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UNITED STATES SECURITIES AND
    EXCHANGE COMMISSION
 Washington, D.C.
    20549
    Form 10-K
  þ

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
    SECURITIES EXCHANGE ACT OF 1934For the fiscal year ended
    September 30, 2007oro

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
    SECURITIES EXCHANGE ACT OF 1934For the transition period
    from          to   Commission File Number 0-27234
   Photon Dynamics, Inc.
 (Exact name of registrant as
    specified in its charter)
  California(State or other jurisdiction
    of
    incorporation or organization)


94-3007502(I.R.S. Employer
    Identification No.
)   5970 Optical Court
 San Jose, CA 95138
 (Address of principal executive
    offices, including zip code)
  (408) 226-9900
 (Registrants telephone
    number, including area code)
    Securities registered pursuant to Section 12(b) of the
    Act:
 None
  Securities registered pursuant to Section 12(g) of the
    Act:
 Common Stock, no par value per share
 (Title of class)
    o þ
  o þ
  þ o
  Regulation S-K Form 10-K Form 10-K. þ
  Rule 12b-2
  o þ o
  Rule 12b-2 o þ
      DOCUMENTS INCORPORATED BY REFERENCE
  Form 10-K, Items 10-14 Form 10-K.




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PHOTON
    DYNAMICS, INC.
    ANNUAL REPORT ON
    FORM 10-K
    For the fiscal year ended September 30, 2007
    EXPLANATORY NOTE
  Form 10-K
  Form 10-K
          Form 10-K Form 10-Q.
  Form 10-K Form 10-Q
  Form 10-K Form 10-K.
  Form 10-K
 i




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##### 



PHOTON
    DYNAMICS, INC.
    ANNUAL REPORT ON
    FORM 10-K
    FOR THE FISCAL YEAR ENDED SEPTEMBER 30, 2007
    TABLE OF CONTENTS
  PageSpecial Note Regarding Forward-Looking
    Statements


iiiPART IItem 1.


Business


1Item 1A.


Risk Factors


10Item 1B.


Unresolved Staff Comments


23Item 2.


Properties


23Item 3.


Legal Proceedings


23Item 4.


Submission of Matters to a Vote of Security
    Holders


24PART IIItem 5.


Market for the Registrants Common Equity,
    Related Stockholder Matters and Issuer Purchases of Equity
    Securities


24Item 6.


Selected Financial Data


26Item 7.


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


30Item 7A.


Quantitative and Qualitative Disclosures About
    Market Risk


67Item 8.


Financial Statements and Supplementary Data


69Reports of Independent Registered
    Public Accounting Firm


70Consolidated Balance Sheets at
    September 30, 2007 and 2006


73Consolidated Statements of Operations
    for each of the three years in the period ended
    September 30, 2007


74Consolidated Statements of
    Shareholders Equity for each of the three years in the period
    ended September 30, 2007


75Consolidated Statements of Cash Flows
    for each of the three years in the period ended
    September 30, 2007


76Notes to Consolidated Financial
    Statements


77Item 9.


Changes in and Disagreements With Accountants on
    Accounting and Financial Disclosure


132Item 9A.


Controls and Procedures


132Item 9B.


Other Information


135PART IIIItem 10.


Directors and Executive Officers of the
    Registrant


135Item 11.


Executive Compensation


135Item 12.


Security Ownership of Certain Beneficial Owners
    and Management and Related Stockholder Matters


136Item 13.


Certain Relationships and Related Transactions


136Item 14.


Principal Independent Registered Public
    Accounting Firm Fees and Services


136PART IVItem 15.


Exhibits and Financial Statement Schedules


136Schedule II Valuation and Qualifying
    Accounts


137Signatures


138Exhibit Index


140EXHIBIT 10.56EXHIBIT 21.1EXHIBIT 23.1EXHIBIT 31.1EXHIBIT 31.2EXHIBIT 32.1   ii




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SPECIAL
    NOTE REGARDING FORWARD-LOOKING STATEMENTS  This Annual Report on
    Form 10-K
    contains certain forward-looking statements within the meaning
    of Section 27A of the Securities Act of 1933 and
    Section 21E of the Exchange Act. All statements included or
    incorporated by reference in this Annual Report on
    Form 10-K
    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 Annual Report on
    Form 10-K
    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 total 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
    United States and foreign federal, state and local laws and
    regulations, 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 this Annual Report on
    Form 10-K
    and elsewhere in this Annual Report on
    Form 10-K.
    The information included in this Annual Report on
    Form 10-K
    is as of the filing date with the SEC 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.
 iii




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PART I  ITEM 1.
    BUSINESS  Introduction
      www.photondynamics.com. Form 10-K, Form 10-Q, Form 8-K, Form 10-K
  Our
    Business Segments
    Flat
    Panel Display
  Industry.
     1




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work-in-progress
    Manufacture of Active Matrix Liquid Crystal
    Displays.
        
    Array Phase.  The first phase of the process
    involves the production of both the array plate and color filter
    plate. This phase of the process is the fabrication of an array
    of thin-film transistors (TFT), each of which is
    connected to a transparent sub-pixel, the smallest addressable
    unit in the display. Three or more sub-pixels are combined to
    produce a pixel, millions of which are fabricated, using
    semiconductor processes, on a large glass substrate. A similar
    process is used to fabricate an array of color filter sub-pixels
    on a large glass substrate. The array fabrication process is the
    most capital-intensive process and is housed in cleanrooms in
    order to minimize particles that can cause pixel defects.
    Cell Assembly Phase.  The second phase, cell
    assembly, is the joining of the TFT array plate and the color
    filter plate with liquid crystal material. 2




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
    Module Assembly Phase.  The third phase, module
    assembly, involves packaging the display and attaching the
    electronics and illumination  or
    backlight  which will allow the device to display
    text, graphics and video images.        Challenges Faced by Flat Panel Display
    Manufacturers.
  
    Demand for Higher Quality.  Increased
    competition among flat panel display manufacturers, improvements
    in the manufacturing process and higher consumer expectations
    are moving the flat panel display industry towards a zero defect
    standard. The manufacturing challenges presented by the goal of
    zero-defect products have been compounded by the increasing
    demand for higher resolution and larger displays.
    Increasing Display Resolutions.  Resolutions of
    advanced flat panel displays now involve several million pixels,
    presenting a challenge when test and inspection equipment must
    exercise each pixel. Traditional methods of physically
    contacting each row and column of pixels with probe cards have
    difficulty handling current advanced displays. Manufacturers
    require new techniques, such as non-contact pixel-addressing
    mechanisms, to more effectively handle these displays.
    High Cost of Materials.  Materials costs
    comprise approximately 50% to 70% of flat panel display costs,
    in contrast to only approximately 10% for semiconductors,
    according to industry sources. Material costs are typically
    incurred at the start of the manufacturing process and expose
    the flat panel display manufacturer to higher overall costs due
    to yield losses incurred during the manufacturing process. High
    performance LCDs for television applications further increase
    the complexities associated with LCD manufacturing. Because of
    the high cost of materials used in the manufacture of LCDs,
    defective LCDs, especially larger displays, represent a
    substantial cost to LCD manufacturers, and can ultimately drive
    up both panel and end product costs. Therefore, it is important
    to test, repair and inspect early in the manufacturing process
    before expensive materials are added to the display in the
    latter assembly phases.
    Need for Increased Yield and Greater
    Throughput.  Greater yields are realized in part
    through more effective test, repair and inspection. In order to
    maintain or improve profitability, flat panel display
    manufacturers need test, repair and inspection equipment that
    will allow them to increase process speed while using larger
    panels.
    Need for Flexibility.  The flat panel display
    industry is producing a larger number of different panel sizes
    as the variety of applications incorporating flat panel displays
    has increased. Manufacturers are seeking test, 3




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repair and inspection equipment that can be reconfigured quickly
    and accurately for different panel sizes, with minimal
    production downtime.  Products.
  Yield Enhancement Products.
  
    Flat Panel Display Array Test Systems.  Our
    ArrayCheckertm
    test systems detect, locate, quantify and characterize
    electrical, contamination and other defects in active matrix
    liquid crystal displays after array fabrication. These systems
    use our proprietary non-contact voltage imaging technology to
    provide a high-resolution voltage map of the entire display and
    our proprietary image analysis software converts this voltage
    map into complete pixel defect data. The
    ArrayCheckertm
    test systems determine whether individual pixels or lines of
    pixels are functional and also find more subtle defects such as
    variations in individual pixel voltage. These defect data files
    are then used for repair and statistical process control.
    Flat Panel Display Array Repair Systems.  Our
    ArraySavertm
    repair systems utilize multiple wavelength laser technology to
    repair defects in flat panel displays during and after array
    fabrication. Our systems can use defect data files downloaded
    from our
    ArrayCheckertm
    test systems or other test and inspection systems to
    automatically position the panel for repair, thereby eliminating
    the time spent by operators locating defects. The
    ArraySavertm
    system includes a high-precision materials handling platform and
    a user-friendly graphical interface allowing for high
    throughput. Our high-precision materials handling platform fully
    automates the precise positioning of the plate for each
    successive repair, thereby substantially increasing throughput.
    Our graphical user interface and software supports
    semi-automated setup of repair programs for common types of
    defects so that repairs can be executed rapidly and accurately.
    These programs provide a series of actions that the system
    automatically executes to repair the particular defect type.  Customer Support.
  Customers. Form 10-K
 4




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Sales, Service and Marketing.
      Form 10-K. Form 10-K
  Manufacturing. tm tm tm tm
 5




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##### Table of Contents



build-up build-up
    Research and Development. Form 10-K,
  tm tm
  High-Performance
    Digital Imaging
  Acquisition of Salvador Imaging.
  Industry.
 6




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Products.
  Customers. Form 10-K.
  Sales, Service and Marketing.
  Manufacturing.
    Research and Development.
  Suppliers
   7




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Intellectual
    Property
  non-U.S. patents non-U.S. pending
    Patents in ForceU.S.


Non-U.S.Yield enhancement products


43



31Other


27



10Total


70



41     Backlog
  work-in-process
  Competition
     8




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Employees
      Business
    Combinations and Acquisitions
     9




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Form 10-K. Form 10-K.
  ITEM 1A.
    RISK
    FACTORS  Our actual results could differ materially from those
    projected in the forward-looking statements included in this
    Annual Report on
    Form 10-K
    as a result of a number of factors, risks and uncertainties,
    including the risk factors set forth below and elsewhere in this
    Annual Report on
    Form 10-K.
    You should carefully consider the risks described below before
    investing in our securities. The risks described below are not
    the only ones facing us. Additional risks not currently known to
    us or that we currently believe are immaterial may also impair
    our business, results of operations, financial condition and
    liquidity.
  We have organized our risks into the following categories:
  
    Risks Relating to our Business
    Risks Relating to Owning our Common Stock
    Risks Relating to Our Restatements and Related Matters  RISKS
    RELATING TO OUR BUSINESS
  We
    have sustained losses and we may sustain losses in the
    future.
  Form 10-K.
    Our
    customers may cancel or defer their purchases at any time and on
    short notice, which could harm our operating
    results.
    
    may stop purchasing our products or defer their purchases at any
    time without penalty; 10




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
    are free to purchase products from our competitors;
    are not required to make minimum purchases; and
    have cancelled, and may in the future cancel, purchase orders
    that they place with us without reimbursing us for any costs
    incurred.    Our
    operating results are difficult to predict and may vary from
    investors expectations, which could cause our stock price
    to fall.
      
    the result of competitive pricing pressures;
    the timing of the receipt of orders from major customers;
    the result of sudden, unanticipated changes in customer
    requirements;
    the cancellation or postponement of firm orders by a customer
    without compensation;
    the receipt of final acceptance on new products;
    the product mix that makes up our revenue;
    the incurrence of warranty expenses;
    our 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;
    the ability to obtain components from our single or limited
    source suppliers in a timely manner;
    the ability to effectively implement our strategy of migrating
    or outsourcing manufacturing offshore;
    the ability of our offshore manufacturing operations to timely
    produce and deliver products in the quantity and of the quality
    our customers require;
    the costs of operations in the global markets in which we do
    business;
    the effects of changing international economic conditions; 11




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
    the effects of currency exchange rate fluctuations;
    the outcome of the appeal of litigation with a former executive
    officer;
    the effects of worldwide political instability;
    the ability to design, manufacture and introduce new products on
    a cost-effective and timely basis;
    the delay between expenses to further develop marketing and
    service capabilities and the realization of benefits from those
    improved capabilities; and
    the introduction of new products by our competitors.    We
    have experienced multiple material weaknesses in our internal
    controls and procedures during our 2003 through 2007 fiscal
    years, including three material weaknesses identified during our
    2007 fiscal year that have not yet been remediated. If we are
    unable to implement our remediation plan effectively or if other
    material weaknesses or control deficiencies develop that we are
    unable to address, the material weaknesses in our internal
    controls could have a significant adverse effect on our
    business, financial condition and results of operations, result
    in our failure to meet reporting obligations and adversely
    affect our stock price.
  Form 10-K.
  We
    have experienced significant employee turnover, including in
    several key financial positions. If we are unable to attract and
    retain key employees, it may disrupt our ability to improve our
    financial controls, meet our reporting obligations and
    effectively manage our business.
   12




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We
    have exposure to various foreign and domestic regulatory risks.
    Our failure to comply with governmental regulations could
    subject us to liability and additional expense.
          If our
    flat panel display products experience performance, reliability
    or quality problems, our customers may reduce their
    orders.
   13




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tm tm
  
    delays in receiving final acceptance from our customers, which
    in turn delays recognition of the associated revenue;
    cancellation of orders by customers;
    assessment of penalties by customers;
    delayed payment by customers;
    renegotiation of our prices by customers;
    reduced orders from our customers;
    additional warranty and service expenses; and
    higher manufacturing costs.    tm
  Capital
    investment by manufacturers of flat panel display products can
    be highly cyclical and may decline in the future.
     14




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We
    depend on sales to a few large customers in the flat panel
    display industry, and if we lose any of our large customers our
    revenue could decrease significantly.
    We
    rely upon sales of a limited range of flat panel display
    products, and if demand for one product decreases for any reason
    it could cause our revenue to decline
    significantly.
    tm tm tm tm tm tm
  We may
    not be able to develop and introduce new products that respond
    to evolving industry requirements in a timely manner, which
    could reduce our ability to compete effectively.
       15




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If we
    are not able to receive sufficient parts to meet our production
    requirements, we may experience significant delays in producing
    our products, which could decrease our revenue for an extended
    period of time.
    Substantially
    all of our revenue from flat panel display products is derived
    from sales to companies located outside the United States, which
    exposes us to risks that we would not experience with domestic
    sales.
    
    political instability and the possibility of hostilities,
    terrorist attacks, or war;
    imposition of governmental controls;
    fluctuations in interest and currency exchange rates;
    customs and export and import license requirements;
    restrictions on the export of technology;
    limited foreign protection of intellectual property rights;
    periodic local or international downturns;
    decreases in productivity, temporary plant shutdowns or
    infrastructure service disruptions resulting from widespread
    health alerts including Severe Acute Respiratory Syndrome
    (SARS) and warnings of an avian flu pandemic;
    changes in tariffs; and
    difficulties in staffing and managing international operations.    Our
    customer qualification and sales cycle is lengthy and
    unpredictable and requires us to incur substantial costs to make
    a sale, and if we fail to make a sale, our increased expenses
    may lead to lower profit margins.
   16




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Our
    ability to efficiently and effectively implement our strategy of
    using both domestic and outsourced offshore manufacturing may
    impact our profitability.
      
    political instability and the possibility of hostilities,
    terrorist attacks, or war;
    imposition of governmental controls;
    fluctuations in interest and currency exchange rates;
    limited foreign protection of intellectual property rights;
    trade restrictions;
    periodic or local international downturns;
    decreases in productivity, temporary plant shutdowns or
    infrastructure service disruptions resulting from widespread
    health alerts such as those relating to SARS and avian flu
    outbreaks; and
    difficulties in staffing and managing international
    manufacturing.    Any
    failure of, or other problems at or with, our third party
    manufacturers could delay shipments of our products, harm our
    relationships with our customers or otherwise negatively impact
    our business.
   17




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If we
    do not compete effectively in our target markets, we will lose
    market share.
    Our
    success depends in large part on the strength of active matrix
    liquid crystal display technology in the flat panel display
    industry.
    We may
    have difficulty integrating businesses or assets that we have
    acquired or developed in new ventures and may acquire or develop
    in the future, and we may not realize the benefits that we
    expect from these acquisitions and new ventures.
  and/or
    
    difficulty in the assimilation of the technologies and products;
    entering markets in which we have no or limited direct prior
    experience;
    loss of key customers;
    diversion of management resources;
    incompatibility of business cultures or practices;
    loss of key employees;
    costs and delays in implementing common systems and procedures;
    potential inefficiencies in delivering services to
    customers; and
    assumption of unknown or undisclosed liabilities. 18




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We may
    never achieve or sustain profitability in our High-Performance
    Digital Imaging business segment.
    If the
    products developed within our High-Performance Digital Imaging
    segment become successful, we may derive a significant portion
    of our revenue from customers that receive their funding for our
    products from U.S. government contracts, which are subject to
    unique risks.
    The funding of U.S. government programs is subject to
    congressional appropriations
  The U.S. government would have the ability to modify,
    curtail or terminate contracts.
  Our contract costs would be subject to audits by
    U.S. government
    agencies.
 19




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Our business could be subject to potential
    U.S. government inquiries and
    investigations.
  Contracts with the U.S. government would be subject to
    specific procurement regulations and other requirements
    affecting us or our customers.
  Certain U.S. government programs are subject to security
    classification restrictions on information.
  Our
    business could be harmed if we fail to properly protect our
    intellectual property.
      Litigation
    may be necessary to enforce or defend against claims of
    intellectual property infringement, which could be expensive
    and, if we lose, could prevent us from selling our
    products.
     20




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Our
    corporate offices and manufacturing facilities and our
    customers manufacturing facilities may be subject to
    disruption from natural disasters.
      We
    rely upon certain critical information systems for our daily
    business operation. Our inability to use or access these
    information systems at critical points in time could unfavorably
    impact the timeliness and efficiency of our business
    operation.
    We may
    experience difficulties with our enterprise resource planning
    (ERP) system and other IT systems. System failure or
    malfunctioning may result in disruption of operations and the
    inability to process transactions, and this could adversely
    affect our financial results.
    RISKS
    RELATING TO OWNING OUR COMMON STOCK
  Our
    stock price may fluctuate significantly.
    
    the need to restate our consolidated financial statements;
    announcements of technological innovations or new products by us
    or by our competitors; 21




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
    failure to comply with government regulations;
    developments in patent or other property rights; and
    developments in our relationships with our customers.    Some
    anti-takeover provisions may affect the price of our common
    stock.
    We do
    not anticipate paying cash dividends.
    RISKS
    RELATING TO OUR RESTATEMENTS AND RELATED MATTERS
  Our
    current restatement of our consolidated financial statements and
    related events, as well as possible future restatements, may
    have a material adverse effect on our business.
  Form 10-K,
  If we
    do not comply with the requirements of NASDAQ, our common stock
    may be delisted from the NASDAQ National Market.
  Form 10-Q Form 10-K
 22




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ITEM 1B.
    UNRESOLVED
    STAFF COMMENTS    ITEM 2.
    PROPERTIES    Location

Type

Principal Use

Footage


OwnershipSan Jose, California

Office and plant

Headquarters, marketing, sales, administration, manufacturing,
    research, engineering


128,520



LeasedMarkham, Ontario, Canada*

Office

Sublet


50,000



LeasedSan Jose, California

Office and plant

Vacant


22,000



OwnedDaeJeon, Korea

Office

Sales, service, marketing, administration, research


12,000



LeasedSeongnam, Korea

Office

Sales, service, marketing, administration, research


11,000



LeasedHsin Chu, Taiwan

Office

Sales, service, marketing, administration, research


10,236



Leased     *
    
    Terminated in November 2007.    ITEM 3.
    LEGAL
    PROCEEDINGS   23




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ITEM 4.
    SUBMISSION
    OF MATTERS TO A VOTE OF SECURITY HOLDERS   PART II  ITEM 5.
    MARKET
    FOR THE REGISTRANTS COMMON EQUITY, RELATED STOCKHOLDER
    MATTERS AND ISSUER PURCHASE OF EQUITY SECURITIES  Common
    Stock Market Price
    December 31,

March 31,

June 30,

September 30,Fiscal 2007 Quarter Ended

2006

2007

2007

2007High

$
11.76


$
12.80


$
10.99


$
9.09Low

$
11.39


$
12.38


$
10.72


$
8.98   December 31,

March 31,

June 30,

September 30,Fiscal 2006 Quarter Ended

2005

2006

2006

2006High

$
19.26


$
22.72


$
19.75


$
13.48Low

$
16.74


$
17.47


$
12.52


$
10.30     Dividends
   24




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Share
    Repurchase Program
      Total SharesAverage

Purchased

Shares YetTotal Shares

Price Paid

as Part

to be PurchasedPurchased

per Share

of the Plan

Under the PlanAugust 1 through August 31, 2006


503,581


$
13.17



503,581



596,419September 1 through September 30, 2006


26,020


$
13.35



529,601



570,399  25




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Performance
    Measurement Comparison
    COMPARISON
    OF 5 YEAR CUMULATIVE TOTAL RETURN*
    
        ITEM 6.
    SELECTED
    FINANCIAL DATA  Form 10-K.
     26




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Form 10-K,
  Year Ended September 30,(As Previously Reported for the 2003 Through 2006  Fiscal
    Years)

2007


2006


2005


2004


2003As


As


As


Aspreviously


previously


previously


previouslyreported


reported


reported


reported(In thousands, except per share data)Consolidated Statements of Operations:Revenue

$
74,267


$
172,872


$
125,813


$
141,870


$
67,196Income (loss) from operations


(38,982
)


1,412



(21,161
)


6,860



(30,692
)Income (loss) from continuing operations before discontinued
    operations


(35,072
)(1)


4,207
(2)


(19,567
)(3)


11,085
(4)


(27,780
)(5)Income (loss) from discontinued operations






(127
)


256



(1,391
)


(44,592
)Net income (loss)

$
(35,072
)

$
4,080


$
(19,311
)

$
9,694


$
(72,372
)Income (loss) per share from continuing operations before
    discontinued operations:Basic

$
(2.09
)(1)

$
0.25
(2)

$
(1.16
)(3)

$
0.67
(4)

$
(1.73
)(5)Diluted

$
(2.09
)(1)

$
0.25
(2)

$
(1.16
)(3)

$
0.65
(4)

$
(1.73
)(5)Income (loss) per share from discontinued operations:Basic

$



$
(0.01
)

$
0.02


$
(0.08
)

$
(2.77
)Diluted

$



$
(0.01
)

$
0.02


$
(0.08
)

$
(2.77
)Net income (loss) per share:Basic

$
(2.09
)(1)

$
0.24
(2)

$
(1.14
)(3)

$
0.58
(4)

$
(4.50
)(5)Diluted

$
(2.09
)(1)

$
0.24
(2)

$
(1.14
)(3)

$
0.57
(4)

$
(4.50
)(5)Consolidated Balance Sheets:Cash, cash equivalents and short-term investments

$
83,810


$
102,769


$
93,026


$
84,155


$
116,469Working capital


88,599



121,411



116,488



132,335



125,624Total assets


148,261



177,613



183,684



207,900



161,919Other non-current liabilities


5,419



119



1,008



1,528



193Shareholders equity


118,184



144,381



142,594



159,959



144,143   27




---



##### Table of Contents



Year Ended September 30,2007


2006


2005


2004


2003(Restatement Adjustments for the 2003 Through 2006 Fiscal
    Years)




Adjustments(6)


Adjustments(6)


Adjustments(6)


Adjustments(6)(In thousands, except per share data)Consolidated Statements of Operations:Revenue

$
N/A


$



$



$



$
Income (loss) from operations


N/A



(1,486
)


(1,117
)


(550
)


(403
)Income (loss) from continuing operations before discontinued
    operations


N/A



(2,039
)


(1,562
)


(713
)


(592
)Income (loss) from discontinued operations


N/A















Net income (loss)

$
N/A


$
(2,039
)

$
(1,562
)

$
(713
)

$
(592
)Income (loss) per share from continuing operations before
    discontinued operations:Basic

$
N/A


$
(0.12
)

$
(0.09
)

$
(0.05
)

$
(0.03
)Diluted

$
N/A


$
(0.12
)

$
(0.09
)

$
(0.04
)

$
(0.03
)Income (loss) per share from discontinued operations:Basic

$
N/A


$



$



$



$
Diluted

$
N/A


$



$



$



$
Net income (loss) per share:Basic

$
N/A


$
(0.12
)

$
(0.09
)

$
(0.04
)

$
(0.04
)Diluted

$
N/A


$
(0.12
)

$
(0.09
)

$
(0.04
)

$
(0.04
)Consolidated Balance Sheets:Cash, cash equivalents and short-term investments

$
N/A


$



$



$



$
Working capital


N/A



(5,116
)


(2,983
)


(1,421
)


(708
)Total assets


N/A



3,157



1,798



911



491Other non-current liabilities


N/A















Shareholders equity


N/A



(5,116
)


(2,983
)


(1,421
)


(708
)   28




---



##### Table of Contents



Year Ended September 30,2007


2006


2005


2004


2003(As Restated for the 2003 Through 2006 Fiscal Years)As restated


As restated


As restated


As restated(In thousands, except per share data)Consolidated Statements of Operations:Revenue

$
74,267


$
172,872


$
125,813


$
141,870


$
67,196Income (loss) from operations


(38,982
)


(74
)


(22,278
)


6,310



(31,095
)Income (loss) from continuing operations before discontinued
    operations


(35,072
)(1)


2,168
(2)


(21,129
)(3)


10,372
(4)


(28,372
)(5)Income (loss) from discontinued operations






(127
)


256



(1,391
)


(44,592
)Net income (loss)

$
(35,072
)

$
2,041


$
(20,873
)

$
8,981


$
(72,964
)Income (loss) per share from continuing operations before
    discontinued operations:Basic

$
(2.09
)(1)

$
0.13
(2)

$
(1.25
)(3)

$
0.62
(4)

$
(1.76
)(5)Diluted

$
(2.09
)(1)

$
0.13
(2)

$
(1.25
)(3)

$
0.61
(4)

$
(1.76
)(5)Income (loss) per share from discontinued operations:Basic

$



$
(0.01
)

$
0.02


$
(0.08
)

$
(2.77
)Diluted

$



$
(0.01
)

$
0.02


$
(0.08
)

$
(2.77
)Net income (loss) per share:Basic

$
(2.09
)(1)

$
0.12
(2)

$
(1.24
)(3)

$
0.54
(4)

$
(4.54
)(5)Diluted

$
(2.09
)(1)

$
0.12
(2)

$
(1.24
)(3)

$
0.53
(4)

$
(4.54
)(5)Consolidated Balance Sheets:Cash, cash equivalents and short-term investments

$
83,810


$
102,769


$
93,026


$
84,155


$
116,469Working capital


88,599



116,295



113,505



130,914



124,916Total assets


148,261



180,770



185,482



208,811



162,410Other non-current liabilities


5,419



119



1,008



1,528



193Shareholders equity


118,184



139,265



139,611



158,538



143,435     (1)
    
    Includes a restructuring charge of approximately
    $1.4 million related to a Company-wide restructuring and
    the discontinuation of the PanelMasterTM product line, an
    impairment charge of approximately $2.8 million related to
    the impairment of an idle manufacturing facility, net
    stock-based compensation of approximately $2.0 million
    related to our stock option plans and our employee stock
    purchase plan, an acquired in-process research and development
    charge of approximately $1.1 million in connection with the
    acquisition of Salvador Imaging and charges for amortization of
    intangibles of approximately $1.7 million.(2)
    
    Includes a restructuring charge of approximately $30,000 related
    to the restructuring of the Companys Markham, Canada
    location, an impairment charge of approximately $81,000 related
    to the impairment of manufacturing capital equipment and charges
    for amortization of intangibles of approximately
    $1.5 million. Effective October 1, 2005, we adopted
    the provisions of SFAS No. 123R, Share-Based
    Payments, and as a result, fiscal 2006 includes net
    stock-based compensation of approximately $4.0 million
    related to our stock option plans and our employee stock
    purchase plan. There were no comparable charges in previous
    fiscal years.(3)
    
    Includes a restructuring charge of approximately
    $1.2 million related to the restructure of the
    Companys Markham, Canada location, an impairment charge of
    approximately $637,000 related primarily to impairment of
    manufacturing capital equipment and charges for amortization of
    intangibles of approximately $1.5 million.(4)
    
    Includes a goodwill impairment charge of approximately $665,000,
    purchased intangible asset write-off of approximately
    $2.1 million and property and equipment impairment charges
    of approximately $234,000, all related to the suspension of the
    low-temperature poly-silicon (LTPS) and inverter
    product lines; acquired in-process research and development
    charge of approximately $210,000 in connection with the
    acquisition of 29




---



##### Table of Contents



certain assets from Quantum Composers, Inc.; gain on fixed
    assets of approximately $427,000 related to the sale of the
    TFT-LCD Backlight Inverter Business, and charges for
    amortization of intangibles of approximately $789,000.(5)
    
    Includes a goodwill impairment charge of approximately
    $10.0 million related to the Akcron and RTP Assets,
    purchased intangible asset write-off of approximately
    $3.5 million related to the Akcron and RTP Assets, and an
    acquired in-process research and development charge of
    approximately $2.5 million related to the acquisition of
    certain assets from Intevac related to Intevacs Rapid
    Thermal Processing Division and the acquisition of substantially
    all the assets of Summit Imaging, and charges for amortization
    of intangibles of approximately $1.2 million.(6)
    
    For a discussion of the adjustments related to the restatement,
    see Restatement of Financial Statements Internal Review
    off Customs Practices, Remediation Plan and Related
    Proceedings in Part II, Item 7.
    Managements Discussion and Analysis of Financial
    Condition and Results of Operations.  ITEM 7.
    MANAGEMENTS
    DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
    OPERATIONS  The following discussion of our financial condition and
    results of operations should be read in conjunction with our
    Consolidated Financial Statements and the related Notes to
    Consolidated Financial Statements in Part II, Item 8,
    Financial Statements and Supplementary Data in this
    Annual Report on
    Form 10-K.
    This discussion contains forward-looking statements within the
    meaning of Section 27A of the Securities Act of 1933 and
    Section 21E of the Exchange Act. Actual results could
    differ materially from those projected in the forward-looking
    statements as a result of a number of factors, risks and
    uncertainties, including the risk factors set forth in
    Part I Item 1A. Risk Factors, and
    elsewhere in this Annual Report on
    Form 10-K.
    Generally, 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 and similar expressions identify
    forward-looking statements. The information included in this
    Annual Report on
    Form 10-K
    is as of the filing date with the SEC 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.
  BUSINESS
    AND COMPANY OVERVIEW
  Our
    Company
    Flat
    Panel Display Market
  tm tm tm
   30




---



##### Table of Contents



tm tm
    Flat
    Panel Display Industry Trends
       31




---



##### Table of Contents



Leveraging
    Core Technologies
      Backlog
  work-in-process
  RESTATEMENT
    OF FINANCIAL STATEMENTS, INTERNAL REVIEW OF CUSTOMS PRACTICES,
    REMEDIATION PLAN AND RELATED PROCEEDINGS
  Background
    on Restatements Related to Customs Duties for Warranty
    Parts
     32




---



##### Table of Contents



Form 10-K Form 8-K
      September 30,2007(In thousands)South Korea

$
3,917Taiwan


2,130Japan


49China


1,148Total liability


7,244Amounts paid at September 30, 2007


(3,691
)Net liability at September 30, 2007

$
3,553         Increased Span of Korean Audit.
 33




---



##### Table of Contents



Foreign Currency Effect
  Lower Declared Values de minimis
  Computed Value mark-up mark-up
  Interest and Penalties
  Value Added Tax (VAT)
    Recoverability
  Excluded Parts
  Drawback Calculation
    Three Months Ended


Year Ended September 30,March 31,


December 31,2007


2006


2006


2005


2004


2003


2002(In thousands)Consolidated Statement of Operations Data:Understatement of cost of revenue

$
291
(1)

$
181
(2)

$
1,624


$
1,473


$
550


$
403


$
85Overstatement (understatement) of interest income and other, net


19
(1)


67
(2)


553



445



164



190



31Overstatement of net income (loss)


310
(1)


248
(2)


2,177



1,918



713



592



116     (1)
    
    Includes the reversal of approximately $85,000 of additional
    charges related to the initial estimate of customs liabilities
    made by the Company in the quarter ended March 31, 2007.
    This amount included a charge of approximately $67,000 to Cost
    of revenue and approximately $16,000 to Interest income and
    other, net.(2)
    
    Includes the reversal of approximately $350,000 of charges from
    the initial estimate of customs liabilities made by the Company
    in the quarter ended December 31, 2006. This amount
    included a charge of approximately $220,000 to Cost of revenue
    and approximately $129,000 to Interest income and other, net.   34




---



##### Table of Contents



September 30,March 31,


December 31,2007


2006


2006


2005


2004


2003


2002(In thousands)Consolidated Balance Sheet Data:Understatement of other current assets

$
3,808


$
3,551


$
3,157


$
1,798


$
911


$
491


$
81Overstatement of other assets


14
(1)


682
(3)


















Understatement of other current liabilities


10,217
(2)


8,632
(4)


8,673



5,137



2,332



1,199



197Understatement of accumulated deficit


6,498



6,113



5,516



3,339



1,421



708



116     (1)
    
    Includes the reversal of $14,000 of additional charges
    capitalized into field service inventory related to the initial
    estimate of customs liabilities made by the Company in the
    quarter ended March 31, 2007.(2)
    
    Includes the reversal of $89,000 of additional customs
    liabilities made by the Company in the quarter ended
    March 31, 2007.(3)
    
    Includes the reversal of the Companys initial $682,000 of
    charges capitalized into field service inventory from the
    initial estimate of customs liabilities made by the Company in
    the quarter ended December 31, 2006.(4)
    
    Includes the reversal of $1.0 million of the original
    estimated customs liability made by the Company in the quarter
    ended December 31, 2006.  Background
    on Restatements Related to Other Accounting Issues
    
    Over-expensing of certain invoices related to inventory receipts
    and operating expenses which affected fiscal 2005 and 2006 and
    the first two quarters of fiscal 2007;
    An over-accrual of a fiscal 2005 management bonus that was
    reversed in the first quarter of fiscal 2006; and
    An over-expensing of certain options related to former executive
    officers due to problems discovered in the supporting software,
    which affected fiscal 2006 and the first two quarters of fiscal
    2007.    Three Months Ended


Year Ended September 30,March 31,


December 31,2007


2006


2006


2005(In thousands)Consolidated Statement of Operations Data:Overstatement of cost of revenue

$
78


$
102


$
190


$
94Over (under) statement of research and development


3



59



(157
)


225Overstatement of selling, general and administrative


66



48



105



37Understatement of net income (loss)


147



209



138



356  35




---



##### Table of Contents



Identification
    of Material Weaknesses
    
    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.  Form 10-K.
  Remediation
    of Material Weaknesses
    
    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; and
    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.     36




---



##### Table of Contents



Related
    Proceedings
  NASDAQ Delisting Hearing: Form 10-Q Form 10-K
  CURRENT
    RESTATEMENT OF PREVIOUSLY ISSUED FINANCIAL STATEMENTS
  Form 10-K
          Form 10-K Form 10-Q.
   37




---



##### Table of Contents



Consolidated
    Statements of Operations data for the year ended September 30,
    2006
  Year Ended September 30, 2006As Previously





AsReported


Adjustments


Restated(In thousands, except per share data)Revenue

$
172,872


$



$
172,872Cost of revenue


112,771



1,434



114,205Research and development


32,420



157



32,577Selling, general and administrative


24,611



(105
)


24,506Income (loss) from operations


1,412



(1,486
)


(74
)Interest income and other, net


3,356



(553
)


2,803Income from continuing operations before income taxes and
    discontinued operations


4,768



(2,039
)


2,729Provision for income taxes


561







561Income from continuing operations


4,207



(2,039
)


2,168Loss from discontinued operations


(127
)






(127
)Net income

$
4,080


$
(2,039
)

$
2,041Net income per share from continuing operations:Basic

$
0.25


$
(0.12
)

$
0.13Diluted

$
0.25


$
(0.12
)

$
0.13Net loss per share from discontinued operations:Basic

$
(0.01
)

$



$
(0.01
)Diluted

$
(0.01
)

$



$
(0.01
)Net income per share:Basic

$
0.24


$
(0.12
)

$
0.12Diluted

$
0.24


$
(0.12
)

$
0.12Weighted average number of shares:Basic


16,978



16,978



16,978Diluted


17,011



17,011



17,011     Research


Selling,


InterestCost of


and


General and


Income and


NetRevenue


Development


Administrative


Other, Net


Income(In thousands)As previously reported

$
112,771


$
32,420


$
24,611


$
3,356


$
4,080Adjustments:Customs and duties


1,624











(553
)


(2,177
)Other Accounting errors


(190
)


157



(105
)






138As restated

$
114,205


$
32,577


$
24,506


$
2,803


$
2,041  38




---



##### Table of Contents



Consolidated
    Statements of Operations data for the year ended
    September 30, 2005
  Year Ended September 30, 2005As Previously





AsReported


Adjustments


Restated(In thousands, except per share data)Revenue

$
125,813


$



$
125,813Cost of revenue


82,732



1,379



84,111Research and development


36,275



(225
)


36,050Selling, general and administrative


24,678



(37
)


24,641Loss from operations


(21,161
)


(1,117
)


(22,278
)Interest income and other, net


2,218



(445
)


1,773Loss from continuing operations before income taxes and
    discontinued operations


(18,943
)


(1,562
)


(20,505
)Provision for income taxes


624







624Loss from continuing operations


(19,567
)


(1,562
)


(21,129
)Income from discontinued operations


256







256Net loss

$
(19,311
)

$
(1,562
)

$
(20,873
)Net loss per share from continuing operations:Basic

$
(1.16
)

$
(0.09
)

$
(1.25
)Diluted

$
(1.16
)

$
(0.09
)

$
(1.25
)Net income per share from discontinued operations:Basic

$
0.02


$



$
0.02Diluted

$
0.02


$



$
0.02Net loss per share:Basic

$
(1.14
)

$
(0.10
)

$
(1.24
)Diluted

$
(1.14
)

$
(0.10
)

$
(1.24
)Weighted average number of shares:Basic


16,890



16,890



16,890Diluted


16,890



16,890



16,890     Research


Selling,


InterestCost of


and


General and


Income and


NetRevenue


Development


Administrative


Other, Net


Loss(In thousands)As previously reported

$
82,732


$
36,275


$
24,678


$
2,218


$
19,311Adjustments:Customs and duties


1,473











(445
)


1,918Other Accounting errors


(94
)


(225
)


(37
)






(356
)As restated

$
84,111


$
36,050


$
24,641


$
1,773


$
20,873  39




---



##### Table of Contents



Consolidated
    Statements of Operations data for the year ended
    September 30, 2004
  Year Ended September 30, 2004As Previously





AsReported


Adjustments


Restated(In thousands, except per share data)Revenue

$
141,870


$



$
141,870Cost of revenue


83,969



550



84,519Income from operations


6,860



(550
)


6,310Interest income and other, net


4,802



(164
)


4,638Income from continuing operations before income taxes and
    discontinued operations


11,662



(713
)


10,949Provision for income taxes


577







577Income from continuing operations


11,085



(713
)


10,372Loss from discontinued operations


(1,391
)






(1,391
)Net income

$
9,694


$
(713
)

$
8,981Net income per share from continuing operations:Basic

$
0.67


$
(0.06
)

$
0.62Diluted

$
0.65


$
(0.06
)

$
0.61Net loss per share from discontinued operations:Basic

$
(0.08
)

$



$
(0.08
)Diluted

$
(0.08
)

$



$
(0.08
)Net income per share:Basic

$
0.58


$
(0.05
)

$
0.54Diluted

$
0.57


$
(0.06
)

$
0.53Weighted average number of shares:Basic


16,631



16,631



16,631Diluted


17,087



17,087



17,087    40




---



##### Table of Contents



Consolidated
    Statements of Operations data for the year ended
    September 30, 2003
  Year Ended September 30, 2003As Previously





AsReported


Adjustments


Restated(In thousands, except per share data)Revenue

$
67,196


$



$
67,196Cost of revenue


44,071



403



44,474Loss from operations


(30,692
)


(403
)


(31,095
)Interest income and other, net


2,968



(190
)


2,778Loss from continuing operations before income taxes and
    discontinued operations


(27,724
)


(592
)


(28,316
)Provision for income taxes


56







56Loss from continuing operations


(27,780
)


(592
)


(28,372
)Loss from discontinued operations


(44,592
)






(44,592
)Net loss

$
(72,372
)

$
(592
)

$
(72,964
)Net loss per share from continuing operations:Basic

$
(1.73
)

$
(0.03
)

$
(1.76
)Diluted

$
(1.73
)

$
(0.03
)

$
(1.76
)Net loss per share from discontinued operations:Basic

$
(2.77
)

$



$
(2.77
)Diluted

$
(2.77
)

$



$
(2.77
)Net loss per share:Basic

$
(4.50
)

$
(0.04
)

$
(4.54
)Diluted

$
(4.50
)

$
(0.04
)

$
(4.54
)Weighted average number of shares:Basic


16,089



16,089



16,089Diluted


16,089



16,089



16,089    41




---



##### Table of Contents



Consolidated
    Quarterly Information
    Three Months Ended


Three Months EndedDecember 31, 2006


December 31, 2005As Previously


As


As Previously


AsReported


Restated


Reported


Restated(In thousands, except per share data)Revenue

$
21,435


$
21,435


$
41,633


$
41,633Cost of revenue


15,871



15,950



22,382



22,671Research and development


7,995



7,936



8,071



8,249Selling, general and administrative


4,930



4,882



6,851



6,834Income (loss) from operations


(8,180
)


(8,152
)


3,895



3,445Interest income and other, net


1,081



1,014



500



420Income (loss) from continuing operations before income taxes and
    discontinued operations


(7,099
)


(7,138
)


4,395



3,865Provision for income taxes


101



101



352



352Income (loss) from continuing operations before discontinued
    operations


(7,200
)


(7,239
)


4,043



3,513Loss from discontinued operations










(680
)


(680
)Net income (loss)

$
(7,200
)

$
(7,239
)

$
3,363


$
2,833Net income (loss) per share from continuing operations:Basic

$
(0.43
)

$
(0.44
)

$
0.24


$
0.21Diluted

$
(0.43
)

$
(0.44
)

$
0.24


$
0.21Net loss per share from discontinued operations:Basic

$



$



$
(0.04
)

$
(0.04
)Diluted

$



$



$
(0.04
)

$
(0.04
)Net income (loss) per share:Basic

$
(0.43
)

$
(0.44
)

$
0.20


$
0.17Diluted

$
(0.43
)

$
(0.44
)

$
0.20


$
0.17Weighted average number of shares:Basic


16,590



16,590



16,946



16,946Diluted


16,590



16,590



17,047



17,047   42




---



##### Table of Contents



Three Months Ended


Three Months EndedMarch 31, 2007


March 31, 2006As Previously


As


As Previously


AsReported


Restated


Reported


Restated(In thousands, except per share data)Revenue

$
13,928


$
13,928


$
50,322


$
50,322Cost of revenue


13,391



13,604



33,069



33,381Research and development


7,197



7,194



8,560



8,556Selling, general and administrative


6,550



6,484



6,984



6,959Income (loss) from operations


(17,433
)


(17,577
)


1,368



1,085Interest income and other, net


2,015



1,996



1,019



808Income (loss) from continuing operations before income taxes and
    discontinued operations


(15,418
)


(15,581
)


2,387



1,893Provision for income taxes


105



105



199



199Income (loss) from continuing operations before discontinued
    operations


(15,523
)


(15,686
)


2,188



1,694Income (loss) from discontinued operations










334



334Net income (loss)

$
(15,523
)

$
(15,686
)

$
2,522


$
2,028Net income (loss) per share from continuing operations:Basic

$
(0.94
)

$
(0.95
)

$
0.13


$
0.10Diluted

$
(0.94
)

$
(0.95
)

$
0.13


$
0.10Net income per share from discontinued operations:Basic

$



$



$
0.02


$
0.02Diluted

$



$



$
0.02


$
0.02Net income (loss) per share:Basic

$
(0.94
)

$
(0.95
)

$
0.15


$
0.12Diluted

$
(0.94
)

$
(0.95
)

$
0.15


$
0.12Weighted average number of shares:Basic


16,591



16,591



17,018



17,018Diluted


16,591



16,591



17,077



17,077   43




---



##### Table of Contents



Three


Three Months EndedMonths


June 30, 2006Ended


As Previously


AsJune 30, 2007


Reported


Restated(In thousands, except per share data)Revenue

$
14,430


$
51,658


$
51,658Cost of revenue


11,215



32,178



32,573Research and development


6,213



8,508



8,492Selling, general and administrative


5,831



6,968



6,929Income (loss) from operations


(8,988
)


3,582



3,242Interest income and other, net


327



999



859Income (loss) from continuing operations before income taxes and
    discontinued operations


(8,661
)


4,581



4,101Provision for income taxes


72



205



205Income (loss) from continuing operations before discontinued
    operations


(8,733
)


4,376



3,896Loss from discontinued operations






(127
)


(127
)Net income (loss)

$
(8,733
)

$
4,249


$
3,769Net income (loss) per share from continuing operations:Basic

$
(0.52
)

$
0.26


$
0.23Diluted

$
(0.52
)

$
0.26


$
0.23Net loss per share from discontinued operations:Basic

$



$
(0.01
)

$
(0.01
)Diluted

$



$
(0.01
)

$
(0.01
)Net income (loss) per share:Basic

$
(0.52
)

$
0.25


$
0.22Diluted

$
(0.52
)

$
0.25


$
0.22Weighted average number of shares:Basic


16,635



17,047



17,047Diluted


16,635



17,077



17,077   44




---



##### Table of Contents



Three Months EndedThree Months


September 30, 2006Ended


As Previously


AsSeptember 30, 2007


Reported


Restated(In thousands, except per share data)Revenue

$
24,474


$
29,259


$
29,259Cost of revenue


15,605



25,142



25,580Research and development


5,404



7,281



7,280Selling, general and administrative


5,879



3,808



3,784Loss from operations


(4,265
)


(7,433
)


(7,846
)Interest income and other, net


853



838



717Loss from continuing operations before income taxes and
    discontinued operations


(3,412
)


(6,595
)


(7,129
)Provision (benefit) for income taxes


3



(195
)


(195
)Loss from continuing operations before discontinued operations


(3,415
)


(6,400
)


(6,934
)Income from discontinued operations






346



346Net loss

$
(3,415
)

$
(6,054
)

$
(6,588
)Net loss per share from continuing operations:Basic

$
(0.20
)

$
(0.38
)

$
(0.41
)Diluted

$
(0.20
)

$
(0.38
)

$
(0.41
)Net income per share from discontinued operations:Basic

$



$
0.02


$
0.02Diluted

$



$
0.02


$
0.02Net loss per share:Basic

$
(0.20
)

$
(0.36
)

$
(0.39
)Diluted

$
(0.20
)

$
(0.36
)

$
(0.39
)Weighted average number of shares:Basic


17,434



16,849



16,849Diluted


17,434



16,849



16,849  45




---



##### Table of Contents



Fiscal 2007Three Months


Three MonthsEnded


EndedDecember 31, 2006


March 31, 2007(In thousands)Cost of revenues:As previously reported

$
15,871


$
13,391Adjustments:Customs and duties


181



291Other accounting errors


(102
)


(78
)As restated

$
15,950


$
13,604Research and development:As previously reported

$
7,995


$
7,197Adjustments:Customs and duties






Other accounting errors


(59
)


(3
)As restated

$
7,936


$
7,194Selling, general and administrative:As previously reported

$
4,930


$
6,550Adjustments:Customs and duties






Other accounting errors


(48
)


(66
)As restated

$
4,882


$
6,484Interest income and other, net:As previously reported

$
1,081


$
2,015Adjustments:Customs and duties


(67
)


19Other accounting errors






As restated

$
1,014


$
1,996Net income (loss):As previously reported

$
(7,200
)

$
(15,523
)Adjustments:Customs and duties


(248
)


(310
)Other accounting errors


209



147As restated

$
(7,239
)

$
(15,686
)   46




---



##### Table of Contents



Fiscal 2006Three Months


Three Months


Three Months


Three MonthsEnded


Ended


Ended


EndedDecember 31, 2005


March 31, 2006


June 30, 2006


September 30, 2006(In thousands)Cost of revenues:As previously reported

$
22,382


$
33,069


$
32,178


$
25,142Adjustments:Customs and duties


358



316



474



476Other accounting errors


(69
)


(4
)


(79
)


(38
)As restated

$
22,671


$
33,381


$
32,573


$
25,580Research and development:As previously reported

$
8,071


$
8,560


$
8,508


$
7,281Adjustments:Customs and duties














Other accounting errors


178



(4
)


(16
)


(1
)As restated

$
8,249


$
8,556


$
8,492


$
7,280Selling, general and administrative:As previously reported

$
6,851


$
6,984


$
6,968


$
3,808Adjustments:Customs and duties














Other accounting errors


(17
)


(25
)


(39
)


(24
)As restated

$
6,834


$
6,959


$
6,929


$
3,784Interest income and other, net:As previously reported

$
500


$
1,019


$
999


$
838Adjustments:Customs and duties


(80
)


(211
)


(140
)


(121
)Other accounting errors














As restated

$
420


$
808


$
859


$
717Net income (loss):As previously reported

$
3,363


$
2,522


$
4,249


$
(6,054
)Adjustments:Customs and duties


(438
)


(527
)


(614
)


(597
)Other accounting errors


(92
)


33



134



63As restated

$
2,833


$
2,028


$
3,769


$
(6,588
)   Results
    of fiscal 2007 Quarterly Operations
  then-current
 47




---



##### Table of Contents



higher-margin tm
  Form 10-K. tm
  Results
    of fiscal 2006 Quarterly Operations
    higher-margin tm
   48




---



##### Table of Contents



CRITICAL
    ACCOUNTING POLICIES AND ESTIMATES
  Form 10-K
    Form 10-K.
    Revenue
    Recognition
  Form 10-K
  and/or and/or
     49




---



##### Table of Contents



Allowance
    for Doubtful Accounts
      Inventories
    part-by-part
  Warranty
    Goodwill
    and Intangible Assets
     50




---



##### Table of Contents



Stock-Based
    Compensation
    Contingencies
    and Litigation
    Form 10-K.
 51




---



##### Table of Contents



RESULTS
    OF OPERATIONS
  Fiscal
    Years Ended September 30, 2007, 2006 and 2005
    Year Ended September 30,2007


2006


2005As


AsRestated


RestatedRevenue


100.0
%


100.0
%


100.0
%Cost of revenue


75.9



66.1



66.9Gross margin


24.1



33.9



33.1Operating expenses:Research and development


36.0



18.8



28.7Selling, general and administrative


31.1



14.2



19.6Restructuring charge


1.8



0.0



1.0Impairment of property and equipment


3.8



0.0



0.5Loss (gain) on sale of property and equipment


0.1



0.0



(0.1
)Acquired in-process research and development


1.4







Amortization of intangible assets


2.3



0.9



1.2Total operating expenses


76.6



34.0



50.9Income (loss) from operations


(52.5
)


0.0



(17.7
)Interest income and other, net


5.6



1.6



1.4Income (loss) from continuing operations before income taxes and
    discontinued operations


(46.8
)


1.6



(16.3
)Provision for income taxes


0.4



0.3



0.5Income (loss) from continuing operations before discontinued
    operations


(47.2
)


1.3



(16.8
)Income (loss) from discontinued operations






(0.1
)


0.2Net income (loss)


(47.2
)%


1.2
%


(16.6
)%   Operating
    Segments
      Revenue
  tm tm tm
 52




---



##### Table of Contents



Fiscal Year Ended September 30,

Fiscal Year Ended September 30,2007

Change

2006

2006

Change

2005(Dollars in thousands)Revenue

$
74,267



(57
)%

$
172,872


$
172,872



37
%

$
125,813     ArrayCheckertmand
    ArraySavertm Product Revenue
  tm tm
  Fiscal Year EndedSeptember 30,2007


2006


2005Revenue by generation:Generation 6 and earlier


24
%


35
%


84
%Generation 7 and 8


49
%


50
%


Revenue by product:ArrayCheckertm


57
%


66
%


60
%ArraySavertm


15
%


19
%


24
%   tm tm
  tm tm
  tm tm
 53




---



##### Table of Contents



PanelMastertmProduct Revenue
  tm tm tm tm tm
  tm tm
  tm
  Customer
    Support and Spare Parts Revenue
  tm tm
    High-Performance
    Digital Cameras
   54




---



##### Table of Contents



International
    Revenue
    Fiscal Year Ended September 30,


Fiscal Year Ended September 30,2007


Change


2006


2006


Change


2005(Dollars in millions)South Korea

$
26.2



(77
)%

$
113.3


$
113.3



173
%

$
41.5Taiwan


23.3



(43
)


41.1



41.1



(23
)


53.2Japan


18.7



144



7.7



7.7



(55
)


17.0China


4.7



(57
)


10.8



10.8



(24
)


14.1United States


1.4



(100
)














$
74.3



(57
)%

$
172.9


$
172.9



37
%

$
125.8       Revenue
    Outlook
  Form 10-K
  Gross
    Margin
  Fiscal Year Ended September 30,

Fiscal Year Ended September 30,2007

Change

2006

2006

Change

2005As

As



Asrestated

restated



restated(Dollars in thousands).Gross Margin

$
17,893



(70
)%

$
58,667


$
58,667



41
%

$
41,702Gross Margin Percentage


24
%


(29
)%


34
%


34
%


(3
)%


33
%   tm
  
    Lower revenue related to the receipt of final customer
    acceptances following completed installation, which have higher
    margins associated with this portion of the sales price, as
    compared to the same period in the prior year;  
    Additional inventory reserves as a consequence of the industry
    slowdown; and,
    The under-utilization of our San Jose facilities as a
    consequence of the industry slowdown. 55




---



##### Table of Contents



tm
  
    Lower revenue related to the receipt of final customer
    acceptances following completed installation, which have higher
    margins associated with this portion of the sales price, as
    compared to the same period in the prior year;
    Costs associated with SFAS No. 123R for which there
    were no comparable charges in the same period of the prior
    fiscal year;
    An additional write-down of excess inventory in our third
    quarter as a result of anticipated lower bookings and
    revenues; and
    A one-time warranty charge for the replacement of two of our
    Generation 7
    ArrayCheckertm
    systems.    
    Reduced production levels as a consequence of either industry
    slowdown, order cancellations or rescheduled product shipments
    requested by our customers;
    Fluctuations in the level of revenue due to the cyclical nature
    of our customers capital expenditures.
    Our revenue mix between higher-margin
    ArrayCheckertm
    systems and lower-margin
    ArraySavertm
    systems;
    Competitive pricing pressures, particularly in the array repair
    market;
    Our ability to achieve cost reductions;
    The additional costs in connection with inefficiencies of
    manufacturing newly-introduced products;
    The success of our strategy of using domestic and offshore
    manufacturing and outsourcing as we migrate the manufacturing of
    our
    ArraySavertm
    systems to South Korea; and
    Increased customer service costs associated with supporting
    potential increased demand from new and existing customers.  Research
    and Development
  Fiscal Year Ended September 30,

Fiscal Year Ended September 30,2007

Change

2006

2006

Change

2005As

As



Asrestated

restated



restated(Dollars in thousands)Expense

$
26,747



(18
)%

$
32,577


$
32,577



(10
)%

$
36,050Percent of Revenue


36
%






19
%


19
%






29
%        56




---



##### Table of Contents



Selling,
    General and Administrative
  Fiscal Year Ended September 30,

Fiscal Year Ended September 30,2007

Change

2006

2006

Change

2005As

As



Asrestated

restated



restated(Dollars in thousands)Expense

$
23,076



(6
)%

$
24,506


$
24,506



(1
)%

$
24,641Percent of Revenue


31
%






14
%


14
%






20
%         Restructuring
    Charge
  Fiscal Year Ended September 30,

Fiscal Year Ended September 30,2007

Change

2006

2006

Change

2005(Dollars in thousands)Expense

$
1,368



4,460
%

$
30


$
30



(97
)%

$
1,197Percent of Revenue


2
%






0
%


0
%






1
%     February
    2007 Restructuring
     57




---



##### Table of Contents



November
    2006 Restructuring
  tm
    April
    2005 Restructuring
        Impairment
    Property and Equipment
  Fiscal Year Ended September 30,

Fiscal Year Ended September 30,2007

Change

2006

2006

Change

2005(Dollars in thousands)Expense

$
2,834



3,399
%

$
81


$
81



(87
)%

$
637Percent of Revenue


4
%






0
%


0
%






1
%       Loss
    (gain) on Sale of Property and Equipment
  Fiscal Year Ended

Fiscal Year EndedSeptember 30,

September 30,2007

Change

2006

2006

Change

2005(Dollars in thousands)Loss (Gain)

$
87



50
%

$
58


$
58



(162
)%

$
(93
)Percent of Revenue


0
%






0
%






0
%


0
%  58




---



##### Table of Contents



Acquired
    In-Process Research and Development
  Fiscal Year Ended

Fiscal Year EndedSeptember 30,

September 30,2007

Change

2006

2006

Change

2005(Dollars in thousands)Expense

$
1,110



100
%

$
0


$
0



0
%

$
0Percent of Revenue


1
%






0
%


0
%






0
%           Amortization
    of Intangible Assets
  Fiscal Year Ended September 30,

Fiscal Year Ended September 30,2007

Change

2006

2006

Change

2005(Dollars in thousands)Expense

$
1,653



11
%

$
1,489


$
1,489



(4
)%

$
1,548Percent of Revenue


2
%






1
%


1
%






1
%      59




---



##### Table of Contents



Interest
    Income and Other, Net
  Fiscal Year Ended September 30,

Fiscal Year Ended September 30,2007

Change

2006

2006

Change

2005As

As



Asrestated

restated



restated(Dollars in thousands)Interest Income and Other, Net

$
4,190



49
%

$
2,803


$
2,803



58
%

$
1,773Percent of Revenue


6
%






2
%


2
%






1
%         Provision
    for Income Taxes
  Fiscal Year Ended September 30,

Fiscal Year Ended September 30,2007

Change

2006

2006

Change

2005(Dollars in thousands)Expense

$
280



(50
)%

$
561


$
561



(10
)%

$
624Percent of Revenue


0
%






0
%


0
%






1
%        60




---



##### Table of Contents



Stock-Based
    Compensation
            Fiscal Year Ended September 30,2007


2006


2005(2)As restated(In thousands)Stock-based compensation expense included in continuing
    operations:Cost of revenue

$
318


$
401


$
Research and development


400



676



Selling, general and administrative


1,255



2,908



Total stock-based compensation expense after income taxes(1)

$
1,973


$
3,985


$
Stock-based compensation expense by type of award:Employee stock options

$
1,318


$
3,630


$
Employee stock purchase plan


498



470



Restricted stock awards


215







Amounts capitalized as inventory and deferred gross margin


(58
)


(115
)


Total stock-based compensation expense after income taxes(1)

$
1,973


$
3,985


$
  61




---



##### Table of Contents



(1)
    
    The income tax benefit on stock-based compensation for all
    periods presented was not material in all periods presented.(2)
    
    No employee stock-based compensation was reflected in net
    income/loss in fiscal 2005, as we accounted for options using
    APB 25 and all options granted under those plans had an exercise
    price equal to the market value of the underlying common stock
    on the date of grant.      DISCONTINUED
    OPERATIONS
    Printed
    Circuit Board Assembly Inspection Business
  Fiscal Year EndedSeptember 30,2007

2006

2005(In thousands)Net Loss

$



$
(154
)

$
(56
)      62




---



##### Table of Contents



Cathode
    Ray Tube Display and High Quality Glass Inspection
    Business
  Fiscal Year EndedSeptember 30,2007

2006

2005(In thousands)Net Income

$



$
27


$
312       LIQUIDITY
    AND CAPITAL RESOURCES
      Operating Activities of Continuing
    Operations.
     63




---



##### Table of Contents



Investing Activities of Continuing
    Operations.
        Financing Activities of Continuing
    Operations.
           64




---



##### Table of Contents



Operating, Investing and Financing Activities of Discontinued
    Operations.
  Fiscal Year Ended2007


2006


2005(In thousands)Cash flows from operating activities:Printed circuit board business

$



$
(1,242
)

$
(543
)Cathode ray tube display and high quality glass inspection
    business






(29
)


(97
)Net cash used in operating activities from discontinued
    operations






(1,271
)


(640
)Cash flows from financing activities:Cathode ray tube display and high quality glass inspection
    business










(313
)Net cash used in financing activities from discontinued
    operations










(313
)Net decrease in cash and cash equivalents from discontinued
    operations:Printed circuit board business






(1,242
)


(543
)Cathode ray tube display and high quality glass inspection
    business






(29
)


(410
)Net decrease in cash and cash equivalents from discontinued
    operations

$



$
(1,271
)

$
(953
)       Contractual
    Obligations
    Payments Due by Fiscal YearTotal


2008


2009


2010


2011


2012


Thereafter(In thousands)Purchase obligations

$
27,970


$
27,844


$
124


$
2


$



$



$
Operating lease obligations


9,868



3,433



2,881



2,830



723



1



Notes payable, including interest


5,600







2,800



2,800











Capital lease obligations


154



115



39















Total

$
43,592


$
31,392


$
5,844


$
5,632


$
723


$
1


$
      65




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##### Table of Contents



Working
    Capital
    Off-Balance
    Sheet Arrangements
  Regulation S-K.
  Transactions
    with Related Parties
        IMPACT OF
    ACCOUNTING PRONOUNCEMENTS
     66




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##### Table of Contents



ITEM 7A.
    QUANTITATIVE
    AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK  FOREIGN
    CURRENCY EXCHANGE RATE RISK
        Form 10-K.
   67




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##### Table of Contents



INTEREST
    RATE RISK
      There





FairSeptember 30, 2007

2008


2009


2010


2011


2012


After


Total


Value(Dollars in thousands)Cash and cash equivalents (variable rate)

$
18,697






















$
18,697


$
18,697Average interest rate


5.30
%Short-term investments (variable rate)





















$
16,235


$
16,235


$
16,235Average interest rate






















6.04
%Short-term investments (fixed rate)

$
26,441






















$
26,441


$
26,405Average interest rate


5.04
%Long-term investments (fixed rate)





$
1,200


















$
1,200


$
1,176Average interest rate






4.97
%   There





FairSeptember 30, 2006

2007


2008


2009


2010


2011


After


Total


Value(Dollars in thousands)Cash and cash equivalents (variable rate)

$
47,941






















$
47,941


$
47,935Average interest rate


3.98
%Short-term investments (variable rate)





















$
46,765


$
46,765


$
46,765Average interest rate






















5.25
%Short-term investments (fixed rate)

$
8,102






















$
8,102


$
8,069Average interest rate


4.37
%Long-term investments (fixed rate)





$
800


















$
800


$
787Average interest rate






3.67
%    68




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##### Table of Contents



ITEM 8.
    FINANCIAL
    STATEMENTS AND SUPPLEMENTARY DATA  Index to
    Consolidated Financial Statements
  Description

PageReports of Independent Registered Public Accounting Firm


70Consolidated Balance Sheets as of September 30, 2007 and
    2006


73Consolidated Statements of Operations for each of the three
    years in the period ended September 30, 2007


74Consolidated Statements of Shareholders Equity for each of
    the three years in the period ended September 30, 2007


75Consolidated Statements of Cash Flows for each of the three
    years in the period ended September 30, 2007


76Notes to Consolidated Financial Statements


77  69




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##### Table of Contents



Report of
    Independent Registered Public Accounting Firm             Internal Control  Integrated
    Framework
   /s/  Ernst &
    Young LLP    70




---



##### Table of Contents



Report of
    Independent Registered Public Accounting Firm
              71




---



##### Table of Contents



/s/  Ernst &
    Young LLP    72




---



##### Table of Contents



PHOTON
    DYNAMICS, INC.
  CONSOLIDATED BALANCE SHEETS
  September 30,2007


2006As restated(1)(In thousands, exceptshare data)ASSETSCurrent assets:Cash and cash equivalents

$
41,170


$
47,935Short-term investments


42,640



54,834Accounts receivable, net of allowance for doubtful accounts of
    $239 and $406, respectively


11,934



29,341Inventories


13,292



18,442Refundable customs obligations


560



3,157Other current assets


3,661



3,972Total current assets


113,257



157,681Long-term investments


1,176



787Land, property and equipment, net


10,583



15,891Other assets


5,365



4,542Intangible assets, net


11,023



1,716Goodwill


6,857



153Total assets

$
148,261


$
180,770LIABILITIES AND SHAREHOLDERS EQUITYCurrent liabilities:Accounts payable

$
4,217


$
7,257Warranty


3,217



8,058Employee notes payable






977Customs obligations


4,114



8,673Other current liabilities


9,874



8,967Deferred gross margin


3,236



7,454Total current liabilities


24,658



41,386Long-term employee note payable


5,381



Other non-current liabilities


38



119Total non-current liabilities


5,419



119Commitments and contingencies (Note 13)Shareholders equity:Preferred stock, no par value, 5,000,000 shares authorized,
    none outstanding, as of September 30, 2007 and 2006,
    respectively






Common stock, no par value, 30,000,000 shares authorized,
    17,740,663 and 16,526,782 shares issued and outstanding, as
    of September 30, 2007 and 2006, respectively


300,290



285,416Accumulated deficit


(181,503
)


(146,431
)Accumulated other comprehensive income (loss)


(603
)


280Total shareholders equity


118,184



139,265Total liabilities and shareholders equity

$
148,261


$
180,770     (1)
    
    See Note 2, Restatements of Consolidated Financial
    Statements and Company Findings in Notes to Consolidated
    Financial Statements.   73




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##### Table of Contents



PHOTON
    DYNAMICS, INC.
 CONSOLIDATED
    STATEMENTS OF OPERATIONS  Year Ended September 30,2007


2006


2005As


Asrestated(1)


restated(1)(In thousands, except per share data)Revenue

$
74,267


$
172,872


$
125,813Cost of revenue


56,374



114,205



84,111Gross margin


17,893



58,667



41,702Operating expenses:Research and development


26,747



32,577



36,050Selling, general and administrative


23,076



24,506



24,641Restructuring charge


1,368



30



1,197Impairment of property and equipment


2,834



81



637Loss (gain) on sale of property and equipment


87



58



(93
)Acquired in-process research and development


1,110







Amortization of intangible assets


1,653



1,489



1,548Total operating expenses


56,875



58,741



63,980Loss from operations


(38,982
)


(74
)


(22,278
)Interest income and other, net


4,190



2,803



1,773Income (loss) from continuing operations before income taxes and
    discontinued operations


(34,792
)


2,729



(20,505
)Provision for income taxes


280



561



624Income (loss) from continuing operations before discontinued
    operations


(35,072
)


2,168



(21,129
)Income (loss) from discontinued operations






(127
)


256Net income (loss)

$
(35,072
)

$
2,041


$
(20,873
)Income (loss) per share from continuing operations:Basic

$
(2.09
)

$
0.13


$
(1.25
)Diluted

$
(2.09
)

$
0.13


$
(1.25
)Income (loss) per share from discontinued operations:Basic

$



$
(0.01
)

$
0.02Diluted

$



$
(0.01
)

$
0.02Net income (loss) per share:Basic

$
(2.09
)

$
0.12


$
(1.24
)Diluted

$
(2.09
)

$
0.12


$
(1.24
)Weighted average number of shares:Basic


16,814



16,978



16,890Diluted


16,814



17,011



16,890     (1)
    
    See Note 2, Restatements of Consolidated Financial
    Statements and Company Findings to in Notes Consolidated
    Financial Statements.   74




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##### Table of Contents



PHOTON
    DYNAMICS, INC.
 CONSOLIDATED
    STATEMENTS OF SHAREHOLDERS EQUITY  Common Stock and





AccumulatedCapital in Excess of





OtherPar Value


Accumulated


ComprehensiveShare


Amount


Deficit


Income (Loss)


Total(In thousands)Balances at September 30, 2004, as restated(1)


16,859


$
285,790


$
(127,599
)

$
347


$
158,538Components of comprehensive loss:Net loss










(20,873
)






(20,873
)Change in unrealized gain on investments














(138
)


(138
)Currency translation adjustments














109



109Total comprehensive loss


















(20,902
)Net issuance of common stock


131



1,797











1,797Tax benefits of stock option transactions






126











126Non-employee stock ownership expense






52











52Balances at September 30, 2005, as restated(1)


16,990



287,765



(148,472
)


318



139,611Components of comprehensive income:Net income










2,041







2,041Change in unrealized loss on investments














273



273Currency translation adjustments














(311
)


(311
)Total comprehensive income


















2,003Net issuance of common stock


116



1,788











1,788Repurchase of common stock, net


(529
)


(6,993
)










(6,993
)Cancellation of escrow shares


(50
)


(1,258
)










(1,258
)Stock-based compensation






4,100











4,100Non-employee stock ownership expense






14











14Balances at September 30, 2006 as restated(1)


16,527



285,416



(146,431
)


280



139,265Components of comprehensive income:Net loss










(35,072
)






(35,072
)Change in unrealized loss on investments














(9
)


(9
)Currency translation adjustments














(874
)


(874
)Total comprehensive loss


















(35,955
)Net issuance of common stock in acquisition


1,084



11,478











11,478Net issuance of common stock for cash


130



1,365











1,365Stock-based compensation






2,031











2,031Balances at September 30, 2007


17,741


$
300,290


$
(181,503
)

$
(603
)

$
118,184     (1)
    
    See Note 2, Restatements of Consolidated Financial
    Statements and Company Findings in Notes to Consolidated
    Financial Statements.   75




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##### Table of Contents



PHOTON
    DYNAMICS, INC.
 CONSOLIDATED
    STATEMENTS OF CASH FLOWS  Year Ended September 30,2007


2006


2005As


Asrestated(1)


restated(1)(In thousands)Cash flows from operating activities:Net income (loss) from continuing operations

$
(35,072
)

$
2,168


$
(21,129
)Adjustments to reconcile net income (loss) from continuing
    operations to net cash provided by (used in) operating
    activities from continuing operations:Depreciation


4,595



5,720



5,037Amortization of intangible assets


1,653



1,489



1,548Stock-based compensation


1,973



3,985



Foreign currency translation adjustment gain recognized upon
    liquidation of a subsidiary


(928
)






Acquired in process research and development


1,110







Impairment of property and equipment


2,834



81



637Non-employee stock ownership expense






14



52Restructuring charge


178



30



171Loss (gain) on sale of property and equipment


87



58



(93
)Accretion of non-interest bearing notes payable


70



39



64Changes in assets and liabilities:Accounts receivable


17,677



(2,274
)


31,274Inventories


5,208



14,218



(829
)Other current assets


2,353



(976
)


(1,017
)Other assets


(268
)


(1,168
)


536Accounts payable


(3,224
)


(5,502
)


(5,642
)Other current liabilities


(9,351
)


7,735



1,617Deferred gross margin


(4,218
)


(5,659
)


1,610Other liabilities


(81
)


79



(91
)Net cash provided by (used in) operating activities from
    continuing operations


(15,404
)


20,037



13,745Net cash used in operating activities from discontinued
    operations






(1,271
)


(640
)Net cash provided by (used in) operating activities


(15,404
)


18,766



13,105Cash flows from investing activities:Purchase of property and equipment


(2,391
)


(2,343
)


(4,880
)Proceeds from sale of fixed assets






50



270Acquisition of Salvador Imaging, net of cash assumed


(2,036
)






Purchase of short-term investments


(92,251
)


(125,928
)


(56,380
)Maturities and sales of short-term investments


104,047



143,319



42,175Net cash provided by (used in) investing activities from
    continuing operations


7,369



15,098



(18,815
)Cash flows from financing activities:Issuance of common stock, net


1,365



1,788



1,923Repurchase of common stock






(6,993
)


Repayment of short-term notes


(93
)


(609
)


(1,205
)Net cash provided by (used in) financing activities from
    continuing operations


1,272



(5,814
)


718Net cash used in financing activities from discontinued
    operations










(313
)Net cash provided by (used in) financing activities


1,272



(5,814
)


405Effect of exchange rate changes on cash and cash equivalents


(2
)


(403
)


110Net increase (decrease) in cash and cash equivalents from
    continuing operations


(6,765
)


28,918



(4,242
)Net decrease in cash and cash equivalents from discontinued
    operations






(1,271
)


(953
)Net increase (decrease) in cash and cash equivalents


(6,765
)


27,647



(5,195
)Cash and cash equivalents at beginning of year


47,935



20,288



25,483Cash and cash equivalents at end of year

$
41,170


$
47,935


$
20,288Supplemental cash flow disclosures:Income taxes paid

$
381


$
768


$
498Interest paid










1Supplemental non-cash financing and investing activities
    disclosure:Value of note payable issued in the acquisition of Salvador
    Imaging


5,334







Value of shares issued in the acquisition of Salvador Imaging


11,478







     (1)
    
    See Note 2, Restatements of Consolidated Financial
    Statements and Company Findings in Notes to Consolidated
    Financial Statements.   76




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##### Table of Contents



PHOTON
    DYNAMICS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL STATEMENTS
  NOTE 1 
    SUMMARY
    OF SIGNIFICANT ACCOUNTING POLICIES  Description of Operations and Principles of
    Consolidation.
  The Company currently operates in two
    segments:
    Management Estimates and Assumptions.
  Fair Value of Financial Instruments. and/or
  Cash Equivalents and Short-Term
    Investments.
 77




---



##### Table of Contents



PHOTON
    DYNAMICS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
    Inventories. (first-in,
  Land, Property and Equipment.
    Goodwill and Intangible Assets.
    Accumulated Other Comprehensive Income
    (Loss).
  Concentrations and Other Risk.
   78




---



##### Table of Contents



PHOTON
    DYNAMICS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
      start-up
  Foreign Currency.
  Derivative Financial Instruments.
      Warranty.
 79




---



##### Table of Contents



PHOTON
    DYNAMICS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  Revenue Recognition.
            Shipping Costs.
  Advertising.
  Research and Development Cost.
  Income Taxes.
     80




---



##### Table of Contents



PHOTON
    DYNAMICS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
    Earnings Per Share.
  Stock-Based Compensation.
  Variable Interest Entity.
  Reclassifications.
  Recent Accounting Pronouncements.
   81




---



##### Table of Contents



PHOTON
    DYNAMICS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
      NOTE 2 
    RESTATEMENTS OF CONSOLIDATED FINANCIAL STATEMENTS AND COMPANY
    FINDINGS (Financial Information with Respect to Dates or Periods
    after September 30, 2007 are Unaudited)
  Background
    on Restatements Related to Customs Duties for Warranty
    Parts
     82




---



##### Table of Contents



PHOTON
    DYNAMICS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
    Form 10-K Form 8-K Form 10-K.
    September 30,2007(In thousands)South Korea

$
3,917Taiwan


2,130Japan


49China


1,148Total liability


7,244Amounts paid at September 30, 2007


(3,691
)Net liability at September 30, 2007

$
3,553         Increased Span of Korean Audit
 83




---



##### Table of Contents



PHOTON
    DYNAMICS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  Foreign Currency Effect
  Lower Declared Values de minimis
  Computed Value mark-up mark-up
  Interest and Penalties
  Value Added Tax (VAT)
    Recoverability
  Excluded Parts
  Drawback Calculation
  Background
    on Restatements Related to Other Accounting Issues
    
    Over-expensing of certain invoices related to inventory receipts
    and operating expenses which affected fiscal 2005 and 2006 and
    the first two quarters of fiscal 2007;
    An over-accrual of a fiscal 2005 management bonus that was
    reversed in the first quarter of fiscal 2006; and
    An over-expensing of certain options related to former executive
    officers due to problems discovered in the supporting software,
    which affected fiscal 2006 and the first two quarters of fiscal
    2007.   84




---



##### Table of Contents



PHOTON
    DYNAMICS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  Consolidated
    Financial Data for the fiscal year ended September 30,
    2006
    September 30,


Cumulative2006


Effect of Prior


Current-


September 30,As Previously


Period


Period


2006Reported


Adjustments*


Adjustments


As Restated(In thousands)Consolidated Balance Sheet Data:Other current assets and customs obligations

$
3,972


$
1,798


$
1,359


$
7,129Accounts payable


7,657



(167
)


(233
)


7,257Other current liabilities and customs obligations


8,967



4,948



3,725



17,640Total current liabilities


33,113



4,781



3,492



41,386Common Stock


285,510







(94
)


285,416Accumulated deficit


(141,409
)


(2,983
)


(2,039
)


(146,431
)Total liabilities and shareholders equity


177,613



1,798



1,359



180,770     *
    
    Amounts consist of the cumulative effect of prior period
    adjustments.  85




---



##### Table of Contents



PHOTON
    DYNAMICS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  Year Ended September 30, 2006As PreviouslyReported


Adjustments


As Restated(In thousands, except per share data)Consolidated Statement of Operations Data:Revenue

$
172,872


$



$
172,872Cost of revenue


112,771



1,434



114,205Research and development


32,420



157



32,577Selling, general and administrative


24,611



(105
)


24,506Income (loss) from operations


1,412



(1,486
)


(74
)Interest income and other, net


3,356



(553
)


2,803Income from continuing operations before income taxes and
    discontinued operations


4,768



(2,039
)


2,729Provision for income taxes


561







561Income from continuing operations


4,207



(2,039
)


2,168Loss from discontinued operations


(127
)






(127
)Net income

$
4,080


$
(2,039
)

$
2,041Net income per share from continuing operations:Basic

$
0.25


$
(0.12
)

$
0.13Diluted

$
0.25


$
(0.12
)

$
0.13Net loss per share from discontinued operations:Basic

$
(0.01
)

$



$
(0.01
)Diluted

$
(0.01
)

$



$
(0.01
)Net income per share:Basic

$
0.24


$
(0.12
)

$
0.12Diluted

$
0.24


$
(0.12
)

$
0.12Weighted average number of shares:Basic


16,978



16,978



16,978Diluted


17,011



17,011



17,011     Research


Selling,


InterestCost of


and


General and


Income and


NetRevenue


Development


Administrative


Other, Net


Income(In thousands)As previously reported

$
112,771


$
32,420


$
24,611


$
3,356


$
4,080Adjustments:Customs and duties


1,624











(553
)


(2,177
)Other accounting errors


(190
)


157



(105
)






138As restated

$
114,205


$
32,577


$
24,506


$
2,803


$
2,041  86




---



##### Table of Contents



PHOTON
    DYNAMICS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  Year Ended September 30, 2006As PreviouslyReported


Adjustments


As Restated(In thousands)Consolidated Statement of Cash Flow DataCash flows from operating activities:Net income from continuing operations

$
4,207


$
(2,039
)

$
2,168Adjustments to reconcile net income from continuing operations
    to net cash provided operating activities from continuing
    operations:Stock-based compensation


4,079



(94
)


3,985Changes in assets and liabilities:Other current assets


383



(1,359
)


(976
)Accounts payable


(5,269
)


(233
)


(5,502
)Other current liabilities


4,010



3,725



7,735Net cash provided by operating activities from continuing
    operations


20,037







20,037Net cash used in operating activities from discontinued
    operations


(1,271
)






(1,271
)Net cash provided by operating activities


18,766







18,766Cash flows from investing activities:Net cash provided by investing activities from continuing
    operations


15,098







15,098Cash flows from financing activities:Net cash used in financing activities from continuing operations


(5,814
)






(5,814
)Effect of exchange rate changes on cash and cash equivalents


(403
)






(403
)Net increase in cash and cash equivalents from continuing
    operations


28,918







28,918Net decrease in cash and cash equivalents from discontinued
    operations


(1,271
)






(1,271
)Net increase in cash and cash equivalents


27,647







27,647Cash and cash equivalents at beginning of year


20,288







20,288Cash and cash equivalents at end of year

$
47,935


$



$
47,935  87




---



##### Table of Contents



PHOTON
    DYNAMICS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  Consolidated
    Financial Data for the fiscal year ended September 30,
    2005
    Year Ended September 30, 2005As PreviouslyReported


Adjustments


As Restated(In thousands, except per share data)Consolidated Statement of Operations Data:Revenue

$
125,813


$



$
125,813Cost of revenue


82,732



1,379



84,111Research and development


36,275



(225
)


36,050Selling, general and administrative


24,678



(37
)


24,641Loss from operations


(21,161
)


(1,117
)


(22,278
)Interest income and other, net


2,218



(445
)


1,773Loss from continuing operations before income taxes and
    discontinued operations


(18,943
)


(1,562
)


(20,505
)Provision for income taxes


624







624Loss from continuing operations


(19,567
)


(1,562
)


(21,129
)Income from discontinued operations


256







256Net loss

$
(19,311
)

$
(1,562
)

$
(20,873
)Net loss per share from continuing operations:Basic

$
(1.16
)

$
(0.09
)

$
(1.25
)Diluted

$
(1.16
)

$
(0.09
)

$
(1.25
)Net income per share from discontinued operations:Basic

$
0.02


$



$
0.02Diluted

$
0.02


$



$
0.02Net loss per share:Basic

$
(1.14
)

$
(0.10
)

$
(1.24
)Diluted

$
(1.14
)

$
(0.10
)

$
(1.24
)Weighted average number of shares:Basic


16,890



16,890



16,890Diluted


16,890



16,890



16,890  88




---



##### Table of Contents



PHOTON
    DYNAMICS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
    Research


Selling,


InterestCost of


and


General and


Income and


NetRevenue


Development


Administrative


Other, Net


Loss(In thousands)As previously reported

$
82,732


$
36,275


$
24,678


$
2,218


$
19,311Adjustments:Customs and duties


1,473











(445
)


1,918Other accounting errors


(94
)


(225
)


(37
)






(356
)As restated

$
84,111


$
36,050


$
24,641


$
1,773


$
20,873   Year Ended September 30, 2005As PreviouslyReported


Adjustments


As Restated(In thousands)Consolidated Statement of Cash Flow DataCash flows from operating activities:Net loss from continuing operations

$
(19,567
)

$
(1,562
)

$
(21,129
)Changes in assets and liabilities:Other current assets


(130
)


(887
)


(1,017
)Accounts payable


(5,475
)


(167
)


(5,642
)Other current liabilities


(999
)


2,616



1,617Net cash provided by operating activities from continuing
    operations


13,745







13,745Net cash used in operating activities from discontinued
    operations


(640
)






(640
)Net cash provided by operating activities


13,105







13,105Cash flows from investing activities:Net cash used in investing activities from continuing operations


(18,815
)






(18,815
)Cash flows from financing activities:Net cash provided by financing activities from continuing
    operations


718







718Net cash used in financing activities from discontinued
    operations


(313
)






(313
)Net cash provided by financing activities


405







405Effect of exchange rate changes on cash and cash equivalents


110







110Net decrease in cash and cash equivalents from continuing
    operations


(4,242
)






(4,242
)Net decrease in cash and cash equivalents from discontinued
    operations


(953
)






(953
)Net decrease in cash and cash equivalents


(5,195
)






(5,195
)Cash and cash equivalents at beginning of year


25,483







25,483Cash and cash equivalents at end of year

$
20,288


$



$
20,288  89




---



##### Table of Contents



PHOTON
    DYNAMICS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  NOTE 3 
    FINANCIAL
    STATEMENT COMPONENTS  September 30,2007


2006(In thousands)Consolidated Balance SheetInventories:Raw materials

$
7,465


$
10,740Work-in-process


4,491



7,036Finished goods


1,336



666Total

$
13,292


$
18,442Land, property and equipment:Land and building

$
5,055


$
7,056Equipment


15,665



15,952Office furniture and fixtures


2,479



2,864Leasehold improvements


8,442



8,59131,631



34,463Less: accumulated depreciation and amortization


(21,048
)


(18,572
)Total

$
10,583


$
15,891Other current liabilities:Compensation

$
4,897


$
3,460Vendor obligation


673



942Professional fees


2,441



891Customer deposits






1,500Other accrued expenses


1,863



2,174Total

$
9,874


$
8,967Deferred gross margin:Deferred system sales

$
10,269


$
12,217Deferred cost of revenue related to system sales


(7,033
)


(4,763
)Total

$
3,236


$
7,454Accumulated other comprehensive income:Foreign currency translation adjustments

$
(543
)

$
332Unrealized losses on available-for-sale securities


(60
)


(52
)Total

$
(603
)

$
280   90




---



##### Table of Contents



PHOTON
    DYNAMICS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  Year Ended September 30,2007


2006


2005As


Asrestated


restated(In thousands)Consolidated Statements of OperationsInterest income and other, netInterest income

$
4,490


$
3,741


$
2,187Interest expense


(627
)


(429
)


(373
)Foreign exchange gain (loss)


532
(1)


(335
)


210Other


(205
)


(174
)


(251
)Total

$
4,190


$
2,803


$
1,773     (1)
    
    In fiscal 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 4 
    DISCONTINUED
    OPERATIONS  Printed
    Circuit Board Assembly Inspection Business
         91




---



##### Table of Contents



PHOTON
    DYNAMICS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  Cathode
    Ray Tube Display and High Quality Glass Inspection
    Business
        NOTE 5 
    ACQUISITIONS  Year
    ended September 30, 2007 Acquisitions
      Purchase
    Price Allocation and Pro Forma Information
       92




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##### Table of Contents



PHOTON
    DYNAMICS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
        AllocationValue(In thousands)Net fair value of acquired tangible assets and assumed
    liabilities

$
750Developed technology


6,340Core technology


1,580In-process research and development


1,110Customer relationships


910Backlog


110Tradename


640Non-compete agreement


1,380Goodwill


6,704Total

$
19,524      93




---



##### Table of Contents



PHOTON
    DYNAMICS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
    Year Ended September 30,2007


2006(In thousands except per share data, unaudited)Total revenue

$
76,000


$
173,434Income (loss) from continuing operations


(34,238
)


2,601Net income (loss)


(34,238
)


2,474Pro forma income (loss) per share from continuing operations:Basic

$
(2.04
)

$
0.15Diluted

$
(2.04
)

$
0.15Pro forma income (loss) per share:Basic

$
(2.04
)

$
0.15Diluted

$
(2.04
)

$
0.15   NOTE 6 
    GOODWILL
    AND OTHER PURCHASED INTANGIBLE ASSETS  Goodwill
      Intangible
    Assets
    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  94




---



##### Table of Contents



PHOTON
    DYNAMICS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
    NonDeveloped


Core


License


CompeteTechnology


Technology


Agreement


Contract


Total(In thousands)Gross carrying amount at September 30, 2006

$
1,006


$
2,408


$
1,138


$
968


$
5,520Accumulated amortization


(578
)


(1,504
)


(948
)


(774
)


(3,804
)Net carrying amount at September 30, 2006

$
428


$
904


$
190


$
194


$
1,716     NonDeveloped


Core


License


Compete


Customer


TradeTechnology


Technology


Agreement


Contract


Relations


Name


Backlog


Total(In thousands)Balance as of September 30, 2005

$
680


$
1,506


$
570


$
449


$



$



$



$
3,205Amortization during the period


(252
)


(602
)


(380
)


(255
)














(1,489
)Balance as of September 30, 2006

$
428


$
904


$
190


$
194


$



$



$



$
1,716Acquired during the period


6,340



1,580







1,380



910



640



110



10,960Amortization during the period


(516
)


(607
)


(190
)


(267
)


(38
)


(27
)


(8
)


(1,653
)Balance as of September 30, 2007

$
6,252


$
1,877


$



$
1,307


$
872


$
613


$
102


$
11,023       NOTE 7 
    RESTRUCTURING
    AND OTHER CHARGES  March
    2007 Impairment of Property and Equipment
     95




---



##### Table of Contents



PHOTON
    DYNAMICS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
    February
    2007 Restructure
          One-TimeTerminationBenefits(In thousands)Inception of liability

$
1,017Cash payments


(926
)Adjustments to the liability


(91
)Balance at September 30, 2007

$
     November
    2006 Restructure
  tm
  tm
   96




---



##### Table of Contents



PHOTON
    DYNAMICS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
      One-TimeTermination


OtherBenefits


Costs


Total(In thousands)Inception of liability

$
173


$
273


$
446Cash payments


(171
)






(171
)Adjustments to the liability


(2
)


(273
)


(275
)Balance at September 30, 2007

$



$



$
     September
    2006 Impairment of Property and Equipment
    September
    2005 Impairment of Property and Equipment
    April
    2005 Restructure
  tm
     97




---



##### Table of Contents



PHOTON
    DYNAMICS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
      One-Time


ContractTermination


TerminationBenefits


Costs


Total(In thousands)Inception of liability

$
430


$
246


$
676Cash payments


(526
)


(21
)


(547
)Costs incurred and charged to expense


521







521Adjustments to the liability


24



(166
)


(142
)Balance at September 30, 2005


449



59



508Cash payments


(492
)


(16
)


(508
)Costs incurred and charged to expense


114







114Adjustments to the liability


(71
)


(5
)


(76
)Balance at September 30, 2006






38



38Cash payments






(14
)


(14
)Adjustments to the liability






1



1Balance at September 30, 2007

$



$
25


$
25     NOTE 8 
    FINANCIAL
    INSTRUMENTS  Short
    Term Investments
    Gross


GrossAmortized


Unrealized


Unrealized


EstimatedCost


Gains


Losses


Fair Value(In thousands)September 30, 2007Corporate debt securities

$
23,641


$
1


$
(63
)

$
23,579Auction rate preferred securities


16,235











16,235Mortgage-backed securities


4,000



3







4,003Money market bank deposits and other


18,697











18,697Total available-for-sale investments

$
62,573


$
4


$
(64
)

$
62,513Amounts included in:Cash equivalents

$
18,697


$



$



$
18,697Short-term investments


42,676



4



(40
)


42,640Long-term investments


1,200







(24
)


1,176Total available-for-sale investments

$
62,573


$
4


$
(64
)

$
62,513  98




---



##### Table of Contents



PHOTON
    DYNAMICS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  Gross


GrossAmortized


Unrealized


Unrealized


EstimatedCost


Gains


Losses


Fair Value(In thousands)September 30, 2006Auction rate preferred securities

$
46,765


$



$



$
46,765Corporate debt securities


20,849







(48
)


20,801Mortgage-backed securities


2,000







(4
)


1,996Money market bank deposits and other


22,167











22,167Total available-for-sale investments

$
91,781


$



$
(52
)

$
91,729Amounts included in:Cash equivalents

$
36,114


$



$
(6
)

$
36,108Short-term investments


54,867







(33
)


54,834Long-term investments


800







(13
)


787Total available-for-sale investments

$
91,781


$



$
(52
)

$
91,729     EstimatedCost


Fair Value(In thousands)Due in less than one year

$
45,138


$
45,102Due in 1 to 3 years


1,200



1,176Due in 3 to 5 years






Due in 5 to 10 years






Due in greater than 10 years


16,235



16,235Total cost and estimated fair values

$
62,573


$
62,513        99




---



##### Table of Contents



PHOTON
    DYNAMICS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
    In a Loss Position

In a Loss Positionfor Less Than

for 12 Months12 Months

or Greater

TotalGross



Gross



GrossUnrealized



Unrealized



UnrealizedFMV

Losses

FMV

Losses

FMV

Losses(In thousands)Corporate debt securities

$
20,476


$
(63
)

$
800


$
(1
)

$
21,276


$
(64
)   yield-at-cost
    Derivative
    Financial Instruments
      (3) non-U.S. dollar
   100




---



##### Table of Contents



PHOTON
    DYNAMICS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
    NOTE 9 
    INCOME
    TAXES    Year Ended September 30,2007


2006


2005(In thousands)Current:Federal

$
27


$
175


$
23State


76



2



8Foreign


210



356



678Deferred:Foreign


(33
)


28



(85
)Provision for income taxes

$
280


$
561


$
624     Year Ended September 30,2007


2006


2005As restated


As restated(In thousands)Domestic

$
(36,755
)

$
1,379


$
(28,558
)Foreign


1,963



1,350



8,053Income (loss) before income taxes

$
(34,792
)

$
2,729


$
(20,505
)  101




---



##### Table of Contents



PHOTON
    DYNAMICS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
    September 30,2007


2006As restated(In thousands)Deferred tax assets:Net operating loss carryforwards

$
44,310


$
31,782Research credit carryforwards


9,049



9,585Foreign research and development expenditures


10,885



10,884Purchased intangibles


3,755



3,005Inventory write-downs


5,807



5,198Depreciation


2,060



1,555Allowance for doubtful accounts


89



152Expenses not currently deductible


3,744



5,310Stock-based compensation


1,714



1,399Deferred revenue


3,360



4,500Total deferred tax assets


84,773



73,370Valuation allowance


(84,685
)


(73,312
)Net deferred tax assets


88



58Deferred tax liabilities






Total net deferred tax assets

$
88


$
58          102




---



##### Table of Contents



PHOTON
    DYNAMICS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
      Year Ended September 30,2007


2006


2005As restated


As restated(In thousands)Expected provision (benefit) at federal statutory rate

$
(12,175
)

$
955


$
(7,177
)Foreign income tax rate differences


99



(79
)


593Losses (benefited)/not benefited


11,961



(827
)


6,986Disallowed business meals, entertainment and penalties


50



196



206Nondeductible stock-based compensation


114



173



Nondeductible VIE losses


231



143



Other individually immaterial items










16Provision for income taxes

$
280


$
561


$
624   NOTE 10 
    SHAREHOLDERS
    EQUITY  Stock Option Exchange Program.
  Common Stock Repurchase Program.
  Total SharesAverage

Purchased

Shares YetTotal Shares

Price Paid

as Part

to be PurchasedPurchased

per Share

of the Plan

Under the PlanAugust 1 through August 31, 2006


503,581


$
13.17



503,581



596,419September 1 through September 30, 2006


26,020


$
13.35



529,601



570,399  103




---



##### Table of Contents



PHOTON
    DYNAMICS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
    Settlement of Escrow Shares.
  Stock Ownership Expense. No. 96-18,
  Shares Reserved.
  September 30,2007Stock options and awards outstanding


1,529,778Stock options and awards, available for grant


1,739,630Shares for employee stock purchase plan


829,915Exchange shares for previous acquisitions


32,699Total


4,132,022   NOTE 11 
    STOCK-BASED
    COMPENSATION PLANS AND OTHER EMPLOYEE BENEFITS   104




---



##### Table of Contents



PHOTON
    DYNAMICS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
    Year Ended September 30,2007


2006As restated(In thousands)Stock-based compensation expense included in continuing
    operations:Cost of revenue

$
318


$
401Research and development


400



676Selling, general and administrative


1,255



2,908Total stock-based compensation expense after income taxes(1)

$
1,973


$
3,985Stock-based compensation expense by type of award:Employee stock options

$
1,318


$
3,630Employee stock purchase plan


498



470Restricted stock awards


215



Amounts capitalized as inventory and deferred gross margin


(58
)


(115
)Total stock-based compensation expense after income taxes(1)

$
1,973


$
3,985     (1)
    
    The income tax benefit on stock-based compensation for all
    periods presented was not material.      Year EndedSeptember 30, 2005As restated(In thousands,except per share data)Net loss  as reported

$
(20,873
)Less: total stock-based employee compensation expense determined
    under fair value based method for all awards


(9,534
)Net loss  pro forma

$
(30,407
)Basic net loss per share  as reported

$
(1.24
)Diluted net loss per share  as reported

$
(1.24
)Basic net loss per share  pro forma

$
(1.80
)Diluted net loss per share  pro forma

$
(1.80
)    105




---



##### Table of Contents



PHOTON
    DYNAMICS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
      Equity
    Incentive and Other Programs
    The 2005 Equity Incentive Plan.
  2006 Non-Employee Directors Stock Incentive
    Plan.
     106




---



##### Table of Contents



PHOTON
    DYNAMICS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
    Valuation
    and Other Assumption
    Expected Volatility.
  Expected Term.
  Risk-Free Interest Rate.
  Expected Dividends.
  Forfeitures.
    Fiscal


Fiscal


Fiscal2007


2006


2005Stock option plan:Expected stock price volatility


43
%


44
%


69
%Risk free interest rate


4.7
%


4.5
%


3.4
%Expected life of options (years)


3.4



3.7



5.3Expected dividends


None



None



None   Bulletin No. 97-1,
 107




---



##### Table of Contents



PHOTON
    DYNAMICS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
    Fiscal


Fiscal


Fiscal2007


2006


2005Stock purchase plan:Expected stock price volatility


43
%


44
%


80
%Risk free interest rate


4.6
%


4.6
%


1.7
%Expected life of options (years)


0.5



0.5



1.6Expected dividends


None



None



None      108




---



##### Table of Contents



PHOTON
    DYNAMICS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  Equity
    Incentive Plan
    Weighted-AverageAwards





Weighted-


RemainingAvailable


Options


Average


Contract


Aggregatefor Grant


Outstanding


Exercise Price


Term (in years)


Intrinsic Value(In thousands)Balances at September 30, 2004


859,004



1,632,209


$
27.73Additional shares reserved


1,200,000







Options granted


(797,800
)


797,800



19.37Options canceled/expired


402,104



(399,144
)


28.89Options exercised






(84,591
)


13.59Balances at September 30, 2005


1,663,308



1,946,274


$
24.64Plan shares expired(1)


(789,818
)






Options granted


(472,950
)


472,950



18.37Options canceled/expired


397,796



(397,796
)


25.36Options exercised






(70,733
)


15.06Balances at September 30, 2006


798,336



1,950,695


$
23.28Additional shares reserved


1,000,000







Plan shares expired(1)


(474,204
)






Options granted


(454,375
)


454,375



11.42Restricted stock units granted(2)


(304,338
)


Restricted stock units canceled(2)


20,142



Options canceled/expired


1,154,069



(1,154,069
)


23.01Options exercised






(5,419
)


4.91Balances at September 30, 2007


1,739,630



1,245,582


$
19.29



5.6


$
103Vested and expected to vest at September 30, 2007






1,052,907


$
20.51



5.5


$
103Exercisable at September 30, 2007






779,927


$
23.21



5.0


$
103     (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 restricted
    stock units outstanding are shown below.     109




---



##### Table of Contents



PHOTON
    DYNAMICS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
        Restricted
    Stock Units
    Weighted-AverageNumber


Grant Dateof Shares


Fair ValueUnvested restricted stock units at September 30, 2006





$
Granted


304,338


$
10.43Vested





$
Forfeited


(20,142
)

$
10.43Unvested restricted stock units at September 30, 2007


284,196


$
10.43       Employee
    Stock Purchase Plan
      Other
    Employee Benefit Plans
  Retirement Savings Plan.
 110




---



##### Table of Contents



PHOTON
    DYNAMICS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
    NOTE 12 
    NET
    INCOME (LOSS) PER SHARE      Year Ended September 30,2007


2006


2005As


Asrestated


restated(In thousands, except per share data)Numerator:Net income (loss) from continuing operations before discontinued
    operations

$
(35,072
)

$
2,168


$
(21,129
)Net income (loss) from discontinued operations






(127
)


256Net income (loss)

$
(35,072
)

$
2,041


$
(20,873
)Denominator:Weighted average shares for basic net income (loss) per share


16,814



16,978



16,890Effect of dilutive securities: Employee stock options



(1)


33




(1)Weighted average shares for diluted net income (loss) per share


16,814



17,011



16,890Earnings per share:Basic net income (loss) per share:Net income (loss) from continuing operations

$
(2.09
)

$
0.13


$
(1.25
)Net income (loss) from discontinued operations






(0.01
)


0.02Net income (loss) per share

$
(2.09
)

$
0.12


$
(1.24
)Diluted net income (loss) per share:Net income (loss) from continuing operations

$
(2.09
)

$
0.13


$
(1.25
)Net income (loss) from discontinued operations






(0.01
)(2)


0.02Net income (loss) per share

$
(2.09
)

$
0.12


$
(1.24
)     (1)
    
    The effect of potentially dilutive securities from employee
    stock options and restricted stock units to purchase 299,792 and
    124,060 shares at September 30, 2007 and 2005,
    respectively, were not included in the computation of diluted
    net loss per share as the effect is antidilutive. 111




---



##### Table of Contents



PHOTON
    DYNAMICS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
   (2)
    
    In accordance with Statement of Accounting Standards
    No. 128 Earnings Per Share, the Company
    included the effect of dilutive securities from employee stock
    options to purchase 33,000 shares in its calculation of
    fiscal 2006 diluted net loss from discontinued operations.    Year Ended September 30,2007


2006


2005(In thousands)Number of shares


1,714



1,949



1,203   NOTE 13 
    COMMITMENTS
    AND CONTINGENCIES  Operating
    and Capital Leases
        Line
    of Credit
    Purchase
    Agreements
   112




---



##### Table of Contents



PHOTON
    DYNAMICS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  Retention
    Bonus
    Warranty
    Obligations
      Fiscal


Fiscal2007


2006(In thousands)Beginning balance

$
8,058


$
5,346Estimated warranty cost of new shipments during the period


4,528



5,903Warranty charges during the period


(10,143
)


(5,112
)Changes in liability for pre-existing warranties, including
    expirations


774



1,921Ending balance

$
3,217


$
8,058   tm
  Guarantees
   113




---



##### Table of Contents



PHOTON
    DYNAMICS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  Legal
    Proceedings
        NOTE 14 
    SEGMENT
    REPORTING AND GEOGRAPHIC INFORMATION     114




---



##### Table of Contents



PHOTON
    DYNAMICS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
      Year Ended September 30,2007


2006


2005(In thousands)Revenue:South Korea

$
26,197


$
113,288


$
41,474Taiwan


23,332



41,108



53,159Japan


18,681



7,665



17,044China


4,655



10,811



14,136United States


1,402







Total

$
74,267


$
172,872


$
125,813     Year Ended September 30,2007


2006


2005(Percent of total revenue)Revenue:ArrayCheckertm


57
%


66
%


60
%ArraySavertm


15



19



24PanelMastertm


1



6



6Customer spares and other


27



9



10Total


100
%


100
%


100
%     Year Ended September 30,2007


2006


2005(Percent of total revenue)Customer A


24
%


*



12
%Customer B


20
%


39
%


22
%Customer C


17
%


12
%


*Customer D


16
%


25
%


10
%Customer E


*



*



12
%Customer F


*



*



11
%     *
    
    Customer accounted for less than 10% of total revenue for the
    period. 115




---



##### Table of Contents



PHOTON
    DYNAMICS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
     September 30,2007


2006(Percent of total receivable)Customer A


28
%


16
%Customer B


26
%


16
%Customer C


19
%


37
%Customer D


*



21
%     *
    
    Customer accounted for less than 10% of total gross accounts
    receivable for the period.    September 30,2007


2006(In thousands)United States

$
27,518


$
16,234South Korea


756



1,229Other


189



297Total

$
28,463


$
17,760   NOTE 15 
    RELATED
    PARTY TRANSACTIONS        NOTE 16 
    NOTES PAYABLE     116




---



##### Table of Contents



PHOTON
    DYNAMICS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  NOTE 17 
    SUBSEQUENT
    EVENTS (UNAUDITED)    NOTE 18 
    QUARTERLY
    CONSOLIDATED RESULTS OF OPERATIONS (UNAUDITED)    
    The condensed consolidated quarterly statements of operations
    for each of the quarters ended March 31, 2007,
    December 30, 2006, September 30, 2006, June 30,
    2006, March 31, 2006 and December 31, 2005,
    The condensed consolidated balance sheets as of March 31,
    2007, December 30, 2006, June 30, 2006, March 31,
    2006 and December 31, 2005,
    The condensed consolidated statements of cash flows for
    year-to-date periods in each of the quarters ended
    March 31, 2007, December 30, 2006, June 30, 2006,
    March 31, 2006 and December 31, 2005.       117




---



##### Table of Contents



PHOTON
    DYNAMICS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  Condensed
    Consolidated Statements of Operations (unaudited)
  Three Months Ended


Three Months EndedDecember 31, 2006


December 31, 2005As Previously


As


As Previously


AsReported


Restated


Reported


Restated(In thousands, except per share data)Revenue

$
21,435


$
21,435


$
41,633


$
41,633Cost of revenue


15,871



15,950



22,382



22,671Gross margin


5,564



5,485



19,251



18,962Operating expenses:Research and development


7,995



7,936



8,071



8,249Selling, general and administrative


4,930



4,882



6,851



6,834Restructuring charge


446



446



62



62Amortization of intangible assets


373



373



372



372Total operating expenses


13,744



13,637



15,356



15,517Income (loss) from operations


(8,180
)


(8,152
)


3,895



3,445Interest income and other, net


1,081



1,014



500



420Income (loss) from continuing operations before income taxes and
    discontinued operations


(7,099
)


(7,138
)


4,395



3,865Provision for income taxes


101



101



352



352Income (loss) from continuing operations before discontinued
    operations


(7,200
)


(7,239
)


4,043



3,513Loss from discontinued operations










(680
)


(680
)Net income (loss)

$
(7,200
)

$
(7,239
)

$
3,363


$
2,833Net income (loss) per share from continuing operations:Basic

$
(0.43
)

$
(0.44
)

$
0.24


$
0.21Diluted

$
(0.43
)

$
(0.44
)

$
0.24


$
0.21Net loss per share from discontinued operations:Basic

$



$



$
(0.04
)

$
(0.04
)Diluted

$



$



$
(0.04
)

$
(0.04
)Net income (loss) per share:Basic

$
(0.43
)

$
(0.44
)

$
0.20


$
0.17Diluted

$
(0.43
)

$
(0.44
)

$
0.20


$
0.17Weighted average number of shares:Basic


16,590



16,590



16,946



16,946Diluted


16,590



16,590



17,047



17,047  118




---



##### Table of Contents



PHOTON
    DYNAMICS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  Condensed
    Consolidated Statements of Operations (unaudited)
  Three Months Ended


Six Months EndedMarch 31, 2007


March 31, 2007As Previously


As


As Previously


AsReported


Restated


Reported


Restated(In thousands, except per share data)Revenue

$
13,928


$
13,928


$
35,363


$
35,363Cost of revenue


13,391



13,604



29,262



29,554Gross margin


537



324



6,101



5,809Operating expenses:Research and development


7,197



7,194



15,192



15,130Selling, general and administrative


6,550



6,484



11,480



11,366Restructuring charge


1,017



1,017



1,463



1,463Impairment of property and equipment


2,834



2,834



2,834



2,834Amortization of intangible assets


372



372



745



745Total operating expenses


17,970



17,901



31,714



31,538Loss from operations


(17,433
)


(17,577
)


(25,613
)


(25,729
)Interest income and other, net


2,015



1,996



3,096



3,010Loss from continuing operations before income taxes and
    discontinued operations


(15,418
)


(15,581
)


(22,517
)


(22,719
)Provision for income taxes


105



105



206



206Loss from continuing operations before discontinued operations


(15,523
)


(15,686
)


(22,723
)


(22,925
)Income (loss) from discontinued operations














Net loss

$
(15,523
)

$
(15,686
)

$
(22,723
)

$
(22,925
)Net loss per share from continuing operations:Basic

$
(0.94
)

$
(0.95
)

$
(1.37
)

$
(1.38
)Diluted

$
(0.94
)

$
(0.95
)

$
(1.37
)

$
(1.38
)Net income (loss) per share from discontinued operations:Basic

$



$



$



$
Diluted

$



$



$



$
Net loss per share:Basic

$
(0.94
)

$
(0.95
)

$
(1.37
)

$
(1.38
)Diluted

$
(0.94
)

$
(0.95
)

$
(1.37
)

$
(1.38
)Weighted average number of shares:Basic


16,591



16,591



16,590



16,590Diluted


16,591



16,591



16,590



16,590  119




---



##### Table of Contents



PHOTON
    DYNAMICS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  Condensed
    Consolidated Statements of Operations (unaudited)
  Three Months Ended


Six Months EndedMarch 31, 2006


March 31, 2006As Previously


As


As Previously


AsReported


Restated


Reported


Restated(In thousands, except per share data)Revenue

$
50,322


$
50,322


$
91,955


$
91,955Cost of revenue


33,069



33,381



55,451



56,052Gross margin


17,253



16,941



36,504



35,903Operating expenses:Research and development


8,560



8,556



16,631



16,805Selling, general and administrative


6,984



6,959



13,835



13,793Restructuring charge (benefit)


(32
)


(32
)


30



30Amortization of intangible assets


373



373



745



745Total operating expenses


15,885



15,856



31,241



31,373Income from operations


1,368



1,085



5,263



4,530Interest income and other, net


1,019



808



1,519



1,228Income from continuing operations before income taxes and
    discontinued operations


2,387



1,893



6,782



5,758Provision for income taxes


199



199



551



551Income from continuing operations before discontinued operations


2,188



1,694



6,231



5,207Income (loss) from discontinued operations


334



334



(346
)


(346
)Net income

$
2,522


$
2,028


$
5,885


$
4,861Net income per share from continuing operations:Basic

$
0.13


$
0.10


$
0.37


$
(0.31
)Diluted

$
0.13


$
0.10


$
0.37


$
(0.31
)Net income (loss) per share from discontinued operations:Basic

$
0.02


$
0.02


$
(0.02
)

$
(0.02
)Diluted

$
0.02


$
0.02


$
(0.02
)

$
(0.02
)Net income per share:Basic

$
0.15


$
0.12


$
0.35


$
(0.29
)Diluted

$
0.15


$
0.12


$
0.34


$
(0.28
)Weighted average number of shares:Basic


17,018



17,018



17,011



17,011Diluted


17,077



17,077



17,062



17,062  120




---



##### Table of Contents



PHOTON
    DYNAMICS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  Condensed
    Consolidated Statements of Operations (unaudited)
  Three


NineMonths


MonthsEnded


EndedJune 30,


June 30,2007


2007(In thousands, except per share data)Revenue

$
14,430


$
49,793Cost of revenue


11,215



40,769Gross margin


3,215



9,024Operating expenses:Research and development


6,213



21,343Selling, general and administrative


5,831



17,197Restructuring charge


(95
)


1,368Impairment of property and equipment






2,834Amortization of intangible assets


254



999Total operating expenses


12,203



43,741Loss from operations


(8,988
)


(34,717
)Interest income and other, net


327



3,337Loss from continuing operations before income taxes and
    discontinued operations


(8,661
)


(31,380
)Provision for income taxes


72



278Loss from continuing operations before discontinued operations


(8,733
)


(31,658
)Income (loss) from discontinued operations






Net loss

$
(8,733
)

$
(31,658
)Net loss per share from continuing operations:Basic

$
(0.52
)

$
(1.91
)Diluted

$
(0.52
)

$
(1.91
)Net income (loss) per share from discontinued operations:Basic

$



$
Diluted

$



$
Net loss per share:Basic

$
(0.52
)

$
(1.91
)Diluted

$
(0.52
)

$
(1.91
)Weighted average number of shares:Basic


16,635



16,605Diluted


16,635



16,605  121




---



##### Table of Contents



PHOTON
    DYNAMICS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  Condensed
    Consolidated Statements of Operations (unaudited)
  Three Months EndedJune 30, 2006


Nine Months EndedAs





June 30, 2006Previously


As


As Previously


AsReported


Restated


Reported


Restated(In thousands, except per share data)Revenue

$
51,658


$
51,658


$
143,613


$
143,613Cost of revenue


32,178



32,573



87,629



88,625Gross margin


19,480



19,085



55,984



54,988Operating expenses:Research and development


8,508



8,492



25,139



25,297Selling, general and administrative


6,968



6,929



20,803



20,722Restructuring charge










30



30Impairment of property and equipment


50



50



50



50Amortization of intangible assets


372



372



1,117



1,117Total operating expenses


15,898



15,843



47,139



47,216Income from operations


3,582



3,242



8,845



7,772Interest income and other, net


999



859



2,518



2,087Income from continuing operations before income taxes and
    discontinued operations


4,581



4,101



11,363



9,859Provision for income taxes


205



205



756



756Income from continuing operations before discontinued operations


4,376



3,896



10,607



9,103Loss from discontinued operations


(127
)


(127
)


(473
)


(473
)Net income

$
4,249


$
3,769


$
10,134


$
8,630Net income per share from continuing operations:Basic

$
0.26


$
0.23


$
0.62


$
0.53Diluted

$
0.26


$
0.23


$
0.62


$
0.53Net loss per share from discontinued operations:Basic

$
(0.01
)

$
(0.01
)

$
(0.03
)

$
(0.03
)Diluted

$
(0.01
)

$
(0.01
)

$
(0.03
)

$
(0.03
)Net income per share:Basic

$
0.25


$
0.22


$
0.60


$
0.51Diluted

$
0.25


$
0.22


$
0.59


$
0.51Weighted average number of shares:Basic


17,047



17,047



17,023



17,023Diluted


17,077



17,077



17,065



17,065  122




---



##### Table of Contents



PHOTON
    DYNAMICS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  Condensed
    Consolidated Statements of Operations (unaudited)
  Three Months


Three Months EndedEnded


September 30, 2006September 30,


As Previously


As2007


Reported


Restated(In thousands, except per share data)Revenue

$
24,474


$
29,259


$
29,259Cost of revenue


15,605



25,142



25,580Gross margin


8,869



4,117



3,679Operating expenses:Research and development


5,404



7,281



7,280Selling, general and administrative


5,879



3,808



3,784Impairment of property and equipment






31



31Loss on sale of fixed assets


87



58



58Acquired in-process research and development


1,110







Amortization of intangible assets


654



372



372Total operating expenses


13,134



11,550



11,525Loss from operations


(4,265
)


(7,433
)


(7,846
)Interest income and other, net


853



838



717Loss from continuing operations before income taxes and
    discontinued operations


(3,412
)


(6,595
)


(7,129
)Provision (benefit) for income taxes


3



(195
)


(195
)Loss from continuing operations before discontinued operations


(3,415
)


(6,400
)


(6,934
)Income from discontinued operations






346



346Net loss

$
(3,415
)

$
(6,054
)

$
(6,588
)Net loss per share from continuing operations:Basic

$
(0.20
)

$
(0.38
)

$
(0.41
)Diluted

$
(0.20
)

$
(0.38
)

$
(0.41
)Net income per share from discontinued operations:Basic

$



$
0.02


$
0.02Diluted

$



$
0.02


$
0.02Net loss per share:Basic

$
(0.20
)

$
(0.36
)

$
(0.39
)Diluted

$
(0.20
)

$
(0.36
)

$
(0.39
)Weighted average number of shares:Basic


17,434



16,849



16,849Diluted


17,434



16,849



16,849  123




---



##### Table of Contents



PHOTON
    DYNAMICS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  Condensed
    Consolidated Balance Sheets (unaudited)
  December 31, 2005


March 31, 2006


June 30, 2006As Previously


As


As Previously


As


As Previously


AsReported


Restated


Reported


Restated


Reported


Restated(In thousands, except per share data)ASSETSCurrent assets:Cash and cash equivalents

$
20,376


$
20,376


$
19,600


$
19,600


$
22,483


$
22,483Short-term investments


72,347



72,347



68,713



68,713



68,147



68,147Accounts receivable, net


28,361



28,361



38,523



38,523



57,253



57,253Inventories


31,392



31,392



31,183



31,183



19,754



19,754Refundable customs obligations






2,033







2,403







2,753Other current assets


3,252



3,252



4,390



4,390



4,379



4,379Total current assets


155,728



157,761



162,409



164,812



172,016



174,769Land, property and equipment, net


18,116



18,116



17,805



17,805



16,867



16,867Other assets


5,172



5,172



3,632



3,632



4,197



4,197Intangible assets, net


2,833



2,833



2,460



2,460



2,088



2,088Goodwill


153



153



153



153



153



153Total assets

$
182,002


$
184,035


$
186,459


$
188,862


$
195,321


$
198,074LIABILITIES AND SHAREHOLDERS EQUITYCurrent liabilities:Accounts payable

$
9,413


$
9,173


$
13,169


$
12,921


$
10,337


$
9,977Warranty


3,898



3,898



4,784



4,784



5,367



5,367Customs obligations






5,810







6,707







7,671Other current liabilities


14,093



14,093



11,194



11,194



13,126



13,126Deferred gross margin


6,251



6,251



5,393



5,393



10,016



10,016Total current liabilities


33,655



39,225



34,540



40,999



38,846



46,157Other non-current liabilities


973



973



982



982



19



19Commitments and contingenciesShareholders equity:Common stock


289,153



289,129



290,300



290,251



291,554



291,483Accumulated deficit


(142,126
)


(145,639
)


(139,604
)


(143,611
)


(135,355
)


(139,842
)Accumulated other comprehensive income


347



347



241



241



257



257Total shareholders equity


147,374



143,837



150,937



146,881



156,456



151,898Total liabilities and shareholders equity

$
182,002


$
184,035


$
186,459


$
188,862


$
195,321


$
198,074  124




---



##### Table of Contents



PHOTON
    DYNAMICS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  Condensed
    Consolidated Balance Sheets (unaudited)
  December 31, 2006


March 31, 2007As Previously


As


As Previously


AsReported


Restated


Reported


Restated


June 30, 2007(In thousands, except per share data)ASSETSCurrent assets:Cash and cash equivalents

$
19,085


$
19,085


$
25,253


$
25,253






$
28,253Short-term investments


78,009



78,009



56,815



56,815







55,909Accounts receivable, net


18,055



18,055



14,255



14,255







18,927Inventories


24,938



24,938



26,187



26,187







18,097Refundable customs obligations






3,551







3,808







4,082Other current assets


3,902



3,902



3,432



3,432







3,518Total current assets


143,989



147,540



125,942



129,750







128,786Long-term investments










8,389



8,389







4,147Land, property and equipment, net


15,054



15,054



11,200



11,200







10,210Other assets


6,063



5,381



5,489



4,793







4,826Intangible assets, net


1,343



1,343



971



971







717Goodwill


153



153



153



153







153Total assets

$
166,602


$
169,471


$
152,144


$
155,256






$
148,839LIABILITIES AND SHAREHOLDERS EQUITYCurrent liabilities:Accounts payable

$
7,199


$
6,638


$
7,217


$
6,572






$
7,033Warranty


7,858



7,858



7,418



7,418







4,691Customs obligations






9,663







10,306







11,144Other current liabilities


10,276



9,245



11,807



10,687







9,679Deferred gross margin


2,841



2,841



2,985



2,985







6,603Total current liabilities


28,174



36,245



29,427



37,968







39,150Other non-current liabilities


118



118



107



107







95Commitments and contingenciesShareholders equity:Common stock


286,681



286,539



287,433



287,228







288,376Accumulated deficit


(148,609
)


(153,670
)


(164,132
)


(169,356
)






(178,088
)Accumulated other comprehensive income


238



238



(691
)


(691
)






(693
)Total shareholders equity


138,310



133,107



122,610



117,181







109,595Total liabilities and shareholders equity

$
166,602


$
169,471


$
152,144


$
155,256






$
148,839  125




---



##### Table of Contents



PHOTON
    DYNAMICS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  Condensed
    Consolidated Statements of Cash Flows (unaudited)
  Fiscal 2007Three Months Ended


Six Months EndedDecember 31, 2006


March 31, 2007


Nine MonthsAs Previously


As


As Previously


As


EndedReported


Restated


Reported


Restated


June 30, 2007(In thousands)Cash flows from operating activities:Net loss from continuing operations

$
(7,200
)

$
(7,239
)

$
(22,723
)

$
(22,925
)





$
(31,658
)Adjustments to reconcile net loss from continuing operations to
    net cash used in operating activities from continuing operations:Depreciation


1,217



1,217



2,541



2,541







3,653Amortization of intangible assets


373



373



745



745







999Stock-based compensation


400



352



1,117



1,006







1,513Foreign currency translation adjustment gain recognized upon
    liquidation of a subsidiary










(928
)


(928
)






(928
)Impairment of property and equipment










2,834



2,834







2,834Restructuring charge


273



273



273



273







178Accretion of non-interest bearing notes payable


8



8



15



15







23Changes in assets and liabilities:Accounts receivable


11,286



11,286



15,086



15,086







10,414Inventories


(6,435
)


(6,435
)


(7,663
)


(7,663
)






428Other current assets


132



(261
)


540



(111
)






(471
)Other assets


(1,521
)


(839
)


(947
)


(251
)






(284
)Accounts payable


(458
)


(619
)


(440
)


(685
)






(224
)Other current liabilities


139



98



1,249



1,762







(1,022
)Deferred gross margin


(4,613
)


(4,613
)


(4,469
)


(4,469
)






(851
)Other liabilities


(1
)


(1
)


(12
)


(12
)






(24
)Net cash used in operating activities from continuing operations


(6,400
)


(6,400
)


(12,782
)


(12,782
)






(15,419
)Net cash used in operating activities from discontinued
    operations


(56
)


(56
)














Net cash used in operating activities


(6,456
)


(6,456
)


(12,782
)


(12,782
)






(15,419
)Cash flows from investing activities:Purchase of property and equipment


(687
)


(687
)


(923
)


(923
)






(1,040
)Purchase of short-term investments


(41,795
)


(41,795
)


(63,815
)


(63,815
)






(82,711
)Maturities and sales of short-term investments


19,373



19,373



54,228



54,228







78,264Net cash used in investing activities from continuing operations


(23,109
)


(23,109
)


(10,510
)


(10,510
)






(5,487
)Cash flows from financing activities:Issuance of common stock, net


710



710



724



724







1,364Capital lease repayments


(21
)


(21
)


(41
)


(41
)






(68
)Net cash provided by financing activities from continuing
    operations


689



689



683



683







1,296Effect of exchange rate changes on cash and cash equivalents


26



26



(73
)


(73
)






(72
)Net decrease in cash and cash equivalents from continuing
    operations


(28,794
)


(28,794
)


(22,682
)


(22,682
)






(19,682
)Net decrease in cash and cash equivalents from discontinued
    operations


(56
)


(56
)














Net decrease in cash and cash equivalents


(28,850
)


(28,850
)


(22,682
)


(22,682
)






(19,682
)Cash and cash equivalents at beginning of year


47,935



47,935



47,935



47,935







47,935Cash and cash equivalents at end of period

$
19,085


$
19,085


$
25,253


$
25,253






$
28,253  126




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##### Table of Contents



PHOTON
    DYNAMICS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  Condensed
    Consolidated Statements of Cash Flows (unaudited)
  Fiscal 2006Three Months Ended


Six Months Ended


Nine Months EndedDecember 31, 2005


March 31, 2006


June 30, 2006As





As





AsPreviously


As


Previously


As


Previously


AsReported


Restated


Reported


Restated


Reported


Restated(In thousands)Cash flows from operating activities:Net income from continuing operations

$
4,043


$
3,513


$
6,231


$
5,207


$
10,607


$
9,103Adjustments to reconcile net income from continuing operations
    to net cash used in operating activities from continuing
    operations:Depreciation


1,439



1,439



2,959



2,959



4,326



4,326Amortization of intangible assets


372



372



745



745



1,117



1,117Stock-based compensation


985



961



2,003



1,954



2,954



2,883Impairment of property and equipment


















50



50Non-employee stock ownership expense


6



6



14



14



14



14Restructuring charge


















30



30Loss on sale of property and equipment


6



6















Accretion of non-interest bearing notes payable


9



9



22



22



31



31Changes in assets and liabilities:Accounts receivable


(1,294
)


(1,294
)


(11,456
)


(11,456
)


(30,185
)


(30,185
)Inventories


1,188



1,188



1,521



1,521



13,084



13,084Other current assets


505



270



(634
)


(1,239
)


(622
)


(1,577
)Other assets


(541
)


(541
)


48



48



(319
)


(319
)Accounts payable


(3,513
)


(3,586
)


243



162



(2,589
)


(2,782
)Other current liabilities


3,611



4,473



1,789



3,548



4,109



6,832Deferred gross margin


(6,862
)


(6,862
)


(7,720
)


(7,720
)


(3,097
)


(3,097
)Other liabilities


(40
)


(40
)


(30
)


(30
)


(40
)


(40
)Net cash used in operating activities from continuing operations


(86
)


(86
)


(4,265
)


(4,265
)


(531
)


(531
)Net cash used in operating activities from discontinued
    operations


(413
)


(413
)


(580
)


(580
)


(1,169
)


(1,169
)Net cash used in operating activities


(499
)


(499
)


(4,845
)


(4,845
)


(1,700
)


(1,700
)Cash flows from investing activities:Purchase of property and equipment


(195
)


(195
)


(1,408
)


(1,408
)


(1,887
)


(1,887
)Purchase of short-term investments


(16,323
)


(16,323
)


(43,175
)


(43,175
)


(100,288
)


(100,288
)Maturities and sales of short-term investments


16,788



16,788



47,383



47,383



105,103



105,103Net cash provided by investing activities from continuing
    operations


270



270



2,800



2,800



2,928



2,928Cash flows from financing activities:Issuance of common stock, net


362



362



1,617



1,617



1,785



1,785Repayment of short-term notes


















(533
)


(533
)Net cash provided by financing activities from continuing
    operations


362



362



1,617



1,617



1,252



1,252Effect of exchange rate changes on cash and cash equivalents


(45
)


(45
)


(260
)


(260
)


(285
)


(285
)Net increase (decrease) in cash and cash equivalents from
    continuing operations


501



501



(108
)


(108
)


3,364



3,364Net decrease in cash and cash equivalents from discontinued
    operations


(413
)


(413
)


(580
)


(580
)


(1,169
)


(1,169
)Net increase (decrease) in cash and cash equivalents


88



88



(688
)


(688
)


2,195



2,195Cash and cash equivalents at beginning of year


20,288



20,288



20,288



20,288



20,288



20,288Cash and cash equivalents at end of period

$
20,376


$
20,376


$
19,600


$
19,600


$
22,483


$
22,483  127




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##### Table of Contents



PHOTON
    DYNAMICS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  Supplemental
    Information (unaudited)
  Adjustments
    Fiscal 2007Three Months


Three MonthsEnded


EndedDecember 31, 2006


March 31, 2007(In thousands)Cost of revenues:As previously reported

$
15,871


$
13,391Adjustments:Customs and duties


181



291Other accounting errors


(102
)


(78
)As restated

$
15,950


$
13,604Research and development:As previously reported

$
7,995


$
7,197Adjustments:Customs and duties






Other accounting errors


(59
)


(3
)As restated

$
7,936


$
7,194Selling, general and administrative:As previously reported

$
4,930


$
6,550Adjustments:Customs and duties






Other accounting errors


(48
)


(66
)As restated

$
4,882


$
6,484Interest income and other, net:As previously reported

$
1,081


$
2,015Adjustments:Customs and duties


(67
)


19Other accounting errors






As restated

$
1,014


$
1,996Net income (loss):As previously reported

$
(7,200
)

$
(15,523
)Adjustments:Customs and duties


(248
)


(310
)Other accounting errors


209



147As restated

$
(7,239
)

$
(15,686
)  128




---



##### Table of Contents



PHOTON
    DYNAMICS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  Fiscal 2007Six MonthsEndedMarch 31, 2007(In thousands)Cost of revenues:As previously reported

$
29,262Adjustments:Customs and duties


472Other accounting errors


(180
)As restated

$
29,554Research and development:As previously reported

$
15,192Adjustments:Customs and duties


Other accounting errors


(62
)As restated

$
15,130Selling, general and administrative:As previously reported

$
11,480Adjustments:Customs and duties


Other accounting errors


(114
)As restated

$
11,366Interest income and other, net:As previously reported

$
3,096Adjustments:Customs and duties


(86
)Other accounting errors


As restated

$
3,010Net income (loss):As previously reported

$
(22,723
)Adjustments:Customs and duties


(557
)Other accounting errors


355As restated

$
(22,925
)   129




---



##### Table of Contents



PHOTON
    DYNAMICS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  Fiscal 2006Three Months


Three Months


Three Months


Three MonthsEnded


Ended


Ended


EndedDecember 31,


March 31,


June 30,


September 30,2005


2006


2006


2006(In thousands)Cost of revenues:As previously reported

$
22,382


$
33,069


$
32,178


$
25,142Adjustments:Customs and duties


358



316



474



476Other accounting errors


(69
)


(4
)


(79
)


(38
)As restated

$
22,671


$
33,381


$
32,573


$
25,580Research and development:As previously reported

$
8,071


$
8,560


$
8,508


$
7,281Adjustments:Customs and duties














Other accounting errors


178



(4
)


(16
)


(1
)As restated

$
8,249


$
8,556


$
8,492


$
7,280Selling, general and administrative:As previously reported

$
6,851


$
6,984


$
6,968


$
3,808Adjustments:Customs and duties














Other accounting errors


(17
)


(25
)


(39
)


(24
)As restated

$
6,834


$
6,959


$
6,929


$
3,784Interest income and other, net:As previously reported

$
500


$
1,019


$
999


$
838Adjustments:Customs and duties


(80
)


(211
)


(140
)


(121
)Other accounting errors














As restated

$
420


$
808


$
859


$
717Net income (loss):As previously reported

$
3,363


$
2,522


$
4,249


$
(6,054
)Adjustments:Customs and duties


(438
)


(527
)


(614
)


(597
)Other accounting errors


(92
)


33



134



63As restated

$
2,833


$
2,028


$
3,769


$
(6,588
)   130




---



##### Table of Contents



PHOTON
    DYNAMICS, INC.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  Fiscal 2006Six Months


Nine Months


Twelve MonthsEnded


Ended


EndedMarch 31,


June 30,


September 30,2006


2006


2006(In thousands)Cost of revenues:As previously reported

$
55,451


$
87,629


$
112,771Adjustments:Customs and duties


674



1,148



1,624Other accounting errors


(73
)


(152
)


(190
)As restated

$
56,052


$
88,625


$
114,205Research and development:As previously reported

$
16,631


$
25,139


$
32,420Adjustments:Customs and duties










Other accounting errors


174



158



157As restated

$
16,805


$
25,297


$
32,577Selling, general and administrative:As previously reported

$
13,835


$
20,803


$
24,611Adjustments:Customs and duties










Other accounting errors


(42
)


(81
)


(105
)As restated

$
13,793


$
20,722


$
24,506Interest income and other, net:As previously reported

$
1,519


$
2,518


$
3,356Adjustments:Customs and duties


(291
)


(431
)


(553
)Other accounting errors










As restated

$
1,228


$
2,087


$
2,803Net income (loss):As previously reported

$
5,885


$
10,134


$
4,080Adjustments:Customs and duties


(965
)


(1,579
)


(2,176
)Other accounting errors


(59
)


75



138As restated

$
4,861


$
8,630


$
2,042  131




---



##### Table of Contents



ITEM 9.
    CHANGES
    IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
    FINANCIAL DISCLOSURE    ITEM 9A.
    CONTROLS
    AND PROCEDURES  Restatement
    of Previously Issued Financial Statements
      Form 10-K Form 10-K).
  Evaluation
    of Disclosure Controls and Procedures
  Rules 13a-15(e) 15d-15(e)
 132




---



##### Table of Contents



Managements
    Report on Internal Control Over Financial Reporting
  Rules 13a-15(f) 15d-15(f)
    Internal Control 
    Integrated Framework.
  Description
    of Material Weaknesses as of September 30,
    2007
    
    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 133




---



##### Table of Contents



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.  Form 10-K
  Form 10-K.
  Remediation
    of Material Weaknesses
    
    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; and
    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.      Inherent
    Limitations of Disclosure Controls and Procedures and Internal
    Control Over Financial Reporting.
   134




---



##### Table of Contents



Changes
    in Internal Control over Financial Reporting
    CEO and
    CFO Certifications
  Form 10-K
  ITEM 9B.
    OTHER
    INFORMATION   PART III  Form 10-K Form 10-K,
  ITEM 10.
    DIRECTORS
    AND EXECUTIVE OFFICERS OF THE REGISTRANT    www.photondynamcis.com Form 10-K
  ITEM 11.
    EXECUTIVE
    COMPENSATION   135




---



##### Table of Contents



ITEM 12.
    SECURITY
    OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
    RELATED STOCKHOLDER MATTERS      ITEM 13.
    CERTAIN
    RELATIONSHIPS AND RELATED TRANSACTIONS    ITEM 14.
    PRINCIPAL
    INDEPENDENT REGISTERED PUBLIC ACCOUNTANT FIRM FEES AND
    SERVICES   PART IV  ITEM 15.
    EXHIBITS AND
    FINANCIAL STATEMENT SCHEDULES  Financial Statements
  Form 10-K,
  Financial Statement Schedules
  Form 10-K.
 136




---



##### Table of Contents



SCHEDULE II  PHOTON
    DYNAMICS, INC.
  VALUATION
    AND QUALIFYING ACCOUNT
  Balance at


Charged to


Charged to





Balance atBeginning


(Credited to)


Other





End ofof Period


Expense


Accounts


Deductions


Period(In thousands)Allowance for doubtful accounts:Fiscal 2007

$
406



233







(400
)

$
239Fiscal 2006

$
153



270







(17
)

$
406Fiscal 2005

$
497



(324
)






(20
)

$
153   3.
    Exhibits  Form 10-K,
  (b)
    Exhibits    (c)
    Financial
    Statement Schedules   137




---



##### Table of Contents



SIGNATURES      By:
    /s/  JEFFREY
    A. HAWTHORNE   President and Chief Executive Officer
    POWER OF
    ATTORNEY
  Form 10-K,
  Pursuant to the requirements of the Securities Exchange Act
    of 1934, this report has been signed below by the following
    persons on behalf of the registrant and in the capacities and on
    the dates indicated.
  Signature

Title

Date/s/  JEFFREY
    A. HAWTHORNEJeffrey
    A. Hawthorne

President, Chief Executive Officer and Director (Principal
    Executive Officer)

January 23, 2008/s/  MICHAEL
    SCHRADLEMichael
    Schradle

Chief Financial Officer (Principal Financial and Accounting
    Officer)

January 23, 2008/s/  MALCOLM
    J. THOMPSONMalcolm
    J. Thompson

Chairman of the Board and Director

January 23, 2008/s/  NICHOLAS
    BRATHWAITENicholas
    Brathwaite

Director

January 23, 2008/s/  TERRY
    CARLITZTerry
    Carlitz

Director

January 23, 2008/s/  MICHAEL
    J. KIMMichael
    J. Kim

Director

January 23, 2008 138




---



##### Table of Contents



Signature

Title

Date/s/  EDWARD
    ROGAS JR.Edward
    Rogas Jr.

Director

January 23, 2008/s/  CURT
    WOZNIAKCurt
    Wozniak

Director

January 23, 2008/s/  DONALD
    C. FRASERDonald
    C. Fraser

Director

January 23, 2008  139




---



##### Table of Contents



EXHIBIT INDEX  Number

Exhibit3.1(H)

Amended and Restated Articles of Incorporation of the Registrant.3.2(C)

Bylaws of the Registrant and amendments thereto.3.3(H)

Certificate of Amendment to Articles of Incorporation of the
    Registrant.4.1

Reference is made to Exhibits 3.1, 3.2 and 3.3.10.1(J)*

Form of Indemnification Agreement between the Registrant and
    each of its executive officers and directors.10.3.1(B)

Lease Agreement between Berg & Berg Developers and the
    Registrant, dated August 6, 1996.10.3.2(V)

Third Amendment to Lease Agreement between Mission West
    Properties L.P. II (fka Berg & Berg Developers) and
    the Registrant dated August 12, 2003.10.9(P)*

Agreement Regarding Change of Control between the Registrant and
    Jeffrey Hawthorne dated December 13, 2005.10.20.1(L)*

Amended and Restated 1995 Stock Option Plan, as amended.10.20.2(P)

Form of Stock Option Agreement under 1995 Stock Option Plan, as
    amended.10.22.1(M)*

2001 Equity Incentive Plan, as amended.10.22.2(W)

Form of Stock Option Agreement under 2001 Equity Incentive Plan,
    as amended.10.25.1(Q)

Lease Agreement between Bruce N. Huntley Contracting Limited and
    Image Processing Systems Inc. dated September 17, 1997.10.25.2(Q)

Option to Renew Agreement between Bruce N. Huntley Contracting
    Limited and Photon Dynamics Canada Inc. dated May 24, 2002.10.25.3(A)

Offer to Sublease, dated April 15, 2005 among Photon
    Dynamics Canada, Inc., Service Results Technology, and Huntley
    Contracting Limited.10.29(R)*

Offer Letter between the Registrant and Richard Okumoto dated
    April 21, 2003.10.30.1(V)*

Consulting Agreement between the Registrant and Malcolm Thompson
    dated July 28, 2003.10.30.2(V)*

Amendment to Consulting Agreement between the Registrant and
    Malcolm Thompson dated September 1, 2003.10.34(S)

Settlement and License Agreement, dated November 10, 2003,
    between Photon Dynamics, Inc., Shimadzu Corporation, Panelvision
    Technology, Inc. and Guillermo Toro-Lira.10.35.1(T)*

Consulting Agreement, dated March 18, 2004, between the
    Registrant and Malcolm Thompson.10.35.2(Y)*

Amendment to Consulting Agreement between the Registrant and
    Malcolm Thompson, dated December 22, 2004.10.36(T)

Termination and Assignment Agreement, dated February 27,
    2004, between Photon Dynamics, Inc. and Ishikawajima-Harima
    Heavy Industries Co. Ltd.10.38.1(W)*

Offer Letter between the Registrant and Mark Merrill dated
    April 27, 2004.10.38.2(X)*

Amendment to Employment Agreement, dated April 5, 2005,
    between Photon Dynamics, Inc. and Mark Merrill.10.42(Z)

Letter Agreement between the Registrant and Malcolm Thompson,
    dated April 8, 2005.10.44.1(G)

Photon Dynamics, Inc. 2005 Equity Incentive Plan, as amended.10.44.2(G)

Form of Stock Option Agreement for use in the 2005 Equity
    Incentive Plan, as amended.10.44.3(G)

Form of Restricted Stock Unit Agreement for use in the 2005
    Equity Incentive Plan, as amended.10.45(N)

Photon Dynamics, Inc. 2005 Employee Stock Purchase Plan.10.46.1(N)

Photon Dynamics, Inc. 2005 Non-Employee Directors Stock
    Option Plan.10.46.2(P)

Form of Stock Option Agreement for use in the 2005 Non-Employee
    Directors Stock Option Plan.10.47.1(U)

Photon Dynamics, Inc. 2006 Non-Employee Directors Stock
    Incentive Plan.10.47.2(U)

Form of Stock Option Agreement for use in the 2006 Non-Employee
    Directors Stock Incentive Plan. 140




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##### Table of Contents



Number

Exhibit10.47.3(G)

Form of Restricted Stock Unit Agreement for use in the 2006
    Non-Employee Directors Stock Incentive Plan.10.48(X)*

Offer letter, dated April 29, 2005, between Photon
    Dynamics, Inc. and Maureen Lamb.10.49(A)*

Separation Agreement, dated May 5, 2005, between Photon
    Dynamics, Inc., and Richard Okumoto.10.50(X)*

Amendment to Employment Agreement, dated April 5, 2005,
    between Photon Dynamics, Inc. and Steve Song.10.53(D)*

Photon Dynamics, Inc. Fiscal 2006 Management Incentive Plan.10.54(F)*

Compensation for Outside Directors, Effective May 24, 2006.10.55(AA)

Agreement between the Company and Michael Schradle dated
    December 10, 200710.56

Agreement and Plan of Merger and Reorganization among Salvador
    Imaging, Inc., David Gardner, Salvador Foundation Charitable
    Remainder Unitrust, James R. Long, Patricia Long, Kerry Rhea,
    Lisa J. Rhea, Photon Dynamics, Inc., Salvador Acquisition, Inc.,
    Salvador Acquisition, LLC and David Gardner, as
    Shareholders Representative, dated July 27, 2007.21.1

Subsidiaries of the Registrant.23.1

Consent of Ernst & Young LLP, Independent Registered
    Public Accounting Firm.24.1

Power of Attorney (included on the signature pages hereto).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:
  (A)
    
    Previously filed as an exhibit to the Registrants
    Quarterly Report Form on
    Form 10-Q
    for the quarter ended June 30, 2005 (Commission File
    No. 000-27234)
    as filed with SEC on August 9, 2005, and incorporated
    herein by reference.(B)
    
    Previously filed as an exhibit to the Registrants Annual
    Report on
    Form 10-KSB
    for the fiscal year ended September 30, 1996 (Commission
    File
    No. 000-27234)
    as filed with the SEC on December 30, 1996, and
    incorporated herein by reference.(C)
    
    Previously filed as an exhibit to the Registrants
    Quarterly Report Form on
    Form 10-Q
    for the quarter ended December 31, 2005 (Commission File
    No. 000-27234)
    as filed with SEC on February 9, 2006, and incorporated
    herein by reference.(D)
    
    Previously filed as an exhibit to the Registrants Current
    Report on
    Form 8-K
    (Commission File
    No. 000-27234)
    as filed with SEC on January 24, 2006, and incorporated
    herein by reference.(E)
    
    Previously filed as an exhibit to the Registrants Current
    Report on
    Form 8-K
    (Commission File
    No. 000-27234)
    as filed with the SEC on July 25, 2001, and incorporated
    herein by reference.(F)
    
    Previously filed as an exhibit to the Registrants
    Quarterly Report Form on
    Form 10-Q
    for the quarter ended June 30, 2006 (Commission File
    No. 000-27234)
    as filed with SEC on August 9, 2006, and incorporated
    herein by reference.(G)
    
    Previously filed as an exhibit to the Registrants
    Quarterly Report Form on
    Form 10-Q
    for the quarter ended December 31, 2006 (Commission File
    No. 000-27234)
    as filed with SEC on February 14, 2007, and incorporated
    herein by reference.(H)
    
    Previously filed as an exhibit to the Registrants
    Registration Statement on
    Form S-1
    (Reg.
    No. 333-76650)
    as filed with the SEC on January 14, 2002, as amended, and
    incorporated by reference herein.(I)
    
    Previously filed as an exhibit to the Registrants Current
    Report on
    Form 8-K
    (Commission File
    No. 000-27234)
    as filed with the SEC on January 7, 2002, and incorporated
    herein by reference. Confidential treatment has been granted for
    portions of this exhibit.(J)
    
    Previously filed as an exhibit to the Registrants Current
    Report on
    Form 8-K
    (Commission File
    No. 000-27234)
    as filed with the SEC on December 20, 2004, and
    incorporated herein by reference. 141




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##### Table of Contents



(K)
    
    Previously filed as an exhibit to the Registrants Current
    Report on
    Form 8-K/A
    (Commission File
    No. 000-27234)
    as filed with the SEC on July 29, 2002, and incorporated
    herein by reference.(L)
    
    Previously filed as an exhibit to the Registrants
    Registration Statement on
    Form S-8
    (Reg.
    No. 333-117021)
    as filed with the SEC on June 30, 2004, and incorporated
    herein by reference.(M)
    
    Previously filed as an exhibit to the Registrants
    Quarterly Report Form on
    Form 10-Q
    (Commission File
    No. 000-27234)
    for the quarter ended March 31, 2003 as filed with the SEC
    on May 9, 2003, and incorporated herein by reference.(N)
    
    Previously filed as an exhibit to the Registrants Current
    Report on
    Form 8-K
    (Commission File
    No. 000-27234)
    as filed with the SEC on March 9, 2005 and incorporated
    herein by reference.(O)
    
    Previously filed as an exhibit to the Registrants
    Registration Statement on
    Form S-3
    (Reg.
    No. 333-49444)
    as filed with the SEC on November 7, 2000 and incorporated
    herein by reference.(P)
    
    Previously filed as an exhibit to the Registrants
    Registration Annual Report on
    Form 10-K
    for the fiscal year ended September 30, 2005 (Commission
    File
    No. 000-27234)
    as filed with the SEC on December 14, 2006, and
    incorporated herein by reference.(Q)
    
    Previously filed as an exhibit to the Registrants Annual
    Report on
    Form 10-K
    for the fiscal year ended September 30, 2002 (Commission
    File
    No. 000-27234)
    as filed with the SEC on December 11, 2002, and
    incorporated here by reference.(R)
    
    Previously filed as an exhibit to the Registrants
    Quarterly Report Form on
    Form 10-Q
    for the quarter ended June 30, 2003 (Commission File
    No. 000-27234)
    as filed with SEC on August 14, 2003, and incorporated
    herein by reference.(S)
    
    Previously filed as an exhibit to the Registrants
    Quarterly Report Form on
    Form 10-Q
    for the quarter ended December 31, 2003 (Commission File
    No. 000-27234)
    as filed with SEC on February 17, 2004, and incorporated
    herein by reference. Confidential treatment has been granted for
    portions of Exhibit 10.34.(T)
    
    Previously filed as an exhibit to the Registrants
    Quarterly Report Form on
    Form 10-Q
    for the quarter ended March 31, 2004 (Commission File
    No. 000-27234)
    as filed with SEC on May 14, 2004, and incorporated herein
    by reference. Confidential treatment has been granted for
    portions of Exhibit 10.36.(U)
    
    Previously filed as an exhibit to the Registrants Current
    Report on
    Form 8-K
    (Commission File
    No. 000-27234),
    filed with the SEC on January 31, 2007, and incorporated
    herein by reference.(V)
    
    Previously filed as an exhibit to the Registrants Annual
    Report on
    Form 10-K
    for the fiscal year ended September 30, 2003 (Commission
    File
    No. 000-27234)
    as filed with the SEC on December 24, 2003, and
    incorporated here by reference.(W)
    
    Previously filed as an exhibit to the Registrants Annual
    Report on
    Form 10-K
    for the fiscal year ended September 30, 2004 (Commission
    File
    No. 000-27234)
    as filed with the SEC on December 14, 2004, and
    incorporated here by reference.(X)
    
    Previously filed as an exhibit to the Registrants Current
    Report on
    Form 8-K
    (Commission File
    No. 000-27234),
    filed with the SEC on November 9, 2005, and incorporated
    herein by reference.(Y)
    
    Previously filed as an exhibit to the Registrants
    Quarterly Report Form on
    Form 10-Q
    for the quarter ended December 31, 2004 (Commission File
    No. 000-27234)
    as filed with SEC on February 9, 2005, and incorporated
    herein by reference.(Z)
    
    Previously filed as an exhibit to the Registrants Current
    Report on
    form 8-K
    (Commission File
    No. 000-27234)
    as filed with the SEC on April 11, 2005, and incorporated
    herein by reference.(AA)
    
    Previously filed as an exhibit to the Registrants Current
    Report on
    form 8-K
    (Commission File
    No. 000-27234)
    as filed with the SEC on December 11, 2007, and
    incorporated herein by reference.*
    
    Indicates a management contract or compensatory plan or
    arrangement.**
    
    The certification attached as Exhibit 32.1 accompanies the
    Annual Report on
    Form 10-K
    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. 142