales are made in U.S. dollars.



Results of Operations


Revenue was $19.2 million and
$36.0 million for the three and six month periods ended March 31, 2000, compared
to $10.3 million and $16.8 million for the same periods of the prior fiscal
year, representing an increase of 86% and 114% for the respective periods. The
Company has experienced increased revenue in both of its operating segments. The
increase in revenue is primarily attributable to increased capital spending by
FPD manufacturers as a result of improved economic conditions in Asia. Backlog
increased to $39.8 million as of March 31, 2000 compared to $19.4 million as of
March 31, 1999. Backlog may not result in future revenue due to order
cancellation and other factors.


Gross margins were 47% and 46% of
revenue for the three and six month periods ended March 31, 2000, compared to
43% and 40% of revenue for the same periods in the prior fiscal year. Gross
margins increased due to improved pricing and increased capacity utilization
resulting from higher production volume. Overall gross margins will fluctuate on
a quarterly basis due to production volume, product mix and other factors.


Research and development expenses
were $2.7 million and $4.8 million for the three and six month periods ended
March 31, 2000, compared to $1.4 million and $2.7 million for the same periods
in the prior fiscal year. As a percentage of revenue, research and development
expenses were 14% and 13% for the three and six month periods ended March 31,
2000 compared to 13% and 16% for the same periods in the prior fiscal year. The
increase in research and development expenses represents the Companys
investment in new product development.


Selling, general and
administrative expenses were $3.2 million and $5.9 million for the three and six
month periods ended March 31, 2000, compared to $2.8 million and $5.3 million
for the same periods in the prior fiscal year. As a percentage of revenue,
selling, general and administrative expenses were 16% for the three and six
month periods ended March 31, 2000 compared to 27% and 31% for the same periods
in the prior fiscal year. The absolute dollar increase in selling, general and
administrative expenses over prior periods is attributable to higher selling
related expenses associated with the increase in revenue. Selling expenses fluctuate based
on the Companys product and geographic sales mix due to the utilization
of  different sales channels and associated cost structures.
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|On November 30, 1999, the Company
acquired CR Technology which resulted in a one-time charge of $860,000. The
charge consisted of costs associated with the acquisition primarily related to
legal, investment banking and accounting fees.


The net of interest income and
expense and other increased $819,000 and $904,000 for the three and six month
periods ended March 31, 2000. The increase is due primarily to increases in
interest income on higher average cash and investment balances in the current
quarter.



The provision for income taxes was
$730,000 and $1.1 million for the three and six month periods ended March 31,
2000 and was based on income before non-recurring acquisition expenses and no
tax benefit on non-deductible acquisition expenses. The effective tax rate was
18% and 16% for the respective periods and is lower than the statutory U.S. tax
rate of 35% for fiscal 2000 due to the realization of net operating loss
carryforwards. The effective tax rate for the three and six month periods ended
March 31, 1999 was 28% and (6%) due to a different relative benefit of net
operating loss carryforwards realization.



Liquidity and Sources of Capital


During the six month period ended
March 31, 2000, cash, cash equivalents, short-term investments, and long-term
investments balances increased to $98.8 million from $8.0 million as of
September 30, 1999. Net cash provided by operations for the six month period
ended March 31, 2000 was $7.3 million compared to $1.6 million net cash used in
operations for the same period of the prior fiscal year. This change resulted
primarily from increased net income before non-cash charges and increases in
inventory, accounts payable and accrued expenses and other current liabilities.
Capital expenditures of $698,000 were primarily for equipment acquired for
applications and development work and for leasehold improvements. In addition,
the Company received $83.6 million net of issuance costs for shares of common
stock issued in an underwritten public offering during the three month period
ended March 31, 2000. Working capital increased to $109.8 million as of March
31, 2000 compared to $20.5 million as of September 30, 1999 primarily as a
result of the proceeds from an underwritten public offering.


The Company has entered into a
$4.0 million revolving line of credit with a bank which expires in March 2001.
This line of credit is secured by substantially all of the Companys assets
and contains certain financial and other covenants. The Company is eligible to
borrow against a portion of accounts receivable. Borrowings under this line of
credit bear interest at prime rate (9.00% as of March 31, 2000). As of March 31,
2000, no amounts were outstanding under this bank line of credit, and the
Company was in compliance with all bank covenants.


The Company has a $1.5 million
revolving bank line of credit that was acquired as part of the CR Technology
acquisition. This line of credit expires in February 2001 and is secured by
substantially all of CR Technologys assets and contains certain financial
and other covenants. The Company is eligible to borrow on an unsecured basis.
Borrowings under this line of credit bear interest at prime rate (9.00% as of
March 31, 2000). As of March 31, 2000, no amounts were outstanding under this
revolving line of credit, and the Company was in compliance with all bank
covenants.


The Company believes that existing
liquid capital resources and funds generated from operations combined with the
ability, if necessary, to borrow funds will be sufficient to meet its operating
and capital requirements and obligations for at least the next twelve months.
The Company believes that success in its industry requires substantial capital
in order to maintain the flexibility to take advantage of opportunities as they
may arise. The Company may, from time to time, invest in or acquire
complementary businesses, products or technologies and may seek additional
equity or debt financing to fund such activities. There can be no assurance that
such funding will be available to the Company on commercially reasonable terms.
The sale of additional equity or convertible debt could result in dilution to
the Companys shareholders.
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|Impact of Year 2000


In prior periods, the Company
discussed the nature and progress of its plans to become Year 2000 compliant. To
date, the Company has made several modifications to its product software,
enterprise software and network software to ensure Year 2000 compliance. As a
result of those efforts, the Company experienced no significant disruptions in
operations and believes these systems successfully responded to the year 2000
date change. As of March 31, 2000, the Company has incurred approximately
$36,000 in costs to achieve Year 2000 compliance. The Company is not aware of
any material problems resulting from Year 2000 issues, either with its products
and internal systems or the products and services of third parties. The Company
will continue to monitor its products and internal systems and those of its
suppliers and vendors throughout the year 2000 to ensure that any latent Year
2000 matters that may arise are addressed promptly.



Impact of Accounting Pronouncements


In December 1999, the Securities
and Exchange Commission issued Staff Accounting Bulletin No. 101, Revenue
Recognition in Financial Statements (SAB 101). SAB 101 provides
guidance on the recognition, presentation and disclosure of revenue in financial
statements. The Company is currently studying SAB 101 and has not determined its
impact on the Companys financial position or results of operations. In the
event that the implementation of SAB 101 requires the Company to report a change
in accounting principles related to its revenue recognition policy, the Company
would be required to report such change no later than the quarter ending
December 31, 2000. In addition to other uncertain risks related to SAB 101, it
is possible that SAB 101 will result in increased fluctuations in the
Companys quarterly operating results and increase the likelihood that the
Company may fail to meet the expectations of securities analysts for any period.



Other Factors Affecting Company Results


The Companys quarterly
results of operations fluctuate significantly. Many factors influence the
Companys results of operations in a particular quarter. These include:
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | volume, mix and timing of orders from the Companys customers;
| | - | --------------------------------------------------------------

| |  | scheduling, rescheduling or cancellation of shipments;
| | - | ------------------------------------------------------

| |  | pricing pressures;
| | - | ------------------

| |  | costs of components and subsystems;
| | - | -----------------------------------

| |  | ability to design, manufacture and commercialize new products on a
cost-effective and timely basis;
| | - | ---------------------------------------------------------------------------------------------------

| |  | delay between the time the Company incurs expenses in developing its marketing
and service capabilities and the time it receives benefits from its improved
capabilities;
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | costs of components and subsystems incorporated into the Companys products;
| | - | ----------------------------------------------------------------------------

| |  | timing of recognition of revenue under development contracts;
| | - | -------------------------------------------------------------

| |  | announcement and introduction of new products by the Companys competitors; and
| | - | -------------------------------------------------------------------------------

| |  | changing conditions in the FPD industry.
| | - | ----------------------------------------

|The Company currently derives a
majority of its revenues from the sale of a small number of FPD yield management
systems ranging in price from $400,000 to $1.5 million. As a result, the timing
of the sale of a single system could have a significant impact on the
Companys quarterly revenue and results of operations.


The Company schedules the
production of its systems based in part upon order backlog. Due to possible
customer changes in delivery schedules and cancellations of orders, the
Companys backlog at any particular date is not necessarily indicative of
actual sales for any succeeding period. A reduction of backlog during any
particular period, or the failure of the Companys backlog to result in
future revenue, could have a material impact on the Companys results of
operations.



The Company Depends On Sales to a Few Large
Customers


The FPD industry is extremely
concentrated, with a small number of manufacturers producing the majority of the
worlds FPDs. Direct sales to the Companys top four customers, each
of which is a FPD manufacturer, accounted for 60% of the Companys total
revenue for the first six months of fiscal 2000 compared to 55% and 67% in
fiscal 1999 and fiscal 1998. The Company currently has no long-term purchase
commitments from its customers, and sales are generally made through purchase
orders. Orders for the Companys products may be delayed or cancelled with
limited or no penalty to customers. If one or more of the Companys
customers cancel or delay their orders, or if one or more customers are lost,
the Companys business could be harmed.


Capital Investment by the FPD Industry Can Be
Highly Cyclical and May Decline in the Future


The Companys business
depends, in large part, upon the amount of money spent by FPD manufacturers on
capital equipment. This, in turn, depends on the current and anticipated market
demand for FPDs and products incorporating FPDs. Capital investment by the FPD
industry has been highly cyclical as the industry has reacted to capacity
shortages and surpluses. Future industry overcapacity would likely reduce
capital equipment expenditures by FPD manufacturers and reduce the demand for
the Companys products. In addition, the Company must continually invest in
engineering, research and development and marketing to penetrate target markets
and to maintain extensive worldwide customer service and support capabilities.
The Companys ability to quickly reduce these expenses is limited, and,
therefore, any downturns or slowdowns in capital investment by the FPD industry
would harm the Companys business.


The Company Faces Risks Associated With Selling Substantially
All of the Companys FPD Yield Management Products to Companies Located
Outside the U.S.


Sales to customers outside the
U.S. are subject to a number of specialized risks. Over three-quarters of the
Companys total revenue for fiscal 1999 came from international sales,
particularly sales in Japan, Korea and Taiwan. The Company expects that most of
the sales will continue to come from these countries, where most of the
worlds FPD manufacturing occurs. Risks related to international sales
include:
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | foreign countries may experience political and economic instability;
| | - | --------------------------------------------------------------------

| |  | the Company may have more difficulty in servicing international customers and
otherwise administering its business internationally;
| | - | -----------------------------------------------------------------------------------------------------------------------------------

| |  | the Company has limited protection for its intellectual property;
| | - | -----------------------------------------------------------------

| |  | the Company may have difficulty in accessing local legal protections if the
Company has a dispute with a local business;
| | - | ------------------------------------------------------------------------------------------------------------------------

| |  | there may be changes in tariffs and taxes in foreign countries;
| | - | ---------------------------------------------------------------

| |  | trade restrictions exist between the U.S. and other countries, and additional
restrictions may be adopted;
| | - | ----------------------------------------------------------------------------------------------------------

|
|

| |  | the Company must comply with a wide variety of foreign and U.S. export laws and
restrictions; and
| | - | -------------------------------------------------------------------------------------------------

| |  | the Company must comply with technical standards established by foreign
regulatory bodies.
| | - | ------------------------------------------------------------------------------------------

|The Companys sales to Japan,
Taiwan and Korea have been hurt by downturns in these economies, most recently
in 1998. A future downturn in economic conditions in these countries could
result in customers failing to place new orders for the Companys products.
Also, if the Japanese, Taiwanese and Korean FPD markets do not grow as the
Company has anticipated, the Companys business would be harmed.


Because sales and sales through
IHI, a value-added reseller, are denominated in U.S. dollars, fluctuations in
currency exchange rates may impact the price of the Companys products in
foreign countries. As a result, both direct sales and sales through IHI may be
affected by changes in demand resulting from fluctuations in interest and
currency exchange rates. In addition, to the extent the Companys sales and
costs are denominated in foreign currency, the Companys revenue and
results of operations may be directly affected by fluctuations in foreign
currency exchange rates.


The Company May Have Difficulty in Integrating the
Businesses of Photon Dynamics and CR Technology


Integrating Photon Dynamics and CR
Technology may be a complex, time-consuming and expensive process. Before the
merger, Photon Dynamics and CR Technology operated independently. Each company
had its own business culture, customers, employees and systems. Following the
merger, Photon Dynamics and CR Technology have commenced operations as a
combined organization, using common information and communications systems,
operating procedures, financial controls and human resource practices. The
Company may experience difficulties in integrating Photon Dynamics and CR
Technology. These difficulties may include:
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | diversion
of management resources from the business of the combined company;
| | - | ----------------------------------------------------------------------------

| |  | incompatibility
of business cultures;
| | - | -------------------------------------

| |  | perceived
adverse changes in customer service standards, business focus, billing
practices or service offerings available to customers;
| | - | ---------------------------------------------------------------------------------------------------------------------------------------

| |  | perceived
uncertainty in career opportunities, benefits and the long-term value of stock
options available to employees;
| | - | ------------------------------------------------------------------------------------------------------------------------

| |  | costs
and delays in implementing common systems and procedures; and
| | - | -------------------------------------------------------------------

| |  | potential
inefficiencies in delivering services to the customers of the combined company.
| | - | -----------------------------------------------------------------------------------------

|Any of these difficulties could
increase the Companys operating costs, harm the Companys financial
performance or cause the loss of customers or employees. Many of these factors
are outside of the Companys control.


The Company May Not Be Able to Obtain Critical
Components from Its Single or Limited Source Suppliers


The Company obtains some of the
components included in its FPD, PCB assembly and advanced semiconductor
packaging yield management products from a single or a limited group of
suppliers. For example, the Company currently obtains materials handling
platforms, ultra high-resolution cameras and high-speed image processing systems
for its FPD products from single source suppliers. The Company also currently
obtains X-ray components for its PCB assembly and advanced semiconductor
packaging products from limited source suppliers. The Company has not entered
into formal agreements with any of these suppliers, other than long-term
purchase orders and, in some cases, volume pricing agreements. In addition,
alternative sources of supply for these components may not be available or may
be available on unfavorable terms. Disruptions in supply, price increases for
these components, or other changes in material terms could:
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|
|

| |  | increase
the Companys manufacturing costs or delay product shipments while the Company
qualifies a new supplier;
| | - | -----------------------------------------------------------------------------------------------------------------

| |  | require
redesigning the Companys products; and
| | - | -----------------------------------------------

| |  | harm
customer relationships.
| | - | ----------------------------

|The Company Depends on IHI to Market Its FPD
Products in Japan


Since June 1997, the Company has
depended on IHI as the exclusive value-added reseller to sell the Companys
array test, repair and inspection systems in Japan, and the Company anticipates
that this relationship will continue in the future. For the first six months of
fiscal 2000, 6% of the Companys revenues came from sales to IHI compared
to 18% and 33% in fiscal 1999 and fiscal 1998. Historically, foreign companies
have experienced difficulty penetrating the Japanese market and often depend
upon local sales channels to sell their products in Japan. If IHI reduced the
resources allocated to the development, systems construction, customization,
sale and support of the Companys array test, repair and inspection systems
in Japan, the Companys business would be harmed.


In addition, IHIs rights to
continue as the exclusive value-added reseller in Japan are currently
unresolved. IHI may have the right to market some or all of the Companys
products in Japan on an exclusive basis, even as to the Company. If so, the
Company may not be able to compete effectively in Japan. Although IHI must
purchase certain critical components from the Company, IHI may manufacture
competing array test systems based on the Companys technology. If this
occurs, the Companys business could be harmed.
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|PART II. OTHER INFORMATION




Item 1. Legal Proceedings


None.



Item 2. Changes in Securities


None.



Item 3. Defaults Upon Senior Securities


None.


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


None.



Item 5. Other Information


None.


Item 6. Exhibits and Reports on Form 8-K


(a) Exhibits
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 27.
Financial Data Schedule
| | ---------------------------

(b) Reports on Form 8-K

| | The
Company filed a report on Form 8-K on January 10, 2000 for the purpose of
reporting financial results for the first fiscal quarter ended December 31,
1999. The results of prior periods were restated to include the financial
statements of CR Technology, Inc. which was acquired on November 30, 1999.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Company filed a report on Form 8-K/A on January 14, 2000 for the purpose of
amending Form 8-K dated November 30, 1999. This amendment to the November 30,
1999 Form 8-K contains the information required by Item 7 of Form 8-K.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|SIGNATURES


Pursuant to the requirements of the Securities Exchange Act of
1934, the registrant has duly caused this report to be signed on its behalf by
the undersigned thereunto duly authorized.
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | PHOTON DYNAMICS, INC.          
  (Registrant)
| | ----------------------------------------------

|Date: May 10, 2000 |  | /s/ Vincent F. Sollitto, Jr.
Vincent F. Sollitto, Jr.Chief Executive Officer(Principal Executive Officer)
|------------------ |  | -------------------------------------------------------------------------------------------------------------------

|Date: May 10, 2000 |  | /s/ Richard L. Dissly
Richard L. DisslyChief Financial Officer(Principal Financial and Accounting Officer)
|------------------ |  | --------------------------------------------------------------------------------------------------------------------